How hard will fuel costs hit China Southern Airlines?

China Southern Airlines (ZNHquote) is set to report earnings Friday, and after Air China and China Eastern Airlines (CEA, quote) both reported earnings this week that came in below expectations, investors are wary. 

Image courtesy Mehdi Nazarinia: Air China and China Eastern cited increased costs for their declining profitability. Specifically, the elevated cost of crude had ramifications for the companies’ respective bottom lines.

Chinese airlines have been at a disadvantage this year because of constraints pertaining to fuel hedging imposed by the Chinese government. After heavy losses from derivatives in 2008, Chinese state-owned companies have been prohibited from trading futures contracts.

These restrictions have hampered Chinese state-owned carriers recently because of sustained high fuel prices. Previously, the government allowed companies to implement a fuel surcharge paid by individual passengers, but these measures are widely considered an inadequate substitute for fuel hedging.

After the reports from Air China and China Eastern, the government, according to China Eastern Chairman Liu Shaoyong, has relaxed its restrictions on jet fuel future purchases for state-owned air carriers, allowing them to hedge up to 20% of their total fuel consumption. This will allow Chinese airlines to better combat high prices in global crude markets more effectively in the future.

These new measures will be of no help to China Southern Airlines when they release their FY 2011 earnings on Friday. Extrapolating from the results of its competitors, ZNH will also likely report a decrease in profit.

The stock is currently in a downtrend, shedding 10% of its value this month. A disappointing report will likely perpetuate this trend.

If ZNH does disappoint, traders should look for the stock to move towards its 200-week moving average, which has served as a level of support for the stock over the past two years. A high-volume move through this level is likely indicative of a further move down.

Conversely, if ZNH finds support at its 200-week moving average, long-term investors might find this an attractive entry point, as the stock’s fundamentals remain relatively healthy and increased fuel-hedging flexibility will benefit the carrier going forward.


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