New strategy to cut costs and boost operation efficiencies; keychanges by mid-2017
A right step in a difficult environment; cost savings to be offsetby restructuring expenses and a 2% wage increase in 2017
Maintain Reduce rating and TP of HKD10.00
Major re-organization to shore up efficiency. Cathay is rethinking its workforce.The carrier plans to reassign employees from some outdated roles to new jobs andremove redundancies. Cathay will create shared services within the company that willconsolidate core functional activities. It plans to implement key changes by mid-yearand the scale of restructuring hasn’t happened for more than 20 years.
Finding ways to lower costs in a challenging environment. With the backdrop ofmacro weakness and overcapacity in the region, there is not much Cathay can do togenerate more revenue. With structural increases in operating expenses, includinghigher airport charges in HK, and the 2% wage increase for HK staff (excluding highlevel positions) in 2017, it makes sense that the carrier streamline its operations andincrease productivity to lower its cost structure in order to remain competitive in themarket in the medium/long term. In the meantime, we have not made any changes toour 2017 expense estimates since Cathay will incur restructuring expenses and keychanges will be effective by mid-2017. As of 1H16, Cathay employed more than33,700 people worldwide, of which 26,000+ are based in Hong Kong. We currentlyestimate staff expenses of HKD19.7bn in 2017e or 21% of total operating expenses.Yield headwinds to persist. In 2017, we see little signs of passenger yields comingback because of: 1) soft premium demand amid macro uncertainties; 2) securityconcerns in the EU region depressing travel demand; 3) currency headwinds, abouthalf of revenue is derived in HKD/USD; 4) capacity in the region continues to grow;we estimate the Chinese airline sector will expand capacity by 8.2% y-o-y in 2017,and believe the major Chinese airlines will focus on developing internationalnetworks. 5) an increasing number of international flights started operation atShenzhen airport.
Maintain Reduce rating and HKD10.00 TP. We forecast the company will reportnegative ROEs in 2017-18, and therefore we think the company’s shares will tradenear historical trough levels in terms of one-year forward P/B ratios. We continue toapply a 0.7x multiple to 2017e book value, which results in a target price ofHKD10.00 and implies c8% downside. We maintain our Reduce rating on Cathaybecause of a muted outlook in 2017-18e. Upside risks: 1) significant operationefficiency improvements; 2) resilient yields; 3) lower-than-expected fuel hedge lossesif the oil price surges.