February 7, 2020

Coronavirus Outbreak is Affecting Airlines

by Tajinder Dhillon.

The coronavirus outbreak has severely impacted industries in China, including hotels and motels, travel and leisure, airlines and transportation services.

Exhibit 1: Coronavirus Impact on Chinese Sectors

Airlines have suffered the most, declining 17.5% year-to-date, compared to a gain of 4.7% this time last year. This makes January 2020 the worst month for global and Chinese airlines since May 2019, as seen in Exhibit 2.

Air China, China’s largest airline by market capitalization, has declined 18.0% YTD, while China Eastern Airlines and China Southern Airlines declined 18.8% and 17.8% respectively.  Other airlines with revenue exposure to Asia including Air France, Cathay Pacific, and Deutsche Lufthansa AG have also declined 11.4%, 10.2% and 10.3% respectively.

Exhibit 2: Chinese Airlines Monthly Performance

Refinitiv’s MarketPsych Indices (RMI) provide financial news and social media sentiment data for global equities. Looking at news sources and social media outlets, fear and anxiety levels have spiked for Air China and Cathay Pacific since January, as shown in Exhibit 3.  As a result, some airlines have reduced flights to the region, interrupting travel for thousands of passengers.

Exhibit 3: MarketPysch Fear Index for Key Airlines

Source: Eikon by Refinitiv.

Analysts have been quick to lower estimates for key airlines in China and Hong Kong, as shown in Exhibit 4.  The Analyst Revisions Model (ARM) is a stock ranking model that is designed to predict future changes in analyst sentiment by looking at changes in estimates across EPS, EBITDA, and revenue over multiple time periods. Air China has an ARM percentile rank of 3 (out of 100), indicating bearish sentiment among analysts. China Southern, China Eastern, and Cathay Pacific all have ARM scores below 30, also indicating a strong bearish signal.

We also find that airlines are likely to miss earnings expectations when they report later this year.  The StarMine Predicted Surprise compares the StarMine SmartEstimate, a refined view of consensus by placing a higher weight on more accurate and timely analysts, vs. consensus.  Cathay Pacific has the largest negative predicted surprise at -29.8%, while China Southern, China Eastern, and Air China have negative predicted surprises of -19.4%, -9.4%, and -5.3%.

Exhibit 4: Key Data for Airlines

Source: Eikon by Refinitiv

To add to the challenging outlook, there are heightened concerns for airlines from a credit default perspective. StarMine Credit Risk models are designed to detect credit default risk over a 12-month period. Our Combined Credit Risk model is a multi-pronged approach which combines our three stand-alone credit models: SmartRatios, Structural and Text Mining. Using the Combined Credit Model, all airlines in Exhibit 4 have a current implied rating below investment grade. China Southern and China Eastern have the lowest rating at BB, while Air China and Cathay Pacific have a rating of BBB-.

Depending on the duration and severity of the outbreak, there will be elevated concerns for airlines given their large revenue exposure to China. China Southern has the largest exposure, with 71% of revenue coming from China. China Eastern and Air China also have significant revenue exposure to China at 67% and 63% respectively, according to Eikon by Refinitiv.

Cathay Pacific has 51% revenue exposure to Hong Kong and mainland China and has taken preventative measures to battle the virus by requesting employees to take three weeks of unpaid leave. This measure will also help improve its credit position by ensuring there is ample cash on hand to deal with any unexpected events.

However, if the situation improves, it could provide a buying opportunity looking on a forward P/E basis, as all airlines in Exhibit 4 are trading below their 10-year average.

Furthermore, when looking at the StarMine Intrinsic Valuation Model, airlines are undervalued when comparing the current price of the stock to their intrinsic value, which is derived using a dividend discount model.  China Eastern is most undervalued, with a Price/Intrinsic Value ratio of 0.44, followed by China Southern, Cathay Pacific, and Air China.

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