Cathay Pacific:Below expectations;yields still pressured,cost control is key

What surprised us

Cathay Pacific reported FY16 revenue of HK$92,751mn (-9% yoy) with a netloss of HK$575mn (-110% yoy). Revenue was in line with GSe/Bloombergconsensus, but the bottom line missed expectations on costs (ex-fuel unitcosts +2.9% yoy; unit revenue -10.6% yoy). Highlights: (1) Passenger yieldsfell 9.2% yoy in FY16: Management noted that premium class (GSe c.30% ofpassenger revenue) is the most challenged, with corporate demand toLondon and New York below management expectations. It guided thatyields in 2M17 are still experiencing significant pressure. (2) Cargo yields fell16.3% yoy: Mgmt. noted that the cargo fuel surcharge was restored in earlyMar-17 and could help support cargo yields. According to media reports, theEU Competition Commissioner is seeking to re-impose penalties for a cargocartel lawsuit previously dismissed by the court (Bloomberg, Mar 9); CathayPacific was refunded €57mn, or HK$471mn, in 2015. While we do not take aview on the outcome, we think the re-imposition of the fine could adverselyimpact Cathay Pacific¡¯s future cargo contract negotiations. (3) Managementshared qualitative details on its Corporate Transformation Programme(Exhibit 3): It aims to reduce ex-fuel unit costs over the next three years andto achieve returns above the cost of capital. (4) Dividends: For the first timesince 2008, management did not propose a second interim dividend.

What to do with the stock

Cathay Pacific operates in a structurally challenging environment and webelieve market focus could shift to the company¡¯s ability to control costs.

However, quantitative details, a key market focus going into earnings,remain limited. We maintain our Sell rating and cut our 2017E-19E EPS by17-113% on cost pressure. No change to our 2017E EV/GCI vs. CROCI/WACCbasedTP at HK$9.80 (cash return multiple 5.36x, unchanged) implying0.70x P/B (0.6x EV/GCI), a floor valuation from asset support. Key risks: (+)Higher-than-expected yields; better-than-expected cost controls.