Yesterday I wrote about Cathay Pacific’s 2016 reported annual loss. The Hong Kong-based airline blamed weak demand for its premium cabin product and fierce competition from Mainland China as the reason. Although I mentioned that Cathay lost money hedging fuel, one reader took me to task for not focusing on that. So today I will.
Reader Mak wrote (bolding mine)–
I think you’ve got this story exactly backwards thanks to poor press reports about CX earnings, and it is a source of continuing fascination to me that reporters in the financial press don’t know how to read an earnings report. Cathay’s loss has little to do with competition — that is the spin that Cathay’s management is trying to sugarcoat this with. In fact, CX had another huge operational profit this year.
Cathay’s earnings results includes a loss of HK$8.46bn on “hedging” the price of jet fuel — that is, wrong bets that the price of jet fuel would rise. Add this self-inflicted wound back into the report, and you can see that CX’s airline is quite a profitable enterprise, and continues to be so despite competition, etc. The even more shocking thing is that this is the second year in a row that CX has had a loss of this order of magnitude (over US$1 Billion!!) in a row.
You seem to think that CX management would prefer if the loss were caused by operations instead of hedging, but you also have this precisely backwards. Of course, CX management would love to blame competition, and things out of its control for the loss, instead of the reality that management is actually directly responsible for the very foolish choices behind this massive loss.
The real story is that management has been running a commodities hedge fund, instead of running an airline, and have lost vast amounts of their shareholders money in doing so. The scandal is even more acute given that CX shareholders own a minority interest in the airlines, and that management has little or no accountability to them.
You should correct the story so as not to promulgate CX management propaganda, as the rest of the media seem to be doing for them.
Is the Fuel Hedging Really the Primary Culprit?
I want to see raw numbers, but the 2016 annual report has not yet been released. We only have this press release from Cathay, which notes but downplays the fuel hedging program.
The interim 2016 report does state–
Lower fuel prices were partially offset by fuel hedging losses.
The Financial Times reports–
Cathay lost HK$8.46bn on fuel hedges in 2016, roughly on par with the HK$8.47bn hedging loss in 2015, as it continued to pay the price for a decision taken in 2015 to protect itself against what it then feared would be high oil prices.
The airline expects to benefit from lower fuel prices this year but is still forecasting a hedging loss for 2017.
So, the answer is YES. Blame the fuel hedging program. Without that, Cathay Pacific would have reported a healthy profit.
What is Worse?
But what is worse — loss due to fuel hedging or loss to do fierce competition?
Mak asserted, “Of course, CX management would love to blame competition, and things out of its control for the loss, instead of the reality that management is actually directly responsible for the very foolish choices behind this massive loss.”
I still take a different view.
The lack of profits are not due to Cathay’s uncompetitive route network or its service or its seats. Nor is it because of the Mainland carriers squeezing it to the point of unprofitably. No, the problem is just one bad decision on fuel. In 2015, Cathay Pacific executives thought fuel would go up in price — I did too. I’m not a fuel expert (Kyle from Travel Codex is welcome to chime in), but I never thought fuel prices would stay so low for so long.
So they locked in a price that turned out to be too high. That is a strategic blunder. A big blunder that should not be missed. But had it paid off, we would all be hailing them now as geniuses. They missed it. Fine. Hopefully they have learned and will guess correctly next time. The good news is the “fundamentals are sound”. Cathay is still running a lean operation with a great product that is otherwise profitable.
Let’s be clear — fuel hedges are the primary culprit for Cathay Pacific’s 2016 annual loss. At the same time, I still view management’s blunder on fuel to be less of a concern that asserting that no one wishes to connect in Hong Kong anymore.