Cathay Pacific
Surviving Quarantine Jul/Aug 2022

Cathay Pacific has been particularly stymied in the last two years. It is the de facto flag carrier for a small island city-state and only has international routes. With borders shut it’s difficult to fly anywhere. It is based in Hong Kong which, pursuing a zero-Covid policy in alignment with Beijing, imposed draconian authoritarian restrictions on travel and movement, particularly to isolate incoming visitors, but also affecting airline pilots and cabin crew.

Once the pandemic restrictions took hold in Feb/Mar 2020 Cathay’s passenger traffic essentially evaporated. For the rest of 2020 it saw passenger demand at only 1% of the levels it enjoyed in 2019 (and 2019, particularly the second half, had been a bad year for Cathay, because of the civil unrest that resulted from the HK Authority’s plans to tear up civil rights).

The following year was not much better, although there was a modest improvement in the third quarter. Passenger numbers in 2021 were only 98% down on pre-pandemic levels. The company had slashed capacity by 97%, but with a mostly widebody fleet it was difficult to adjust capacity to the new levels of demand. It must have been a strange empty experience for those who did travel: for much of 2020 Cathay achieved load factors in the low 20s%, with a nadir of 13% in January 2021.

Cargo demand wasn’t particularly affected by border closures, and benefited from a significant increase in yields as supply-chain difficulties hit the global economy. Although Cathay, and subsidiary Air Hong Kong do have dedicated freighters, a large part of the group’s freight operations in normal times is carried in the belly-holds of passenger aircraft, and it did try to generate extra capacity by operating cargo-only passenger flights and “preighters”. The group’s share of air cargo tonnage shipped through Hong Kong’s Chek Lap Kok halved to 25%. But in 2021 Cathay’s cargo traffic (in tonne kilometres) was only 30% down on the levels in 2019, with a load factor of 84%, 20 percentage points higher. Revenue from cargo was up by 50% — and accounted for nearly 80% of total group revenue.

Financial losses needless to say were phenomenal. Over the two years to end December 2021 Cathay Pacific reported cumulative operating losses of HK$12bn (US$1.5bn) and net losses of HK$28bn (US$3.5bn). But, as a percentage of reduced turnover the negative operating margin of 13% over the two years is a lot better than some peers (and it virtually broke even at the operating level in 2021). Within net income Cathay includes its share of (significant) losses at associate Air China.

The balance sheet has hardly been damaged. Cathay entered the crisis with cash of HK$15bn (and undrawn facilities of HK$5bn) at the end of 2019. By June 2020 cash balances had halved and the group orchestrated a massive recapitalisation to raise HK$31bn (US$4bn) in new equity.

• It launched a rights issue to existing shareholders (backed by major shareholders Swire Pacific, Air China and Qatar Airways — who between them own 85% of the shares) to raise HK$11.5bn. (The rights issue was heavily oversubscribed).
• It issued $19.5bn new preference shares to the Hong Kong Government (along with warrants that could give the government a 6% stake in the ordinary shares).
• The government also provided a HK$7.8bn two-year bridge loan facility (recently extended to June 2023) and has the right to appoint two (non-voting) observers to the board.

Hong Kong’s Finance Secretary, Paul Chan, said at the time that the investment in Cathay was to help protect Hong Kong’s role as a leading international aviation hub while generating a reasonable financial return. “It is not our intention to become a long term shareholder of Cathay Pacific,” he stated. “It is not our intention to interfere with the operation and management of Cathay.”

Cathay has consequently been able to maintain an elevated liquidity position throughout the past two years and ended 2021 with cash of HK$19.2bn (and undrawn facilities of HK$11.1bn) while balance sheet debt had fallen from HK$77bn to HK$68bn.

Difficult first half

The result for the half year to June 2022 showed some recovery on prior year levels but were still dire.

In January, in an attempt to combat the spread of the Omicron variant of COVID-19, Hong Kong introduced a ban on flights from nine countries, including some of Cathay’s key markets in the UK and US, and banned transit and transfer services at Chep Lap Kok.

The government also tightened quarantine rules for Hong-Kong based aircrew, requiring a three-night stay in a designated quarantine hotel before being allowed to isolate at home, and this time including cargo air crew. This made it virtually impossible for Cathay to schedule crew rostering through the open loop system it had developed in the wake of the rules introduced the previous year (see box), and practically grounded the cargo operation in January.

In April, Hong Kong started relaxing the rules. It removed some of the flight bans (including from the UK and US), reduced quarantine rules for residents from two weeks to seven days, allowed non-residents to enter the territory (for the first time since the outbreak of the pandemic) under the same quarantine and isolation conditions as residents. Importantly for Cathay, it freed the cargo crew from quarantine requirements and relaxed those for passenger crews.

In the six months to end June, Cathay’s passenger capacity fell by 30%, but demand more than doubled giving (almost) respectable load factors of 59% (up from 19% in the prior year).

Cargo traffic also was down, by 36% in tonne-kilometre terms and 5% in tonnage, but cargo yields jumped by 70%.

Revenues grew by 17% to HK$18.6bn (a third of the level it might have expected pre-pandemic) while operating costs fell by 2%. Underlying operating losses improved to HK$(1.3)bn from HK$(4.5bn). Allowing for a near doubling in the share of losses from associates to HK$(2.5)bn, the group published total net losses of HK$(5.0)bn compared with an underlying HK$(6.7)bn loss in the first half of 2021.

Optimism for recovery

In August, at the interim results presentation, Cathay Pacific management expressed confidence that the company could see some recovery on the horizon.

At the beginning of August, the government again relaxed restrictions for arriving passengers, shortening the hotel quarantine requirement to three days (from seven), followed by four days of self-monitoring. At the results briefing management pointed to improving travel sentiment, saying that the company was seeing passengers booking forward to the Christmas and New Year period compared with a last-minute booking behaviour in the last two years.

Cathay is slowly bringing more of its aircraft parked outside the territory back to Hong Kong, and by the end of the year will have restored its network to 60 destinations (compared with the previous “normal” 108), and recovered passenger capacity to a quarter of pre-pandemic levels — although it notes that further increases are constrained by crew quarantine requirements.

It is even on the lookout to hire 4,000 new staff, to restore some of the 6,000 positions lost in the last two years.

For cargo operations it is expecting to operate 65% of pre-pandemic capacity, and is expecting a “solid peak season”.

Saying that monthly cashflow had turned positive towards the end of the first six months, it guided to a second-half performance stronger than the first.

The best news Cathay could expect would be a full reopening of the border. The Hong Kong Monetary Authority is planning a Global Banking Summit in November, in an attempt to reinvigorate the territory’s position as a leading financial centre. The Hong Kong Sevens rugby tournament will follow, for the first time since 2019.

The top brass at the world’s investment banks are unlikely to attend if they have to go through quarantine.