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A Steep Ascent At China's Number One Airline


China Southern Airlines Co. (ZNH) may be mainland China's largest, but until recently it barely registered on the radar of international travelers such as Andrea Behrens Schmidt, a technology exec in Beijing. When business took her to the airline's home base of Guangzhou in early March, however, she gave China Southern a try. Her verdict: "The food's not great, but the service is very nice. I'd fly it again."

Not exactly a ringing endorsement, but good enough for China Southern's management. The carrier is in the midst of an ambitious expansion that execs hope will catapult it into the big leagues. China Southern flies its 132 planes to more than 80 destinations, it's midway through a deal to purchase 20 new Boeings to replace older planes in its fleet, and it's negotiating to buy 21 new Airbus jets for both domestic and long-haul international routes. And this summer it will move out of the existing Guangzhou airport, a 1950s relic that looks like an aging bus station. Its new home: a spectacular steel and glass palace with triple the capacity. "The old airport is so congested," says Su Liang, the airline's company secretary, who serves as a top adviser to the board of directors. "The move will let us really increase our network."

The new airport and planes will help China Southern expand in one of the world's fastest-growing markets. By some estimates, air travel in China could jump 30% this year and keep up double-digit growth for years. Business travel is booming, and 20 million mainlanders are likely to travel abroad this year, up from 3 million five years ago.

China Southern is well placed to capture much of that traffic. Its Guangzhou base means it can draw on the thriving Pearl River Delta. Passenger loads so far this year are up 10% from the same period last year. Earnings, meanwhile, are expected to grow to $155 million this year on sales of $2.65 billion, up from a loss of $58 million on revenues of $2.03 billion in 2003, ING (ING) estimates.

STATE CONTROL

There could, however, be some turbulence ahead. A big concern is the continuing restructuring of China's airlines. After brutal price wars squeezed the industry in the 1990s, Chinese officials in 2002 began a consolidation around the three strongest carriers: Air China, China Eastern, and China Southern. Fares were fixed, airlines were given less flexibility on route selection, and each of the big three was told to take over smaller players.

The restructuring highlights another fundamental problem: state control. As a result of the reorganization, China Southern will be forced to address the problems of two weaker carriers, China Northern and Xinjiang airlines, rather than being allowed to grow on its own. The Airbus talks were announced in January while President Hu Jintao was visiting Paris. While there's no indication that China Southern didn't want the planes, politics will clearly play a part in the operations as long as the state is the largest shareholder.

Then there's the competition. The Delta has five airports within a three-hour drive of Guangzhou, including Chek Lap Kok in Hong Kong, home to Cathay Pacific Airways Ltd. and Dragonair, which are beefing up service within China. "We'll be stepping on each other's toes as time goes on," says Tony Tyler, Cathay's director of corporate development.

China Southern execs maintain they're not worried. The new Guangzhou airport -- where the airline will control more than half the flights -- is every bit as modern and efficient as Hong Kong's, says Su. China Southern plans to use it to build domestic traffic to Guangzhou -- and then increase international service to feed those flights. "Our real opportunity is domestic," Su says. And he insists that consolidation with the two smaller airlines is going smoothly. Now if only they could do something about the food. By David Rocks in Guangzhou, with Bruce Einhorn in Hong Kong


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