Lingnan University

Term 2, 2016-2017

RIM2200 Principles of Risk Management

Group Project Report

Chan Ho Wing (4057154)

Lee Shu Yu

Table of Contents
1
 Page

1. Executive Summary 3

2. Introduction 3-4

3. Financial Risks 5-9

4. Internal Operational Risks 10-12

5. External Operational Risks

6. Strategy Risks

7. Risk Analysis

8. Recommendation 17

9. Reference 18

Executive Summary
In our report, we aim to have a comprehensive analysis of the risk of Cathay
Pacific Airways Limited. Cathay Pacific is a prominent airline around the
world, one of the best world-famous airline. It provides the outstanding flight
experiences and a high-quality service to its passengers and public. In our
report, we identify four major type of risk are financial risks, internal and
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external operational risk, and strategy risks. We will analyze those risks and
make related recommendations in these parts.

In financial risks, it focusses on the credit risk, liquidity risk, market risk. Next,
the internal operational risks involve health and safety risk, risk on lack of
knowledge and skills just like technology risk. In addition, regulation risk,
terrorist risk and inclement weather risk would be analyzed as external
operational risks in our report. Last, we will analyze supplier risk and
employees contract risk and use five porters analysis model to analyze the
strategy risks of Cathay Pacific.

Introduction
Cathay Pacific an international airline registered and based in Hong Kong,

offering scheduled passenger and cargo services to 181 destinations in 43

countries and territories. The airline was founded in Hong Kong in 1946 .It has
been deeply committed to its home base over the last seven decades, making
substantial investments to develop Hong Kong as one of the worlds leading
international aviation centres. The Cathay Pacific Group operated 202 aircraft
at 31st December 2016. Cathay Pacific itself had 146 aircraft at that date. Its
other investments include catering and ground-handling companies and its
corporate headquarters and cargo terminal at Hong Kong International Airport.
Cathay Pacific continues to invest heavily in its home city. 1
In 2016, the annual revenue of Cathay Pacific was 92.751 billion which was
9.4% less than 2015 annual revenue. The main reasons of the decrease in
revenue should be the change in the price of fuel and the management.
SWOT Analysis of Cathay Pacific

1 C. (n.d.). Cathay Pacific Airways Limited Annual Report 2016. Retrieved from
https://www.cathaypacific.com/content/dam/cx/about-us/investor-relations/interim-
annual-reports/en/CX16_Final_en.pdf
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Strengths: Weaknesses:
- presence in the market for a long time - The poor financial health

(First mover advantage) - The poor management (bad

- 181 destinations in 43 countries (market investment decision)

bargaining power) - Intensive competition

- a well-established reputation
Opportunities: Threats:
- an increase in demand on flight recently - an increase in labor cost

(increase of purchasing power) -the increasing competitions in airline

- a decrease in fuel cost industry

Financial Risks
1. Credit risk

As of 31st December 2016, the Cathy Pacific granted credit to customer with

using Collateral and guarantees around HK$1,331 million (2015: HK$1,373

million), a decrease with $42 million than the previous year. In the company

policy, the company allows 30 days credit term to clients. The clients have to

follow the local industry standard with the debt in certain circumstances being

partially protected by bank guarantees or other monetary collateral. The

majority of the agents are connected to the settlement systems operated by

the International Air Transport Association (IATA) which is responsible for

checking the credit worthiness of such agents and collecting bank guarantees

or other monetary collateral according to local industry practice. In most cases

amounts due from airlines are settled on net basis via an IATA clearing house.

The credit risk is relatively low.2

2 C. (n.d.). Cathay Pacific Airways Limited Annual Report 2016. Retrieved from
https://www.cathaypacific.com/content/dam/cx/about-us/investor-relations/interim-
annual-reports/en/CX16_Final_en.pdf
4
Existing Policies

To manage credit risk, the company decide that all the deposits and funds are

only carried out with financial institutions which have high credit rating and set

a trading limits which are regularly reviewed. Risk exposures are monitored

regularly by reference to market value

2. Liquidity Risk

(Source: BOC stock data)

Liquidity can represent the capability of the company to refinance its debt

without using capital or earning during the process. Liquidity risk evaluates

how easy an asset can be transformed to cash to meet the debt obligations.

From the above table, Cathay pacific has a high current (0.712) and quick

ratio (0.678). The current ratio and quick ratio is bigger than the previous year

but less than 2014. In addition, the current ratio can be used to take a rough

measurement of a companys financial health. The higher the current ratio, the

more capable the company is of paying its obligations, as it has a larger

proportion of asset value relative to the value of its liabilities. It shows that

company has low leveraged and low risk. Therefore, the company can pay off

its debt easily.

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Existing Policies

The company maintains enough liquidity reserves and assets in the

requirement within the lending covenants. Moreover, diminishing risk

exposures and at the same time meeting the criteria of security, profitability

and liquidity are the Cathy Pacifics core target for the risk department.

3. Market risk

Market risk is a type of exposure that arises from the market fluctuation. The

Company is exposed to market risk, including foreign currency risk, interest

rate risks and fuel price risk.

3.1 Foreign Currency Risk

Since Cathay Pacific operates its business in 43 countries and territories, it is

exposed to foreign currency risk, the different currency received in business

process, loss caused by the movement of the foreign currency. Adverse

foreign currency movements will put downward pressure on the yield. The

currencies giving rise to a risk of translation in the Groups financial

statements in 2016 are primarily United States dollars, Euros, Australian

dollars, Singapore dollars, Renminbi and Japanese yen. Those currencies are

used to trading on assets, obligations under finance leases, commercial

transactions, borrowings, trade creditors and other payables. In addition to the

exposure above, the company is exposed to currency risk from its future net

operating cash flows in foreign currencies, principally United States dollars,

Renminbi, Australian dollars, New Taiwan dollars, Euros, Pound sterling,

Indian rupees, Japanese yen and Indonesian rupiahs. 3

Existing Policies

3 C. (n.d.). Cathay Pacific Airways Limited Annual Report 2016. Retrieved from
https://www.cathaypacific.com/content/dam/cx/about-us/investor-relations/interim-
annual-reports/en/CX16_Final_en.pdf
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The Companys policy is hedging a percentage of its forecast net foreign

currency cash flows, primarily using foreign exchange forwards and swaps to

reduce its exposure to foreign exchange risk.

Since capital expenditure, debt repayments and fuel purchases are typically

denominated in USD, it manages the risk by matching its receipts and

payments in each currency. The surpluses of convertible currencies are sold

for USD as soon as possible.

3.2 Interest Rate Risks

Interest rate risk of Cathay Pacific is primarily in long-term borrowings at

floating rates, causing to cash flow interest rate risk.

Existing Policies

to continue an appropriate fixed/floating interest rate mix, the interest rate

profile of interest-bearing financial liabilities is controlled by interest rate

swaps on a currency by currency basis.

3.3 Fuel Price Risk

Fuel is a significant cost to the Cathay Pacific, accounting for 29.4% of its

operating expenses. However, the high fuel cost due to the failure hedging in

fuel cause huge loss in 2016 ($8456 million). Although the fuel cost had

decreased in 2016 (from $24494 million drop to $19497 million), the failure

fuel hedging still cause the high fuel cost in the company.

Existing Policies

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In order to reduce exposure to fuel price risk, the Company hedges a

percentage of its expected fuel consumption by the use of a combination of

fuel derivatives. These policies supposed to help stabilize the fuel price within

a particular range to be against the fluctuations.

However, the company make the wrong decision in hedging the fuel price

cause a high loss in fuel cost. In the hedging contract, Cathy Pacific need to

continue the contract until 2019. In the other words, Cathy Pacific have the

high probability that keeping the high fuel cost exposure until the due date of

the contract. The failure of hedging cause the increasing in expense and

decreasing in profit.

Internal Operational Risks

Some major internal operational risks in Cathay Pacific are people risks and

technology risks.

1. Health and safety (People risk)

Health and safety are always being the biggest issue in the aviation industry.

Cathay Pacific are serving a large number of customers, either in the air and

on the ground, staff was required it full attention on it jobs. In addition, the

flight crews play arguably the most important role in the airline after the plane

left the airport. In aviation industry, every single mistake might lead to serious

consequence, threatening passengers lives. Moreover, captains work

experience is of our biggest concern. According to the annual report, the

company have the strictly training and observation to it captains. For average,

the beginner captains need at least 7 years training and practice to be a

formal captain. We can say that all it captains are reliable and professional.

However, most of it captains are work overtime, even them exceed the

working hours limit. It will be the risk for company if the overtime working

bringing some negative effect on captains performance.

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Existing risk management

For the existing and known problem, the company had set up some policy to

manage the risk, such as fatigue problem. Cathy Pacific minimize risk with

preventative measures by Fatigue Risk Management System (FRMS).

Further, the company design the captains rosters to ensure fatigue problem is

minimized. It follows the requirements of the Hong Kong Civil Aviation

Department(CAD), including the captains operating hours and the number of

crew required in a flight.

Recommendation

The company should not only use its money on hiring more experienced

captains. It should spend more money on new captains and provide training,

increasing the number of captain to reduce the fatigue problem.

2. System failure (Technology risk)

Cathay Pacific has made a huge amount of investment in expanding its global

passenger network to maintain its reputation as a world-leading airline. In its

daily operation, it has to process 181 destinations in 43 countries. Because of

the huge number of business and operation process, the quality of aircraft

system, will be the most important section for their daily operations. Some

accidents such as plane crashes and crash landing are the results of system

failure. Despite those accidents rarely happened, it will cause death of

numerous people if failure does happen once.

Existing risk management

Cathay Pacific invest a lot of money in updating and maintaining operational

system to keep air travelling as safe as possible. For example, if a fault is

identified for a model of aircraft, all aircrafts with this model will be grounded

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immediately until the issue is solved. Moreover, there are many staffs who are

routinely check and repair problems in aircrafts systems.

Recommendation

Cathay Pacific should keep records of the checking each time. For the

checking, the related staffs should give a report for the problem identified, so

that the company can solve the problem following the corresponding solution

and safety is ensured.

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