Is Cathay Pacific ripe for a 2015 rebound?

Amid increase in 2014 profit.

Cathay Pacific's 2014 profit reached HKD3.15bn, up 20% y-o-y but 20% below HSBC Global Research's forecast due to fuel hedging losses.

According to a research note from HSBC Global Research, however, strong passenger bookings, continued cargo recovery and fuel cost savings suggest robust earnings rebound in 2015.

Further, the report noted that passenger revenues were better than expected but cargo was slightly worse (annual cargo contracts mean that most of the recent pick-up in the spot cargo yield will be enjoyed only in 2015).

However, operating costs were 2% higher than expected due to fuel hedging losses (HKD0.9bn loss vs forecast of HKD0.4bn gain).

Cathay has extended fuel hedging to 2018. The airline has 61% of 2015e fuel needs hedged at Brent of USD95/bl, and 60% of 2016 at Brent of USD85/bl.

The hedging book was marked to market at year-end 2014, generating unrealised losses of HKD14.3bn, (there were also unrealised currency hedging gains of HKD1.8bn).

HKD6.7bn of the fuel loss should reverse in 2015. Associates Air China and Air China Cargo have no fuel hedging.

Here's more from HSBC Global Research:

Management's guidance was bullish, largely driven by the good position Cathay now finds itself in rather than a strong pick-up in the overall market. Passenger demand is very strong, although yields are under pressure, and cargo continues to rebound.

Most of the benefits of the recent fall in fuel prices will be felt in 1Q15 as Cathay buys fuel about 1.5 months in advance and much of the fuel surcharge income in early 2015 was set at higher fuel prices.
We also believe that Cathay will boost underlying yields to help offset the fall in surcharges. In addition, despite hedging, Cathay estimates it will enjoy net fuel savings of HKD5bn in 2015 if Brent is at USD60/bl.

We forecast a strong rebound in earnings and make no material change to our 2015 forecast which is 17% above consensus.

OW rating, TP lowered slightly to HKD21.1 (from HKD21.5). Since 2000, Cathay Pacific has traded at an average one-year forward book value of 1.25x and, given our forecast of normalising ROE, we believe Cathay's PB level should return to this average.

Hence we derive our target price of HKD21.1 from this level (the decline is caused by a slightly lower 1-year forward book value, which is impacted by unrealised hedging losses). Earnings momentum − a key share price driver − remains positive; the key downside risk is US dollar strength.