Cathay Pacific returns to profitability on cargo and mail growth

Cathay Pacific Airways Limited (OTC: CPCAY), the Hong Kong-based airline, released its full-year financial results for 2018: the biggest news was that after two years of losses, CPCAY returned to profitability. The airline group reported an attributable profit of HK$2.345 billion for 2018, equivalent to US$300 million, after losing HK$1.25 billion in 2017.

Cathay Pacific has come under pressure in recent years from the rapid expansion of Chinese budget airlines and, on the other side of the price spectrum, from increased competition from premium carriers like Emirates and Etihad, which offer similar luxury experiences. Chief Executive Officer Rupert Hogg, who took over Cathay Pacific two years ago, laid off more than 600 employees and pulled back from some overseas business after miscalculated fuel hedging doubled its 2017 losses.

Airlines’ fuel hedging strategies are complicated by basis risk, i.e., the difference in the asset they’re exposed to (in this case jet fuel) and the asset they’re able to hedge (in this case crude oil). If the spread between jet fuel and crude oil widens considerably, the airlines’ hedges are less effective. Over the course of 2017, the jet fuel-crude oil spread increased from about $6.60/barrel to $9.57/barrel; that amount of widening would tend to hurt hedges but should not have been devastating to Cathay Pacific’s books. The airline’s hedging strategies, of course, were not made public.

CPCAY grew its overall capacity, measured in available seat-kilometers, by 3.5 percent from 2017 to 2018, and increased revenue per passenger-kilometer by 3.1 percent. Strong demand for premium-class seating drove overall passenger revenue up by 10.1 percent year-over-year, the airline said.

Cargo and mail growth outperformed the passenger side in 2018. Overall cargo and mail revenue grew 20 percent on the back of 14.7 percent growth in cargo and mail yield and 16.7 percent growth in cargo and mail revenue per available seat-kilometer. Higher fuel surcharges and a shift toward high-value specialist cargo, including temperature-sensitive pharmaceuticals. drove the gains in yield, Cathay Pacific said. The airline’s cargo and mail load factor improved by 100 basis points to 68.8 percent on strong e-commerce shipments from Asia.

Cathay Pacific did warn that its load factor dropped toward the end of 2018, declining in both November and December. Air cargo rates from Hong Kong to North America (AIRUSD.HKGNOA) peaked at $5.69 per kilogram on November 19 and fell to $4.37 by December 31, according to SONAR data.

The airline has a fleet of 202 aircraft, 21 of which are freighters, and has 71 scheduled deliveries of new aircraft through 2021 so far.

Cathay Pacific said that it continues to reorganize its operations outside of Hong Kong, investing in both digital technology and lean process training in the pursuit of further efficiencies. The new technology includes internal analytics, better data visualization across the business group, and an air cargo blockchain proof-of-concept to improve contractual management of cargo handling.

The outlook portion of the annual report was muted. All of the positive points related to Cathay’s ongoing transformation and cost control initiatives, while negatives including a “challenging” overall business environment due to a strong U.S. dollar and trade uncertainties, intense competition in the passenger business, slowing cargo growth, and inflationary pressures on the cost side of the balance sheet.