It looks like there’s a chance that the high-flying Chinese airlines will begin with their descent soon. After a stunning eight-week flight they are beginning to find themselves in altitudes where the air may be a wee bit thin. For example, the best performer of the bunch, China Southern, more than doubled over the past two months. On a year’s return basis, they were up more than 200% when the stock hit its all-time high of HKD8.38 early last month. Both China Eastern and Air China have also registered equally stunning returns, albeit slightly below China Southern’s performance. The sector has a compelling revaluation story. Growth in the top line is spurred largely by the huge appetite for travel by China’s growing middle class, both for tourism and commerce. Concurrently bottom-line margin improvements have also been propped up in these past nine months by the lower energy costs following the collapse of crude. With the Chinese government enforcing a ban on airlines from hedging their fuel requirements, these companies are able to reap almost immediate benefits from their lower energy bills. However, things could also turn the corner pretty quickly for this group. Valuations, while still relatively low in PER terms, are twice where they were just a short time ago. Oil too has had a ‘stealth’ rally of almost 50% since its low at the beginning of March. Ironically, this was the same time Chinese Airlines took off in this almost ‘capitulation’ manner! With the oncoming headwinds faced by the Chinese stock markets in general, perhaps we should also ‘fasten our seat belts’ here. Let’s only hope that the landing will not be a hard one!
Possible pair trade on Cathay vs SIA
Cathay Pacific and SIA compete in largely the same operating environment. They both have strong appeal to premium travelers, and compete on efficiency and service. Operationally also, they share similarly aggressive fuel-hedging policies. As a result, they have both languished behind the Chinese carriers in earnings growth and also in price performance. Cathay’s stock, however, has pulled away from SIA significantly since the middle of March, pulled largely by the focus in Hong Kong on airline stocks there, thanks to the Chinese carriers. Is there an opportunity for a pair trade here on the back of a ‘reversion to mean’ theoretical assumption?
Cathay vs SIA - 10% from 'equilibrium'?
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