China Eastern Airlines Corp. Ltd. (ADR) (CEA), China Southern Airlines Co Ltd (ADR) (ZNH) – A Look at Foreign Airlines Part Three: China

When taking a global approach to the airline industry, it is important to consider airlines that operate in emerging markets. With so much of the developed world’s air travel already saturated with capacity, even major carriers from developed countries are turning to expanding developing markets. But for investors looking for a more pure play on air travel in emerging markets, three of the best opportunities can be found in China.

The big three

The American travel market is soon expected to be home to three large carriers (Delta Air Lines, Inc. (NYSE:DAL), United Continental Holdings Inc (NYSE:UAL), and the merged American Airlines US Airways) plus Southwest Airlines and a host of smaller carriers. While the shrinking of the number of U.S. based airlines is the result of industry mergers, China’s airline policy creates three main Chinese carriers based around regulatory interest.

The skies of China are home to numerous airlines but are dominated by Air China, China Eastern Airlines Corp. Ltd. (ADR) (NYSE:CEA), and China Southern Airlines Co Ltd (ADR) (NYSE:ZNH). Much of this market domination is due to a rule issued in 2007 that restricted the creation of new airlines in China. However, the Wall Street Journal reported that this rule was lifted about a month ago allowing new airlines to enter the Chinese air travel market.

As a result, shares of all three large carriers have slipped on fears of new competition and increased capacity. While the air travel markets in emerging countries are expanding, the large carriers would still like to keep capacity in check on popular routes and the emergence of new competitors threatens the large carriers ability to continue their domination on new routes that are opened.

Political risk

Rules for airlines in China are set by the Civil Aviation Administration and are issued in ways the CAAC believes will benefit the national interest. The latest move to repeal the restriction on new airlines is being seen by many as a liberalization of the economy, one of the things the Chinese government is trying to project to the rest of the world.

Since the actions of the administration are done in the national interest, not the airlines’ interests, airline investors will need to be aware that Chinese political policy could drastically change the environment the airlines operate in and even how they operate. The latest move was one of economic liberalization but if the political winds change, the Administration could support a plan to nationalize the Big Three airlines if it were to chose to do so. All in all, most companies carry with them some political risk but airlines in a country with China’s style of government see a higher amount of political uncertainty.

Other industry highlights

Unfortunately for Air China, the carriers troubles are not just government related. Bloomberg reported a sharp drop in the airline’s shares on June 10 after a UBS analyst cut earnings estimates citing lower passenger yields. But even after this, Air China still trades for only around 10 times estimated 2013 earnings however investors should watch for analyst opinion changes following reported news of weaker demand from Europe.

While the European Union is asking for emissions reductions, Chinese carriers will not be accepting these measures according to the Times of India. As a small gesture toward reducing emissions, China Eastern Airlines Corp. Ltd. (ADR) (NYSE:CEA) is having special winglets put on its Airbus A320 aircraft.  But this is not just a climate change fighting move; the winglets make economic sense for China Eastern Airlines Corp. Ltd. (ADR) (NYSE:CEA) as well. In an industry the consumes so much fuel, improved fuel consumption should benefit China Eastern Airlines Corp. Ltd. (ADR) (NYSE:CEA)‘s bottom line as it helps to reduce aircraft emissions.

As China Eastern adds winglets to its fleet, China Southern Airlines Co Ltd (ADR) (NYSE:ZNH) is making big moves in the new aircraft department. Bloomberg is reporting that China Southern Airlines Co Ltd (ADR) (NYSE:ZNH) will be the only Chinese airline to operate both The Boeing Company (NYSE:BA) 787 Dreamliners and Airbus A380 superjumbos. This fleet modernization strategy should help with fuel costs but the capital used to acquire these planes means China Southern Airlines Co Ltd (ADR) (NYSE:ZNH) is betting on higher travel demand to drive earnings growth over the coming years.

Alternative airlines

Investors tend to see airlines as operating in a largely developed market where capacity cutting is a higher priority than creating new routes. But in emerging markets such as China, a growing middle class is asking for more leisure travel and expanding industries are demanding more business travel. Air China, China Eastern Airlines Corp. Ltd. (ADR) (NYSE:CEA), and China Southern Airlines Co Ltd (ADR) (NYSE:ZNH) all offer investors exposure to this market but are also accompanied by political risks in addition to the risks inherent in the airline industry. For investors willing to bear the political risks, these Chinese airlines may be worthwhile investments as a play on growth in China.

The article A Look at Foreign Airlines Part Three: China originally appeared on and is written by Alexander MacLennan.

Alexander MacLennan owns shares of Delta Air Lines. This article is not an endorsement to buy or sell any security and does not constitute professional investment advice. Always do your own due diligence before buying or selling any security. The Motley Fool has no position in any of the stocks mentioned. Alexander is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.