Summary

As the gradually stabilizing global economy, the turnround in Cathay's major business that began in the last quarter of 2009 continued throughout 2010 and gained momentum so far. The Company expected its 2010 net profit to at least 12.5 billion Hong Kong dollars (US$1.6 billion) , up 179% compared to 2009's 4.48 billion,

The passenger traffic turnover (RPK) and the Cargo/mail tonne kilometres were up by 8% and 23.2% yoy respectively for 2010. The passenger and freight load factor was up 2.9 ppts and 4.9 ppts respectively to 83.4% and 75.7%.

Considering the recent traffic data of Cathay, we upgrade our EPS forecast to HK$3.2 and HK$3.1 in 2010 and 2011. We maintain our 12-month target price of HK$ 23.2, equating to 7.5x 2011P/E or 1.6x 2011P/B. BUY for 18.7% upside.

Prepare to report record net profit

Cathay Pacific recently announced that it expected its 2010 net profit to at least 12.5 billion Hong Kong dollars (US$1.6 billion) due to the booming passenger/freight demand and strong earnings, 179% higher than 2009's 4.48 billion, 78% higher than the prosperous 2007's profit.

The 2010 earnings will include: (1) a HK$2.165 billion gain from the sale of the remaining 15% stakes in Hong Kong Air Cargo Terminals Ltd. and Hong Kong Aircraft Engineering Co to its major shareholder Swire Group, (2) the European Commission's imposition on Cathay Pacific of a fine of Euros 57.12 million (equivalent to HK$0.618 billion).

Stronger-than-expected demand

The total number of passengers carried in 2010 was 26,796,249, an increase of 9.1%, while the passenger traffic turnover (RPK) and the passenger capacity (ASK) rose by 8% and 4.1% yoy respectively.

Specifically, the China market was quite solid as the strong business travel demand between Hong Kong and mainland China. The region's turnover saw a yoy growth ratio of 15.3%. Japan & Korea region's and North American market rebounded apparently, with passenger number up 14.8% and 10.1% respectively. Southwest Pacific and Europe market also performed better than expected.

The cargo booming continued throughout 2010 with good demand and yields out of Hong Kong on all key routes. In addition, demand into Japan and Australia was a high as a result of the strong currencies in both countries. The total tonnage carried in 2010 was 1800 thousand tonnes – a rise of 18.1%. Cargo/mail tonne kilometres were up by 23.2% for the year compared to a more aggressive capacity increase of 15.2%.

Yield improved significantly

The Company's capacity growth was slower than traffic growth as a whole. Thus high passenger load factors were seen across the system and stood 83.4% for the whole year of 2010, a rise of 2.9 ppts. We expect its yields in premium cabins would record double-digital growth given the excellent demand. Cathay's cargo business recovered to the pre-downturn levels. The Company has to mount extra sectors and charters where possible in line with market demand. Helped by support from the contract agent partners, the freight load factor was up 4.9 ppts to 75.7% in 2010 despite a big increase in capacity yoy. It will see some slackening in the market in early January 2011 though we still anticipate an improvement in the second half of the month prior to the Chinese New Year holiday.

Risks

Impact by recessed global economy, bearish of aviation demand may go beyond expectation;

Hedging loss will further enlarge due to global crude oil price fluctuations

Crisis such as terrorism, flu and wars

Air fare war

Valuation

Considering the recent traffic data of Cathay, we upgrade our EPS forecast to HK$3.2 and HK$3.1 in 2010 and 2011. We maintain our 12-month target price of HK$ 23.2, equating to 7.5x 2011P/E or 1.6x 2011P/B. BUY for 18.7% upside.

Financial forecast：

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