Cathay Pacific refocusing on yield instead of market share but Hong Kong Airlines threat looms

Cathay Pacific company logo

Cathay Pacific Airways Ltd (293:HK)

Price Target: HK$14.00 | Rating: Buy

20 June 2018, Hong Kong Cathay Pacific’s passenger traffic and load factor performance for May 2018 pale in comparison with Singapore Airlines and the Big 3 Chinese carriers’ performance during the same month.

Weak passenger traffic performance in May 2018

Cathay Pacific (293:HK)’s passenger traffic barely grew at 0.2% y/y in May 2018, in contrast with Singapore Airlines’ 6.8% growth and the Big 3 Chinese carriers’ 11.6% growth on average in May. This is a slowdown from its 2.2% passenger traffic growth year-to-date (Jan-May 2018).

Cathay Pacific’s passenger load factor fell 2.2ppts y/y while Singapore Airlines (SIA:SP) and China Eastern Airlines (670:HK) reported 2.1ppts and 1.2ppts y/y passenger load factor improvement in May. Air China (753:HK) and China Southern Airlines (1055:HK) experienced smaller y/y declines in their passenger load factors compared to Cathay.

Chart: Passenger traffic growth of Cathay Pacific versus Singapore Airlines and Big 3 Chinese carriers (May 2018)

Passenger traffic growth of Cathay Pacific versus Singapore Airlines and the Big 3 Chinese carriers (May 2018)

Chart: Passenger load factor growth/decline of Cathay Pacific versus Singapore Airlines and Big 3 Chinese carriers (May 2018)

Passenger load factor growth:decline of Cathay Pacific versus Singapore Airlines and Big 3 Chinese carriers (May 2018)

Reflects Cathay Pacific’s focus on profitability and not market share

Given Cathay Pacific’s higher fuel cost base this year compared to some of its sector peers due to its expensive legacy fuel hedges and the higher spot jet fuel prices this year, it is pragmatic for the airline to limit its capacity growth and promotional fare discounting this year, in our view, as aggressive capacity growth would only lead to wider losses given Cathay’s higher breakeven cost.

See our previous report on the implications of Cathay Pacific and Singapore Airlines’ fuel hedges:

A Tale of Two Airlines’ Fuel Hedging Strategy – SIA to beat Cathay

Passenger yields trending up but Hong Kong Airlines’ aggressive capacity growth will prove challenging for Cathay Pacific

It is therefore positive to hear from Cathay Pacific management that the carrier saw “good growth in overall (passenger) yield”, helped by more favourable traffic mix with stronger business travel demand and stronger foreign currency translated revenue.

However, we will need to seea sustained and significant improvement in passenger yield for Cathay Pacific’s profit margins to improve meaningfully this year. This may be challenging given that Cathay Pacific faces stiff competition from Hong Kong Airlines which is expanding capacity aggressively at its home base.

Competitor Hong Kong Airlines (HKA) grew passenger capacity by 41% y/y in May 2018 and is gaining market share while Cathay Pacific kept its capacity steady y/y.

Cathay Pacific Cargo continues to perform well, with stronger traffic, load factor and yields

Meanwhile, the cargo business continues to be Cathay Pacific’s bright spot, with cargo traffic surging 7.4% y/y in May and cargo load factor improving 2.3ppts y/y to 68.6% plus stronger cargo yields according to Cathay management. Note that 2017 was already a very strong base.

Cathay Pacific is the world’s second largest international cargo airline. Cargo contributes 25% of Cathay Pacific’s total revenue.Escalating China-US trade tensions have so far not hurt Cathay’s cargo operations but we expect the carrier’s cargo and passenger business segments to be negatively impacted if protectionism broadens and tourism curbs are implemented. See our previous report for more details:

Will China unleash tourism curbs against US in escalating trade war?

 

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.

Independent Research Declaration: Crucial Perspective does not own any position in the equities featured in this report nor have we received any compensation for writing this report. 

 

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