Do budget airlines spell trouble for China Eastern (CEA), China Southern (ZNH) and Air China?

Includes: CEA, ZNH
by: Ezra Marbach

While companies like Chinese startup, Okay Airlines, hope to model themselves on foreign budget carriers known for cheap flights and low overhead, analysts are skeptical that this is possible. Here's why:

New carriers will suffer from:

  • High fuel costs, route and airport charges, aircraft costs, and taxes.
  • High commissions: With debit and credit cards uncommon, selling tickets online is difficult. So expect new airlines to be stuck paying large commissions to travel agencies to sell their tickets.

Competition is fierce:

  • China Eastern (ticker: CEA), China Southern (ticker: ZNH) and Air China are established players.
  • There are at least seven new airlines vying for regulatory approval before commencing operations.
  • Foreign carriers like AirAsia, Orient Thai and Virgin are also considering entering the China market.

The good news:

  • Labor costs are low.
  • Analysts believe that as bureaucracy diminishes, fuel, service and tax costs will drop.
  • China is a huge land mass with many potential air routes.
  • China has 1.3 billion people, many of whom have little disposable income, and would be more inclined toward a low-cost airline.
  • And even those with disposable income just might prefer flying a lower-cost airline anyway.
  • Leisure travel is increasing (See eLong's (ticker: LONG) comments from its latest conference call).
  • In 2004, air passengers increased 38%, taking around 120 million trips.
  • The growing influx of foreign tourists, and the government's easing of visa restrictions can only increase air travel.

Quick thought: So it looks like new carriers will not be "budget airlines" as we see them presently in the United States. While the longer term environment could be different, China's lack of secondary airports (which played a large role in the growth of low-cost airlines in the US) could also pose a problem. The good news is that China is quickly improving roadways to make car travel that much easier, and traveling longer distances to airports more realistic. So airports will have more reach.

For now, China Southern, China Eastern, and Air China should continue to prosper and enjoy the growing influx of tourists to the Mainland, and increasing domestic travel by the Chinese. As for new "budget airlines", we will all have to wait and see.