Investors need positive news to muster up the conviction to return to Chinese stocks. This thesis played out in how Chinese travel stocks reacted to the official relaxation of the country’s Covid-19 policy.
On 11 November China's National Health Commission announced that, for people entering China (and also for those with close contact to patients infected with Covid-19), the quarantine period has been shortened to five-day centralised plus a three-day home quarantine. That compares with the previous policy of seven days centralised quarantine with three days of home health monitoring.
In addition, among other relaxations, Covid-19-related suspensions have been scrapped for flights and only one negative PCR test taken 48 hours prior to boarding is required from inbound travellers.
On the same day as these announcements, Trip.com (09961) jumped 17.4% higher. Premium luggage maker Samsonite International (01910) rose 3.6%. The rise in air carrier stocks is around single-digits, with China Eastern Airlines (00670) leading. Hong Kong-based Cathay Pacific Airways (00293) also traded 3.6% higher.
Recovery Path Will Be Gradual, Not V-Shaped
Despite this small change, China is not turning its back entirely on its zero-tolerance mindset to Covid-19. The current inbound quarantine of eight days will still stand in the way of a full rebound. Although further relaxations are anticipated over the next few quarters, analysts think a V-shaped recovery is unlikely in 2023. The whole hospitality and travel industry will only recover to its pre-pandemic levels by 2025.
Cheng Wang, our analyst covering the sector, says: "although sentiment around the Chinese travel industry may improve as a result of the announcement, we do not expect a V-shaped recovery in 2023, but rather a gradual revitalisation of the travel industry."
The mainland’s reopening path may look similar to that of Hong Kong, he thinks. The city lifted flight bans in July 2022. Through September, air traffic remained subdued, increasing to only 11% of its pre-pandemic levels, compared to 2% in March. In China, international air traffic was 2%-5% of 2019 levels in the third quarter of 2022. "Therefore, we do not expect a sharp increase in travel yet," Wang says.
Some Will Benefit More from Relaxations
According to our analysts, Trip.com’s international business will set to benefit from the relaxation. Wang raised his value estimate for Trip.com by 30% to HK$ 249 and says:
"There could be further positive catalysts for Trip.com in the event of any further relaxation of China’s pandemic restrictions. [...] We view any additional policy revisions as further tailwinds, but the timing of a substantive relaxation of China’s border restrictions remains difficult to predict, and we remain comfortable with our assumption of a steady reopening." Trip.com’s international business contributed 25% of the firm’s revenue before the pandemic but dropped to 10%-15% of total revenue in 2022.
Wang continues: "we believe the bigger catalyst to the valuation upside will be a full recovery in international travel to and from China. The increase in our fair value estimates mainly reflect more optimistic assumptions of international revenue. We now expect 2025 revenue from international airline and hotel bookings to reach 22% and 10% of 2019 levels, respectively, compared with our previous assumptions of 6% and 7%."
For Samsonite, its constant currency sales in China were still down 34% in the third quarter compared with 2019. According to Ivan Su, senior equity analyst at Morningstar, the firm’s management sees some improvements in the fourth quarter and expects more material recovery starting in the second quarter of 2023. Samsonite’s fair value estimate is lifted by 1% to HK$ 23.20, to reflect a faster and more rapid recovery of China sales.
Su thinks, in addition to China’s reopening story, other Asian markets will help lead the next leg of recovery. "Korea and Japan recently reopened their borders for tourists, and luggage demand shot up immediately. [...] With Asia being the most profitable region for Samsonite, we expect the ongoing release of pent-up demand will translate to better margins in 2023."
The Boost Will Be Smaller For Airlines
Without a V-shape recovery, airline businesses continue to look tough. Wang says: "while we do not predict a significant boost to travel recovery from this policy change, we think the relaxation marks a positive step toward an eventual transition to living with Covid-19."
Even as the country resumes international flights, he sticks to the original base-case assumption that China will only meaningfully ease its zero-Covid policy in the second half of 2023. The fair value estimates for the three airlines are also unchanged.
"We note upsides to our 2023 earnings estimates if China opens the border after the Lunar New Year, as per recent management guidance from Asia aviation industry peers," Wang continues.
"This may bring capacity rebound one quarter ahead of our current estimates. However, we are more comfortable with our current assumptions given the time required to prepare for reopening such as mass vaccination and medical resources ramp-up." Investors may therefore want to wait for better entry points.
There is one piece of positivity, though. Wang says domestic airlines have competitive advantages over their European peers given their ability to fly over Russian airspace.
"This will shorten trips to Europe by four hours which is not only attractive for customers, but will also help with the margins due to higher passenger yields and lower jet fuel costs, netting out the hedging costs," he says.
After a rally fuelled by relaxation news, Morningstar-covered travel stocks in Hong Kong and mainland China are fairly valued, or trading slightly above their fair value estimates. In particular, China Eastern Airlines trades most expensively, at 26% above its fair value estimate. The year to date performance of travel stocks looks mixed, with Samsonite and Cathay Pacific leading the board.
