No-moat Cathay Pacific reported weak 2016 results that came in below our Expectations amid intense competition, currency headwinds, and Operating cost inflation pressure. The company posted its first annual operating loss in eight years, amounting to a loss of HKD 575 million, and it missed our full-year estimate by roughly HKD 1 billion, while the 9.4% year-on-year drop in revenue to HKD 92.8 billion was roughly in line with our expectations. The underperformance was largely driven by nearly 9.2% and 16.2% year-on-year declines in passenger and cargo yield, respectively. Additionally, key operating items such as maintenance and fuel hedging were higher than anticipated and offset the lower Brent oil price input. We expect the pressure to persist into the near future, driven by another 2%-3% annual yield decline in 2017-18, on top of a marginal drop in overall passenger load factor.

Things will get worse before they get better for Cathay. Competition remains intense as Chinese airlines ramp up their international expansion, and fuel-cost savings will narrow due to a low base effect from last year. Without disclosing detailed figures, management stated that its aim is to reduce operating costs via a mixture of job cuts and flight schedule optimization. However, we are skeptical as to whether this will generate a sustainable boost to company’s bottom line in the long run. In our view, Cathay’s biggest challenge is not necessarily its operational management. Rather, it has to do with the diminishing attractiveness of Hong Kong as a preferred destination/interchange to popular global tourist stops. Unless Cathay can make a meaningful breakthrough in the mainland market by establishing a significant presence in top tier-one/tier-two cities or deepening cooperation with Air China Ltd (H) (753 HK), we do not anticipate any significant improvement to the company’s fundamentals.

We lower our fair value estimate to HKD 8.5 per share (from HKD 9 per share) and at the current share price, we view shares as overvalued relative to the company’s bleak growth outlook and uncertainty surrounding its three-year cost-cutting program. 

Analyst: John Hu

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