Cathay Pacific builds flexibility while embracing opportunities

In posting an 83.3% drop in its 2012 full-year net profit to HK$916 million (US$118 million) from 2011′s HK$5.5 billion (US$708.5 million), Hong Kong-based Cathay Pacific Airways has ridden through a turbulent year that saw Asia’s largest international carrier posting a HK$935 million 2012 first-half loss, its first since the 2003 SARS crisis, amid a cargo conundrum, softening passenger yields in premium classes and stubbornly high fuel prices.
The result which beat analysts’ estimate of a HK$538.7 million full-year net profit, according to a Bloomberg survey, showed the airline’s cost-cutting measures, including withdrawing the fuel-guzzling Boeing 747-400 aircraft from its fleet at an accelerated pace, trimming long-haul flying, were bearing fruit that was underlined by a HK$1.85 billion second-half profit.
As Cathay Pacific heads further into 2013, a pick-up in business travel to North America as a result of an improving US economy, a more normal profit and loss statement without non-recurring items which weighed heavily on its profitability in 2012, as well as the continued fleet renewal programme, will hopefully produce a material improvement in the carrier’s 2013 net profits.

Image Courtesy of Bloomberg

A more normal P&L statement in 2013
As Cathay Pacific accelerates the pace at which it conducts its fleet renewal programme, the profit and loss statement in 2012 has been plagued by one-off special items, especially in aircraft depreciation and impairment.
Cathay Pacific recorded around HK$719 million non-recurring special items on the airline’s operating profit before tax during the year, including a HK$247 million impairment on 1 Boeing 747-400 BCF (Boeing Converted Freighter). Another HK$140 million of impairment was booked against 2 747-400 BCFs sold to its Shanghai-based Air China Cargo (ACC) joint venture (JV) and HK$52 million against the 4 747-400 BCFs that will later be sold to Boeing under a trade-in deal struck in March this year. The remaining over HK$200 million charge and HK$80 million were respectively booked against higher depreciation expense as Cathay Pacific withdrew 3 747-400s passenger aircraft last year, including 2 in September and 1 in December, and carbon emission reduction units it bought for the European Union (EU) emissions trading scheme (ETS) where the price for carbon dioxide allowance has notoriously slumped by 40% within a short timespan in January and its current price is €4.77 a tonne compared to the €20 a tonne the EU originally envisaged.
Similarly, Cathay Pacific witnessed a 70% drop in fuel hedging gain from HK$1.81 billion the prior year to HK$544 million in 2012. Had there not been this plummet in fuel hedging gain and the around HK$719 million charge, the airline operation of Cathay Pacific and Dragonair would have recorded a HK$2.17 billion profit before tax (PBT) and a HK$1.9 billion profit after tax, versus the HK$158 million PBT and a HK$110 million after-tax loss. The 2012 full-year net profit would also be boosted to HK$2.9 billion, a less pronounced 46.6% drop than the 83.3% headline decline.
Yet these special items could hardly mask the underlying challenging environment Cathay Pacific faced in 2012, arguably more than any other airline owing to the reliance on its cargo operation which could take as high as 30% of its total revenue in good times and 24.7% in 2012.
Total revenue rose by 1% to HK$99.4 billion in 2012 from HK$98.4 billion in 2011, whereas operating expenses soared considerably faster at 5% to HK$97.6 billion in 2012 from HK$92.9 billion the year prior, thus leading to a 67.5% decline in operating profit to just HK$1.79 billion from HK$5.5 billion a year earlier. Profit before tax (PBT) for the group declined by 76.1% to HK$1.55 billion from HK$6.47 billion the prior year, while profit after tax slumped 80.1% to HK$1.1 billion in 2012 from HK$5.67 billion in 2011.
Needless to say, weakness in the air cargo market and sustained high fuel price impacted Cathay Pacific significantly, since it is the world’s largest cargo carrier.
Cargo revenue for 2012 plummeted by 5.5% from HK$26 billion a year earlier to HK$24.6 billion in 2012 with a 5.2% drop in the number of tonnes of cargo carried to 1.563 million tonnes in 2012 from 1.649 million tonnes the prior year. Freight traffic, measured in freight tonnage kilometre (FTK), slumped by 7.3% year-over-year to 8.942 billion, which outpaced a 3.1% decline in cargo capacity, measured in available tonnage kilometre (ATK) to 13.926 billion, thereby leading to a 3% decrease in cargo load factor to 64.2%. While cargo yield remained stagnant at HK$2.42, factoring in a 1.7% increase in average into-plane fuel price, the underlying cargo yield actually declined by 1.7%.
The airline trimmed its base freighter service to Europe from 22 flights per week to 11 flights per week in February 2013 in light of the weak European economy, suspended service to Zaragoza, Spain in November last year as a contract with a major shipper ended and will not serve Brussels and Stockholm as freighter destinations anymore.
Though the airline also pursued growth in airfreight by launching dedicated freighter flights to Zhengzhou, Henan province in China in March 2012, which proved to be so successful such that it increased its frequency from 2 per week to 6 per week. The airline also launched a weekly cargo flight to Colombo in Sri Lanka in December last year, in addition to the Hyderabad, India flight launched in May. Services to Bangalore temporarily increased to 3 flights per week before reverting back to 2 per week this January.
While its cargo business suffered from a severe air cargo market downturn, its passenger business seemed to be on a brighter note and was brisker, with passenger revenue soaring by 3.5% from HK$67.8 billion in 2011 to HK$70.1 billion in 2012, backed up by a 5% increase in the number of passengers carried to 29 million passengers in 2012 from 27.6 million the prior year, indicative of a fall in passenger yield. Similar to its cargo business, while passenger yield, measured in revenue per revenue passenger kilometre (RPK), rose by 1.2% from HK66.5 cents in 2011 to HK67.3 cents in 2012, a 1.7% increase in average into-plane fuel price meant the underlying passenger yield declined by around 0.5%, with restrictions in corporate travel hampering efforts to boost yield in premium cabins and offsetting a slight increase in yield in the economy class, Cathay Pacific finance director Martin Murray said in an analysts’ briefing.
Passenger traffic, measured in revenue passenger kilometre (RPK), rose by 2.3% to 103.8 billion whereas passenger capacity, measured in available seat kilometre (ASK), rose by 2.6% to 129.6 billion from 126.3 billion a year earlier, thereby leading to a 0.3% decline in passenger load factor to 80.1% in 2012 from 80.4% the prior year.
Cathay Pacific continued to invest heavily in improving its passenger products, rolling out its New Business Class, Premium Economy Class and New Long-haul Economy Class unabatedly, with 48 long-haul aircraft being fitted with the premium economy class at the end of 2012, before being featured on 86 aircraft by the end of 2013. The New Long-haul Economy Class, which features significantly thickened cushioning, a small storage space beneath the personal television screen, improved reclining and a touchscreen for its award-winning StudioCX audio/video on demand (AVOD) in-flight entertainment system (IFE), will be available on all long-haul 777-300ERs and A330-300s by the end of 2013.
It also launched the New Regional Business Class in January this year, which will be featured on all regional 777-200s, 777-300s and A330-300s by the end of 2014, as well as reopening the refurbished first class lounge in February 2013, The Wing business class lounge in January 2012 and a brand new first and business class lounge in Paris in August 2012.
Meanwhile, fuel remained the single biggest cost, increasing 4.1% to HK$40.47 billion from HK$38.88 billion a year earlier net of fuel hedging gain and accounting for 41.1% of the Cathay Pacific Group’s total cost last year. As a result, the airline took advantage of a short-lived plunge in Brent fuel price in May and June last year to engage in more fuel-hedging activities, and is now approximately 30% hedged for 2013 at a Brent oil price of US$105 per barrel, 20% hedged for 2014 at US$95 per barrel and 11% hedged for 2015 at roughly the same level.
While fuel cost indeed soared in 2012, Cathay Pacific made a remarkable achievement by being able to produce a 0.7% decrease in total fuel consumption despite the 2.6% growth in passenger capacity in available seat kilometre (ASK), which symbolised its swapping of 747-400 to 777-300ER, which is 22% more fuel efficient per payload tonne than the ageing jumbo jet, on European routes and its fleet renewal programme that saw 19 new aircraft being taken deliveries of in 2012, including 4 Airbus A320s, 6 Airbus A330-300s, 5 Boeing 777-300ERs and 4 747-8F freighters, are working and producing significant benefits.
Maintenance cost, on the other hand, decreased by HK$307 million owing to fewer expensive Rolls-Royce RB211-524H2-T engine shop visits and D-checks as the retirements of 747-400s were carefully timed to avoid these outlays. Though Cathay Pacific said there is little further room for maintenance cost to decline dramatically, as the rest of the fleet still needs to be maintained, notwithstanding the withdrawal of 6 747-400s this year.
“And on the maintenance side, a lot of the shop visits for even the 747s that are coming out this year were planned. The visits would have been done in 2012 so we’re not expecting from the 2012 numbers a significant drop in our maintenance costs, any further drop. The new aircraft still all need to be maintained and things so there’s not going to be a significant reduction in maintenance going forward. The timing of it very much depends on HAECO [Hong Kong Aircraft Engineering Company] etc, so it can vary,” Cathay Pacific finance director Martin Murray cautioned.
Nevertheless its unit cost, measured in cost per available tonnage kilometre (CATK) soared by 5.5% from HK$3.45 in 2011 to HK$3.64 in 2012, primarily owing to the 2.6% growth in passenger capacity which led to a HK$757 million increase in in-flight service cost, an average of 5% salaries increase in 2012. Additionally, this was compounded adversely by withdrawing 4 747-400 BCFs (Boeing Converted Freighters) last year alone, which pushed up the share of passenger costs onto the cargo operation.
“But now that you’re cutting, taking freighters out, the cost per freighter compared to passenger is about half so in terms of all the extras that you have on the passenger in terms of crew and meals, etc. So with the cost per ATK we’re going to have to think how we’ll work that out because the freighters, the denominator in that equation is down over double digit, so it’s down 11%. So it’s much more – it’s a huge impact on the operating cost,” Cathay Pacific director of corporate development James Barrington said.
That said, with the impairment for scrapping and selling numerous 747-400 BCF (Boeing Converted Freighter) aircraft already taken on in 2012, Cathay Pacific has largely bitten the bullet for laying the groundwork of improving its profitability, albeit its depreciation expense is still going to be at a heightened level as the 6 747-400s are withdrawn.
“No, we’re not expecting any further impairment in 2013,” Cathay Pacific finance director Martin Murray commented.

Regional focus & the rising dragon
As Cathay Pacific works to deploy the right aircraft on the right route in its long-haul network, by shifting Boeing 777-300ERs to European routes and reducing Los Angeles, New York and Toronto routes in September last year which will be restored to 10 and 20 flights per week to Toronto and Los Angeles, respectively, there is a growing regional focus as burgeoning Asia/Pacific economies such as Vietnam, Indonesia, Myanmar and the rising dragon – China, and their rising disposable incomes enable strong intra-region air traffic growth.
For instance, Cathay Pacific increased frequencies to Singapore, Ho Chi Minh City, Bangkok, Penang, Kuala Lumpur, Singapore and Chennai, India from 4 per week to daily while Dragonair, its wholly-owned subsidiary, resumed services to Guilin, Xi’an and Taichung in Taiwan during the year in addition to launching flights to Haikou. Dragonair also launched flights to Clark near Manila and Jeju, South Korea in May, as well as Chiang Mai, Thailand in July, although the initial performance to Clark was unsatisfactory and only started to improve, the airline noted.
Cathay Pacific will also add 3 flights a week to Bangkok while switching 3 Hong Kong-Mumbai flights to non-stop ones, whose morning arrival enables onward connection and caters to the need of business travellers.
In the first 3 months of 2013, Dragonair has already launched flights to Zhengzhou and Wenzhou in China, Yangon in Myanmar and Da Nang in Vietnam, highlighting the importance of growing in Asia and China. Dragonair will also increase flights to Qingdao from 10 to 14 weekly, Airline Route reported; while its flights to Wuhan will increase to 10 per week from daily and its Kota Kinabalu flights will increase to daily, whereas its flights to Jeju and Chiang Mai will rise to 4 and 5 per week, respectively. The proportion of revenue made in North Asia, Southeast Asia, India and the Middle East of the total passenger revenue at Cathay Pacific Group rose by slightly more than 1% from 69.6% in 2011 to 70.7%, which Aspire Aviation believes will only grow further as Asia/Pacific economies outgrow their European and American counterparts.
This growing regional focus is also evidenced by the Cathay Pacific Group’s investment. Dragonair has rolled out a new business class based on its parent’s New Regional Business Class that features a 47-inch seat pitch and a 21-inch seat width, up from the existing product’s 45-inch and 21-inch, respectively. The largest recline angle has also been increased to 60 degrees from 38-55 degrees and features a 12.1-inch private television screen with a new audio/video on demand (AVOD) in-flight entertainment system (IFE) named StudioKA, in addition to providing power port and iPad/iPod/iPhone USB port at each individual seat. The airline will also adopt Cathay Pacific’s New Long-haul Economy Class seats as its new economy product.
Furthermore, Dragonair has just rolled out a new customer-facing staff uniform, including flight attendants’, which updates its previous design that has been in use for 13 years.
“As one of the world’s leading regional airlines, we constantly look for ways to enhance our products and services, and to expand our network and increase the choice we offer to our customers. We also invest a great deal of effort in strengthening our brand and boosting our corporate image,” Dragonair chief executive Patrick Yeung said.
Most importantly, besides its Air China Cargo (ACC) joint venture (JV), Aspire Aviation thinks the fullest potential of its strategic tie-up with Air China has yet to be fully realised and further benefits could realistically be reaped through a multi-pronged partnership.
For instance, the brand recognition of Cathay Pacific, while being very prominent in overseas market, remains substantially below that of Dragonair in China. A joint marketing campaign with Air China both overseas and in China could remedy Cathay Pacific’s relative marketing weakness in China and Air China’s one in overseas market.
Moreover, the rise of Middle Eastern carriers on the traditional Kangaroo route, which along with the commencement of the Qantas/Emirates partnership, has seen 25% of Australia-Europe traffic shifting to a Middle Eastern hub and Cathay Pacific said that competition has become stiffer on the Australia-London market, a revolutionary, let alone game-changing partnership with Air China could yield significant revenue synergies on Australia-Europe and Australia-China market.

Image Courtesy of Tian Xiaofei

This revolutionary partnership with Air China that Aspire Aviation is proposing specifically targets lucrative, price-inelastic but time sensitive business travellers and less towards price-elastic leisure travellers and covers two areas in one fell swoop.
As China is currently Australia’s top export partner owing to the mining boom of which the rising dragon is the world’s largest consumer of minerals, with which Australia trades 19.9% of its goods and services worthing A$121.1 billion in 2011, the latest government figure available showed. This spurred the trade link between the countries to grow significantly.
Cathay Pacific, located at the doorstep of China, has been feeding origin and destination (O&D) traffic from China, Asia, North Asia countries such as Japan, South Korea, North America and Europe to its Southwest Pacific – Australia and New Zealand flights very successfully and profitably. The airline operates 4-daily flights to Sydney and has multiple flights to major Australian ports such as Adelaide, Perth, Brisbane, Melbourne and Cairns using 3-class Airbus A330-300 featuring a disproportionately large New Business Class with 39 seats on each aircraft.
The Australia-China air travel market is booming, not least because of China Southern Airlines’ pursuit of its “Canton Route” strategy that aims to build its Guangzhou Baiyun Airport into a hub between Australia and Europe. China Southern Airlines registered a robust 24.6% growth in the number of passengers carried to 642,210 in 2012 from 515,370 in 2011, according to Aspire Aviation‘s compilation using Bureau of Infrastructure, Transportation and Regional Economics (BITRE) figures. China Eastern Airlines (CEA) also recorded a 26.6% growth in the number of passengers carried to 346,690 in 2012 from 273,905 in 2011.
With Cathay Pacific focusing on improving its yields with already very full Australia flights rather than on boosting the volume, the Hong Kong-based carrier has recorded roughly no growth at all over the past year in the number of passengers being carried at the 1.44 million level.
As many Australian companies conduct trades and business in China, such as ANZ Bank, Rio Tinto, BHP Billiton, law firm Clayton Utz, coal company HRL Limited, Atlas Iron Limited, many firms do have corporate offices in both Beijing, Shanghai and Hong Kong and hence many business travellers make trips between these destinations.
Therefore Aspire Aviation proposes a metal-neutral partnership which entails the first business trip sector flying from Sydney or Melbourne to Hong Kong on Cathay Pacific before flying a second sector between Hong Kong and Shanghai or Beijing on either Cathay Pacific, Dragonair or Air China where no particular airline is favoured over each other; the final sector involves travelling Shanghai-Sydney or Shanghai-Melbourne or Beijing-Sydney non-stop flights on Air China, or in the reverse direction. Any incremental profits generated from the partnership would be equally split between Cathay Pacific and Air China.
Currently Air China operates 4-weekly Shanghai Pudong-Sydney, 5-weekly Shanghai Pudong-Melbourne and daily Beijing-Sydney flights whereas Shanghai-based China Eastern Airlines (CEA) operates the former two routes on an once daily basis.
Similarly, the Cathay Pacific/Air China partnership has the potential to counter Qantas/Emirates or Virgin Australia/Eithad Airways partnerships, especially for business travellers, by delving into a wide-ranging European partnership. This would entail business travellers who need to visit Europe and Beijing, Shanghai or Hong Kong in one business trip travelling on Cathay Pacific from Sydney, Melbourne, Cairns, Brisbane, Adelaide to Hong Kong and onward Cathay Pacific flights to London Heathrow, Rome, Milan, Paris and Frankfurt. Next, business travellers could fly on Air China flights from Rome, Milan, London Heathrow, Paris and Frankfurt to Beijing or Paris, Milan and Frankfurt to Shanghai, before flying on the Shanghai Pudong-Sydney, Shanghai Pudong-Melbourne and Beijing-Sydney routes.
This partnership in the carriers’ combined European network would also be metal-neutral where no particular carrier’s metal is favoured over the other’s and split incremental profits between the two.
While sceptics may question whether such wide-ranging partnership is realistically and operationally feasible given the complexity involved such as the alignment of products between the two carriers, as well as whether this will decimate Cathay Pacific’s European and Australian flights, these concerns are arguably misplaced.
Air China’s 5.65% increase in its number of passengers carried to 297,954 in 2012 from 282,025 in 2011 was below its peers and this partnership, both the Australia-Europe and Australia-China ones, will help bolster growth of the Chinese flag carrier on its Australian operation.
For Cathay Pacific, any business travellers needing to visit multiple ports in a single business trip stopping over in Hong Kong and Beijing/Shanghai from Australia would not have travelled on the oneworld member on the Europe-China and China-Australia sectors anyway and this partnership offers unrivalled convenience for passengers for which Cathay Pacific, along with Air China, can charge a revenue premium where no other airline partnership could offer.
Further, Cathay Pacific’s significantly more superior service and in-flight products and unparalleled offer of flight frequencies, coupled with a venerable Marco Polo Club frequent flyer programme (FFP), mean Cathay Pacific will still be the preferred airline for many business travellers. In addition, given the astounding 20%+ growth rate the Australia-China air travel market is witnessing, this partnership offers a clear path for Cathay Pacific to have a profitable and pivotal share of this growth.
As a result, Cathay Pacific may not have to increase its capacity on Australian, Chinese and European routes at all. Rather, this game-changing partnership specifically targeting business travellers, could be utilised as a means to further improve yields by achieving a better traffic mix where only premium travellers, or high-yield economy passengers on business travel, demand such premium travel products while it is much less likely to see leisure or price-elastic travellers engaging in this type of air travel behaviour.

Image Courtesy of Dragonair

Yet before such a wide-ranging and revolutionary partnership takes place, Cathay Pacific should strengthen its Australian operation by forging a codeshare partnership with Virgin Australia. In doing so, this would increase the access of the Cathay Pacific network to 18 secondary Australian destinations such as Townsville from Cairns, Mount Isa, Emerald, Gladstone, Rockhampton, Bundaberg, Moranbah, Hamilton Island from Brisbane, Sunshine Coast, Gold Coast, Ballina, Coffs Harbour, Port Macquarie, Canberra, Albury, Hobart, Launceston and Ayers Rock from Sydney while increasing the feed on its Hong Kong-Australia flights.
This would make much more commercial sense in the interim, which is also much less complex to achieve and easier to obtain the regulatory approval from the Australian Competition and Consumer Commission (ACCC) since the codeshare partnership is highly unlikely to lessen its competition with Virgin Atlantic on the Hong Kong-Sydney route (“Qantas, Virgin Australia face new industry normal“, 6th Mar, 13). For Virgin Australia, while a partnership with Cathay Pacific means more competition for its sister airline Virgin Atlantic, it would provide instant access and shorter travel time to North Asia and China where Singapore Airlines (SIA) and SilkAir do not serve many destinations such as Haikou, Sanya, Guilin, Hangzhou, Xi’an, Nanjing, Ningbo, Fuzhou and Qingdao in China, Busan, Taichung, Kaohsiung while having considerably longer flight times to Seoul, Tokyo Narita and Haneda and Beijing via Singapore, etc.
Though Cathay Pacific and Air China should fix its loss-making Air China Cargo (ACC) venture first, which made a HK$600 million operating loss in 2012, albeit its aggressive expansion that saw it launch Shanghai-Chennai-Chongqing-Shanghai, Shanghai-Chengdu-Amsterdam, Shanghai-Chongqing-Amsterdam and Zengzhou-Shanghai-Chicago cargo routes in 2012 and Shanghai-Zhengzhou-Amsterdam and Shanghai-Chongqing-Frankfurt cargo routes in 2013.
In the meantime, the trade-in deal with Boeing that will eventually see Air China Cargo (ACC) selling 7 Boeing 747-400 BCFs (Boeing Converted Freighters) and replacing them with 8 fuel-efficient 777F freighters and Air China ordering 2 additional 747-8I Intercontinentals, 1 777-300ER and 20 737-800s, is going to enable the Shanghai-based carrier to temporarily reduce capacity from 11 aircraft to 7 examples as Boeing will take back the -400 BCFs faster than it delivers the 777F. By the end of 2013, Air China Cargo’s fleet will consist of 3 production 747-400Fs, 3 747-400 BCFs and 1 777F while Boeing will take back 4 -400 BCFs in March, May, July and October this year.
“They are in a much better position as of March 1 with this deal. They have 11 old aircraft of which they are selling 7 and getting 8 new efficient ones, the timing of which means they’ll be able to significantly reduce their capacity from 11 to 7 this year and then slowly build it up again, so again with a fuel-efficient fleet. So we’re now very excited about the re-fleeting that this deal has managed to bring to our joint venture,” Cathay Pacific finance director Martin Murray commented.
With reduced capacity and an ultimate dramatically more fuel efficient fleet, Cathay Pacific is looking beyond present challenges for Air China Cargo and remains confident in its long-term growth and profit potential.
“So the rationalisation of cargo capacity plus the introduction of more efficient cargo capacity, I think bearing in mind all the BCFs, 4 of the BCFs will be gone and that we’ll be left with 3 production freighters, 3 BCFs and 1 777, will certainly massively increase, A.) the matching of supply and demand, and B.) the beginning of the efficiency. The introduction of the 777s really only comes into play next year so the first 777 comes in December this year. But, as I say, don’t forget the rest of Air China Cargo has a revenue stream which is dependent on the bellies of the – the belly sales of Air China itself,” Cathay Pacific director of corporate development James Barrington asserted.

Image Courtesy of Cathay Pacific

Flexibility means ability to respond to changes swiftly
The March 1st trade-in deal with Boeing, under which Cathay Pacific cancelled its orders for 8 777F freighters, ordered 3 additional 747-8F freighter due to be delivered later this year and took the options on 5 Boeing 777F freighters, while selling 4 parked 747-400 BCFs (Boeing Converted Freighters) back to the Chicago-based airframer, has added flexibility to its cargo operation, where cargo capacity, measured in available tonnage kilometre (ATK) is anticipated to grow by 2.6% in 2013.

As Cathay Pacific heads into the second-quarter, airfreight demand is still weak, with the number of tonnes being carried soaring 14.7% year-over-year in January to 132.8 million tonnes before plunging by 12% to 103.8 million tonnes in February due to factory closures for the Chinese New Year, although there is a silver lining on the corner.

Business confidence index, such as the JP Morgan Markit index, has been rising consistently since the beginning of the year, which is a major factor underpinning Geneva-based industry body International Air Transport Association’s (IATA) upgrade of the industry’s 2013 net profits to US$10.6 billion from the previous projection of US$8.4 billion, which also boosted its freight traffic growth forecast to 2.7% from 1.4%. IATA also said yesterday airfreight volume grew by 2% year-over-year in February after stripping out seasonal factors, as global freight traffic and Asia freight traffic were down 6.2% and 14.7% year-over-year, respectively, owing to factory closures during the Chinese New Year.

Yet should a much hoped-for strong recovery in the cargo market materialise after countless false dawns in the past 2 years or so, Cathay Pacific stands to gain the most from a significant rebound.

“I think firstly we think that the airfreight market is a good market to be in. We think if you’re setting up an air freight business you’d want to be either in Hong Kong first, secondly in Shanghai. We’re 100% of Hong Kong. We’re 49% of Shanghai. We think that’s a good strategy. What I think we think we’ve done is we’ve slightly right-sized our business, inasmuch as we probably had over-invested and got our freighter business a little bit too big. But we don’t – that doesn’t suddenly mean we’re thinking of getting out of the freighter business. I think what we’ve learned is that we want to build more flex into it so that we have options to grow in line with the market,” Cathay Pacific director of corporate development James Barrington said.

And the HK$5.9 billion Cathay Pacific cargo terminal, which started operations in February 2013 with high-valued goods such as diamond and mail in stage one, where in second stage it will take transshipment and import before being fully operational in September and able to handle other airlines’ cargoes starting from 2014, will be a state-of-the-art facility handling 2.6 million tonnes of cargo annually and employing more than 1,800 employees.

While the concurrent handling of Cathay Pacific’s cargo at its in-house terminal and HACTL will incur a one-off cost of HK$0.5 billion, the efficiency and extra revenues it will bring, such as slashing cargo handling time from 8 hours to 3 hours, more than outweighed its costs.

Importantly, as the airline receives more Boeing 777-300ERs this year, it increasingly has the flexibility to choose from a range of options to respond to cargo market volatility swiftly, either by utilising belly cargo space on air cargo markets that see dwindling airfreight demand and the ability to add dedicated freighter services should European cargo demand pick up. The 777-300ER has a revenue cargo volume of 5,200ft³ from a total cargo volume of 7,120ft³, a significant increase compared to the venerable 747-400 it is replacing while burning 22% less fuel per payload tonne.

“You’re absolutely right that the amount of belly space to Europe where, A.) there’s a huge amount of belly space which is available and saleable versus North America, where there’s less belly space and, B.) the payload restrictions means that with the number of – when you’ve got full passenger flights, there’s a lot less belly space available,” Cathay Pacific director of corporate development James Barrington conceded.

“Means that the freighter demand, the demand for freighters transpacific where we’re by far and away the biggest freighter operator now and the acquisition of 3 more 748s [747-8Fs] on top of the 10 we’ve already got will give us 13 of the biggest freighters available in the market, which we will plan to deploy to the USA because it’s a good market, is different from the thinking to Europe where we certainly do need to watch out for the incremental, the by-product belly space versus the dedicated freighter space,” Barrington explained.

Which brings us back to the flexibility of the passenger operation. With a backlog of 26 Airbus A350-1000s and an eventual strong fleet of 50 Boeing 777-300ERs, Cathay Pacific does not have to order any very large airplane (VLA) such as the Boeing 747-8I Intercontinental or Airbus A380, of which the former has a revenue cargo volume of 3,895ft³ from a total cargo volume of 6,345ft³, whereas the latter has a revenue cargo volume of only 2,995ft³ from a total cargo volume of 5,875ft³. While the VLAs may have the power to carry such a payload on transpacific routes, their lacks of revenue cargo volume render this capability useless and it can afford to wait for the 407-seat 777-9X which provides growth opportunities and balances frequency and capacity nicely but will not enter into service until mid-2019 (“Boeing 777X to spark mini-jumbo war“, 28th Mar, 13).

The airline will take delivery of 19 new aircraft this year, including 5 Boeing 747-8F freighters, 9 777-300ERs and 5 Airbus A330-300s, of which 4 A330-300s will go to the mainline Cathay unit and directly replace the 4 outgoing examples being returned to lessors. 5 more A330-300s and 7 more 777-300ERs will be delivered to the carrier in 2014. Cathay Pacific also agreed to lease 2 more new Airbus A321s for Dragonair which will be delivered in February and October 2014.

Meanwhile, 6 Boeing 747-400s passenger aircraft are going to be withdrawn and the 4 parked 747-400 BCFs (Boeing Converted Freighters) will leave the fleet, leaving 1 remaining operating example, which Aspire Aviation strongly urges Cathay Pacific to retire the lone example in light of its fuel inefficiency.

Simply put, with a backlog of 85 aircraft and a HK$21 billion of capital expenditure, of which HK$18 billion is earmarked for aircraft, HK$1.5 billion for the cargo terminal and the rest for information technology (IT), the airline could wait for the 323-seat 787-10X that will be ideal for replacing the A330-300s while burning 25% less fuel and better payload/range performance with a 7,000-7,100nm (nautical miles) range while strengthening its balance sheet, which has seen the net debt-to-equity ratio increasing 0.19 times from 43% to 62% and a 49% higher net borrowing at HK$35.4 billion from HK$23.7 billion to fund growth.

A noteworthy point is, Aspire Aviation believes the profit potential of the premium economy class, whose fullest potential is yet to be seen as it is still being rolled out across its fleet. A premium economy class is designed to be a long-haul product that extracts consumer surplus (total use value – total exchange value, or TUV-TEV, the amount of a good one is willing to forego in order to obtain all of the amount of another good) from those who are willing and able to pay twice the economy class fare, in exchange for better seats, services and in-flight catering, yet are unprepared to pay for a full business class fare whose fare is triple or quadruple the economy class fare.

Provided that a premium economy class be structured properly, it should minimise the trade-down from business class to economy class while maximise the upgrade from economy class by utilising a powerful revenue management system (RMS) with price differentiation. Cathay Pacific seems to be doing just that with the premium economy proving to be very successful, popular and beating expectations.
“Firstly I think we would say that our premium economy as a product has been a winner. Then premium economy if you look at it as a separate business has been a winner in some places, but has taken time to pick up in others. So in markets where we were late into the market, in some ways surprisingly where premium economy had already been established in the market, specifically London, premium economy has been an outright winner. And by an outright winner I mean the amount of extra revenue we gain versus the amount of seats taken out has been heavily in favour of premium economy,” Cathay Pacific director of corporate development James Barrington declared.
“The premium economy is growing fast in North America where there are much less premium economy operators. So it started slowly and picked up fast and as you would imagine on flights to places like New York, where a 16, 17-hour flight in economy versus premium economy would incentivise people to pay a little bit more, that is starting to be a real winner. The place where the jury is still out is to Australia where there is an established market with Qantas. On the other hand it’s only between – depending whether you’re Perth or Sydney or Melbourne, only a 6.5 to 8-hour flight, but it’s much more price sensitive. And premium economy the jury is still out there. It’s a winner for the connecting traffic to Europe and it’s taking time to pick up between Hong Kong and Australia.
“So that’s where we are, but I think we consciously chose not to make it a product that was region by region, to make it system-wide in the knowledge that it would be from a customer proposition point of view very hard to sell if it was on some routes and not others. So I think it’s, I would say it’s exceeded expectations,” Barrington concluded.
In conclusion, with many more opportunities awaiting the carrier on the horizon, including a potential game-changing partnership with Air China in the China-Australia and Europe-Australia markets, a potential codeshare with Virgin Australia that makes every business sense and expands the access of its network in one of its most important markets, Cathay Pacific is building flexibility which few of its rivals have into its system, with passenger capacity, measured in available seat kilometre (ASK) expected to shrink 1.5% this year and cargo capacity, measured in available tonnage kilometre (ATK), expected to grow by 2.6% this year.
With a substantially larger fuel efficient Boeing 777-300ER fleet, the fuel consumption of the Cathay Pacific Group should further decline significantly, while its heavy product investments in premium economy class and new regional business class, Dragonair’s new business and economy classes, shall give passengers “a reason to fly Cathay Pacific”. This flexibility to respond to market changes swiftly, will bode well even as it faces low-cost competition where low-cost carriers (LCCs) have accounted for 5% of capacity at Hong Kong International Airport and Spring Airlines and Jetstar Hong Kong expanding at its home turf.
While low-cost carriers (LCCs) are undeniably likely to produce traffic growth in Hong Kong, Cathay Pacific’s profitability may not be significantly undermined as a plethora of such carriers, Hong Kong Express, Jetstar Hong Kong, Spring Airlines and to a lesser extent Hong Kong Airlines, engages in cut-throat price competition, which could enable Cathay Pacific to prevail in the high-yield sector while competing effectively using heavy discounts such as its “fanfares” without the complexity and risk involved in running an in-house low-cost carrier at a slot-restricted, high-cost premium hub where premium seats account for 11.1% of all seats in Hong Kong being versus a global average of 4.6%. This formed a stark contrast to low-cost carriers’ capacity share in Asia/Pacific which grew from 1.1% in 2001 to 24% in 2012, according to the Centre for Aviation (CAPA).
All told, flexibility is the new name of the game.

 

http://www.aspireaviation.com/2013/04/03/cathay-pacific-builds-flexibility-while-embracing-opportunities/