Cathay flies into economic storm clouds
Hong Kong // It has been a tough year for Cathay Pacific, the airline that once lorded it over the Pacific skies.
In October, the Hong Kong carrier spooked investors by scrapping its second-half dividend and revealing a sharp rise in fuel hedging costs. Then last month it did what was once almost unthinkable, posting a full-year net loss of HK$575 million (Dh272m). It was all the more shocking given that Cathay had only the previous year reported a profit of HK$6 billion.
Nor can the carrier promise either its 23,000 staff or its key shareholders, led by the conglomerate Swire Pacific and Air China, a swift return to form. Data for last year included a 9.4 per cent slump in sales as well as a 9.2 per cent fall in passenger yields, a key measure of profitability based on the money earned by flying a passenger a single kilometre. Cathay’s Hong Kong-listed shares skidded to the lowest level since 2009, losing 16.2 per cent in the 12 months to March 28, when they closed at HK$11.60. Since then they have slipped further, closing at HK$11.16 yesterday. Cathay has warned that the operating environment would remain “challenging” through 2017, prompting analysts at Jefferies to predict another year of losses.
At a glance:
■ What: Once the leader in South East Asian aviation, Cathay Pacific finds itself under pressure trying to claw back its position.
■ Why: Competiton from Arabian Gulf and local carriers has seen the airline post a loss with some major challenges ahead.
■ Further reading: Major airlines are finally beating budget carriers again.
At first, Cathay seemed not to realise the gravity of the situation, pointing the finger at a host of external causes, from overcapacity to lower demand for premium service to whipsawing foreign currencies. Announcing last year’s torrid results, the chief executive Ivan Chu promised to cut costs by 3 per cent, boost productivity, and streamline the group into seven units.
But after gauging the market’s reaction – a typical comment came from the analyst Will Horton at the aviation consultancy CAPA, who called the carrier’s supine response “shocking” – Cathay rethought its position. In March, a humbled Mr Chu pledged to slash the cost of middle and senior management roles at its head office by 30 per cent, admitting the firm needed a “simplified” head office structure that would “inevitably” lead to job losses.
In truth, he had little choice. While some of Cathay’s struggles are beyond its control, there is plenty of blame to go around. Energy prices are at multi-year lows, yet Cathay’s management team conspired to lose US$1.8bn last year by hedging its fuel needs at prices far higher than those in the prevailing spot market. It was an uncomfortable echo of 2008, when the carrier contrived to lose millions of dollars by bungling its hedging contracts. That also marked the last year Cathay posted a full-year loss.
One of Cathay’s main problems is its consummate inability to move with the times. It is still a wonderful service to fly – friendly, clean, efficient and much liked by premium and economy customers. But so what? Budget carriers, wooing punters with the promise of low prices and reliable (if not dazzling) service, are eating into its margins.
Moreover, many of Asia’s older, full-service carriers are sprucing up tired fleets and making their own push for glory. Skytrax’s latest ranking of the world’s best 100 airlines, published in 2016, contained nine Asian carriers. And while Cathay slotted in at number four, ensuring that it retained regional bragging rights, it fell a single place from third.
Cathay also finds itself squeezed by the enduring excellence of the Middle East’s big three carriers. Emirates won Skytrax’s 2016 award for best global airline, with Qatar Airways second and Etihad Airways sixth. And the challenge from across the border is no less great. Mainland China boasts 48 operators, ranging from would-be super-majors (China Eastern, Air China) down to buzzing start-ups (Colorful Guizhou Airlines), all of which routinely launch price wars with one another, further crushing prices and margins.
The Hong Kong carrier faces other challenges. It has been cosseted by local authorities, leaving it poorly equipped to compete in a more open market. And it relied for too many years, reckons Michael Beer, an aviation analyst at Citi in Hong Kong, on a single trump card: its image as a bridge between China and the outside world. “Cathay used to basically sit still and print money,” he tells The National. “They could charge whatever they wanted, as everyone had to come through Hong Kong to get to Beijing or Shanghai. In the end, they got so scared of losing their image as a China play that they forgot they were a global carrier.”
Then there is the fact that Cathay and Hong Kong are often viewed as interlocking brands, each bound by history and invested in the other’s future. As one goes, so does the other. Can it be chance that the carrier’s troubles have coincided with a slump in the number of tourists visiting the city itself? The chairman of Hong Kong’s tourism board, Peter Lam, tips inbound tourist arrivals to fall 2.2 per cent this year, after slumping 4.5 per cent in 2016. Panicked politicians reacted by forging ahead with a third runway, and waiving or cutting the cost of airport licences for travel agents, shops and restaurants. But analysts wonder if this belated act of munificence is too little, too late.
Cathay is not the only full-service carrier suffering from high costs and external competition. Singapore Airlines pipped Cathay for third place in last year’s Skytrax poll and is just as beloved by business travellers. But it is also feeling the pinch. Profits fell 36 per cent year-on-year in the three months to end-December, with South East Asia’s largest operator blaming fewer passengers, overcapacity and the cost of rebranding one of its budget carriers, Tigerair.
The carrier has warned of another tough year ahead. A spokesman tells The National that Singapore Airlines is “proactively” looking for ways to make it more flexible and nimble while generating “new engines of growth”. It is working hard to build out new airlines in India (where it co-owns Vistara with Tata Group), and in Thailand, where it part-owns another budget operator, NokScoot, in an effort to tap into new traffic flows. Cathay declined to comment when contacted by The National.
So what does the future hold for these two venerable airlines? Both have reacted sensibly to their financial woes this year, cutting costs and streamlining, and their respective stock prices have reacted positively. But it is hard to shake the feeling that Singapore Airlines is in a stronger position. It has vied with the big Arabian Gulf carriers for premium passengers flying the “Kangaroo” route between Australia and Europe for far longer, giving it time to hone its competitive edge. Singapore is also, arguably, in a better financial state. It posted a return on assets (ROA) and return on equity (ROE) of 3.3 per cent and 5.4 per cent, respectively, in 2016. Compare that with Cathay, whose ROA and ROE fell last year to 0.16 per cent and 0.11 per cent.
Analysts asked to ponder Cathay’s future are divided. One suggests that Air China, state-backed and already the second-largest shareholder in Cathay with a 19.9 per cent stake, would be the ideal long-term owner. “It would provide the perfect exit for Swire,” the analyst, who prefers to remain anonymous, tells The National. “And it’s the last vestige of a big, family-run Hong Kong firm being sold to a Chinese state enterprise, so it’s kind of inevitable in that way, too.”
Others are not so sure, pointing to Hong Kong’s uncertain future as a global aviation hub. “A sale would be in Cathay’s best interests, but not in Air China’s,” says K Ajith, an aviation analyst at UOB Kay Hian.
Cathay Pacific remains a great airline brand, but for how long? “Cathay is a very high quality, high service airline, but that’s not the way the industry is trending right now,” says Jim Corridore, a New York-based analyst at CFRA Research. “There is very little customer loyalty left any more.”
It may be painful to admit, but rising competition, high costs and last year’s sudden plunge into the red have left investors and analysts wondering if Cathay has already seen its best days as an independent airline.
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Updated: April 10, 2017 04:00 AM