1H16 result misses. 1H16 net profit tumbled 82% y-o-y to HKD353m or HKD0.09per share; this is worse than market consensus. Passenger yield fell 10% y-o-y dueto 1) weak long-haul premium demand; 2) intense competition; 3) suspension of fuelsurcharges; 4) adverse currency movements. Cathay incurred HKD4.49bn in fuelhedging losses in 1H16. Cargo yield fell 18% y-o-y to the lowest level in a decade inlight of chronic overcapacity and lower fuel surcharges.
More challenges to overcome. We expect further yield erosion in 2H16 because ofweak demand and rising competition. The read across on PRC airlines with no fuelhedge position suggests intense competition on long-haul international routes hascontinued into the summer travel season. Moreover, the collection of AirportConstruction fees including transit passengers is likely to translate into morepromotional activities. On the cost front, Cathay will start paying more for landing andparking charges in effect from September 2016 which is estimated to be an increaseof 17-19%. Landing and parking expenses accounted for about 15% of totaloperating expenses in 2015. Our 2016-17e EPS estimates are 37% and 71% belowconsensus, respectively.
Analyst briefing highlights. No surprise, management guided for an overallchallenging business environment. Net passenger yields excluding currency and fuelsurcharges are largely flat in 1H16. The performance in the 2nd half of the year istraditionally stronger than the 1st half despite the challenges of higher airport chargesin Hong Kong. Looking into 3Q, it expects yield pressure given most of the travel isleisure oriented and there are promotional activities to fill front-end seats. Thecompany expects capacity to grow 3% y-o-y in 2016, down from 5% in early 2016.
Maintain Hold with TP unchanged at HKD12.5. The company has traded at anaverage one-year forward price to book value of 1.1x since 2012 with an averageROIC of 6% in 2012-15; With 2016-17e ROIC of only 2-4%, we apply 0.8x to our oneyearforward book value (2017e book value) to derive our target price of HKD12.5.With 4.9% upside, we maintain Hold because of the muted outlook for 2016-17.Upside risks: 1) significant operation efficiency improvements; 2) resilient yields; 3)less-than expected fuel hedge losses. Downside risks: 1) intense fare competitionand yield erosion; 2) larger-than-expected loss of traffic; 3) a strong USD.