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Chinese airline losses pared by accounting maneuver

Despite red ink, state-owned groups manage to improve cash position

HONG KONG -- China's biggest airlines, like their peers elsewhere, posted substantial losses for the first half of 2020 -- but their figures would have been even worse without a timely accounting change.

The combined revenue of China Southern Airlines, China Eastern Airlines and Air China, the country's state-owned "big 3" groups, fell 52.4% to 93.76 billion yuan ($13.65 billion) in the six months ended June 30. Their combined net loss reached 26.16 billion yuan, compared with a profit of 6.76 billion yuan a year earlier.

The results, disclosed on Friday, disappointed some analysts.

Andrew Lee of investment bank Jefferies said on Monday that the aggregate net losses "were larger than expected." He said the half-year figures amounted to around 80% to 90% of the full-year loss estimates made by him and many other analysts.

The accounting changes by China Southern and Air China, however, eased the flow of red ink. Both changed how they recorded depreciation costs from overhauling aircraft engine components to tie charges to actual flying hours rather than spreading the costs out evenly as an annual charge.

A China Southern executive said the airline's accounting change "can more accurately reflect the actual consumption of overhaul components of engine[s] and more objectively reflect the financial position and operating results."   © Reuters

Xie Bing, company secretary at Guangzhou-based China Southern, said in the company's results statement on Friday that the change "can more accurately reflect the actual consumption of overhaul components of engine[s] and more objectively reflect the financial position and operating results."

The depreciation savings raised eyebrows among some analysts, given the fortuitous timing as losses reach historic levels.

China Southern was able to decrease its pretax net loss by 660 million yuan for the April-June quarter, equivalent to 5.5% of its pretax net loss for the half-year. For Beijing-based Air China, the savings totaled 899 million yuan for the first half of the year, 6.9% of its pretax net loss.

Neither group estimated how much further they expect the change to cut losses for the full year, but given that their jets are flying fewer hours due to the coronavirus pandemic, additional savings on depreciation seem likely.

"This is an aberration from the industry standard," said David Yu, a finance professor at New York University Shanghai who focuses on aviation. That said, he supported the airlines' move as "we are in a different time" and the change "aligns better with reality."

China Eastern did not change its corresponding accounting policy.

While taking extraordinary measures to amend depreciation methods could change the companies' bottom lines, the amount of cash drainage cannot be altered. The aggregate free cash flow of the three companies amounted to a negative 38.94 billion yuan for the first half, compared to a positive 15.86 billion yuan in the same period a year earlier.

On that front, the three airlines were able to rake in a net 65.41 billion yuan from their financial activities during the period and ended up sitting on a larger pile of cash than before the pandemic.

Shanghai-based China Eastern issued 24 tranches of super short-term debentures and one tranche of corporate bonds, raising 51.7 billion yuan during the first half while China Southern brought in net cash of 26.46 billion yuan, mainly from bank borrowings, issuance of shares and medium-term notes.

Air China said that several unnamed domestic banks granted a loan quota of up to 158.64 billion yuan during the period and that 30.16 billion yuan had been utilized so far.

"The remaining amount is sufficient to meet our demands on working capital and future capital commitments," Zhou Feng and Huen Ho Yin, the company's joint secretaries, said in the group's results statement.

Said Yu of NYU, "The fact that they have been successful in financing demonstrates that they are getting strong backing from the government and the financing parties."

The funding position of the "big 3" contrasts sharply with Hainan Airlines, which is not under the direct control of the central government. The Shanghai-listed unit of cash-strapped HNA Group recorded a 66.6% decline in revenue to 11.71 billion yuan for the first half while turning in a net loss of 11.82 billion yuan.

Hainan Airlines said on Saturday that it had missed a total of 26.84 billion yuan in principal and interest payments while repaying or negotiated a rescheduling of only 10.6% of its loan obligations as of the end of June. The company warned that the overdue loans and interest payments could trigger separate penalty clauses under other loans, financing leases and asset securitization products.

Despite major losses by the three largest airlines, analysts are generally positive on their outlook.

Kelvin Lau at Daiwa Capital Markets in Hong Kong on Monday reiterated "buy" ratings for all three, given the encouraging recovery track in air travel in China's massive domestic market. His only caveat is "lower-than-expected passenger volume and yield growth" as a key risk going forward.

Market reaction on the Hong Kong Stock Exchange was mixed on Monday. China Eastern and China Southern ended the day up 2.6% and 1.7%, respectively, from Friday's close, while Air China slipped 0.9%.

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