Cathay Pacific stays on the course of expansion

Call it a déjà vu. For Hong Kong-based Cathay Pacific Airways, Asia’s largest international airline by passenger traffic as well as the world’s largest cargo airline in terms of traffic in 2010, bumps along the ride are not a new thing nor are they unanticipated. Its then chief executive Tony Tyler, who went on to become the director general (DG) of the Geneva-based industry body International Air Transport Association (IATA), famously said “the one thing I have learned during my airline career is that just when you think things could not get worse, they usually do”.

This could not be more true for the oneworld alliance member. After enjoying a robust year of 2010 in which record cargo traffic drove the airline to become the world’s most profitable carrier by posting a full-year profit of HK$14 billion (US$1.8 billion), 2011 has proved to be a challenging year for Cathay with cargo traffic which accounts for 30% of its total revenues, measured in freight tonnage kilometres (FTKs), slumping for every month since April 2011 while passenger traffic, measured in revenue passenger kilometres (RPKs), continued to grow steadily over the same period.

As the global economy took a turn for the worse in the summer, with the political impasse in Washington leading to an unprecedented downgrade of the US’s coveted triple-A credit rating in August, followed by the European sovereign debt crisis that dragged on since the global financial meltdown from 2007 to 2009, business confidence, to which the air freight market is closely correlated, took a hit with the International Air Transport Association (IATA) showing a 3.1% decline in freight traffic in November 2011 versus the same month a year ago, whereas cargo capacity, measured in available cargo and mail kilometres, grew by 1.9% in the same month, resulting in a decline in industry-wide cargo load factor to 46.9%.

With Asia/Pacific carriers holding a 40.5% market share of the world’s total cargo traffic, these carriers, including Cathay Pacific, took a bigger hit than their European and North American counterparts in this renewed cargo slump amid global economic uncertainties that led to a 4% lower industry-wide cargo traffic compared to the start of 2011 and a 6% lower cargo load factor compared to the mid-2010 peak.

At Cathay Pacific, the picture is nothing but bleaker. The typical pick-up in cargo demand in the fourth quarter just before the holiday sales season did not materialise in 2011, with Cathay’s November cargo traffic slumping 9.8% against the same month a year ago following a 15.9% decline in October’s cargo traffic versus a year ago.

“Somebody cancelled Christmas as really the cargo volume has not been there,” Cathay Pacific chief executive John Slosar told Bloomberg, while adding the cargo traffic is going to be soft in the first quarter of 2012.

“Cargo was weak in the last quarter of this year [2011] and I suspect it will carry on in 2012. It looks like the world economy is facing some challenges, so that is probably going to mean we will have some challenges too,” Slosar said at an industry luncheon organised by the Pacific Asia Travel Association.

Though there is a stark difference between the scenarios facing Cathay Pacific back in 2008 and 2012. Unlike 2008, when Cathay Pacific was at a crossroads and was evaluating its commercial strategy going forward, it now has a clear and sound strategy to realise its bright growth potential, the potential that is arguably the best in the airline industry with the world’s manufacturing powerhouse China at its doorstep, which is to keep investing in new cabin products such as the new premium economy class and revamped economy class seats that Cathay is rolling out in March 2012, in-flight connectivity with on-board wi-fi system, as well as the construction of a HK$5.5 billion dedicated cargo terminal that is going to enter into service in early 2013.

Coupled with aircraft orders for 91 new aircraft, these continuous investments are meant to enable Cathay Pacific staying the course in order to reap the benefits when a turnaround in the global economy comes.

Image Courtesy of Seth Jaworski

Premium economy best hedge against recession risks, boosts profitability
Since its revelation in August 2011 confirming the airline’s intention to launch a premium economy class (“Cathay Pacific’s premium economy to improve profitability“, 24th Aug, 11), Cathay Pacific has released details on its new premium economy class and revamped long-haul economy class seats, which the airline claims will be tailored products significantly enhancing their quality.

The premium economy class seats, which will be entering service on routes to Toronto and Sydney beginning March 2012, will have a 38-inch seat pitch, 19.3-inch seat width and a 8-inch recline, whereas its new long-haul economy class will have a seat pitch of 32 inches, a seat width of 18.1 inches to 18.5 inches depending on aircraft type and a 6-inch recline, a considerable improvement over the 4-inch recline of its existing long-haul economy class fixed-back shell seats which drew a significant amount of criticisms over an insufficient cushioning and recline.

“We are really excited about these latest innovations. As always, the comfort of our customers was front and centre of our design process and we believe the results represent a very significant upgrade in the product we offer. Premium economy will be a real upgrade over economy, and passengers will get great value for a great product. The seat will have a generous recline and plenty of legroom, and passengers will also enjoy improved service and many other extras,” Cathay Pacific chief executive John Slosar commented.

Cathay plans to fit 87 aircraft, including 777-300ERs, 747-400s, A330-300s and A340-300s, with the premium economy class by the end of 2013 whose seats will have a range of features from a large meal table, cocktail table, footrest, a 10.6-inch personal television to in-seat power outlet and multi-port connector to personal devices such as smartphones and tablet computers.

Cathay Pacific’s premium economy class is compatible with other carriers’ offering, such as British Airways’ (BA) new World Traveller Plus which has the same seat pitch and recline with Cathay’s offering albeit BA’s premium economy seats have an 18.5-inch seat width whereas Cathay’s have 19.3 inches or Qantas’ premium economy class seats on its Airbus A380 which have a seat pitch and width of 38-42 inches and 19.5 inches, respectively; Cathay’s premium economy class promises to be a “real upgrade” over the economy class, with complimentary snacks and beverage, priority check-in and boarding and increased baggage allowance from 20 kg to 25 kg, as well as an amenity kit, socks, toothbrush, large pillows and noise-cancelling headsets provided.

Meanwhile, the new long-haul economy class will feature cradle seats, which will be fitted onto 36 Boeing 777-300ERs and 26 Airbus A330-300s by December 2013, is going to be a significant improvement over the existing shell seats from 4 inches of recline to 6 inches as well as an increase in seat width from 17.45-18.5 inches to 18.1-18.5 inches, in addition to a high-resolution touchscreen on the personal television.

Most importantly, besides providing customers a real upgrade in product and service offerings, the new premium economy class is going to boost the profitability of Cathay Pacific.

First of all, the premium economy class enables Cathay Pacific to maximise the capture of consumer surpluses, targeting middle-class consumers who are willing and able to pay for the extra services, improved in-flight experience the premium economy class offers, including a wider and more comfortable seat but either being unable or unwilling to pay for a business class seat that costs as much as 5 times or more the airfare of an economy class seat whereas a premium economy class seat costs around 2 times more than an economy class seat.

For example, the roundtrip airfare of an economy class seat on a British Airways (BA) flight from Hong Kong to London Heathrow International Airport on 22nd March 2012 costs HK$6,320 (US$810) whereas the roundtrip fares in the premium economy class and business class cost HK$11,600 (US$1,487) and HK$45,160 (US$5,790) excluding taxes and fuel surcharges.

As the Chinese economy continues to grow albeit at a slower rate in 2012 as a result of the global economic slowdown, the expanding middle class is likely to fly on the premium economy class, thus maximising the revenue stream derived from those passengers who would otherwise have travelled on the economy class.

Moreover, Cathay Pacific could utilise part of the higher revenue to provide more discounting on economy class seats in order to remain competitive in light of the intensifying competition in the low-yield economy class segment and the exponential growth of low-cost carriers (LCCs) in the Asia/Pacific region, including Singapore Airlines’ wholly-owned subsidiary Scoot Airlines and HNA Group subsidiary Hong Kong Express which is going to be transformed into a low-cost carrier in the summer of 2012 (“Hong Kong Airlines assumes big risks in its ambitious expansion plan“, 28th Nov, 11).

Source: Cathay Pacific

While the 340-seat Boeing 777-300ER featuring Cathay’s new premium economy class, dubbed “77G” in the global distribution system (GDS), is not going to feature a first class initially, Aspire Aviation believes Cathay Pacific will eventually settle on two different configurations on the 777-300ER, the 3-class one that features 40 new business class seats, 32 premium economy class seats and 268 economy class seats and the 4-class one that features a first class and a shrunk economy class.

Indeed, this makes a lot of sense by enabling Cathay to optimise the traffic mix and hence the overall yield of the flight by deploying the 3-class 777-300ER on competitive routes or those routes whose the local economy is in malaise while deploying the 4-class 777-300ER aircraft on lucrative routes. In doing so, the business risks involved in launching new routes to secondary European and North American destination, an endeavour which Cathay will embark on when the first of 32 Airbus A350-900s on order arrives in late 2015, could be minimised by initially deploying the 3-class aircraft to these new markets before deciding whether to upgrade the aircraft to a 4-class one.

Simply put, by settling on the 3-class and 4-class configurations on the mainstay of its long-haul fleet, this maximises the flexibility in launching new routes or responding to market changes.

Furthermore, while the business case of the premium economy class is not built for trade-downs from business class as the former is considerably more price elastic, a premium economy does provide the best natural hedge against recession risks should the global economy deteriorate markedly.

This provides a shield for Cathay Pacific in an economic downturn in the future. Over the long term, however, the premium economy class is going to enable Cathay to improve its profitability by applying its strong revenue management system (RMS) with discriminatory pricing to limit trade-downs from the business class to premium economy while maximising paid upgrades from the economy class.

“The key with something like premium economy is to understand that it is an economy plus product, not a ‘business class minus’ product – at least from a philosophical perspective, but not as a product definition” Cathay Pacific general manager (GM) for product Alex McGowan told the Australian Business Traveller.

“Trading down from business class into premium economy is not the game we are in. It is for people in economy who want more space, more exclusivity, and a few details like better catering and wine. It is also about capturing people who may want not to travel in economy but cannot afford to travel in business class. [Premium economy] is not seeking to capture people who want to trade down from business class. Realistically if you are a frequent business traveller who has important deals to do when you get to your destination, you need that flat bed and you need an environment that is conducive to sleep and work so you can be at your peak when you arrive,” McGowan asserted.

On the other hand, Aspire Aviation has learned that Cathay Pacific is very likely to transfer the existing fixed-back economy class seats from the long-haul fleet to its short-haul one, which is suitable for the design with less recline and thinner cushioning.

“We are reviewing our options for the Cathay Pacific regional fleet and we will make a proper announcement when there are more concrete details,” Cathay Pacific spokeswoman Carolyn Leung clarified.

Outlook for 2012 & beyond
As the eurozone is expected to enter into a mild recession in the first quarter of 2012, the air freight market is likely to follow suit and remain depressed over the first and possibly the second quarter of 2012. On the passenger side, the premium traffic which has stayed consistently strong in 2011 while non-premium traffic showing some signs of weakness, is going to be at a critical moment as cargo traffic is typically a leading indicator for premium traffic with a period of around 6 months or so. With Cathay’s cargo traffic declining month after month since April 2011, early-2012 would be a defining moment to see whether the premium traffic derived from business trips to and from China and the Asia/Pacific region driven by the faster growth in emerging economies is sufficient to offset any decrease in premium traffic as a result of the European sovereign debt crisis.

Compounding the issue is the growth in passenger and cargo capacities. For most of 2011, the growth in passenger and cargo capacities, measured in available seat kilometres (ASKs) and available cargo and mail tonnage kilometres, respectively, has far outpaced the growth in passenger and cargo traffic, thereby resulting in a precipitous decline in passenger and cargo load factors.

However, a decline in passenger and cargo load factors should not be considered as detrimental to passenger and cargo yields in all cases, as availability is a key pillar of the premium product that a premium carrier such as Cathay Pacific or British Airways (BA) offers. The last-minute walk-up business travellers who are price-inelastic and must travel at short notice usually pay the highest fares and are the most lucrative. Likewise, air freight is designed for just-in-time delivery and therefore availability directly affects the ability of an airline to charge a higher rate.

Further, supply in air transport market including passenger and cargo operations is capital-intensive and inelastic and carriers have to add capacity in advance of the actual growth in traffic in order to maintain the availability of seats or cargo space, or otherwise there will simply be not enough capacity to cope with a strong turnaround in cargo traffic when the global economy ultimately makes a comeback, as the activity of restocking inventories in 2010 boosted Cathay Pacific’s cargo business and enabled it to become the world’s largest cargo carrier following the frightening declines of more than 20% in cargo traffic seen in 2008.

Nonetheless it is a prudent practice to keep capacity in check in order to avoid overcapacity issue which will in turn depress the yields and as a result of the anticipated weak cargo traffic in early-2012, Cathay Pacific has decided to defer 2 of its 747-8F freighter deliveries from 2012 to 2013, thus leading to a downwardly-revised passenger and cargo capacity growth target of 7% and 10%, respectively, against the original respective targets of 7% and 17%.

“We have decided to defer the delivery of 2 747-8F to 2013. Four have already joined our fleet, and we will continue to take delivery of 4 more in 2012 and 2 in 2013,” Cathay Pacific spokeswoman Carolyn Leung confirmed.

Aspire Aviation thinks Cathay Pacific should reduce the long-haul flying or even the flight hours of gas-guzzling Boeing 747-400 aircraft while increasing the utilisation rate of fuel efficient Boeing 777-300ER aircraft in light of high fuel costs. Utilising the 777-300ER on long-haul flights more, which Cathay says is 22% more fuel efficient than the ageing 747-400 per payload tonne, could reduce fuel costs, maintenance costs and ownership costs while reducing capacity modestly in one fell swoop.

In addition, as 2 additional Boeing 747-400BCF (Boeing Converted Freighters) freighters are going to be sold to its cargo joint venture with Air China, the Shanghai-based Air China Cargo (ACC) in 2012, coupled with 1 or 2 more examples being transferred to Air Hong Kong, Aspire Aviation thinks Cathay Pacific should replace its 747-400BCF fleet with the 8 777F freighters on order as the 777F burns 15% and 24% less fuel per payload tonne than the 747-400F and 747-400BCF, respectively, while carrying a similar amount of payload.

The 777F freighter can fly 4,900 nautical miles (nm) with 102 tonnes of payload whereas the 747-400BCF has a range of 4,091 nm with 107.8 tonnes of payload.

“At present, there are 8 BCFs in the Cathay Pacific fleet and there are no plans to decommission them,” Cathay Pacific spokeswoman Carolyn Leung said.

Meanwhile, Cathay Pacific is going to hold a competition between the Boeing 747-8I Intercontinental and Airbus A380 superjumbo in 2012, with Aspire Aviation‘s sources at the Hong Kong-based carrier confirming around 10-15 aircraft are to be acquired.

“Airbus and Boeing have been talking to us, and we will study both the A380 and the 747-8 Intercontinental next year,” Cathay Pacific chief executive John Slosar told flightglobal Pro.

“We last looked at what the 747-8 Intercontinental can do on paper two and a bit years ago. Now that we will have the aircraft flying next year, and we will have real hard data and then a clearer idea of what it can offer. That will help us make a better decision,” Slosar added.

Aspire Aviation believes the 747-8I Intercontinental is the frontrunner in the race, not least of its commonality with the -8F freighter which Cathay already operates, but also the significantly larger revenue cargo volume that the 747-8I has as well as the 747-8I fitting Cathay’s frequency-based business model better (“Initial 747-8 woes will not affect aircraft’s business case“, 18th Oct, 11).

For instance, 70% of Cathay Pacific’s cargo is carried by the belly of its passenger aircraft and it is crucial for carrying lucrative cargo in revenue cargo volume, the remaining sellable cargo space after loading passengers’  luggage, to destinations whose cargo volume is not sufficient to sustain a dedicated freighter service.

The A380 has a total cargo volume of 5,875 cubic feet and a revenue cargo volume of 2,995 cubic feet, whereas the 747-8I has a total cargo volume and revenue cargo volume of 2,995 cu. ft. and 3,895 cu. ft., respectively.

Source: Boeing

Furthermore, the 747-8I Intercontinental suits Cathay Pacific’s frequency-based business model, instead of a capacity-based one, better, which enables Cathay to retain the same number of flight frequency and hence offer more flexibility to price-inelastic, last-minute walk-up business travellers who would otherwise fly on other airlines’ flights and result in spilled-over demand.

For example, the introduction of A380 flights results in a reduction of frequencies on routes, such as Singapore Airlines’ launch of a daily A380 flight to Zurich, replacing the previous 12-weekly 777-300ER flights operated by the Singaporean flag carrier, as well as Air France’s A380 flight between Paris Charles de Gaulle Airport and New York John F. Kennedy (JFK) International Airport replacing a 777-200ER and an A340-300 flight. Economics theories state the smaller the difference between business travellers’ preferred departure time and the flights’ actual departure time, the bigger the chance in successfully converting potential demand into actual demand, therefore replacing two flights with an A380 flight may lead to spill-over demand from business travellers to other airlines.

With 73% of Hongkongers participating in Airport Authority Hong Kong (AAHK)’s Master Plan 2030 opting for the construction of a third runway at Hong Kong International Airport, the capacity constraint at the Cathay Pacific’s base is eliminated in the longer term, it is likely that Cathay Pacific will stick to its existing frequency-based business model while undergoing its expansion.

Coupled with the slim possibility that European plane-maker Airbus will launch a stretched variant of the A380 which Cathay demanded, the 747-8I Intercontinental has the competitive edge over the A380 in this competition.

“That will be one of the things we will want to know about when we begin this study. What we would really like to do is understand from Airbus where the aircraft and its development is heading. When you look at the A380 and its wings, it looks like it was designed to be stretched and that means you will get to the maximum design efficiency. You would get more passengers, but having 500 passengers or so would not be a bad thing on the high-yield slot-restricted routes the aircraft would be deployed on,” Cathay Pacific chief executive John Slosar told flightglobal Pro.

“We would like only one type of aircraft in our fleet as that would be more economical. I do not see how having both would work for us. By next year, we will get details on the strengths and weaknesses of both aircraft and how they will fit into our route network, and be in a better position to make that decision,” Slosar conceded.

Separately, Aspire Aviation has learned that Boeing was still pitching the 787-9 Dreamliner to Cathay Pacific at a party hosted by Boeing at a local yacht club in mid-December where Boeing Commercial Airplanes (BCA) vice president (VP) and general manager (GM) of airplane programmes Pat Shanahan was present, despite losing the mid-size widebody battle to the Airbus A350-900 aircraft when the carrier ordered 32 examples in August 2010.

Aspire Aviation learned, however, that Cathay Pacific is more interested in the stretched 787-10X as an A330-300 replacement, which will accommodate 320 passengers with a 6,800 nautical miles (nm) range powered by two 74,000 lbs (329 kN) engines that will burn 20% less fuel than an Airbus A330-300 with a 10% and 5% lower operating cost than the A350-900 XWB and A350-1000 XWB, respectively.

“It was an absolutely strategic decision to order the A350s and it will be a great fit for us. We took a look at both the A350 and the 787, and the delivery position of the aircraft was crucial to the decision. We like what it gives us in terms of range and performance,” Cathay Pacific chief executive John Slosar commented, while adding the oneworld member is interested in the revamped 777X as well (“New Boeing 777X likely to be a highly efficient derivative“, 14th Sep, 11).

“When we take delivery of all of the 777-300ERs we have ordered, we will have 50 in total and that will make us the second largest operator of the aircraft. I think that clearly shows that we like the type, and that it is a good fit for the company.

“We would be very interested if they decided to make it better. Boeing have reached out to all of the existing 777-300ER customers, and we have given them our input as well,” Slosar said.

Last but not least, a strong partnership with Chinese flag carrier Air China, uniquely positioned at the doorstep of China, which is the world’s second-largest economy, coupled with state-of-the-art cargo planes such as the Boeing 747-8F and the 777F freighters on order, as well as the dedicated cargo terminal at Hong Kong International Airport that promises to boost efficiency and lower handling cost, Cathay Pacific will be amongst the first to benefit from an eventual turnaround in the global economy. Further taking into account its prudent financial management and a persistent focus on services, the new premium economy class is going to give Cathay’s profits wings to soar in years to come.

Image Courtesy of Cathay Pacific