Published June 30, 2009

AIRLINE STOCKS
Fuel price hike ironically a boon for carriers

43% surge seen curbing hedging losses at SIA, Cathay, Air China

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(SINGAPORE) Cathay Pacific Airways, Air China and Singapore Airlines can take some solace from the 43 per cent surge in the price of jet fuel this year - they'll curb losses from their hedges.
Some solace: A US$5 rise in the price of a barrel of jet fuel could cut SIA's hedging losses by S$50 million

The rise in jet fuel price this year may help Hong Kong's Cathay and Air China trim paper losses from wrong-way bets on oil. Cathay, which posted its first annual loss in a decade last year, could recoup HK$1.1 billion (S$206 million), according to Citigroup Inc, while Air China may write back more than 4 billion yuan (S$851 million), estimated Deutsche Bank AG.

The gains come as Asia Pacific airlines struggle to reverse an 11-month slump in passenger traffic that may lead to an industrywide US$3.3 billion loss this year for the region.

Rewards from fuel hedging could narrow losses at Cathay and help Air China return to profit this year, according to Louis Wong, who manages US$50 million at Phillip Securities HK Ltd.

'What has been a negative for airlines may have turned positive with oil prices rising,' said Mr Wong.

'Any write-back will give airlines the breathing space they need during these times.'

The drop in the price of jet fuel from a record US$181.85 a barrel in July last year to a low of US$46.05 in March worked against airlines which locked in fuel-hedging contracts at higher prices than those in the spot market.

With prices rising, most carriers will cut the value of their unrealised hedging losses and write back amounts they have already provisioned.

Singapore Airlines, Asia's most profitable airline, made a S$543 million loss on fuel hedging in the quarter ended March, including a S$112 million deficit from early termination of some contracts before maturity.

'The silver lining of rebounding oil prices is that SIA will incur smaller hedging losses and write back some of its previous mark-to-market fair value losses on balance sheet,' Corrine Png, an analyst at JPMorgan Chase & Co, wrote in a June 15 report. A US$5 rise in the price of a barrel of jet fuel could cut SIA's hedging losses by S$50 million, she said.

Cathay doesn't disclose any numbers, said Carolyn Leung, a spokeswoman for the carrier, adding that high fuel prices 'are not good for airlines'.

Nicholas Ionides, a spokesman for SIA, declined to comment.

Not everyone is optimistic.

The gains will be one-time and will do little to offset the plunging demand, said Steven Lim, who manages about US$200 million at Daiwa SB Investments in Singapore.

'Right now, I am more concerned about the underlying growth in demand and how soon a recovery will be seen in first or business class travel,' said Mr Lim.

'Airlines are still putting in place cost cuts which means the underlying demand is still weak.'

The global recession has hammered premium-class traffic, where carriers such as Cathay and SIA get about 40 per cent of their revenue.

Worldwide premium-travel revenue fell by about 44 per cent from a year earlier in April, according to the International Air Transport Association, or Iata.

Passenger traffic in Asia Pacific sank 14 per cent in May, the steepest of any region, Iata said on June 25.

The industry globally may post losses of US$9 billion this year, as the spread of H1N1 flu compounds the effects of the recession.

Asia-Pacific will lead with a US$3.3 billion loss, it said.

To cope with the recession, Cathay, SIA and other carriers have altered networks, cut capacity and parked planes.

SIA chief executive officer Chew Choon Seng will take a pay cut of 20 per cent starting in July, while Cathay's CEO Tony Tyler, chairman Christopher Pratt and chief operating officer John Slosar will all forego their 2008 bonuses.

Cathay in January said unrealised fuel-hedging losses stood at HK$7.6 billion as at Dec 31.

The carrier, with contracts extending to 2011, said in March that if Brent crude prices average US$75 a barrel, it would face no further cash costs from the hedges and will be able to recoup provisions made this year.

Air China slumped to its first loss since its 2004 listing after losing 7.47 billion yuan on wrong-way bets on fuel prices.

Fair value losses on its fuel-hedging contracts may fall by as much as 4.4 billion yuan this year if oil prices rise by 30 per cent from the end of last year, it said in February.

The Beijing-based airline hedges the most fuel among Chinese carriers as it operates the largest international network.

The country's airlines can only hedge fuel purchases for overseas flights as domestic prices are state-controlled.

Jet fuel traded at US$77.45 a barrel in Singapore trading on June 26.

'This is a relief for many airlines,' said Kelvin Lau, an analyst at Daiwa Institute of Research Ltd in Hong Kong.

'This year, most airlines in Asia are expected to recognise profits from fuel hedging because last year many recorded high marked-to-market fair value hedging losses. Some of this could be huge.' - Bloomberg