In late July, Delta Air Lines (NYSE: DAL) invested $450 million for a 3.55% stake in China Eastern Airlines (NYSE: CEA). This investment into the H-shares of China Eastern expands the existing partnership between the two airlines. Between the two, they accounted for 24% of U.S.-China route seat capacity in July.
China Eastern is one of China’s big three state-owned carriers. The other two are China Southern Airlines (NYSE: ZNH) and Air China (OTC: AIRYY). However, China Eastern is considered to be the most innovative of the three.
The reason behind Delta’s investment is rather straightforward. Despite recent turmoil in the Chinese stock market, Chinese air travel and China’s tourism industry are still growing rapidly. Delta would like a piece of that growth to offset stagnation in the developed markets.
China’s Commercial Aviation Industry Soaring
China is forecast to become the world’s largest aviation market by 2033. Growth in the sector is being accelerated by the Chinese government. It will spend $80 billion this year alone on 193 aviation-related infrastructure projects. It is projected that China will have 240 airports by the end of the decade, up from about 200 today.
The airports will be needed. Growth in the Chinese airlines has been phenomenal to say the least.
Passenger seat capacity expanded from approximately 100 million in 1996 to about 600 million in 2014. Chinese airlines today fly 553 routes to 127 cities in 51 countries. Another 83 routes will be added later this year.
Most of this growth is being pushed along by the surge of Chinese tourism. Look at these numbers from the consulting group McKinsey & Company:
- In 2013, 97 million Chinese traveled overseas, spending $129 billion.
- In 2014, those figures rose to 112 million Chinese spending a record-breaking $164.8 billion.
Of course, some of that tourism was to the United States. And the Chinese airlines noticed.
This summer, for the first time ever, Chinese airlines will offer more flights (2,028 weekly) to and from the United States than their American counterparts (1,853 weekly). They now operate 140% more seats on U.S.-bound flights than they did just five short years ago.
The travel trend continued into this year. Outbound passenger traffic in the January-May period in China grew by 39% year-on-year.
Chinese Airlines Benefiting
This rapid growth has allowed Chinese airlines to fly higher than their competition. Their return on capital, according to McKinsey, is about 15%, although that has tailed off very recently. Their competitors in recent years have averaged returns on capital of less than 5%.
McKinsey foresees the growth in travel continuing. Specifically with regard to air travel, it says that over the next 10 years there could be a tripling in the number of people able to afford air travel.
The implications are enormous. With only 4% of its population having passports, China still managed to become the world leader in international travel in 2012.
And as pointed out earlier, those numbers have soared since. No wonder famed international investor Jim Rogers has touted Chinese airline stocks many times in the past.
US Airlines at Risk?
Why Delta Air Lines is so anxious to firm up its partnership with China Eastern is now obvious.
But are the U.S.-based airlines at risk from Chinese airlines? Will China’s air carriers become the leaders in international air travel?
The real possibility is there. Therefore, it makes sense for Delta and others to invest into Chinese airlines.
Another company that may do so is United Continental Holdings (NYSE: UAL). Its CEO, Jeff Smisek, said, “The Chinese market is very profitable and important for us.”
United Continental is still the largest carrier in the U.S.-China route, although Air China disputes that. It will be interesting to see if the two do join in some sort of joint venture. Air China has asked for a deeper partnership in the past, but United has rejected the overtures.
United and Air China are partners in the Star Alliance network. Delta and China Eastern are partners in the SkyTeam Alliance network.
And perhaps American Airlines Group (NASDAQ: AAL) of the oneworld alliance network – and also a big player in China – may be interested in further expansion. There were rumors that China Eastern was going to jump to oneworld. Maybe that’s why Delta made its move when it did.
The bottom line here is that China and Chinese tourists will be a big driver of international air travel for many years to come. Airlines that want to remain relevant globally have to become a player on those routes carrying Chinese tourists.
The American airline companies seem to be coming to that realization.