Examining and addressing Cathay Pacific’s problems

Examining and addressing Cathay Pacific’s problems

Cathay Pacific has had a tough time of it lately.

Two weeks ago, Cathay team members at all levels were taken by surprise when Qatar Airways Group announced its acquisition of 9.61% of the airline’s shares. While this could be seen by some as alarming given Qatar’s outspoken CEO, I don’t believe they will be an activist investor.

A few days later, the Hang Seng Indexes Company announced that Cathay would lose its blue-chip status on Hong Kong’s benchmark index after a 31-year run. Its stock has slowly fallen from a 2010 high of USD3.10 to USD1.58 at press time.

These developments follow an August report that it’d lost USD260M in the first half of 2017, marking its worst performance in 20 years. The airline blamed tough competition and higher fuel prices for the losses, and said they didn’t expect that the second half of 2017 would be any better.

Cathay’s present financial situation is not hopeless – despite the headwinds, there are some actions that management can take to curb the losses and return the airline’s revenues to black. Before highlighting some recommendations on how best to go about doing this, I’ll briefly examine its present challenges.

Jet A1 costs

This is where the carrier’s argument about higher fuel costs has to be parsed out somewhat: the price of oil fell in 2014 and hasn’t fully recovered since. This has been great for many airlines, because the price of jet fuel is directly correlated to the price of oil.

But not for Cathay. In 2015, management believed that fuel prices would rise, so they pre-purchased fuel (hedging) somewhere in the USD90 to 100 range. Saying this was a bad bet would be the understatement of the century. In both 2015 and 2016 respectively, Cathay lost over USD1B due to their hedging program.

To be fair, a number of airlines have been stuck carrying those costs long-term as well – few predicted the price of oil would stay low for this long. The important thing to note is that the decisions on hedging have been made, and there is nothing Cathay can do at this stage to change that apart from finding ways to offset the losses.

Competition

A Bloomberg article from January spelled it out with a very 40,000 foot approach: Hong Kong-based (HKG) Cathay and Singapore-based Singapore Airlines are being “crushed between the tectonic plates of the Chinese and Gulf carriers.” This is certainly true, and low-cost carriers (LCCs) haven’t helped the situation. In its 2017 Interim Report, Cathay notes, “yield on routes between Hong Kong and Mainland China and Southeast Asia was under pressure because of increased competition, particularly from low-cost carriers.”

Cathay is also increasingly having to compete with direct, point-to-point flights in the region from Chinese and foreign airlines that forgo regional hubs altogether (i.e. China Southern operating Guangzhou-San Francisco, Hainan Airlines with Xian-Sydney).

To add to its problems, Cathay’s main competitor, Hong Kong Airlines (HKA), has grown rapidly over the last several years. Its latest expansion is on two prime routes for Cathay, from Hong Kong to Los Angeles and San Francisco. Cathay flies 3x daily to each of these California cities. HKA will launch daily service to Los Angeles mid-December, and in March will begin flying to San Francisco 4x weekly (that flight will go daily starting in August). Both routes will be serviced by their brand new A350-900, which features just 33 seats in Business, 108 in Economy Comfort and 193 in standard Economy.

HKA and Hong Kong Express (a HKG-based LCC) are both owned by a Mainland aviation powerhouse, HNA Group. HNA Group has stakes in a variety of other airlines, including Hainan. The holding company has money and political connections, critical at a time when the Mainland’s control over the Special Administrative Region (SAR) of Hong Kong is strengthening.

Cathay’s home base of HKG is one of the most congested airports in the world. The airline flies a lot over, to, and from the Mainland, where air traffic control restraints are high, and delays at their airports are the worst in the world: “At the 13 Chinese airports that rank among the world’s top 100, flights are delayed by 43 minutes on average. The global norm, excluding China, is 27 minutes.”

Thus it is difficult for Cathay to record a high on-time performance. More delays, longer hold times, and missed connections mean higher costs for the airline.

Reassess, plan and execute

While the fuel hedging program has been a more significant factor in Cathay’s losses, that will come off the books at some stage in the next year or two; competition and other costs that can be adjusted downward will remain. The rise of Chinese carriers and the opening of direct services to and from first, second and third tier Mainland cities by local and international airlines is a trend that’s very likely to continue well into the future. Cathay should completely reassess its model and, indeed, its corporate raison d’être. The risk of not doing so means the airline could fold.

Cathay can’t seem to address its problems possibly because of a division at the highest level pitting more conservative thinking with more forward thinking. I believe this is the case because, despite their horrendous financial performance of late, the airline has still not deployed cost-cutting and enhanced marketing measures that have proven to provide better returns for legacy carriers.

It’s easier said than done. To understand the problem, you must understand the conservative mindset that is deeply rooted in Cathay’s culture. The airline sees itself – rightly so – as sophisticated and high-class, as concerned with style, design and aesthetics, as it is with providing the best service in Asia. Few would argue with them on these points.

The conservative, slow-to-change group do not want to trade the service and style for the adoption of low-cost carrier policies as many legacy carriers have. But at what cost? Is it not possible to find a middle ground that will allow the airline to retain its sense of sophistication and class with more revenue? The other group certainly believes so, but it requires innovative thinking.

Recommendations

Here are several examples of how Cathay can turn things around.

  1. Increase the marketing budget. Cathay has a fantastic marketing team, but it seems the lines they operate in are very rigid. Most marketing campaigns, ads, and social media posts I’ve seen are positive, refined, and picture-perfect. Cathay calls this philosophy “softly spoken, strongly felt.” Yes, we understand that your airline has style, sophistication and great service, and we appreciate it. But how is that an advantage to the many travelers and corporate bean counters looking at their bottom line? Appeal to their check-books by highlighting, more directly, your value. Be more aggressive with your ads (within cultural norms). Do you have a premium product that far exceeds your competitors’? Shout it out loud. Do you offer more meals than they do? Let’s hear about it. Blanket your struggling markets with ads and PR campaigns.
  2. Make faster route network decisions and changes. It’s critical for airlines to actively manage their capacity by constantly reassessing their routes. In the last couple of years, Cathay has already cut some money-losing routes and redeployed the aircraft on profitable ones. A great example is their Middle East footprint, where they cut some flights, like Riyadh and Doha, redeployed their assets on profitable routes, and launched Tel Aviv, which has done really well so far. Management should continue making route changes like this, but be faster to make the decisions. As far as joint ventures and partnerships go, Cathay should drop unprofitable partnerships and forge new ones – even outside the Oneworld alliance. Qantas’ tie-up with Emirates is a great example of that – and now, a couple of years in, they’re dialing back the relationship because it makes business sense to do so.
  3. Cost-saving measures. Three years ago, Qantas embarked on an ambitious agenda to cut costs and turn a profit after bleeding money due to a capacity battle with Virgin Australia. The situation was so dire that the Australian government refused to guarantee the flag carrier’s debt. CEO Alan Joyce embarked on an aggressive cost-cutting program. His efforts bore fruit: in August 2016 – just two years later – the company paid their shareholders the first dividend in 7 years and gave employees who’d had an 18-month pay freeze a USD2,270 bonus. Cathay can get there but they need to follow a similar cost-cutting plan – for instance, launch new products in economy to diversify its revenue streams (i.e. sell lounge access during off-peak periods, restrict baggage allowances and sell extra, offer premium food & beverage options for a fee). Un-bundling Economy fares is an obvious revenue-boosting move that many full-service airlines around the world have made and are making to great results (i.e. British Airways, the US legacy carriers). Cathay should also boost their premium offerings (they’re already doing this to an extent by launching dine-on-demand) to give them a further edge over their competitors. Market this as “your money going farther.”
  4. Launch an LCC. Repositioning Cathay Dragon (KA) as such might seem like a good move, but changing the cost base of a full-service carrier to low-cost is a massive, expensive challenge. It would be easier to launch a new LCC that competes directly with HK Express. Open Skies slots (i.e. Cebu, Bangkok) could be passed down from KA, and the airline would be well-established ahead of the opening of the third runway at HKG in six years.  Qantas has Jetstar, Emirates has Fly Dubai, Lufthansa has Eurowings. All of which are bringing in money and helping offset the long-haul flights, which are not typically as profitable. It works! It brings in revenue and on certain routes it helps feed connecting traffic.

Bright spots

Cathay’s latest traffic figures – from September – show that there was an increase in front-end demand, meaning they’re selling more premium class tickets. They also showed that its flights to Japan were in higher demand, in line with a longer-term trend for that important market. The airline still has the best lounges and hard products in the region – there is a lot of value there.

It is a well-respected brand, but the team needs to do more to elevate Cathay’s brand penetration. Take the competition head on marketing-wise and seek to reduce costs by changing suppliers and renegotiating existing contracts. With a little innovation and change of attitude, Cathay can definitely turn it around – I hope they do.

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