New duty-free concession rate of 42.5% Shanghai Airport announced the results of the duty-free concession auction on 21 Jul. The winning bid was from Sunrise Duty Free Group (Shanghai), an associate of CITS and the current duty-free operator of Pudong Airport. Sunrise (Shanghai) offered a 42.5% concession rate and total guaranteed revenue of RMB41bn over the expected contract term from 1 Jan 2019 to 31 Dec 2025. The operating areas include Pudong Airport T1, T2 and the new satellite concourse, which is expected to open mid-2019. The new contract terms are expected to come into effect from 1 Jan 2019 for T2, from 1 Jan 2022 for T1 and from the commencement of operations in mid-2019 for the satellite concourse. Shanghai Airport and Sunrise (Shanghai) are finalizing further details of the contract. Adjusted forecasts to factor in traffic growth and concession rate changes We have increased our 2018E NP forecast by 7% to take into account the better-than-expected traffic growth YTD (our 2018 forecast now assumes 6% pax traffic growth compared to 5.4% previously) and cut our 2019-2020E NP forecasts by 10% due to the lower concession rate assumption of 38%, compared to our previous assumption of 45%. The adjusted NP forecasts for 2018-2020E are RMB4,453m, RMB5,549m, and RMB5,937m respectively. We cut our TP by 6% to RMB70; maintaining Buy. 1H18 results expected on 25 Aug In 1Q18, Shanghai Airport reported NP of RMB 1,017m up 28.6% yoy, supported by a 5.5% yoy increase on total passenger traffic and the new airport fee standards. For the first half of 2018, total passenger traffic was 36.69m (up 7.5% yoy) and international pax traffic growth was 12.6% yoy. We are forecasting RMB 2,064m NP for 1H18, representing 22% yoy growth.

Yield bottomed out in 2Q17; 25% 1H17profit decline due to increase in cost Spring reported 1H17gross revenue growth of 28.1% YoY to RMB5.1bn on theback of 29.1% passenger traffic (RPK) growth, while passenger yield remainflattish. However, operating expenses increased 42.4% YoY mainly due to 1)higher fuel cost amid rising fuel price; 2) increasing marketing and advertisingexpenses; and 3) higher staff wages, according to the company. Together with1) RMB1.1m investment income (vs. investment loss in 1H16) and 2)RMB655.1m non-operating income (+8.6% YoY) mainly from route subsidies,the airline’s 1H17net profit declined by 25.2% YoY to RMB554.0m. On a quarterly basis, 2Q17gross revenue grew 33.8% YoY to RMB2.5bn on32.0% YoY RPK increase and with encouraging sign of yield recovery of c.1%YoY during the quarter. However, with 42.8% YoY jump in operating expensesand 15.2% YoY decline in non-operating income, 2Q17net profit dropped32.9% YoY to RMB250.7m. Deutsche Bank view – worst is behind; pax yield to pick up in 3Q17E As Spring’s 1H17profit accounted for 55% of our full-year earnings estimateand 48% of consensus, we consider the results in-line. We maintain Buy as weexpect the airline’s yield to bottom out in 3Q17with load factor staying atc.90%. We believe Spring Airlines will be a key beneficiary of China’s LCCdevelopment, which is still in its infancy stage at the moment with only 9%penetration. Our target price is set at a target 3.5x FY18E P/BV (unchanged).We believe this is justified vs. sustainable ROE of about 15-16%. Downsiderisks include 1) excessive new capacity on international routes, 2) slower-thanexpecteddemand growth in the North Asia and ASEAN routes, and 3)competition in domestic and regional routes.

Yield: Spring attributes the passenger yield recovery mainly to yieldmanagement, especially on routes with high load factor, but less to ticketpricing increase. Management commented that yields in tier-1cities suchas Shanghai and Shenzhen recovered by double-digit in 1H17.。 Load Factor: The 1.2ppt YoY drop in load factor in 1H17was due tonew domestic flights started during the period. However, load factor onnew routes recorded sequential improvement, according to the airline. Inaddition, the company is confident to maintain load factor at over 90%level.。 Capacity: Spring recorded 31% YoY ASK growth in 1H17on the back ofadditional 7aircrafts. Domestic ASK expanded (+44% YoY) faster thaninternational ASK (+11% YoY). The airline plans to add another 4aircrafts(1self-owned; 3under operating lease) in 2H17E and 10fleets (operatinglease) in 2018E to maintain an annual ASK growth of c.15-20%.。 Domestic ASK: Domestic ASK accounts for 66% of total ASK in 1H17,an increase vs. 60% a year ago. According to management, most ofthe additional capacity was added in tier-2cities such as Shenyang,Shijiazhuang, Yangzhou, Ningbo and Harbin, while ASK growth inShanghai and Shenzhen remained muted given limited slots availability.。 International ASK: Most of the incremental international ASK was addedto Thailand market, which recovered faster than they expected despiteload factor staying low. For international routes, Spring cut somedomestic departure airports from 28to 20by the end of first-half, whilemaintained the number of international destinations unchanged at 19.。 Cost control: Spring attributes the 42% YoY increase in operatingexpenses to faster growth in fuel cost and take-off/landing charge.Although the fuel price is likely to stay high, the company aims toreduce its cost base in 2H17E by optimizing aircraft utilization, fuel savingmeasures and operating efficiency.。