Key points of investment

[Core logic]

Huaxia Airlines is the only large-scale independent regional airline in China. Factors suppressing capacity recovery continue to ease, and it is expected that future net profit will exceed market expectations after utilization returns.

[Mid-term Perspective]

The blue ocean market penetration rate of regional aviation has great potential to increase, and the construction of regional fleets and regional air networks has built the company's core competitiveness. In 2019, China's regional airports accounted for 69% and regional routes accounted for 12% of passenger traffic. In the future, the increase in consumer demand in low-tier cities will support the growth in demand for regional aviation. The company is the only large-scale independent regional airline in China, and has basically built a nationwide regional aviation network. At the end of 2022, solo flights accounted for 89% of flight routes, and the differentiated route network has significant advantages. Taking into account accessibility needs and economy, we believe that local governments will maintain a strong willingness to pay in the medium term. As capacity recovers, institutional capacity purchase revenue and ticket revenue will both be restored as capacity recovers. We expect that the company's mid-term fleet size growth rate will remain above the industry average. In the future, the increase in tourism demand in low-tier cities is expected to support an increase in the share of passenger ticket revenue, unleash greater profit elasticity, and support high performance growth.

[Market Expectations]

1. The company is under high pressure to consolidate production safety. Currently, the number of captains is in short supply, and the training cycle is long. The market expects the pace of recovery in fleet utilization to be slow.

2. Companies and institutions account for a relatively large share of revenue from purchasing capacity, and are highly dependent on subsidies. The market is concerned that companies bear a greater risk of declining willingness to pay and declining subsidies from local governments.

[Exclusive preview]

1. We expect that in 2024, the company is expected to achieve a good match between the number of captains and the size of the fleet. The fleet utilization rate is expected to return to 2019 levels. After capacity returns to the normal pace of growth, the performance is expected to exceed expectations. According to company announcements and flight managers, the fleet size of Huaxia Airlines in November 2023 increased by about 39% compared to the end of 2019, and the average daily flight volume decreased by about 10% compared to the same period in 2019. We believe that the slow pace of capacity recovery in the early period was mainly limited by the shortage of captains. Through external introduction and independent training, captain restrictions will continue to be relaxed. In 2024, the number of company captains is expected to be a good match with the size of the fleet, and capacity will be restored at an accelerated pace.

2. The willingness of local governments to pay has not abated, and the scale of subsidies received by companies is expected to resume as flight volume resumes. The sources of income from corporate subsidies and institutional capacity purchases are scattered, and the risks faced are limited. According to the Civil Aviation Administration, the total amount of regional aviation subsidies in 2024 was 1,405 billion yuan (the 2024 budget is based on 22H2-23H1 transportation data, and so on), an increase of about 28% over the scale of subsidies in 2020. It can be seen that local governments maintain a high level of support for regional aviation. Among them, Huaxia Airlines' 2024 regional airline subsidy is 145 million yuan. We believe that the second consecutive reduction in subsidies is mainly affected by the slow pace of flight volume recovery, while the scale of the subsidy is linked to strong flight volume. As local government finances improve marginally and the company's flight volume continues to recover, we believe that the scale of subsidies received by the company will recover somewhat.

3. The revenue structure is expected to continue to be optimized, and the company's profit elasticity is expected to increase. In 2019, the company's institutional capacity purchase revenue accounted for about 30%, and passenger ticket revenue accounted for about 70%. On the one hand, local governments are more willing to pay by using “small capital” to draw “big benefits” into the local market, and companies can guarantee the basic business market of institutions through brand effects and service quality; on the other hand, by promoting travel products and travel products, the company is expected to continue to increase the share of passenger ticket revenue, optimize the revenue structure, widen the margin of safety, and increase the profit elasticity of the demand boom cycle.

[Profit Forecast and Valuation]

The company's net profit for 2023-2025 is estimated to be -9.6, 6.1, and 1.03 billion yuan respectively, and the current price corresponding to 24-25 PE is 16.2 and 9.6 times, respectively. The company's valuation based on normal performance is at a low level among private airlines. The company's fleet expansion and growth rate is expected to be higher than the industry average, and the pace of capacity growth is gradually returning to normal. After utilization returns, performance is expected to exceed expectations and be upgraded to a “buy” rating.

[Risk Reminder]

Demand falls short of expectations, capacity recovery falls short of expectations, risk of large fluctuations in oil prices and exchange rates, and risk of accounts receivable.