* Chinese airlines face fresh challenge as yuan depreciates
* Air China, Hainan Air warn of impact of forex volatility on earnings
* Beijing's austerity measures continue to bite
By Fang Yan and Matthew Miller
BEIJING, March 27 (Reuters) - Chinese airlines, already grappling with half-empty premier cabins due to Beijing's austerity drive, will be tested next in their ability to hedge against currency risks as China looks set to allow greater two-way swings in the yuan.
The yuan has gained some 30 percent against the dollar since 2005 as China slowly loosens its grip on the currency. In recent weeks, however, Beijing allowed the yuan to slide sharply to punish speculators, adding more volatility in the market.
With the end of the yuan's consistent appreciation against the dollar, carriers including Air China Ltd, China Southern Airlines Co Ltd and China Eastern Airlines Corp Ltd will be challenged on two fronts - operating costs and foreign currency-denominated debts.
"Currency risk was hardly an issue for Chinese airlines before, as they've always ended up with foreign exchange gains," said Wang Xiaohua, a senior consultant with Xiamen, China-based Kent Ridge Consulting Co Ltd. "They'll have to be more skilful in currency hedging now that the yuan can go both ways."
People in the industry say the yuan adjustment will be a short-term discomfort for Chinese airlines and will not alter their long-term plans to expand their fleets to meet rising demand in the world's fastest-growing aviation market.
While the recent slowdown in the Chinese economy has put a damper on airline earnings, one in four people from China travelled by plane last year. That number is set to rise to virtually the whole active population in the next two decades, Airbus says.
On Tuesday, Air China said its 2013 net profit tumbled nearly a third to 3.3 billion yuan ($532.05 million). The carrier blamed it mostly on the slowing economy.
The decline would have been steeper had the airline not booked foreign exchange gains of 1.9 billion yuan, an increase of 1.8 billion yuan from 2012.
China Eastern and China Southern, set to release their annual results later this week, are also expected to report huge forex gains due to the yuan's appreciation.
Air China warned that volatile exchange rates will cut its earnings due to the size of its foreign currency debts. About 70 percent of its 111.6 billion yuan in foreign debts are denominated in dollars.
"Currency volatility will also affect the company's procurement cost of aircraft, components, fuel and push up our take-off and landing cost in foreign airports," it said.
All the aircraft orders that Chinese airlines have placed with Airbus Group NV and Boeing Co are settled in dollars, industry observers say.
Hainan Airlines Co Ltd has also flagged foreign exchange risks.
In 2012, a slower rise in the yuan trimmed China Southern's foreign exchange gains by 2.4 billion yuan compared with 2011. China Eastern's forex gains also shrank to 148 million yuan at the end of 2012, a fraction of the year-earlier level.
About three-quarters of China Eastern's 67.6 billion yuan of foreign debts as of the end of 2012 were denominated in dollars.
The yuan's fall against the dollar last week took the Chinese currency's year-to-date losses to 2.8 percent, unwinding the gain it made in the whole of 2013.
While overall passenger load factor remains at around 80 percent, Chinese airlines have been struggling to fill their business and first-class cabins as Beijing clamps down on lavish spending by government officials, including luxury trips abroad.
China Eastern alone lost about 1 million premier clients, or 1.1 billion yuan in revenue, last year, local media said. Company president Ma Xulun admitted publicly the difficulties the airline industry has been going through but has declined to be specific.
The situation has not improved so far this year.
There are hardly any full-price first-class seats even on popular routes such as the Beijing-Shanghai and Beijing-Guangzhou routes, and discounts may widen to as much as 70 percent, according to online travel agency Ctrip.com International Ltd.
"The impact of the anti-graft campaign won't go away quickly, and airlines need to live with it," Ma Chulun, president of China Eastern Airlines, told Reuters. ($1 = 6.2024 Chinese Yuan) (Reporting by Fang Yan and Matthew Miller in BEIJING; Editing by Ryan Woo)
- Air China
- China Eastern Airlines