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Steer Clear of This Chinese Industry

I'm going to tell a story about airlines, so the temptation to use metaphors such as smooth takeoff and hard landing will follow me like a first-class passenger chasing a drink cart. But the only metaphor worth knowing is the aviation axiom of balancing lift and thrust against weight and drag.

From an investor's point of view, China's top three airlines have too much weight and drag to stay airborne in world financial markets.

That forecast may come as a surprise as the airlines turn to lavish sales of bonds or generous government injections of capital to reduce debts. But Air China, China Eastern and China Southern, the country's flagship international carriers, have higher-than-normal debt-to-asset ratios and keep expanding their aircraft fleets to keep up with growth in international routes.

The Chinese government has encouraged that growth as a nationalistic means of ensuring that China doesn't rely too much on foreign airlines. Today 30% to 50% of business by Air China and China Eastern goes to flights overseas, with China Southern behind at 10% to 15%.

The nationalism is coming at a cost, and the airlines hardly need any more of that. Efforts this year to raise capital may boost investor confidence for now but won't cure the longer-term expenditure issues facing Chinese airlines.

Like many state-owned firms, the big three carriers are overstaffed. As the government runs Chinese airports as well, the airlines are stuck with flat terminal use fees rather than being set loose to negotiate them as they would in a free-market environment. Jet fuel rates are also set by the government, and prices run extra high in China for lack of an open-market pricing system.

Stock market performances for the big three carriers reflect those burdens as well as fallout from the world economic problems that spun off from Europe in August. Air China share have fallen 35% in a year, with China Eastern down 29% and China Southern off 15%.

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