Room to Soar

11/19/2008 11:30 am EST

Focus: STOCKS

Robert Hsu

Editor, China Strategy and Asia Edge

Robert Hsu, editor of China Strategy, says this airline has an opportunity to ‘fly’ with declining oil prices.

China Southern Airlines (NYSE: ZNH) is the nation's largest airline company. Based in Guangzhou, the company provides passenger, cargo, and mail airline services throughout mainland China, Hong Kong, and Macau, as well as in the rest of Asia and connecting Europe, America, Australia, and Africa.

At the end of last year, the company operated a fleet of 332 aircraft (30% of the country's total) on 689 routes. Its flight network covers a large majority of commercial centers and rapidly developing economic regions in mainland China. In addition, China Southern ranked first in 2007 among all Chinese airlines in terms of its fleet size, flight route network, and volume of passenger traffic.

China Southern recently joined with SkyTeam Alliance, establishing a network that reached 841 global destinations, connecting 162 countries and regions around the world. The company plans to establish an air cargo joint venture with Air France by the end of this year, which should help expand its flight network and boost its bottom line.

After suffering a rough financial year in 2006, China Southern’s operating revenue rose 18% to 54.5 billion yuan, or $7.5 billion and profits soared 912% to 2.1 billion yuan, or $283 million, for 2007. Passenger numbers climbed 16% to 56.9 million, enabling the airline to fill 75% of its seats. For 2008, I'm expecting China Southern's ticket sales to remain strong. But the real catalysts for the stock are the stronger Chinese yuan and plunging fuel costs.

This year, in addition to an increase in Chinese tourism, China Southern has benefited nicely from the strengthening Chinese yuan. The stronger Chinese currency reduces the repatriated value of the airlines' dollar-denominated fuel bills and debt. So every 1% appreciation in Chinese currency adds about 380 million yuan (or $50 million) to China Southern's net income. So far, the yuan has appreciated more than 7% year-to-date, which translates to about $350 million in income.

China Southern's profitability has increased also because of decreased fuel costs. Crude oil prices have recently dropped more than 40% from their record high in early July. And since fuel accounts for about 40% of costs to Chinese air carriers, higher fuel surcharges also allow the company to pass more of its fuel costs on to passengers.

Despite strong earnings momentum, China Southern's stock is down over 75% since January because of surging fuel prices earlier this year, the slowing global market, and weakness in Chinese stocks. But now that Chinese tourism is increasing, fuel prices are lowering, and China Southern is expanding and improving its business, I believe the stock has the opportunity to turn around. Buy ZNH under $10. I expect the stock to hit $15 in a year.

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