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Bailout of Hong Kong's Cathay Pacific gets investors' scrutiny

Analysts say $5bn plan comes amid uncertain long-term outlook for global industry

Cathay Pacific aircraft at Hong Kong International Airport. The carrier has been suffering from a decline in business and leisure travelers as a result of anti-government protests last year and the coronavirus pandemic now.   © AP

HONG KONG -- A day after the Hong Kong government said it would spend about $5 billion to bail out Cathay Pacific Airways, the city's leading airline, analysts remained skeptical on the company's long-term outlook, even though the rescue plan will address some short-term cash issues.

Shares in Cathay jumped 19% on Wednesday morning as trading on the Hong Kong Stock Exchange resumed after being halted on Tuesday ahead of the announcement. That seemed to indicate some investors initially approved of the unprecedented government-led rescue plan for the ailing airline. But the stock price quickly tumbled, closing down 1.02% at HK$8.72.

Analysts noted that the airline's problems will linger because a swift rebound in global aviation travel, which has been dented by the coronavirus pandemic, is not on the horizon. In addition, Cathay's fortunes are tied to the economic health of Hong Kong, and, to a certain extent, mainland China, where it operates an extensive network of flights. The airline had already been suffering from a decline in business and leisure travelers as a result of anti-government protests last year.

The rescue package comes at a time when both Cathay and its parent, Swire Pacific, have openly supported Beijing's new national security law for Hong Kong.

Cathay's outlook also remains closely linked to how it is treated by authorities in mainland China. The airline found itself in some political turbulence last year after Beijing intensified pressure over airline employees' involvement in the anti-government protests and the initial supportive comments from Cathay's top management. The open threat by Beijing to close down Chinese airspace to all Cathay flights was followed by the resignation of both the airline's CEO and chairman.

Hong Kong Financial Secretary Paul Chan attends a news conference on June 9 on Cathay Pacific's bailout. The government will be sending two "observers" to the airline's board.   © Reuters

Cathay on Tuesday said the 39 billion Hong Kong dollar ($5.03 billion) bailout plan includes HK$19.5 billion from the issuance of preferred shares and HK$7.8 billion in bridge loans. Also, existing major shareholders including Swire Pacific, Air China and Qatar Airways will subscribe to a HK$11.7 billion rights issue.

"The latest recapitalization proposal is timely and offers a much-needed and significant cushion for [Cathay]'s depleting cash reserves," Calvin Wong, a transport analyst at JPMorgan Securities in Hong Kong, said in a report on Wednesday.

Likewise, Andrew Lee at Jefferies Hong Kong said the recapitalization plan "removes the key liquidity overhang" for the airline.

Patrick Healy, chairman of Cathay Pacific, said on Tuesday that the company "would shortly be running out of cash" if not for the government's lifesaving support. The bailout was "absolutely critical to the survival of Cathay Pacific," he said, and it was essential as "the commercial debt market is effectively closed to airlines today if you do not have extensive government and shareholders' support."

But many analysts were prudent.

Nathan Gee of Bank of America Merrill Lynch maintained a "neutral" rating on Cathay stock, expecting it to level off at around HK$9.30, based on a price-to-book multiple of 0.75 times, which is a historical trough for the Hong Kong carrier. But that already is below the initial market response on Wednesday morning, which had traded above the HK$10 mark.

"While Cathay Pacific faces the challenge of no domestic market, making it far more dependent on the lower-for-longer international travel, it has a leading cargo business which benefits from tightness caused by reduced passenger flights," Gee said in a research note.

Wong of JPMorgan kept his stock price rating at "underweight," given "the meaningfully enlarged equity base from the recapitalization plan as well as the uncertainty over air travel recovery in the near term." The target price until the end of the year is HK$6.80, based on a forward price-to-book multiple of 0.5 times, factoring in further negative aspects to come and reflecting a bleaker view of the company.

Under terms of the rights issue, Swire will maintain its 45% stake in Cathay's common stock. Air China will remain at 29.99% and Qatar Airways at 9.99%. If the Hong Kong government exercises share warrant rights under its plan, it will acquire a 6.08% stake in the common shares, while the others' interests are slightly reduced.

Lee of Jefferies noted the deep dilution of the bailout, which involves substantial equity issuance. "We estimate this leads to -42.6% earnings dilution and -44.2% dilution if warrant [is to be] exercised," he said in a report, the latter referring to the potential additional subscription of warrants by the Hong Kong government under certain circumstances.

The positive news to cover a monthly cash burn of HK$2.5 billion to HK$3 billion and rebuilding its capital base only comes "at the expense of 44% earnings dilution," Lee said. 

Kelvin Lau at Daiwa Capital Markets cut Cathay's stock rating two notches to "sell," the lowest among its five-level evaluation scale. Although he sees some respite for Cathay's imminent liquidity concerns, "its share price will come under pressure due to the resultant dilution." He shaved his target price by 24% after the bailout announcement to HK$6.50.

The Hong Kong government, which will be sending two "observers" to the airline's board after the capital and cash injection, reiterated on Tuesday that it has no intention of interfering with Cathay's daily operation, but concerns remain that some sort of influence is unavoidable given the presence of the appointees.

Hong Kong Express, Cathay's low-cost unit, will extend the suspension of flights to July 11. The airline has grounded its entire fleet since March 23.   © Reuters

Jeremy Tam, a member of Hong Kong's Legislative Council who until last year worked as a Cathay pilot, told the Nikkei Asian Review on Tuesday that although this was the first time the Hong Kong government had injected capital into a private company, it did not consult lawmakers beforehand.

Additionally, there are concerns over the financial standing of Cathay's parent.

S&P Global Ratings said on Wednesday that Swire Pacific's "financial buffer accumulated in the past two years will be fully consumed by its participation in the bailout plan for its associate company Cathay Pacific Airways." Its rating was left unchanged at A-minus, with its "stable" outlook intact.

The International Air Transport Association's latest statement about the financial outlook of the global air transport industry adds to the pessimism. The global aviation industry group expects the world's airlines to lose $84.3 billion this year, while revenues will be halved to $419 billion. 

"Financially, 2020 will go down as the worst year in the history of aviation," Alexandre de Juniac, IATA director general and CEO, said on Tuesday. The average daily net loss for the industry is $230 million and the airlines are estimated to lose $37.54 per passenger according to their assumptions. "That's why government financial relief was and remains crucial as airlines burn through cash," he said.

However, government support will not be sufficient and Cathay itself understands that. Healy said the capital infusion "does not mean we can relax."

"Indeed, quite the opposite," he said. "It means we must redouble our effort to transfer our business in order to become more competitive."

Meanwhile, Cathay's low-cost unit, Hong Kong Express, said on Wednesday that it will extend the suspension of flights until July 11. The airline has grounded its entire fleet since March 23.

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