Cathay Pacific expected to post a profit rise despite hedging loss

Airline makes wrong-way bets on price of aviation fuel as cost of crude oil plunges

PUBLISHED : Sunday, 06 March, 2016, 10:01pm
UPDATED : Sunday, 06 March, 2016, 10:00pm

Cathay Pacific Airways, reporting full-year results on Wednesday, is expected to post a profit increase that is mostly thanks to fuel savings, though its loss from fuel hedging could be bigger.

The group, in a poll of 19 analysts by Bloomberg, is expected to post net profit of HK$5.5 billion for last year, up 75 per cent from HK$3.15 billion in 2014. Their estimates for revenue average at HK$104.5 billion, a slight decrease from HK$105.99 billion a year ago.

Cathay Pacific, which made wrong bets on oil prices by having locked in prices at higher than current levels, did not benefit as much from plunging oil prices that are helping the airline industry save on its largest single cost. The International Air Transport Association estimate global airlines had saved

US$$91.1 billion on their fuel bills in 2015, though lowered fuel surcharges are eroding airline revenues despite boosting traffic.

Daiwa Capital Markets forecast Cathay would report a hefty fuel hedging loss of HK$7 billion against a net profit of HK$5.6 billion.

This year] is going to be difficult if oil price stops dropping and yield sees no improvement
Geoffrey Cheng, Bocom International

Bocom International forecast Cathay’s hedging loss would be HK$7.5 billion, while net earnings would be HK$5.2 billion.

Cathay’s fuel hedging contracts extend till 2019, with roughly 60 per cent of its 2016 fuel consumption hedged at about US$85 per barrel, according to the company.

Daiwa analyst Kelvin Lau said: “We are most concerned with the fuel hedging loss and its forward strategy: whether it would continue to add hedging contracts or review its practice of hedging future fuel consumption on a rolling basis.”

In 2014 fuel hedging cost Cathay HK$911 million in earnings and HK$12.5 billion in reserves, which eroded its book value by about 20 per cent.

Still, the carrier is expected to have saved on fuel despite the hedging losses. CLSA analyst Rajani Khetan estimates Cathay’s fuel bill is down HK$6.03 billion from HK$39.47 billion last year to

HK$33.45 billion, while Bocom International’s Geoffrey Cheng estimates its fuel bill will decrease to HK$30 billion.

Fuel surcharges that passengers pay on outbound flights from Hong Kong – scrapped starting from last month – were shaved over the course of last year. The surcharge was HK$129 for short-haul flights and HK$566 for long-haul in January 2015, compared to HK$25 for short-haul and HK$112 by the end of the year, according to the Civil Aviation Department’s website.

Analysts also said persistent weak demand for seats in the front of Cathay’s plane is a major concern even though traffic growth remains strong, and that the outlook for its cargo business is dim as the global air cargo slump continues.

“[This year] is going to be difficult if oil price stops dropping and yield sees no improvement,” said Cheng, referring to the unit profitability indicator. “It will continue to be subject to fierce competition. They have already greatly increased the load factor – that is, maximised asset utilisation, so there is limited room for improvement there.”

In a note, Khetan wrote: “A key potential upside risk is a strong and sudden economic pick-up causing a one-off rebound in air cargo demand. Strengthening of economic activities could cause a rise in demand for premium travel – one of Cathay’s key revenue drivers.”

Cathay Pacific in January said passenger load factor had risen to a record 86 per cent for the month, but its premium cabins remained not full enough. It announced a rebranding of its short-haul subsidiary Dragonair as Cathay Dragon in order to leverage on the premium image of the Cathay brand.

The stock traded down 28.9 per cent in 2015 – worse than the Hang Seng Index’s 19.7 per cent decline. In January, Deutsche Bank analyst Joe Liew upgraded the stock to a buy.

“The stock is trading more than one standard deviation below its 26-year historical mean. This appears unwarranted given our forecasts of an uptrend in ROEs.”

The bank forecasts Cathay’s return on equity ratio to be a healthy 12 per cent over 2016-2017. “Investor fears appear linked to its China exposure,” Liew wrote, but pointed out the yuan is only 14 per cent of Cathay Pacific’s revenue while its associate Air China is estimated to contribute about 20 per cent of pre-tax profit in 2016.

Lau forecast a 9 per cent yield decline for Cathay last year and 3 per cent yield decline for 2016. “We expect the top line to be flat,” he said.

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