P/B valuation looks fair relative to 3-6% 2016-18 core ROE forecast
Operating conditions remain challenging, with passenger yield pressurespersisting and premium travel looking lacklustre. We have cut our earningsforecasts given weak 1H results and July/August traffic numbers not lookingmuch better. Consensus earnings have been trending downwards, and wethink this will continue. At 0.9x 2017E P/B, the stock now looks fairly valued.We are downgrading our recommendation to Hold from Buy.
Jet fuel price declines more than offset by lower yields
The 82% y/y decline in 1H 2016 net profit was caused by a 10.1% drop inpassenger yields and a 17.6% decline in cargo yields. Management has saidthat competition is intense and that the second half is expected to be affectedby a similar set of adverse factors. Looking around the region, it appears thatyield declines have been much more pronounced at the international servicesof full-service airlines compared with domestic services.
Cutting earnings significantly, and we expect the street to head down too
We have cut our net profit forecasts from HK$ 6,876m/6,672m/7,710m to HK$1,554m/2,705m/3,275m for 2016/17/18, as we take into account the weak 1H2016 results. 2H is seasonally stronger than 1H, so we do expect some q/qrecovery in earnings.
Target price (TP) cut to 0.9x 2017E P/B; key risks
With the cut in our ROE forecasts, we reduce our TP from 1.1x to 0.9x 2017EP/B. We expect our 2018 ROE forecast of 6.2% to be below our estimated COEof 7.4% (risk-free rate 2.7%, risk premium 4.9%, beta 0.9). Within our regionalairlines universe, we prefer to buy the Chinese airlines, like Air China, or theJapanese airlines (ANA and JAL). Upside/downside risks: better-/worse-thanexpectedrecovery in premium business and corporate travel.