After rollicking start, Cathay Pacific shares return to Earth

After surging the most in more than a decade, Cathay Pacific Airways Ltd. shares reversed course and closed down 1%, a day after the carrier unveiled a $5 billion government-backed plan to rescue it from collapse.

Cathay soared 19% in pre-market trading in Hong Kong, but then faltered almost as soon as the regular session began. Traders said a rush to cover short positions was behind the biggest move in company shares since 2008. Trading was halted Tuesday before the HK$39 billion lifeline from the Hong Kong government, Swire Pacific Ltd. and Air China Ltd. was made public.

Analysts welcomed the proposed recapitalization—which includes the issuance of preference shares, rights and the extension of a bridge loan—but warned that longer-term challenges remain for the Hong Kong carrier as it continues to hemorrhage as much as HK$3 billion a month because of Covid-19 travel curbs.

While the plan eases concerns over Cathay’s liquidity, the recovery outlook is “dim,” and its monthly cash burn likely will remain high, Credit Suisse Group AG said as it downgraded the stock to the equivalent of sell. Daiwa Securities Group Inc. also lowered its rating to sell, saying minority shareholders will be diluted by Cathay’s issuance plans.

Cathay has dropped 24% this year, just outperforming a Bloomberg gauge of Asia Pacific airlines, which is down 25% after the pandemic destroyed travel demand. Short interest in Cathay shares was about 13% of free float as of Monday, according to IHS Markit Ltd. data.

The International Air Transport Association said Tuesday airlines are expected to lose $84.3 billion this year, with revenue projected to slump 50% to $419 billion.

“Financially, 2020 will go down as the worst year in the history of aviation,” said the industry group’s Director General Alexandre de Juniac said. “On average, every day of this year will add $230 million to industry losses.”

Cathay said the plan is designed to provide sufficient funds to survive the industry downturn and allow the airline to begin transforming its business. Chairman Patrick Healy, who warned that the business would collapse without the recapitalization, also said the airline will cut executives’ salaries and offer more unpaid leave to its workers. Job cuts are possible.

The recapitalization plan will secure Cathay’s survival but dilute earnings per share by as much as 43%, Bloomberg Intelligence analysts James Teo and Chris Muckensturm said.

“Shareholders subscribing to its rights issue face 6% dilution if warrants are fully exercised,” they said. “An offering of preferred shares may result in a HK$585 million annual dividend paid to the Hong Kong government, leaving less for other shareholders.”

Prior to the pandemic, Cathay already faced enormous financial strain due to Hong Kong’s anti-government protests, which affected traffic numbers and led to the exit of the company’s former chief executive officer. Passenger revenue is only about 1% of prior year levels.

The airline posted an unaudited loss of more than HK$2 billion in February alone, and since then it has been losing HK$2.5 billion to HK$3 billion a month. Its main shareholders Swire Pacific, Air China and Qatar Airways have undertaken to vote in favor of all resolutions for the recapitalization plan.

“Financially, this gives them probably enough for a year to two years,” Sobie Aviation’s Brendan Sobie told Bloomberg Television on Wednesday. “This is just one step to survive the crisis.”

He said the plan was the best scenario for those involved and maintains the shareholding balance for Swire Pacific, Air China and Qatar Airways. It also helps preserve Hong Kong’s position as an aviation hub. Next, Cathay will have to make strategic decisions on fleet size, capacity and other areas to align with an international market that will take time to recover.

Healy said “tough decisions” would need to be made in fourth quarter to get the airline to the right size and shape to compete effectively, and that “nothing is off the table” in terms of what needed to be done.

The company may access equity and debt capital markets again to strengthen its balance sheet if conditions are right, Healy said.

“The fund-raising gives Cathay about 13 to 16 months of liquidity,” said Paul Yong, an analyst at DBS Group Holdings Ltd. in Singapore. “But short-term profitability remains highly challenged because the rate of the international travel market opening is happening slowly and cautiously. Also there is social unrest in Hong Kong.”

Coronavirus-related travel restrictions have put immense pressure on airlines globally, and none are certain about how the future will pan out as new travel requirements come into force and travelers’ attitudes change.

Cathay and its Cathay Dragon unit have been operating a “bare skeleton” passenger service since April after slashing capacity by 96% and cutting their route networks. Hong Kong Express, the budget carrier Cathay acquired last year, said Wednesday it will gradually resume flight operations from July 12.

“Cathay’s dominance in Hong Kong was strengthened by its acquisition of HK Express last year, which should serve it well as the city remains a key Asian financial and trade hub,” Bloomberg Intelligence’s Teo and Muckensturm wrote in a note.

Air traffic is likely beyond the worst of its collapse, provided there isn’t a second, more damaging wave of the virus, according to IATA. At its lowest point in April, global air travel was about 95% below 2019 levels, and passenger numbers this year will likely slide to 2.25 billion, which is roughly the same as 2006 levels, it said. Costs, meanwhile, aren’t falling as fast as demand.

“That’s why government financial relief was and remains crucial as airlines burn through cash,” IATA’s de Juniac said. “The challenge for 2022 will be turning reduced losses of 2021 into the profits that airlines will need to pay off their debts from this terrible crisis.”