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Sector Update Summary

Core Content

This document provides a sector update on the Korean airline industry, focusing on the performance and outlook for Jeju Air, Korean Air, and Asiana Airlines for the third quarter of 2016 (3Q16) and future periods. It includes financial forecasts, valuation metrics, and key factors influencing the performance of these airlines.

Main Points

3Q 2016 Performance

• Korean Air (KAL): Sales and operating profit rose by 7.4% and 59%, respectively, to KRW5t and KRW597.1b, meeting consensus estimates.
• Asiana Airlines: Sales and operating profit also increased by 6.2% and 94.3%, respectively, to KRW1,633.2b and KRW134.8b.
• Jeju Air: Sales and operating profit surged by 31.8% and 128.2%, reaching KRW219.6b and KRW38.3b, with a 17.4% operating margin.

Key Drivers of Performance

• Passenger yields increased due to peak seasonality and the MERS base effect.
• Fuel cost reduction: Average jet fuel prices fell 12% y-y to USD55/bbl, contributing to improved profitability.
• Outbound demand: Strong growth in outbound passenger numbers supported sales growth.
• Cost management: Improved bargaining power and fleet expansion helped reduce costs and enhance profitability.

Key Information

Company-Specific Outlook

Jeju Air (089590 KS)

• Rating: BUY
• Target Price: KRW45,000 (40.8% upside)
• Reasons for Buy:
  • Fleet expansion and route additions are expected to drive top-line growth.
  • Launch of the Value Alliance will enhance access to long-haul routes.
  • Stronger bargaining power is anticipated to enable cost savings.
• Outlook: Expected to deliver its best-ever earnings in 3Q16, with continued growth in 2017.

Korean Air (003490 KS)

• Rating: HOLD
• Target Price: KRW37,000
• Reasons for Hold:
  • Long-haul focus makes it less vulnerable to competition.
  • Code-sharing with Delta Airlines from November is expected to boost earnings.
  • Subsidiary-related risks are expected to diminish as Hanjin Shipping accelerates asset disposals and labor restructuring.
• Outlook: Expected to post its highest profit since the 2010-11 boom in 3Q16.

Asiana Airlines (020560 KS)

• Rating: HOLD
• Target Price: KRW5,300
• Reasons for Hold:
  • Long-term profitability may improve with the launch of Air Seoul.
  • Economies of scale and group-related risk dissipation are expected to take time.
• Outlook: Expected to achieve profitability in 3Q16, though it's unlikely to outperform in the near term.

Valuation Overview

Oil Price Concerns

• Oil price surge has caused airline shares to retreat, but the analyst believes the pullback is overblown.
• Reasons:
  • OPEC members may struggle to agree on output cuts.
  • Even if cuts are agreed, implementation is uncertain.
  • US shale production could lead to a drop in oil prices.
• Fuel cost-to-sales ratio: Expected to remain at 28–32%, below historical highs of 40%.

3Q16 Financial Highlights

Summary Financial Data (Jeju Air)

Market Context

• One-Year Performance: Jeju Air had a flat performance in 2016, with a 0.0% change in EPS.
• Market Cap: Jeju Air's market cap is KRW829.61b/USD731m.
• Shares (float): 25,965,758 (24.4% of total shares).
• 52-Week High/Low: KRW48,100/KRW29,200.
• Average Daily Trading Value: KRW4.2b/USD3.7m.

Conclusion

The analyst highlights that Jeju Air is the top pick for the sector due to its growth potential and cost management strategies. Korean Air and Asiana Airlines are expected to show improvement in profitability, with Korean Air benefiting from long-haul routes and Asiana from the launch of Air Seoul. Despite concerns over oil prices, the analyst believes the impact on fuel costs will remain manageable. The sector is rated OVERWEIGHT, suggesting a positive outlook for the industry as a whole.