Investors focused on the details of the company’s three-yeartransformation plan, cost savings, and 1H17e business outlook
Material transformation plan targets to cut unit cost excludingfuel despite inflation pressures and rising operating expenses
Maintain Hold and TP of HKD11.20
We hosted a Cathay Pacific post-results lunch on 17 March 2017.
The transformation plan will be material. Cathay is undergoing a three-yeartransformation with targeted returns above its cost of capital. The company plans totransition to a leaner and more agile organisation structure with appointed directorsfocusing on key functions such as customers, services, etc. Cathay plans to open oradd frequency to attractive destinations and chop out routes that are not performing. Inthe short term, it plans to cut staff costs by 30% at its headquarters, mainly involvingmiddle and senior management. The cost savings will be significant, but not massive,as the majority of its staff cost comes from front-line employees. It plans to driveefficiency gains by simplifying the number of sub-fleets, reducing costs and complexity.Lowering unit cost, excluding fuel. Over the next three years, the company targetsto cut this cost by 2%. While the cut may not look significant, it is a major achievementconsidering that HK is an expensive location to run business from, with inflationpressures. The unit cost reduction will be material for achieving higher returns giventhe rising operating expenses from labour, landing fees, etc.
Maintain Hold and an unchanged TP of HKD11.2. We forecast that the company
will report losses in 2017e, but its 2018e results may improve on smaller fuel hedgelosses and efficiency gains from the transformation programme. We apply a 0.7x PBmultiple (unchanged; historical trough valuation to reflect low returns in 2017-18) toaverage 2017-18e book value, and this gives us a target price of HKD11.2 implying 1%downside from the current share price. We maintain our Hold rating on the stockgiven earnings prospects in 2018e and expected book value recovery. Upside risksto our view include unanticipated operational efficiency improvements, more resilientyields than we project, smaller fuel hedge losses than we now forecast (if the oil pricesurges), and a re-launch of passenger fuel surcharges. Downside risks includesevere yield erosion and a material loss of transit volumes to competitors.