Cathay Pacific braces itself for "loss-making" 2017

It has just withdrawn the 2H16 profit guidance.

Cathay Pacific has withdrawn its 2H16 profit guidance, implying a much worse 2H16.

According to a research note from HSBC Global Research, the company has said overcapacity and strong competition is putting particular pressure on its passenger business, with continued shortfalls in revenue compared with forecasts and heavy pressure on yield. Against this background, it is no longer expected that the company's 2H16 results will be better than those of 1H16.

Business update, meanwhile, is worse than expected: The implied 2016 earnings forecasts are well below market expectations, and we expect the 2H16 result to be worse than 1H16, despite 3Q16 being the peak season. It's been less than two months since Cathay issued its previous profit guidance.

Here's more from HSBC Global Research:

So what's changed? We think there has been intense pressure on passenger yields in recent months after the introduction of an Airport Construction Fee (HKD70-180 per departing passenger) at HKIA in August 2016. We estimate about 50% of traffic carried by Cathay Pacific represents transit passengers, therefore the carrier would have to lower prices in order to retain this traffic and maintain satisfactory load factors.

Forecast significant losses in 2017e: Given the much worse-than-expected passenger yield erosion, we have substantially reduced our FY16/17 EPS forecasts to HKD-0.10/-0.71 from HKD0.78/0.40, respectively. We now forecast the company will report significant losses in 2017e, given a large undesirable fuel hedge position (51% of fuel usage hedged at USD90/bbl), expected intense competition from Chinese and other global airlines, and structural negatives such as the Airport Construction Fee (August 2016) and a 17-19% hike in landing and parking expenses at HKIA (September 2016); these will be effective for the whole of 2017.

Downgrade to Reduce from Hold, cut TP to HKD10.0 from HKD12.5 on expected losses: Yield erosion continued as expected but the decline is worse than we anticipated. We forecast the company to report negative ROEs in 2017-18, and therefore we think the company's shares will trade near historical trough levels in terms of one-year forward P/B ratios.

We apply 0.7x (from 0.8x previously) to our one year forward book value (2017e book value), which yields a new target price of HKD10.0, which implies 8% downside. We downgrade Cathay to Reduce from Hold because of the deteriorating business environment and a muted outlook in 2017-18e. Upside risks: 1) significant operation efficiency improvements; 2) resilient yields; 3) lower-than-expected fuel hedge losses if the oil price surges; 4) potential government support or subsidies.