- Cathay Pacific has a new Chinese incoming chief executive
- Cargo conundrum stark contrast to a robust passenger business
- Revenue management, optimising regional network essential to fight LCCs
- Cathay Pacific could fly above the fray as Jetstar Hong Kong, Hong Kong Express in low-cost fare war
- Cathay Pacific should connect Africa with Dragonair’s unrivalled Chinese network
- Cathay’s 5th London flight records “95% average load factor” in initial phase
- Boeing markets 777-9X as 420-seat “ULH heavy-duty airliner” in CX configuration: document
- Cathay calls 777-9X folding wingtip mechanics & warning systems “all fairly straightforward”: document
- Cathay says 777-9X “10 years from service”, in line with possible delivery timeframe to CX
Hong Kong-based Cathay Pacific Airways is in times of change. After being at the helm of the oneworld member since 2011 and succeeding Tony Tyler, who eventually went on to become Geneva-based industry body International Air Transport Association’s (IATA) director general (DG) and chief executive, Cathay Pacific’s chief executive John Slosar will step down from his role in March 2014.
Slosar will in turn become the chairman of the airline’s parent and 45% shareholder Swire Pacific, replacing predecessor Christopher Pratt who is retiring after 8 years at the top of one of the oldest trading firms in the former British colony whose roots date back to 1816. Slosar, meanwhile, will be succeeded by the current chief operating officer (COO) Ivan Chu destined to become the airline’s second-ever Chinese chief executive after Philip Chen.
In doing so, Cathay Pacific has established a clear succession policy in promoting chief operating officers (COOs) to the chief executive role that will create stability, predictability and transparency that will help the airline cope with changing times, not just internal management shuffles, but also a vastly different competitive landscape the highly successful airline finds itself in.
The challenges facing the incoming chief executive are anything but simple. They include the establishment of Jetstar Hong Kong, a low-cost joint venture (JV) between Qantas Airways, China Eastern Airlines (CEA) and Shun Tak Holdings with each partner holding a 33.3% stake which Cathay Pacific contends to be a violation of the Basic Law and does not meet the principal place of business clause despite naming Pansy Ho, the daughter of the local gambling magnate Stanley Ho, as its chairwoman, as well as confronting the rise of Middle Eastern carriers such as the Qantas/Emirates alliance that attempt to steal a march on Cathay’s thriving business on the Kangaroo Route.
Robust passenger business boosts bottom-line
These challenges come amid Cathay Pacific returned to the black in 2013 first-half, after having eked out a HK$24 million (US$3.09 million) interim profit from last year’s restated HK$929 million 2012 first-half loss. Its net profit margin improved to 0.1% from -1.9% as a 3.3% drop in operating expenses to HK$47.55 billion in 2013 first-half from HK$49.17 billion in the prior year period offset a 0.6% dip in revenue to HK$48.6 billion from HK$48.86 billion a year ago.
This was primarily attributable to a remarkable 8.5% lower fuel cost net of fuel hedging gain at HK$18.67 billion in the first 6 months of this year versus the HK$20.4 billion recorded last year driven by a 5% fall in total fuel consumption as Cathay Pacific phased out 6 fuel-guzzling Boeing 747-400 aircraft and replaced them with 3 new Boeing 777-300ER aircraft that the airline has taken deliveries of during 2013 first-half which the airline previously said are 22% more fuel efficient per payload tonne.
“On a per-trip basis, the total fuel consumption of the 777 versus the 747 is about 25% less. The cost per seat will be down by about 16% or 17%. So it’s a big difference. You can have an unprofitable 747 route that becomes a very profitable 777 route,” Cathay Pacific director of corporate development James Barrington commented.
Another benefit in replacing the 747-400 is that the ageing jumbos and its Rolls-Royce RB211 engines are maintenance-heavy, therefore timing their withdrawals before expensive D-checks has produced a HK$839 million saving in 2013 first-half, which, combining with the HK$1.71 billion reduction in fuel cost, accounted for the airline’s reversal of fortunes.
Overall, the passenger side of the business remained brisk, as passenger revenue soared by 7.6% year-over-year to HK$35 billion from HK$34.7 billion last year. It was indeed a commendable achievement that this 7.6% growth in 2013 first-half passenger revenue came despite a 3.4% lower 2013 first-half passenger traffic to 50.5 billion revenue passenger kilometres (RPKs) from 52.3 billion RPKs in the year-ago period and a 4.8% lower capacity at 62.19 billion available seat kilometres (ASKs) from 65.4 billion ASKs produced in 2012 first-half, principally stemming from the modest down-gauging by replacing the 747-400s with smaller 777-300ERs. As a result, passenger load factor during the first-half increased by 1.2 percentage points to 81.3%.
Importantly, passenger yield increased by 4.4% year-over-year to 69.0 HK cents from 66.1 HK cents in 2012 first-half, underlining the effectiveness of Cathay Pacific’s strategy in launching the premium economy class, which was featured on 68 aircraft as at 30th June and will be featured on 85 aircraft by the end of this year. Cathay Pacific said the premium economy class “is growing in popularity with passengers and has helped to improve economy class yield”.
The passenger yield growth was particularly prominent on North America routes where yield increased by 13.6% despite a 14.3% trimming in capacity to 14.76 billion available seat kilometres (ASKs) from 17.22 billion ASKs in the prior-year period and the load factor was the highest across all regions at 89.3%, a 1.9 percentage points improvement over the year-earlier result. As Cathay Pacific has just restored all the cancelled long-haul flights implemented in 2012 as part of a cost-saving measure, including 3 times daily flights to Los Angeles from June onwards, Toronto to 10 flights per week from March 2013 onwards as well as restoring the 4 times daily frequency to New York John F. Kennedy (JFK) beginning this month, coupled with the fact that all North American flights are now operated by the 777-300ERs except 1 San Francisco flight, there is going to be a moderation in reduction in North America passenger capacity in the second half of this year.
Surprisingly, Cathay Pacific’s European operation also posted the second-highest increase in passenger yield of 4.9% and a 2.8% higher year-over-year load factor to 86.8% despite 4.6% less capacity was produced at 10.3 billion ASKs compared to 10.8 billion ASKs produced a year earlier, mainly buoyed by its lucrative London route. The only weak spot was North Asia, where a confluence of factors – the outbreak of the avian flu significantly dampened travel demand to China in April and May, yen depreciation hurting outbound travel demand as relative price increases despite the mounting of additional flights during the summer peak, and stiff competition that culminated in a 5% fall in passenger yield.
Cathay Pacific’s Southwest Pacific routes, meanwhile, recorded a 2.3% increase in passenger yield despite a 7.4% lower year-over-year capacity to 8.78 billion ASKs from 9.48 billion ASKs in 2012 first-half, consistent with Aspire Aviation‘s compilation of Bureau of Infrastructure, Transport and Regional Economics (BITRE) figures that showed a 6.6% fall in the number of passengers carried by Cathay Pacific on Australia’s international operations to 681,917 in the first 6 months of 2013 from 729,938 carried in the prior year period. This is likely the result of Cathay’s focus on higher-yield passengers, particularly those from British Airways (BA) after extending its codeshares on all of Cathay’s routes to Australia after being constrained by the cap of 70 services a week under the bilateral air services agreement (ASA) between Hong Kong and Australia. Given the cap is already hit and there is no room for expansion unless a new ASA is struck, Cathay Pacific has no choice but to focus on generating higher yields from a relatively steady stream of passengers.
Looking ahead, the passenger business is undergoing a network expansion, with inaugural 4-times weekly flights on Wednesday, Thursday, Saturday and Sunday to Male, Maldives operated by 3-class Airbus A330-300s featuring the New Business Class, Premium Economy Class and New Long-haul Economy Class scheduled to commence on 27th October, in addition to inaugural daily flight to Newark, New Jersey from 1st March 2014 onwards onboard 3-class Boeing 777-300ER aircraft, complementing its existing 4 times daily flights to New York John F. Kennedy (JFK) and offering greater flexibility to business travellers in one of the world’s most important business travel markets. The airline also added 5 weekly flights on its Bangkok route, bringing the number of weekly flights to 47.
At the same time, its wholly-owned subsidiary Dragonair expanded its regional network rapidly throughout the first-half, with new flights to Wenzhou, Yangon and Zhengzhou launched in January, Da Nang in Vietnam in March and Sieam Reap this upcoming October. Additional frequencies were mounted on the Kaohsiung in February, Chiang Mai, Kota Kinabalu and Wuhan in April.
Cathay Pacific’s confidence in its passenger business’ bright future is laid bare by its significant investment in new products, though not without reasons. In the week ending 13 July, the passenger revenue has beaten its internal target by 3.7% where the 5th flight to London Heathrow “recorded an average load factor of 95% in both directions” whereas the premium economy class on the San Francisco route had a load factor of 88%, a message to employees obtained by Aspire Aviation shows, thereby highlighting the strength of its passenger business during the summer peak, let alone business travel picks up during the last quarter of 2013.
For instance, Cathay Pacific had appointed Foster+Partners to refresh its First Class, with highly glossy dark-grey materials, natural leather, artworks, a more adjustable meal table, larger room in personal closet, a new 4.3-inch liquid crystal display (LCD) touch screen controller, new reading lights, the new Bose noise-cancelling headphones being featured to give a smoother and softer touch to first-class fliers. The first 777-300ER with the refreshed first class cabin has entered into service on 26th July and the whole refresh project will have finished by the third-quarter of 2014.
Its product rollout continues unabated as 4 aircraft are now equipped with the New Regional Business Class whose retrofitting will be completed by December 2014, whereas the New Business Class and New Long-haul Economy Class are now found on 32 Boeing 777-300ERs and 24 Airbus A330-300s. At Dragonair, 8 aircraft are fitted with the New Business Class seats which share an identical design to its parent airline’s regional business class seat and New Economy Class seats which have the same design as Cathay’s new long-haul economy class seats and 20 aircraft will feature the new cabins by March 2014. In doing so, not only could Cathay Pacific and Dragonair create product consistency on their regional networks all the while improving customer experience, it could also lower the seat procurement costs considerably by reaping the benefits from economies of scale.
Prevailing against LCCs Jetstar HK, HK Express achievable
Regionally, Cathay Pacific is facing an onslaught of low-cost competition, not least from the 17 existing low-cost carriers (LCCs) that serve Hong Kong such as Spring Airlines, Juneyao Airlines, Peach, AirAsia and Tigerair Singapore, but also the potential threat posed by home-grown LCCs Jetstar Hong Kong and Hong Kong Express.
In particular, Jetstar Hong Kong, a joint venture (JV) between Qantas Airways, China Eastern Airlines (CEA) and Shun Tak Holdings, poses the biggest potential threat, as it aims to grow to 18 aircraft accounting for 6%-7% of capacity share within 3 years of commencement of operations. That is, quite frankly, that Jetstar Hong Kong be allowed to take off by securing a local air operator’s certificate (AOC) first.
While the US$198 million investment in Jetstar Hong Kong remains unchanged, the perennial obstacles Jetstar Hong Kong has hit imply deepening start-up losses as the Hong Kong Housing and Transport Bureau has halted processing any application for air operator’s certificate (AOC) and the licence to operate scheduled services as it reviews the designation of local carriers and the principal place of business clause. It also means the initial fleet of Jetstar Hong Kong is reduced from 3 aircraft to 2 examples while the commencement date is repeatedly postponed from mid-2013 to late-2013, which appears increasingly challenging.
In an attempt to maximise its chance of successfully meeting the requirement, Jetstar Hong Kong has sold a 33.3% stake in the carrier to Shun Tak Holdings owned by local gambling magnate Stanley Ho, which reduced Qantas’ upfront investment from US$99 million to US$66 million, in addition to appointing Pansy Ho as its chairwoman. Subsequently, Jetstar Hong Kong’s Air Transport Licence Application (ATLA) was officially gazetted on 28th August.
Yet these did not quell local concerns and the Jetstar franchise has met fierce local opposition instead, where Cathay Pacific has found unlikely partners in Hong Kong Airlines and Hong Kong Express all of which have filed formal objections to the establishment of Jetstar Hong Kong alongside Cathay’s wholly-owned subsidiary Dragonair.
“Hong Kong Airlines and HK Express have filed a formal objection to the application. We believe that the government will make the appropriate judgment based on the long-term development of local aviation industry and the overall economic interests of Hong Kong,” Hong Kong Airlines said in an e-mailed statement.
Likewise, Cathay Pacific and Dragonair argued that Jetstar Hong Kong would not meet Article 134 of the Basic Law which stipulates all air operator’s certificate (AOC) holders to have a principal place of business in Hong Kong.
“Public statements previously made in Australia by Jetstar and its parent company Qantas Airways make it clear that Jetstar Hong Kong is a franchise of Jetstar in Australia and that management control of Jetstar Hong Kong would rest in Australia with Jetstar and Qantas Airways. This means that Jetstar Hong Kong’s principal place of business would be in Australia, not Hong Kong. The Hong Kong residence of a particular shareholder of Jetstar Hong Kong and the number of shares held by that shareholder do not determine management control or principal place of business under the Basic Law. Nor does the fact that particular officers of Jetstar Hong Kong are residents in Hong Kong. Any local franchise operation has local managers. This does not stop it from being controlled from overseas. Management control of the Jetstar Hong Kong franchise clearly rests in Australia,” Cathay Pacific asserted.
“Approval of this application would set a dangerous precedent by granting control of Hong Kong’s hard-negotiated sovereign air traffic rights to a carrier that is nothing more than a franchise operation controlled by a foreign airline. Handing over Hong Kong’s air traffic rights to a carrier that is a franchise controlled by an Australian airline that itself can influence the Australian government’s negotiations with Hong Kong creates a clear conflict of interest where Hong Kong loses out,” Cathay Pacific alleged.
Make no mistake, while it is true that Cathay Pacific, Dragonair, Hong Kong Airlines and Hong Kong Express would benefit in eliminating a potential competitor from the beginning, the principal place of business concern is a legitimate one as all airlines have numerous managers around the world in different key markets, yet they only amount to local operation of a foreign carrier whose control rests in its headquarters. By the same token, should Jetstar Hong Kong be allowed to operate from Hong Kong, not only would it be inconsistent with the principal place of business clause, whose control is made clear when the Australian Competition and Consumer Commission (ACCC) approved co-ordination between Jetstar Japan, Jetstar Hong Kong, Jetstar Asia and Jetstar Pacific on pricing, schedule and more this March, it would also open a floodgate of foreign LCCs establishing a local franchise such as Spring Airlines and Peach that have already expressed an interest in doing so, as well as foreign airlines seeking a base in Asia, ironically such as Qantas itself that once mulled a “RedQ” premium carrier in Singapore or Kuala Lumpur.
“It is inevitable an incumbent service provider will defend its interest, which was what we did when Macau opened the gaming market for foreign players about 10 years ago. But we faced the reality of change, and changed our stance. The fewer the players, the easier it is for the existing operators to work out their numbers. But Hong Kong needs more players to balance the market, and we know how to manage capacity and efficiency,” Jetstar Hong Kong chairwoman Pansy Ho countered in a South China Morning Post interview.
Besides, strong revenue management, regional network optimisation and the strengthening of its Hong Kong hub could enable Cathay Pacific to tackle the low-cost challenge effectively and successfully.
First of all, the powerful revenue management system (RMS) has already proven itself on Cathay’s premium economy product, evidenced by the 4.4% increase in 2013 first-half passenger yield. It maximises the revenue stream accrued from the premium economy product by limiting the revenue dilution arising from a trade-down in business class seats in setting the full flexible premium economy fares close to the lowest business class fares, while enticing the economy class passengers that pay the full fare to pay an incremental premium, particularly on long-haul journey, to upgrade to premium economy class.
This bodes well for Cathay Pacific to tap into the expanding middle class in the Pearl River Delta whose catchment area has a 87 million population, US$13,500 GDP per capita and is the world’s third-largest metropolitan area, according to Shenzhen Airport chairman Wang Yang at the 3rd annual China International Air Routes Summit 2013, as they are willing and able to pay for better seats, catering and services but not 4 times the economy fares for a business class seat.
In this low-cost battle, revenue management could be a useful tool to combat Jetstar Hong Kong without the complexities involved in running an in-house low-cost carrier (LCC) that threatens to create brand confusion and cannibalise revenues, while Jetstar Hong Kong and Hong Kong Express engage in a cut-throat fare war, of which the latter is removing all business class seats and adding 22 extra seats on its Airbus A320s to feature 174 seats. Hong Kong Express aims to offer 30% cheaper fares than full-service carriers and will have a fleet of 30 aircraft in 5 years’ time whereas Jetstar Hong Kong aims to offer up to 50% cheaper fares.
Cathay Pacific is already moving in the right direction, with 3 million hits on its “fanfares” website covering 60 destinations, including new destinations such as Yangon, Wenzhou and Da Nang in the first 6 months since its inception which offers a limited number of tickets that are sold at a steep discount matching low-cost carriers’, yet with onboard amenities such as the audio/video on demand (AVOD) StudioCX in-flight entertainment (IFE) system, complimentary meals and 500 Asia Miles points.
Cathay Pacific and Dragonair even go a step further in introducing new economy fare classes “S”, “N” and “Q” that will offer earning opportunities to Asia Miles’ 5.3 million members of 25% of the actual miles flown. When compared to LCCs’ price/service offering, this seems generous as Hong Kong Express has terminated its shared frequent flyer programme with Hong Kong Airlines’ Fortune Wings Club.
“This is an exciting development that will make flying in Economy Class on Cathay Pacific an even more attractive proposition for our passengers,” Cathay Pacific general manager (GM) in revenue management James Tong said.
In doing so, Cathay Pacific is creating tiers of fare classes at the bottom of the economy segment that will meet different consumers’ needs and maximise its revenue as offering such “fanfares” and “S”, “N”, “Q” economy fares does not necessarily lead to a significant cannibalisation in passenger yields. After all, these “fanfares” and “S”, “N”, “Q” fares are mainly offered on regional flights whose demand is below expectations and optimal levels, which also act as a perfect tool to stimulate demand on new routes. These seats carry basically zero marginal cost (MC) as they would otherwise have been flown empty and such perishable products would be irrecoverable. On the other hand, should there be sufficient demand on higher-yield economy fares, it simply does not make sense to compete with low-cost carriers (LCCs) for competition’s sake that dilutes its own yield.
Moreover, Cathay Pacific retains a 25.1% capacity share at Hong Kong International Airport whereas Dragonair holds another 15.2%, or a 40.3% share as a group. This is paramount as this large slice in a premium hub where premium seats account for 11.1% of all seats in Hong Kong versus a global average of 4.6% ensures a significant and profitable share of the market for Cathay and Dragonair (“Cathay Pacific to be a smarter & leaner airline in 2013“, 3rd Jan, 13). As Hong Kong airport’s two runways are going to hit their maximum capacity of handling 68 aircraft movements per hour by 2015 and the third runway is not going to be available until at least early 2020s when handling capacity will increase to 102 aircraft movements per hour, it is difficult to see low-cost carriers (LCCs) expanding its 5% capacity share in Hong Kong, let alone doubling or tripling it, versus a 24% low-cost capacity share in Asia/Pacific in 2013.
To a certain extent, Cathay Pacific’s case is arguably similar to that of its oneworld partner British Airways (BA), which faces stiff low-cost competition with easyJet and Ryanair accounting for 17% and 16% of United Kingdom’s seat share, respectively, against BA’s 20% share of seats, which responded in a similar fashion by offering “hand baggage only” fares on flights originating from London Gatwick. The success of this strategy is seeing the “hand baggage only” fares being expanded to BA’s Heathrow and City operations from September 24th onwards, in addition to consolidating its operation at the venerable London Heathrow hub.
This strategy is working, as British Airways (BA) posted a €210 million operating profit before special items in the second quarter of this year, more than doubling the prior year quarter’s €78 million operating profit. Unit revenue measured in revenue per available seat kilometre (RASK) also rose strongly by 5.2% year-over-year and its operating margin expanded by 4.3% to a robust 7.1%.
Furthermore, Cathay Pacific could optimise its regional network by focusing more on regional flights that carry a majority of higher-fares economy passengers, especially those connecting ones that will fly on Cathay Pacific internationally. This cross-feeding between Cathay Pacific’s international network and Dragonair’s regional one is going to be of greater and greater importance as the airline evaluates new routes to Dallas-Fort Worth using new Boeing 777-300ERs in addition to smaller European destinations such as Brussels, Madrid and Barcelona using the Airbus A350-900s that Cathay will receive beginning 2016.
The next big expansion opportunities lie in Africa where Cathay Pacific’s new chief executive will have to tackle the challenges posed by the Gulf carriers such as fellow oneworld member Qatar Airways eyeing secondary cities such as Chengdu and Chongqing, of which flights to the former destination have started on 4th September. Indeed, the Gulf carriers such as Emirates and Qatar Airways are better positioned geographically to tap into China-Africa air traffic and it would be impossible for Cathay Pacific and its partner Air China to match the market breadth of these Gulf carriers that connects Beijing, Shanghai and Guangzhou with the likes of Khartoum, Dar Es Salaam, Tunis, Entebbe, Kigali and many more, although Cathay Pacific and Air China do have their strengths over Gulf carriers.
The African strategy for Cathay Pacific and Air China where both do not presently fly to the continent, could connect China with its major trading partners such as Lagos in Nigeria where bilateral trade has reached US$10.57 billion in 2012 from just US$2 billion in 2002 and ex-financial foreign direct investment (FDI) has reached US$8.7 billion, in addition to Algiers in Algeria where some 50 Chinese construction firms are contracted for government projects. This will utilise Cathay Pacific’s extensive Chinese and North Asia network which includes destinations such as Wenzhou, Zhengzhou, Fuzhou, Changsha, Guilin, Kunming, Nanjing, Xi’an, Qingdao and Air China’s flights from Hong Kong to Guiyang, Tianjin and Dalian in China, that the Middle Eastern carriers could not match. Such flights to Lagos and Algiers could be flown by the A340-300s which will be made available as the 777-300ERs replace the quad-engined jet on more and more European routes before the A350-900 replaces them.
Cargo conundrum hurts Cathay; signs of stabilisation
On the cargo side, things are not as rosy as the passenger business, if not grim. The cargo conundrum since mid-2011 has still shown no signs of recovery, with Cathay’s cargo revenue down 5.2% from HK$11.9 billion in 2012 first-half to HK$11.28 billion this year. Had cargo revenue remained at the 2012 level, Cathay Pacific would have recorded a 0.7% increase in total first-half revenue to HK$49.2 billion.
Instead, freight traffic slumped by 4.6% year-over-year to 4.12 billion cargo and mail revenue tonnage kilometres, outpacing a 1.8% year-over-year drop in available cargo and mail kilometres to 6.6 billion, thereby producing a 1.9% lower cargo load factor at 62.4%, a 5-year low. Cargo yield plunged by 3.3% to HK$2.33 per FTK from HK$2.41 per FTK in 2012 first-half whereas the number of tonnes carried declined by 1.7% to 741,000 tonnes in the first six months of 2013 from 754,000 tonnes carried in the year-earlier period.
In response, Cathay Pacific merged its Chongqing and Chengdu cargo route to slash costs while reducing the frequencies on the Zhengzhou route to 3 times a week from 6 times a week while suspending the Brussels and Stockholm services in February. Cathay Pacific also struck a multi-party deal to cancel its order for 8 Boeing 777F freighters and order 3 additional 747-8F freighters which will be delivered later this year, in return for selling 4 Boeing 747-400 BCFs converted freighters back to Boeing. In August, it also parked another 747-400 BCF in its fleet, leaving only 1 example in operation.
A noteworthy point is, this reduction in the number of freighters also had an impact on the cost per available tonnage kilometres (CATK) without fuel which increased slightly by 2.3% to HK$2.23 per ATK from HK$2.18 per ATK in 2012 first-half, although CATK including fuel decreased by 0.8% to HK$3.69 per ATK this year from HK$3.72 per ATK last year due to lower fuel costs, Cathay Pacific finance director Martin Murray said.
Additionally, Cathay Pacific relied more on passenger belly space to carry cargoes in order to cut costs, as the marginal cost of underbelly cargo is quite low while the profit margin could be as high as 60%.
“50% of our revenue goes on the passenger – of our cargo revenue goes on passenger bellies. It’s pretty hard to say Cathay Cargo is unprofitable. But the freighters themselves, although they cover their cash costs, a lot of them did not cover the full financing cost,” Cathay Pacific director of corporate development James Barrington commented.
As Cathay Pacific will take 6 more 777-300ERs in 2013, 8 in 2014 and 4 in 2015, in addition to 6 A350-1000s in 2018 and then 10 each in 2019 and 2020, it is reasonable to question whether Cathay Pacific needs such a large dedicated freighter fleet that will total 26 by the end of 2013. Since both of the 777-300ERs and A350-1000s feature a large revenue cargo volume, let alone the upcoming stretched 407-seat 777-9X, coupled with the fact that Cathay Pacific will continuously expand its passenger network where underbelly cargo will inevitably become a byproduct, Aspire Aviation believes it makes business sense to further boost the ratio of all cargoes being carried in passenger bellies to 60%, or even as high as 70%.
Although doing so would mean parking the remaining 1 747-400 BCF converted freighter and possibly part of the 6 747-400F freighter fleet as 3 more 747-8Fs join the fleet later this year, Aspire Aviation thinks the cost saving and high profit margin generated by focusing more on passenger belly cargo will outweigh the capital cost that is still incurred even the freighters are grounded. Parking these freighters will build more slack or flexibility into Cathay’s cargo business in case the notoriously unpredictable cargo market picks up dramatically such as that seen in 2010, albeit any such prospect is unrealistic and unlikely in the near term.
Putting an increasing emphasis on belly cargo is a prudent move, given that forward booking nonetheless seems muted despite a swathe of new technological gadget launches such as the Apple Inc. iPhone 5S, 5C and the rumoured iPad 5 and the second-generation of iPad Mini 2 tablets in October, which may coincide with improving consumer confidence, a US economy that is showing green shoots of recovery and a stabilising eurozone that may indicate upside to the cargo market.
“Hopefully [cargo] yields have plateaued. We don’t see it in forward bookings yet, but there is more positive talk about what’s going to happen in September because of the number of technology gadgets that are planned for the Christmas season this year. So we are hopeful rather than anticipating at the moment,” Cathay Pacific finance director Martin Murray cautioned.
In addition, Shanghai-based Air China Cargo (ACC) continued to bleed red ink in the first half, losing HK$50-60 million per month, which was compounded by start-up loss of around HK$350 million in the first half at the sprawling Cathay Pacific Cargo Terminal, which has completed its first 2 stages and is now handling all transhipments, import cargoes and valuable cargoes.
These losses are hopefully going to narrow as Air China Cargo (ACC) receives its first 777F under the aforementioned multi-party deal under which Air China Cargo (ACC) has ordered 8 Boeing 777F freighters in return for selling 7 gas-guzzling 747-400 BCFs converted freighters back to Boeing. On the HK$5.9 billion cargo terminal, it will in fact boost Cathay Pacific Cargo’s profitability as it drastically slashes the handling time from 8 hours to just 3 hours once it starts receiving export cargoes and cargoes from other airlines, which will show the remarkable efficiency and growth potential.
Simply put, at a carrier where cargo could account for as many as 30% of its total revenue and has a large exposure to both the Hong Kong and Shanghai cargo markets, Cathay Pacific is hardly completely out of the woods albeit there are early signs of a stabilisation, with the International Air Transport Association (IATA) reporting a 1.2% July year-over-year growth in freight traffic and a 0.5% month-on-month growth versus June, consistent with a moderation in the drop in freight traffic recorded at Cathay in July.
But after so many false dawns in the past several years, any talk of an imminent cargo upturn would be misplaced.
In the meantime, Cathay Pacific appears to be one of the launch customers of the much-anticipated Boeing 777X whose details are going to be finalised at an October customer working group (CWG) ahead of its launch in November’s Dubai Air Show (“Airbus is still name of the game“, 30th Aug, 13), along with British Airways (BA), Emirates, Japan Airlines (JAL) and All Nippon Airways (ANA).
For instance, Cathay Pacific is one of the airlines in the CWG actively co-operating with Boeing on the design of the 777X, especially on the 787-styled cockpit, with Aspire Aviation‘s sources at Cathay Pacific confirming 777 pilots have been sent to Seattle for such joint efforts.
“One cockpit design aspect we were asked to comment on was a proposal by Boeing to significantly change the EFB [Electronic Flight Bag] philosophy. The right seat of the sim was fitted with a standard Boeing EFB. The left seat was instead fitted with an iPad (yes, on a mount for the 777). The iPad (or any device) is connected to the forward screens via a secure wireless network. FMC position, speed, etc. is also transmitted to the mobile device. All independently of the aircraft systems, significantly simplifying certification requirements, and dramatically increasing flexibility to the airline – instead of being tied to hardware and software that will always be technologically dated by certification requirements, airlines can supply their own display management device, and pilots can display information from the device to their forward screens,” Cathay Pacific wrote in an internal newsletter exclusively obtained by Aspire Aviation.
Cathay Pacific also characterised the folding wingtip of the 777X, which folds the outermost 11ft (3.35m) of the -9X’s 71.1m wingspan with a hydraulics actuator and a piano-type topside hinge that keep it as an International Civil Aviation Organisation (ICAO) Code E aircraft at airport gates with a 64.8m (212.7ft) wingspan while being a Code F aircraft on the runway, as “straightforward”.
“This requires wings that fold outboard of the ailerons for taxi and parking. We practiced the mechanics and warning systems for this in the sim, all fairly straightforward,” the Cathay newsletter wrote.
Above all, the Cathay newsletter dated September 4th sheds light on Boeing’s marketing campaign on the 407-seat 777-9X with a 8,100nm (nautical miles) range, which Cathay dubs as “10 years from service” and “the aircraft in theory will achieve incredible efficiencies through increased with a significantly extended wingspan”. Cathay also says “Boeing is planning to market the 777X stretch to CX as a 420 seat (in CX configuration) ULH heavy duty airliner”.
This is significant as pitching the 777-9X as a 420-seater in Cathay’s configuration, most likely in a 10-abreast economy class seat in a 4-inch wider cabin than the -300ER, the 777-9X is very likely to make Cathay bypass any very large airplane (VLA) such as the Airbus A380 superjumbo and Boeing 747-8I Intercontinental to avoid the significant inherent financial risk carried by the need to fill the VLAs, whilst having the same unit cost in cost per available seat kilometre (CASK) and a 20% lower block fuel burn than the 777-300ER and 15% lower cash operating cost (COC) per seat.
For Cathay, a 420-seat 777-9X also offers growth opportunities on trunk routes such as 5 times daily flights to London Heathrow and 4 times daily flights to New York John F. Kennedy (JFK) airport, without compromising flight frequencies that will lead to spill-over demand should such price-inelastic demand from last-minute, walk-up business travellers not be filled.
While Airbus A380 proponents brand Cathay Pacific’s 5 daily flights to London Heathrow as “inefficient” with 2 pairs of flights, CX255 and CX251, departing 1 hour within each other and another pair, CX239 and CX237, departing in 20 minutes of each other, the aforementioned 95% average load factor on Cathay’s fifth London flight demonstrates that 777-9X would strike the “sweet spot” between capacity growth and passenger yield as flying a very large airplane (VLA) such as the A380 risks cannibalising passenger yields as airlines use discounts to fill it up during financial turmoils.
Even this does not take into account the unprecedented revenue cargo volume that the 76.48m long 777-9X has, which builds on -300ER’s 5,200ft³ offered, whereas the 747-8I Intercontinental has a small revenue cargo volume of 3,895ft³ out of a total cargo volume of 6,345ft³; and the A380 a revenue cargo volume of 2,995ft³ out of a total cargo volume of 5,875ft³.
In conclusion, the passenger business is going to be the primary driver in an improving 2013 second-half financial performance, which builds on a HK$281 million profit before tax (PBT) that symbolised a significant turnaround from the HK$1.037 billion pre-tax loss recorded in 2012 first-half. In the two biggest challenges facing the airline, namely the establishment of Jetstar Hong Kong and the proliferation of LCCs in Hong Kong, as well as intensifying competition with Middle Eastern carriers, Cathay Pacific could utilise strong revenue management as a powerful tool to offer more economy fare classes to better match consumers’ needs alongside “fanfares” with little yield cannibalisation as those seats would otherwise be flown empty. On the Africa strategy that is the prerequisite to taking on the Gulf carriers, Cathay Pacific could partner with Air China to jointly develop this fast-growing market by launching routes to Lagos and Algiers where Chinese investment is significant, leveraging the unrivalled strength of Dragonair’s extensive Chinese network and Air China’s dominant market position at Beijing Capital International Airport with its 41% capacity share there.
After all, Cathay Pacific knows its game well. Backed by a strong balance sheet with a debt-to-equity ratio of 0.60, a 4.8% improvement from the 0.63 times at the end of 2012, it will invest heavily in new aircraft – 3 Boeing 747-8F freighters, 2 A330-300s and 6 Boeing 777-300ERs due to be delivered in the remainder of this year, as well as new cabin products in the New Business Class, Premium Economy Class, New Long-haul Economy Class, New Regional Business Class, not to mention the refreshed First Class product. All these will lead to a HK$15 billion capital expenditure by the end of 2013, representative of Cathay Pacific’s approach to continuously invest in its core businesses and partnerships to make it sustainable, such as boosting its stake in Air China to 20.13%.
It will also roll out a new Amadeus customer management (CM) system from September to December in 2014 that allows travellers to receive updates, book the next available flight when encountering delays and obtaining upgrades, processing payment on the same counter, while finalising a supplier in the next 12 to 18 months over self-boarding gates equipped with face-detection camera to create a smoother travel experience.
It is indeed changing times. And Cathay Pacific is going to excel in and profit from these challenging times.