July 14,2006 China Eastern Airlines (0670.HK) Goldman Sachs Global Investment Research 1 July 14,2006 COMPANYUPDATE China Eastern Airlines (0670.HK) Cutting 06/07 ests, introduce 08; remain cautious What's changed We are sharply cutting our 2006E forecast from a Rmb134mn net loss to a Rmb919mn net loss. Our new 2007E net loss is Rmb989mn vs. a net profit forecast of Rmb281mn previously. This is driven by continued domestic passenger yield pressure, falling load factors on routes to Hong Kong, high jet fuel prices compounded by an inability to control other non-fuel operating costs, and rising interest costs due to rapidly rising borrowings. We are introducing a 2008E net profit forecast of Rmb797mn. Implications We remain negative on CEA: while there is strong traffic growth in China, we do not believe that CEA can translate this into profitable growth in the near term. We believe domestic competition will continue to exert pressure on yields. High jet fuel prices compound management’s inability to control other non-fuel operating costs; the jet fuel surcharge could help but only partially. Furthermore, CEA has a heavy debt servicing burden: we estimate interest expense to hit Rmb1.6bn as net debt/equity climbs to 964%. One positive would be further Rmb revaluation, which would be highly beneficial for CEA as it is short USD (USD-costs > USD-revenue); also there would be a large forex translation gain from its USD-denominated debt. Nonetheless, we believe this is still insufficient to outweigh the other negatives. Valuation We are adjusting our 12-month target price from HK$1.32 to HK$0.90 as we roll over our 1.0X target P/B multiple to 2007. If CEA’s share price falls below book value – say a 10% discount which would correspond to circa HK$0.80 – we would view it as a short term trading opportunity, as we note that since 2004 CEA’s share price has seldom stayed below book value for long periods of time. Key risks A key risk to our 12-month target price would be a further sharp spike in jet fuel prices. Impact on related securities We have adjusted our earnings estimates for CEA’s ADR, and also adjusted the target price to US$11.54 from US$16.28. INVESTMENTLISTMEMBERSHIP Neutral Coverage View: Cautious China: Airlines Growth Returns * Multiple Volatility Volatility Multiple Returns * Growth Investment Profile: China Eastern Airlines Low High Percentile 20th 40th 60th 80th 100th * Returns = Return on Capital For a complete description of the investment profile measures please refer to the disclosure section of this document. 0670.HK Asia Pacific Transportation Peer Group Average Key data Current 0670.HKPrice / price target (HK$) 1.04 / 0.90 CEAPrice / price target ($) 13.22 / 11.54 Market cap (HK$ mn / US$ mn) 5,061.6 / 650.9 Foreign ownership (%) -- 12/0512/06E 12/07E 12/08E EPS (Rmb) New (0.10) (0.19) (0.20) 0.16 EPS revision (%) (1,065.2) 586.1 (452.2) -- EPS growth (%) (245.7) (96.7) (7.6) 180.6 EPS (dil) (Rmb) New (0.1) (0.2) (0.2) 0.2 P/E (X) NMNMNM 6.5 P/B (X) 0.91.01.21.0 EV/EBITDA (X) 11.713.010.78.1 Dividend yield (%) NMNMNMNM ROE (%) (7.4) (16.3) (21.1) 17.4 Price performance chart 0.95 1.00 1.05 1.10 1.15 1.20 1.25 1.30 1.35 1.40 1.45 Jul-05 Oct-05 Jan-06 Apr-06 26 28 30 32 34 36 38 40 42 44 46 China Eastern Airlines (L) MSCIChina (R) Share price performance (%) 3 month 6 month 12 month Absolute (15.4) (20.0) (16.1) Rel. to MSCIChina (12.1) (28.2) (38.3) Source: Company data, Goldman Sachs Research estimates, FactSet. Price as of 7/13/2006 close. Julie Lim +65-6889-2470 | email@example.com Goldman Sachs (Singapore) Pte Jean-Louis Morisot +65-6889-2466 | firstname.lastname@example.org Goldman Sachs (Singapore) Pte Analysts employed by non-US affiliates are not required to take the NASD/NYSE analyst exam. The Goldman Sachs Group, Inc. does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. For Reg AC certification, see the text preceding the disclosures. For other important disclosures go to /research/hedge.html. The Goldman Sachs Group, Inc. Global Investment Research July 14,2006 China Eastern Airlines (0670.HK) Goldman Sachs Global Investment Research 2 China Eastern Airlines: Summary financials Profit model (Rmb mn) 12/0512/06E 12/07E 12/08EBalance sheet (Rmb mn) 12/0512/06E 12/07E 12/08E Total revenue 27,516.536,859.044,062.952,306.3 Cash & equivalents 1,864.01,395.21,726.31,065.7 Cost of goods sold (21,254.7) (29,585.5) (34,629.4) (39,749.5) Accounts receivable 1,918.42,014.32,115.02,220.8 SG&A (2,519.1) (3,064.4) (3,426.5) (3,841.8) Inventory 0.00.00.00.0 R&D -- -- -- -- Other current assets 2,234.92,607.82,176.02,730.9 Other operating profit/(expense) 0.00.00.00.0 Total current assets 6,017.46,017.46,017.46,017.4 EBITDA 3,742.74,209.16,006.98,715.1 Net PP&E 38,347.545,904.251,314.155,941.8 Depreciation & amortization (3,911.7) (4,654.9) (5,446.3) (5,827.5) Net intangibles 688.3653.9621.2590.1 EBIT (169.0) (445.9) 560.62,887.6 Total investments 3,547.53,547.53,547.53,547.5 Interest income 128.7109.498.599.4 Other long-term assets 10,721.216,509.520,653.424,198.1 Interest expense (1,121.7) (1,615.2) (2,035.2) (2,381.2) Total assets 59,321.972,632.582,153.590,294.9 Income/(loss) from uncons. subs.0.00.00.00.0 Others 584.6918.4263.9290.3 Accounts payable 3,394.93,564.63,742.93,930.0 Pretax profits (577.4) (1,033.3) (1,112.2) 896.1 Short-term debt 20,982.719,617.220,686.521,298.7 Income tax 138.7165.3178.0 (143.4) Other current liabilities 7,237.49,443.810,206.511,751.5 Minorities (28.6) (51.1) (55.0) 44.4 Total current liabilities 31,614.932,625.734,636.036,980.3 Long-term debt 17,970.631,370.639,870.644,870.6 Net income pre-preferred dividends (467.3) (919.1) (989.3) 797.1 Other long-term liabilities 2,636.82,636.82,636.82,636.8 Preferred dividends 0.00.00.00.0 Total long-term liabilities 20,607.434,007.442,507.447,507.4 Net income (pre-exceptionals) (467.3) (919.1) (989.3) 797.1 Total liabilities 52,403.366,633.177,143.484,487.7 Post-tax exceptionals 0.00.00.00.0 Net income (467.3) (919.1) (989.3) 797.1 Common stock & premium -- -- -- -- Other common equity -- -- -- -- EPS (basic, pre-except) (Rmb) (0.10) (0.19) (0.20) 0.16 Total common equity 6,096.15,177.04,187.74,984.7 EPS (basic, post-except) (Rmb) (0.10) (0.19) (0.20) 0.16 Minority interest 822.5822.5822.5822.5 EPS (diluted, post-except) (Rmb) (0.10) (0.19) (0.20) 0.16 DPS (Rmb) 0.000.000.000.00 Total liabilities & equity 59,321.972,632.582,153.590,294.9 Dividend payout ratio (%) 0.00.00.00.0 Free cash flow yield (%) (218.9) (282.7) (209.5) (158.0) BVPS (Rmb) 1.251.060.861.02 Growth & margins (%) 12/0512/06E 12/07E 12/08ERatios 12/0512/06E 12/07E 12/08E Sales growth 30.834.019.518.7 ROE (%) (7.4) (16.3) (21.1) 17.4 EBITDA growth (1.0) 12.542.745.1 ROA (%) (0.9) (1.4) (1.3) 0.9 EBIT growth (111.4) (163.8) 225.7415.0 ROACE (%) 0.80.81.24.0 Net income growth (245.7) (96.7) (7.6) 180.6 Inventory days NMNMNMNM EPS growth (245.7) (96.7) (7.6) 180.6 Receivables days 24.019.517.115.1 Gross margin 22.819.721.424.0 Payable days 41.742.938.535.2 EBITDA margin 13.611.413.616.7 Net debt/equity (%) 608.4957.91,404.91,306.1 EBIT margin (0.6) (1.2) 1.35.5 Interest cover - EBIT (X) NMNM 0.31.3 Valuation 12/0512/06E 12/07E 12/08E Cash flow statement (Rmb mn) 12/0512/06E 12/07E 12/08E Net income pre-preferred dividends (467.3) (919.1) (989.3) 797.1 P/E (analyst) (X) NMNMNM 6.5 D&A add-back 3,911.74,654.95,446.35,827.5 P/B (X) 0.91.01.21.0 Minorities interests add-back 28.651.155.0 (44.4) EV/EBITDA (X) 11.713.010.78.1 Net inc/(dec) working capital 2,037.01,520.71,272.01,071.6 Dividend yield (%) NMNMNMNM Other operating cash flow (682.8) (749.7) (55.0) 44.4 Cash flow from operations 4,827.24,558.05,729.07,696.2 Capital expenditures (19,105.6) (18,000.0) (15,000.0) (14,000.0) Acquisitions 0.00.00.00.0 Divestitures 0.00.00.00.0 Others 414.6698.50.00.0 Cash flow from investments (18,691.0) (17,301.5) (15,000.0) (14,000.0) Dividends paid (common & pref) 0.00.00.00.0 Inc/(dec) in debt 13,365.812,034.69,569.35,612.2 Common stock issuance (repurchase) 0.00.00.00.0 Other financing cash flows 204.3240.132.731.1 Cash flow from financing 13,570.112,274.79,602.05,643.2 Total cash flow (293.7) (468.8) 331.0 (660.6) Note: Last actual year may include reported and estimated data. Source: Company data, Goldman Sachs Research estimates. Analyst Contributors Julie Lim email@example.com Jean-Louis Morisot firstname.lastname@example.org July 14,2006 China Eastern Airlines (0670.HK) Goldman Sachs Global Investment Research 3 Exhibit 1: We forecast that CEA will continue to generate losses in 2006 and 2007 CEA 2006-8E forecasts: new vs. old (In Rmb mn unless otherwise stated) Previous New 2006E 2007E 2008E 2004A 2005A 2006E 2007E 2008E Key financials Sales 30,747 35,895 NA 21,350 27,516 36,859 44,063 52,306 Operating cost 30,347 34,057 20,239 27,685 37,305 43,502 49,419 Operating profit 400 1,838 1,111 (169) (446) 561 2,888 Operating margin 1.3% 5.1% 5.2% -0.6% -1.2% 1.3% 5.5% Net profit (134) 281 321 (467) (919) (989) 797 Net margin -0.4% 0.8% 1.5% -1.7% -2.5% -2.2% 1.5% EPS (Rmb) 0.10 0.01 0.06 (0.09) (0.19) (0.21) 0.17 Key operating assumptions Domestic passengers ASK growth 14.0% 15.0% 29.7% 33.1% 60.0% 15.0% 17.0% RPK growth 18.0% 18.0% 40.7% 39.8% 62.0% 18.0% 18.0% Yield % change -1.0% 0.5% 5.3% -1.3% -3.0% 0.5% 0.5% Regional passengers ASK growth 10.0% 10.0% 31.6% 8.9% 11.0% 10.0% 12.0% RPK growth 9.0% 9.0% 57.1% 8.1% 5.0% 8.0% 12.0% Yield % change -1.0% -1.0% -12.4% 3.0% -3.0% -1.0% 0.0% International passengers ASK growth 15.0% 15.0% 58.2% 22.1% 15.0% 15.0% 15.0% RPK growth 18.0% 18.0% 74.1% 27.6% 20.0% 22.0% 20.0% Yield % change 2.0% 2.0% -5.4% 8.2% 5.0% 5.0% 3.0% Total Passengers ASK growth 14.0% 14.5% 39.7% 26.0% 38.2% 14.6% 16.0% RPK growth 17.2% 17.2% 53.2% 31.9% 42.1% 18.5% 18.2% Yield % change -0.2% 0.7% -1.2% 1.8% -1.3% 1.6% 1.2% Total Cargo AFTK growth 16.0% 15.0% 58.9% 21.2% 15.0% 15.0% 15.0% RFTK growth 15.0% 15.0% 44.6% 14.8% 16.0% 16.0% 16.0% Yield % change -1.5% -2.0% -3.9% -2.3% -3.0% -1.0% -1.0% Total Airline ATK growth 14.9% 14.7% 48.1% 23.8% 27.5% 14.8% 15.6% RTK growth 16.4% 16.4% 49.3% 24.3% 32.5% 17.6% 17.5% Total yield % change -0.1% 0.5% -0.6% 4.1% 1.8% 1.6% 1.2% Total unit revenue % change 1.1% 2.0% 0.2% 4.5% 5.8% 4.1% 2.9% Total unit cost % change 1.0% -2.2% -2.8% 10.5% 5.7% 1.6% -1.7% - of which jet fuel unit cost % change 10.0% -4.0% 20.4% 32.3% 22.0% 5.0% -3.0% Source: Goldman Sachs Research estimates. July 14,2006 China Eastern Airlines (0670.HK) Goldman Sachs Global Investment Research 4 Exhibit 2: Valuations are hovering around book value now CEA 12-month forward rolling P/B 0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 Fe b- 97 Fe b- 98 Fe b- 99 Fe b- 00 Fe b- 01 Fe b- 02 Fe b- 03 Fe b- 04 Fe b- 05 Fe b- 06 Price 0.2X 0.4X 0.6X 0.8X 1.0X 1.2X Source: Datastream, Goldman Sachs Research estimates. July 14,2006 China Eastern Airlines (0670.HK) Goldman Sachs Global Investment Research 5 RegAC I, Julie Lim, hereby certify that all of the views expressed in this report accurately reflect my personal views about the subject company or companies and its or their securities. I also certify that no part of my compensation was, is or will be, directly or indirectly, related to the specific recommendations or views expressed in this report. Investment profile The Goldman Sachs Investment Profile provides investment context for a security by comparing key attributes of that security to its peer group and market. The four key attributes depicted are: growth, returns, multiple and volatility. Growth, returns and multiple are indexed based on composites of several methodologies to determine the stocks percentile ranking within the region's coverage universe. The precise calculation of each metric may vary depending on the fiscal year, industry and region but the standard approach is as follows: Growth is a composite of next year's estimate over current year's estimate, e.g. EPS, EBITDA, Revenue. Return is a year one prospective aggregate of various return on capital measures, e.g. CROCI, ROACE, and ROE. Multiple is a composite of one-year forward valuation ratios, e.g. P/E, dividend yield, EV/FCF, EV/EBITDA, EV/DACF, Price/Book. Volatility is measured as 30-day historical volatility, annualized and adjusted for dividends. Quantum Quantum is Goldman Sachs proprietary database providing access to detailed financial statement histories, forecasts and ratios. It can be used for in-depth analysis of a single company, or to make comparisons between companies in different sectors and markets. Disclosures Coverage group(s) of stocks by primary analyst(s) Julie Lim: Asia Pacific Airlines, Asia Pacific Shipping. Jean-Louis Morisot: Asia Pacific Airlines, Asia Pacific Shipping. Asia Pacific Airlines: Air China, AirAsia, Cathay Pacific, China Airlines, China Eastern Airlines, China Eastern Airlines (ADS), China Southern Airlines, China Southern Airlines (ADS), EVAAirways, Jet Airways, Korean Air, Singapore Airlines, Thai Airways. Asia Pacific Shipping: China COSCOHoldings, China Shipping Container, China Shipping Development, Evergreen Marine, Great Eastern Shipping, Hanjin Shipping, Malaysian Int'l Shipping, Neptune Orient Lines, Orient Overseas Int'l, Pacific Basin Shipping, Precious Shipping, STXPan Ocean, Thoresen Thai, Wan Hai Lines, Yang Ming Marine. Company-specific regulatory disclosures The following disclosures relate to relationships between The Goldman Sachs Group, Inc. (with its affiliates, "Goldman Sachs") and companies covered by the Global Investment Research Division of Goldman Sachs and referred to in this research. Goldman Sachs expects to receive or intends to seek compensation for investment banking services in the next 3 months: China Eastern Airlines (HK$1.04) and China Eastern Airlines (ADS) ($13.22) Goldman Sachs has received compensation for non-investment banking services in the past 12 months: China Eastern Airlines (HK$1.04) and China Eastern Airlines (ADS) ($13.22) Goldman Sachs had an investment banking services client relationship during the past 12 months with: China Eastern Airlines (HK$1.04) and China Eastern Airlines (ADS) ($13.22) Goldman Sachs had a non-investment banking securities-related services client relationship during the past 12 months with: China Eastern Airlines (HK$1.04) and China Eastern Airlines (ADS) ($13.22) Goldman Sachs had a non-securities services client relationship during the past 12 months with: China Eastern Airlines (HK$1.04) and China Eastern Airlines (ADS) ($13.22) Distribution of ratings/investment banking relationships Goldman Sachs Investment Research global coverage universe Rating Distribution Investment Banking Relationships Buy Hold Sell Buy Hold Sell Global 27% 59% 14% 57% 49% 45% July 14,2006 China Eastern Airlines (0670.HK) Goldman Sachs Global Investment Research 6 As of July 1,2006, Goldman Sachs Global Investment Research had investment ratings on 2,129 equity securities. 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Being assigned a Buy or Sell on an Investment List is determined by a stock's return potential relative to its coverage group as described below. Any stock not assigned as a Buy or a Sell on an Investment List is deemed Neutral. Each regional Investment Review Committee manages various regional Investment Lists to a global guideline of 25-35% of stocks as Buy and 10-15% of stocks as Sell; however, the distribution of Buys and Sells in any particular coverage group may vary as determined by the regional Investment Review Committee. Return potential represents the price differential between the current share price and the price target expected during the time horizon associated with the price target. Price targets are required for all covered stocks. The return potential, price target and associated time horizon are stated in each report adding or reiterating an Investment List membership. Coverage groups and views: A list of all stocks in each coverage group is available by primary analyst, stock and coverage group at . The analyst assigns one of the following coverage views which represents the analyst's investment outlook ASONDJFMAMJJASONDJFMAMJJASONDJFMAMJ 2003200420052006 0.80 1.00 1.20 1.40 1.60 1.80 2.00 15 20 25 30 35 40 IL China Eastern Airlines (0670.HK) Goldman Sachs rating and stock price target history Currency: Hong Kong Dollar Source: Goldman Sachs Investment Research for ratings and price targets; Reuters for daily closing prices as of 07/01/06. Rating Price target Price target at removal MSCIChina; pricing by FactSet Covered by Julie Lim, as of Sep 5,2003 Not covered by current analyst 1.50 1.60 1.70 1.60 11.10 1.32 St oc k Pr ic e In de x Pr ic e New equity ratings, were adopted on June 24, 2006 but are not yet reflected above. The new Buy, Neutral and Sell are equivalent to OP, IL and U. The price targets shown should be considered in the context of all prior published Goldman Sachs research, which may or may not have included price targets, as well as developments relating to the company, its industry and financial markets. ASONDJFMAMJJASONDJFMAMJJASONDJFMAMJ 2003200420052006 12 14 16 18 20 22 24 26 15 20 25 30 35 40 IL China Eastern Airlines (ADS) (CEA) Goldman Sachs rating and stock price target history Currency: U.S. Dollar Source: Goldman Sachs Investment Research for ratings and price targets; Reuters for daily closing prices as of 07/01/06. Rating Price target Price target at removal MSCIChina; pricing by FactSet Covered by Julie Lim, as of Sep 5,2003 Not covered by current analyst 20.68 12.33 16.28 St oc k Pr ic e In de x Pr ic e New equity ratings, were adopted on June 24, 2006 but are not yet reflected above. The new Buy, Neutral and Sell are equivalent to OP, IL and U. The price targets shown should be considered in the context of all prior published Goldman Sachs research, which may or may not have included price targets, as well as developments relating to the company, its industry and financial markets. July 14,2006 China Eastern Airlines (0670.HK) Goldman Sachs Global Investment Research 7 on the coverage group relative to the group's historical fundamentals and/or valuation. Attractive (A). The investment outlook over the following 12 months is favorable relative to the coverage group's historical fundamentals and/or valuation. Neutral (N). The investment outlook over the following 12 months is neutral relative to the coverage group's historical fundamentals and/or valuation. Cautious (C). The investment outlook over the following 12 months is unfavorable relative to the coverage group's historical fundamentals and/or valuation. Not Rated (NR). The investment rating and target price, if any, have been removed pursuant to Goldman Sachs policy when Goldman Sachs is acting in an advisory capacity in a merger or strategic transaction involving this company and in certain other circumstances. Rating Suspended (RS). Goldman Sachs Research has suspended the investment rating and price target, if any, for this stock, because there is not a sufficient fundamental basis for determining an investment rating or target. The previous investment rating and price target, if any, are no longer in effect for this stock and should not be relied upon. Coverage Suspended (CS). Goldman Sachs has suspended coverage of this company. Not Covered (NC). Goldman Sachs does not cover this company. Not Available or Not Applicable (NA). The information is not available for display or is not applicable. Not Meaningful (NM). The information is not meaningful and is therefore excluded. 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