Citigroup said that China Airlines Ltd (CAL, 中華航空) and EVA Airways Corp (EVA, 長榮航空), the nation’s No. 1 and No. 2 airlines, would not return to profitability until 2010 because of rising jet fuel costs and slowing air traffic demand.
Although Taiwan and China started direct charter passenger flights on July 4, there is also concern that the CAL and EVA will see limited contributions from the flights over the next 18 months, Citigroup said in a client note released on Friday.
For this year, Citi forecasts a 3 percent contribution to CAL’s total revenue from the direct flights, though this figure could reach 7 percent by next year. As for EVA, Citi sees a 7 percent revenue contribution from the flights this year and 10 percent by next year.
The global investment bank forecast net losses per share this year of NT$2.77 for CAL and NT$2.95 for EVA, and initiated “sell” ratings on the two Taiwanese airlines, said the note authored by Peter Kurz, head of Taiwan equity research at Citigroup Global Markets.
Citigroup offered a target price of NT$10.20 for CAL, a 5.12 percent discount from the company’s closing price of NT$10.75 on Friday in Taipei trading. It recommended a target price of NT$9.5 for EVA, which represents an 18.46 percent downside potential for the airline after its shares closed at NT$11.65 on Friday.
To date, shares of CAL and EVA are down this year 26 percent and 16 percent respectively, compared to a 17 percent decline in the benchmark TAIEX since the beginning of the year.
CAL and EVA are among the world’s major airlines facing dwindling profitability because of high fuel costs and weakening traffic demand. The International Air Transport Association (IATA) recently estimated net losses of between US$2.3 billion and US$6.1 billion for the global airline industry this year.
Merrill Lynch, the world’s largest brokerage firm, also issued a research report on Friday anticipating record losses for both airlines this year and foresees these losses to continue well into next year.
Paul Dewberry, a research analyst at Merrill Lynch & Co based in Singapore, shared Kurz’ view that direct flights would be insufficient to turn the fortunes of these carriers.
In addition, both Citigroup and Merrill Lynch said that if weekend charter flights progressed to daily charter services between Taiwan and China as expected, the anticipated traffic reduction on Taiwan/Hong Kong and Taiwan/Macau routes would pose another risk to the battered carriers’ revenues in the next few years.
On the issue of planned direct cargo flights, Kurz expects China’s negotiators to stall because Chinese airliners currently flying cargo for Taiwanese counterparts via Hong Kong are unlikely to relinquish this slice of business.
Moreover, “high oil prices and maturation of the tech cycle” means Taiwan’s contract-based technology businesses are experiencing shrinking gross margins and its products are becoming less time-sensitive. Kurz said in the report that he saw a switch from air cargo to marine cargo as an obvious cost-cutting measure for these firms.
The issue of cross-strait charter cargo flights had been raised during the former Democratic Progress Party government and the current Chinese Nationalist Party (KMT) government has said it wanted to complete talks with China to start the service.
Amid the current headwinds, Merrill Lynch said it is pessimistic about both carriers and suggested major re-capitalization and complete restructuring of the Taiwanese airline industry to save these ailing companies.
On the macroeconomic front, Dewberry said the only way back to profitability is through a global economic rebound and lower oil prices.
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