Air China Pushes Back Global Top 10 Target to 2015-2017

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State-owned Air China Ltd. (SSE: 601111, HKSE: 00753) now plans to become a global top 10 airline by 2015 to 2017 instead of the original target of 2010, scaling back its ambitions drastically after the flag carrier sustained heavy losses in 2008, chairman Kong Dong told Caijing in an interview.

Air China sustained a net loss of 9.2 billion yuan in 2008 - the biggest loss among the country's top three airliners – stemming from fair value losses of 7.47 billion yuan on jet fuel hedging contracts.  The carrier reported a net profit of 3.7 billion yuan in 2007.

"It is the first time for Air China to have such a disappointment since the flag carrier was restructured in 2003," Kong said.  Air China merged with smaller rivals in 2003 before listing in Shanghai the following year.

However, Kong believes that the carrier's operations and competitiveness have not been severely damaged and remains confident about the company's prospects for 2009.  

He said that excluding losses from fuel hedging and investments in Cathy Pacific and Air Macau, Air China's 2008 operating loss was only 1.95 billion yuan – far lower than its nearest competitors.

"We were still a market leader in 2008," Kong said.

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"The quality of our first quarter earnings is even more attractive than for the same period last year, when Air China had around one billion yuan non-recurring foreign exchange gains," said Kong.

In a 2007 interview Kong told Caijing that Air China plans to enter the global top 10 by 2010. At the time, China's growth prospects remained undimmed. Kong added that Air China was then ranked 17th in terms of "overall strength." He did not elaborate on the criteria for compiling this list.

China's two other major carriers also posted multi billion-yuan losses in 2008. China Southern had a net loss of 4.8 billion yuan, while China Eastern recorded a 13.9 billion yuan net loss, including a fuel hedging loss of 6.4 billion. China Southern closed out its positions before the fuel price collapse in late 2008, thus avoiding greater losses.

According to its first-quarter financial results released last month, Air China booked a net profit of 981.2 million yuan due to an upturn in domestic passenger traffic and lower jet fuel costs, though net profit was still down 5.7 percent from a year earlier. Non-operating income rose as a result of a 655-million-yuan refund from the CAAC Infrastructure Development Fund, which previously levied charges on domestic airlines in order to build civil aviation infrastructure.  

"As the fundamentals of China economy improve, the domestic air transport sector has seen double-digit growth in the first quarter, and our operation data in April is even better than the previous months……The situation is not bad," Kong said.

China has bailed out the other two airline majors, who are struggling with high debt and weakening demand.

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China Southern Airlines received a 3-billion-yuan bailout, while China Eastern was granted a 7 billion yuan capital injection from its state-owned parent via a new share issue early this year, and is currently waiting for an additional 2 billion yuan in government aid that was approved in March.

Air China has yet to receive any government aid.

"We have reported our difficulties to the government," Kong replied when asked if the company has requested financial assistance from the government.  

"As a company leader, it is not realistic for me to say that we do not want the fund infusion. But I feel that we can weather the storm (even without the bailout) … as our operations in the first quarter were normal. Our financing is safe and cash flow is stable," Kong said.

Yet the company chairman admitted that risks remain, including foreign exchange, fuel prices and the condition of the European market, which could prove to be "very large obstacles" to growth.

Kong said Air China has learned its lesson from the fuel hedging losses.

"We are closely watching oil prices, though we do not have the ability to completely foresee oil price trends," Kong said.

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Regarding other threats to the health of the company and the industry, Kong expressed concern over H1N1 flu, though he added it is difficult to say whether the current outbreak will have the same negative impact as the SARS episode in 2003.  

"I am worried about the H1N1 flu virus in a certain way, and people in the aviation industry are all very sensitive to this as the epidemic does resemble SARS," said Kong.  

"We are watching the situation and considering measures to deal with it," he said.

However, with the financial crisis having a greater effect on the international market Air China does face downside pressures from its partnerships with Air Macau and Cathay Pacific.

Air Macau is facing "very big difficulties" due to falling passenger numbers after the mainland recently opened direct transport links with Taiwan, Kong said.  Air China has a 51 percent stake in Air Macau.

Previously, passengers coming from Taiwan had to enter the mainland via transfer flights in Hong Kong or Macau.

Air Macau "has to expand into new markets including Japan and South Korea for future growth," said Kong.

Air China booked an investment loss of 1.15 billion yuan in 2008, against income of 1.24 billion in 2007, largely due to its investment in Cathay Pacific, in which Air China holds a 17.5 percent stake.

Cathay booked a net loss of 8.56 billion Hong Kong dollars in 2008.

Kong said that Hong Kong-based Cathay is in a more difficult situation and has fewer means to overcome its difficulties.

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"But I am confident in (Cathy Pacific). It is such a good company that once the economy begins to recover, (Cathy Pacific) will continue to be outstanding," he said.

With the European and US markets weakening significantly, Air China has also "made adjustments accordingly and moved some international capacity to the domestic market," Kong said. "It was necessary for our survival."

Air China set up two major units in Shanghai and Hubei during the first quarter of this year in a move to raise its domestic competitiveness, according to Kong.  

China Eastern and Shanghai Airlines jointly dominate the Shanghai market, while Air China's stronghold is Beijing.

"Setting up the Shanghai unit has been our dream for a long time as, after all, Shanghai is the country's largest city in economic terms."

Air China formed its Hubei unit late last month after receiving approval from the Civil Aviation Administration of China, and is confident about the prospects for expansion into the central China market.

The Hubei unit is seen as a vehicle for acquiring assets of collapsed private carrier East Star Airlines Co.

Kong told Caijing that as East Star has now filed for bankruptcy protection and its assets are subject to the disposal of the court. Air China is not expected to assume any of East Star's debts.  

East Star Airlines began bankruptcy proceedings after a local court accepted GE Commercial Aviation Services' lawsuit against the airline on March 30. East Star Airlines owes GECAS and its six affiliates more than 74 million yuan. The bankruptcy presents an opportunity for Air China to gain a foothold in the local market.

"Wuhan is a strategically important transport hub. We were absent there before due to the restriction of our fleet capacity. This is an opportunity amid the crisis, and we won't miss it," said Kong.  

Kong has served as Air China chairman since 2007. Previously he headed Shenzhen Airport Group, China National Aviation Co Ltd and DragonAir, which is now controlled by Cathay Pacific.