China is one of the fastest growing aviation market in the world. However, aviation is also known to investors as one of the worst industry to invest in at all. Warren Buffett has in many occasions’ mentioned that airlines are terrible investments due to the large capital expenditure needed to grow the business and the tiny profits margin investors can expect from them. However, if you are still interested to look at this industry due to the huge growth potential, here are the big four you cannot missed.
1) Air China Ltd (0753:HKG)
2) Cathay Pacific Airline (0293:HKG)
3) China Eastern Airline (0670:HKG)
4) China Southern Airline (1055:HKG)
All four airlines operate in the domestic and overseas market. Besides Cathay Pacific, all the carriers have their main hub in mainland China. However, despite the huge growth in revenue, all of the carriers have seen their operating margins decline compared to 5 years ago. China Eastern Airline, only managed a net profit margin of 0.1% for the 2014 interim year.
Furthermore, most of them are in relatively higher leverage compared to other industries, having leverage ratio of around 2 to 4 times, as huge capital is needed for the purchase of new planes.
More risks than just poor economics
Many feel that the trouble of the airline industry is only high fixed cost of doing business. In fact, with high speed train service in the system is building up capacity rapidly, the airline in China does not seem to be doing much to address this threat. However, this risk is real and already happening in Cities already connected to the high speed train.
Value In Action
So, the airline industry seems to be undergoing a margin decline, a bad economics, a slowing economy and a major threat from other mode of transport such as the high speed train. However, I do not see the industry in a structural decline. As long as there are people wanting to travel, air travel will continue to be in high demand. However, I do feel that companies do need to explore new revenue stream and business model or risk being obsolete in the not too distant future.
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All views and opinions articulated in the article were expressed in Stanley Lim’s personal capacity and does not in any way represent those of his employer and other related entities. Stanley Lim does not own any shares in the companies mentioned above.