Improving cargo market drove Cathay Pacific's earnings prospects

Combined with lower fuel prices.

An improving cargo market and falling fuel prices have improved Cathay Pacific's earnings prospects and caused the stock to re-rate over the past three months.

According to a research note from HSBC Global Research, it argues that this re-rating can continue. Over the past five years, high fuel prices have cut long-haul competition for Cathay and it now dominates its key long-haul routes.

After a lull over the New Year, the airline has reported that buoyant air cargo growth has resumed in January and HSBC Global Research expect this to be supported by the chronic nature of US West Coast port congestion.

Cathay Pacific and its joint venture, Air China Cargo, are well placed in Asia's two most important air cargo hubs, Hong Kong and Shanghai.

The report also said that indeed, Air China Cargo is also leveraged to domestic express parcel growth and is benefiting from the modernisation of its fleet.

Here's more from HSBC Global Research:

Lower HSBC 2014e net profit, but raise 2016e. In this report we factor in a lower assumed jet fuel price of USD80/bl for 2015-16e (from USD105/bl), the recent US dollar strength and the latest Air China consensus forecasts.

We lower 2014e to reflect higher hedging levels and raise 2016e to reflect lower fuel prices. Earnings momentum - a key share price driver for Cathay Pacific - has started to rebound.

As our 2015-16e estimates are 21-35% ahead of consensus, we expect upgrades by the market to continue.

Target price raised to HKD21.5 (from HKD19.0), remain OW. We believe a period of depressed earnings has now come to an end and ROE will gradually recover to normalised levels.

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 set our new target price of HKD21.5 at this level.

Our previous target price of HKD19 was based on 1.1x book value, which was the top end of its 2012-14 trading range.

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