Hong Kong's leading airline Cathay Pacific Airways is expected to post strong earnings growth for 2007 driven by high passenger traffic and yields.

Cathay's net income is likely to have increased 43.1 percent to HK$5.85 billion from HK$4.09 billion last year, according to a poll of analysts by Thomson Financial.

The company will announce its earnings on Mar. 5.

"Higher passenger yields from price increases, fuel surcharges and new products mean we expect the company to report a record net income for the year," Paul Dewberry, a Merrill Lynch analyst, said in a research note.

Merrill Lynch is expecting 45 percent growth in Cathay's 2007 profit to HK$5.94 billion.

The airline's consolidated traffic increased by 12.1 percent last year. Passenger yield or revenue per passenger rose 12 percent, said Merrill Lynch.

The yield, excluding fuel surcharges and data from Dragonair, was up 10.9 percent at 51 cents, Cathay's highest in 10 years, said Nomura International.

Dragonair is a subsidiary of Cathay Pacific which concentrates on the Chinese market.

In addition to the heavy traffic and high yields, Cathay's earnings will also be helped by the 17.5 percent stake it owns in China's largest international carrier Air China. Merrill Lynch expects the contribution from Air China to reach up to HK$600 million.

Cathay, which along with Swire Pacific holds major interests in Hong Kong Aircraft Engineering Co Ltd (HAECO), will also benefit from the aircraft maintenance company's performance.

Operating profit is expected to go up by 34 percent to HK$7 billion, according to Thomson Financial's poll, as oil prices and jet fuel prices remained relatively benign through 2007, averaging US$84 a barrel compared US$80 in 2006.

However, oil prices flared in the fourth quarter of 2007 to over US$100 a barrel, dampening the profit outlook for 2008.

Earnings per share is expected to come in at HK$1.49 against HK$1.16 in 2006.

Cathay is likely to announce a dividend of 73 cents per share compared to 84 cents in the previous year, according to the analysts polled by Thomson Financial.

Cathay reported 55 percent growth in net profit to HK$2.58 billion in the first half of 2007. Profits were helped by higher average passenger prices, especially on long-haul flights to North America and Europe, which helped offset a decline in cargo demand and fuel price increases.

Bearish Outlook

Despite a robust performance in 2007, most analysts have taken a bearish view of Cathay's prospects in the current year.

"We think passenger yield has peaked in 2007 and jet fuel prices will remain high for 2008," said Chin Y Lim, an analyst with Morgan Stanley.

Morgan has cut its target price on Cathay to HK$15 from HK$20.25, and Lim expects other analysts to follow suit after the airline announces its earnings next week.

Global air traffic was 4.3 percent higher in January 2008 as compared with a 7.6 percent growth in 2007. The slowdown was led by transatlantic premium travellers and transpacific cargo from the US.

"We see Cathay Pacific as one of the most exposed to a downturn, given its focus on the long-haul, premium and air cargo markets, which are our main areas of concern," said Merrill Lynch's Dewberry.

Dewberry expects Cathay's net profit to fall 20 percent in 2008 given the weakening macro economic environment, with the US and Japan heading towards a likely recession and Europe slowing down.

In addition to the reduced demand, Cathay is also faced with increased competition from the low-cost carrier Oasis Hong Kong Airlines as well fast-growing Middle-East based airlines like Emirates, Qatar Airways and Etihad Airways.

Direct Air Link

Cathay will also be handed another blow if a direct air link is established between mainland China and Taiwan following the elections in Taiwan in March 2008.

At present, passengers and cargo moving between mainland China and Taiwan have to be routed through a third destination, usually Hong Kong and Macau. Cathay accrues significant revenues from this route.

The outcome of the upcoming elections in Taiwan may thaw relations between mainland China and Taiwan and lead to stronger economic ties between the two. This, in turn, may see the establishment of a direct air link between the two sides.

"With an estimated 60 percent of all passengers on the Hong Kong-Taiwan route being pure transit passengers, direct links between mainland China and Taiwan, eliminating the need to transit via Hong Kong, would likely hurt Cathay Pacific," said Jim Wong, an analyst with Nomura International.

Cathay may also take a hit if implicated in the ongoing investigation by the US Department of Justice and European Union Commission into claims of cargo fuel surcharge price fixing.

Credit Suisse has lowered its passenger traffic growth estimate for Cathay by 1 percent. It also expect's the airline's passenger yield to decline 2 percent in 2008, reflecting weaker travel demand. Cargo yield decline is seen at 2 percent in 2008.

"We estimate that every one percent decline in overall traffic or yield would cut Cathay's 2008 profit by 10-11 percent, while every US$1 a barrel increase in fuel will reduce FY09 profit by 1 percent," said Credit Suisse analyst Cusson Leung.

The brokerage has cut its 2008-09 earnings forecast for Cathay by 29 percent.

On Feb. 29, shares in Cathay Pacific closed 28 cents or 1.7 percent lower at HK$16.24. The stock has given up more than 20 percent since the end of 2007 and nearly 29 percent from its Nov. 1 record of HK$23.