June 30, 2008

China to Taiwan Route to Affect Cathay Pacific Direct Flights Would Cut Out Carrier

By Joseph Chaney

Direct weekend flights between China and Taiwan starting this week are likely to give a boost to carriers on both sides of the Taiwan Strait at the expense of Hong Kong, but probably not until all restrictions are lifted.

Beijing and Taipei on June 13 signed a deal to launch the first regular weekend flights since 1949 after a decade-long stalemate between China and the neighboring island it claims as its own.

Most flights between China and Taiwan now have to stop at a third external destination, like Hong Kong or Macao, providing a lift for airlines in those hubs.

Over the long term, unlimited direct flights would wipe nearly 10 percent off the bottom line of Hong Kong's flagship carrier, Cathay Pacific, which has enjoyed a large chunk of the business of flying passengers on the roundabout route, according to Nomura.

The deal is relatively limited, allowing for a small number of direct flights only on weekends (defined as Friday through Monday) that still must pass through Hong Kong airspace.

Taiwan's new president, Ma Ying-jeou, has said he wants to make the flights daily and more direct, with a broader deal possible as soon as next year.

Analysts say that Taiwan's China Airlines and Eva Airways and China's China Eastern will benefit the most from fully direct flights.

Other top Chinese airlines like Hainan Airlines, Air China and China Southern have also fought to take business from Cathay.

"Certainly this represents a circuit breaker and growth opportunity for airlines in Taiwan," said Derek Sadubin, chief operating officer at the Center for Asia Pacific Aviation.

He added that the shift will be gradual, noting that as long as the new routes pass through Hong Kong airspace, the time savings will not be huge.

China has claimed self-ruled Taiwan as its territory since the end of the Chinese civil war in 1949 and pledged to bring the island under its rule, by force if necessary. But relations have improved notably in the last two months under a newly elected China-friendly administration that took office in May.

The deal allows for up to 18 round-trip chartered weekend flights starting July 4, and for now analysts believe demand for the flights will outstrip supply.

But Nomura estimates a nonstop cross-strait service will shave 600 million Hong Kong dollars, or $76.86 million, off Cathay's bottom line - about 8.5 percent of its 2007 net profit of 7.02 billion Hong Kong dollars.

Cathay operates about 15 daily flights to Taiwan, and the routes account for about 8 percent to 10 percent of its revenue.

Cathay shares have shed more than a quarter of their value so far this year, versus a 21 percent loss for the broader market.

"You can say it's one of our busiest flights," said Carolyn Leung, a Cathay spokeswoman.

Not all of the carriers set to gain from the deal will get the same benefit, depending on their hubs.

For example, China Eastern's hub is Shanghai, home to the biggest population of Taiwanese living in China.

"The biggest beneficiary by far will be China Eastern because they will have four flights from Shanghai to Taipei, the most profitable route, and the most popular with business travelers," said Kelvin Lau, an analyst for Daiwa Institute of Research.

The new routes could give China Eastern a 229 million yuan, or $33.4 million, net gain to its bottom line in the first year of unlimited direct flights, Nomura says.

But for China Southern, based in Guangzhou, the gain would be a relatively paltry 35 million yuan, it estimated.

Air China, based in Beijing, could actually lose 260 million yuan of earnings in the first year because of its 17.5 percent stake in Cathay Pacific and its 51 percent stake in Air Macau, which will take a major hit, Nomura added.

On the Taiwan side of the strait, China Airlines could see a roughly 18 percent increase in passenger volumes, while Eva might get a 13.5 percent increase, experts say.

Another part of the deal allows up to 3,000 mainland Chinese tourists to visit Taiwan each day, with Taiwan hoping to raise that to 10,000 per day by 2012.

Assuming a 20 percent market share each for the 3,000 tourists, Eva and China Airlines would see an extra 1,200 passengers a day, increasing daily passengers for Eva and China Airlines by 7 percent and 3 percent respectively, according to Merrill Lynch.

A continued warming of cross-strait ties and easing of restrictions could help double cross-strait traffic to 2.36 million passengers, up from 1.26 million in 2007, analysts say.

More than 1.5 million Taiwanese call mainland China home, and Taiwanese companies have invested up to $100 billion there.

Originally published by Reuters.

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