Air China surge adds US$1.6 Billion to Cathay Pacific valuation

Cathay Pacific (293:HK) Fair value: HK$14
Cathay Pacific (293:HK) Rating: Outperform

Air China (753:HK) Fair value: HK$11.5
Air China (753:HK) Rating: Outperform

22nd January 2018, Hong Kong – Cathay Pacific’s stock is looking undervalued. Air China’s 90% share price surge in the past year has added US$1.6B or HK$3.25 per share to Cathay Pacific’s valuation. Cathay Pacific’s stake in Air China is now worth US$3.5B or HK$6.94 per share, half of Cathay’s own market cap. Furthermore, Cathay Pacific has a “liquidation” value of HK$55B or HK$14 per share based on our analysis, higher than its current share price of only HK$12.78. We believe much of Cathay Pacific’s weak earnings outlook is already priced in and its earnings recovery from this year and potential M&A interest could lift its share price higher.

Chart: Market value of Cathay Pacific’s stake in Air China (Jan 2018 vs Jan 2017)

Chart: Market value of Cathay Pacific’s stake in Air China (Jan 2018 vs Jan 2017)

Chart: Air China H share price (2017 to 2018)

Chart: Air China H share price (2017 to 2018)

CATHAY PACIFIC LOOKS UNDERVALUED CONSIDERING ITS STAKE IN AIR CHINA IS WORTH US$3.5B – HALF OF CATHAY’S OWN MARKET CAP

Cathay Pacific’s (293:HK) stock is looking undervalued considering the market valuation of its stake in Air China (753:HK). Following Air China’s 90% share price rally in the past year, Cathay Pacific’s 18.13% stake in Air China is now worth US$3.5B based on Air China’s current H share price from HK$1.9B a year ago. This amounts to 54% of Cathay Pacific’s own current market capitalisation of US$6.5B or HK$6.94 per Cathay Pacific share.

Chart: Cathay Pacific’s current market capitalisation versus the value of its investment in Air China

Chart: Cathay Pacific’s current market capitalisation versus the value of its investment in Air China

CATHAY PACIFIC IS TRADING BELOW ITS “LIQUIDATION” VALUE OF HK$14 PER SHARE

Digging deeper, we assess what could be the potential “liquidation” value of Cathay Pacific. Based on our analysis, Cathay Pacific has a “liquidation” value of HK$55B or HK$14 per share, higher than its current share price of only HK$12.78.

The current market value of Cathay Pacific’s owned aircraft fleet amounts to HK$83B while the market value of its 18.13% stake in Air China is worth HK$27B. If we offset these against Cathay Pacific’s net debt of HK$55B, the potential “liquidation” value of Cathay Pacific will be HK$55B, equivalent to HK$14.0 per share.

Chart: Cathay Pacific Airways Limited – Estimated “liquidation” value

Chart: Cathay Pacific Airways Limited - Estimated “liquidation” value

We believe much of Cathay Pacific’s weak earnings outlook is already priced in and its earnings recovery from this year and potential M&A interest could lift its share price higher.

We reiterate our previous thesis that it would make sense for Air China to acquire or merge with Cathay Pacific in the longer term with the combined carrier becoming the world’s largest cargo airline and second largest passenger airline.

Interestingly, Qatar Airways has recently acquired a 9.61% stake in Cathay Pacific and could become instrumental in making or breaking an Air China-Cathay Pacific union in the longer term.

Note: Stocks with upside of more than 10% based on our fair value are assigned an Outperform rating. Stocks with downside of more than 10% based on our fair value are assigned an Underperform rating. Stocks with upside or downside of less than 10% based on our fair value are assigned an In-line rating. These are Crucial Perspective’s proprietary rating classifications and by no means serve as investment recommendations.

Related Reports:

Cathay Pacific Airways (293:HK) Initiation Research Report 2017 – Cathay Pacific outlook to stay gloomy?

Cathay Pacific (293:HK) upgraded to Outperform: Takeover by Air China (753:HK) likely

Air China Initiation Research Report 2017: Top choice among the Chinese airlines

Why Qatar Airways bought a 9.61% stake in Cathay Pacific (293:HK)?

 

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