China’s move benefits most airlines and lessors

Dino D'Amore
By Dino D'Amore August 12, 2015 15:36

China’s move benefits most airlines and lessors

Almost on a weekly basis lately I find myself questioning just what lessors must have done in a previous life to deserve such good luck. Over and over we see events conspiring to give lessors a further edge. Warren Buffett has always been somewhat blinkered to the benefits of aviation investment and once again you have to wonder why the sage of Wall Street never bothered to invest in an aircraft lessor.

China’s dramatic move to devalue the yuan yesterday by 1.9% followed today by another 1.3% all but guarantees that the Chinese airlines will have to keep sale-and-leasebacks as the optimum choice of finance for aircraft deliveries. It may cause many Chinese airlines to question sale-and-leaseback rates again and this could drive prices lower, but on the whole the devaluation of the yuan is a benefit to lessors globally. We must also ask if the US and UK can move to increase interest rates by the end of January 2016 by the planned quarter to one half of a percent as this move will risk manufacturer output. Spot yuan in China dropped to as low as 6.4510 per dollar, its weakest since August 2011, after the central bank set its daily midpoint reference at 6.3306, but in trading the currency fared worse, lowering to 6.59. The yuan has lost 3.5% in China in the last two days, and around 4.8% in global markets.

Chinese airline shares were understandably hit very hard yesterday, nearly by as much as in the days post 9/11, since the yuan devaluation will increase the size of their dollar-denominated debt lower earnings. China Southern fell 18% in Hong Kong, Air China and China Eastern Airlines declined more than 13%.

China Southern stated previously in 2014 that every 1% fall in the value of the yuan cuts 767 million yuan (US$122 million) so they have lost some US$400m in the past 48 hours from this year of account. Carrying large foreign debt is for a Chinese airline fast becoming a toxic liability.

At the end of 2014, 93.3% of China Southern’s debt was in US dollars, China Eastern has 97.2% of debt in US dollars and Air China is carrying 78.2% of debt in US dollars.
However, the double devaluation of the yuan indicates that the Chinese economy is slowing far more rapidly than we have been lead to believe. Central government cannot have civil unrest caused by large scale factory layoffs. The course of action immediately sent oil prices lower towards sub $40 dollars a barrel territory, but today oil prices steadied after an upbeat report from the IEA balanced out the Chinese market shocks.

The IEA report shows that while demand from China is slowing dragging down oil prices at a time of oversupply by producers in the Middle East, oil demand in the US and Europe is accelerating as lower prices stimulate additional consumption.  “While a rebalancing has clearly begun, the process is likely to be prolonged as a supply overhang is expected to persist through 2016 – suggesting global inventories will pile up further,” the IEA stated.

Brent crude is up 30 cents a barrel at $49.48 as I type. US light crude oil is also up 30 cents at $43.38. World oil production is running at around three million barrels per day (bpd) above consumption at this time, but the IEA forecasts world oil demand will grow by 1.6 million bpd this year, up 200,000 bpd from its previous estimate because of the additional demand stimulated by the low prices. So, if the yuan devaluation increases Chinese manufacturing output, we could see oil prices start to climb. But in the short term at least, China’s moves are good news for airlines the world over outside of China.

OPEC pumped the most crude oil last month in more than three years as Iran returned output to the highest level since international sanctions were strengthened in 2012. The 12-member group, responsible for 40% of world oil supplies, raised output in July by 100,700 barrels a day to 31.5M. The increase came even as Saudi Arabia, which often curbs output toward the end of the summer, told OPEC it cut production by the most in almost a year as it balances the Iran market impact.

Indeed it should be noted that Spring Airlines saw shares rebound today closing up nearly 10ppts on the day at 114.88 as oil prices fell.

Also we must remember that Chinese airlines are set to announce record earnings for this period, China Southern for example has stated that said it swung to a profit of 3.6 billion yuan from a net loss of 1.1 billion yuan a year earlier. Air China has also warned that net income in this period is up as much as 743% – so the devaluation of the yuan is a problem but, given low oil prices and the massive benefit derived from the same, it is in the scale of things small fry.

Dino D'Amore
By Dino D'Amore August 12, 2015 15:36