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Hong Kong Airlines continues expansion; Jetstar HK appoints CEO & Dragonair to grow closer to Cathay

11-Feb-2013

The previous one-size-fits-all regional market from Hong Kong continues to go through rapid segmentation as competition diversifies. Fast-growing Hong Kong Airlines will significantly expand its frequency over early 2013, especially into mainland China, allowing it to match or surpass full-service peer Dragonair on overlapping cities.

The additional frequency will also elevate its expansion ahead of LCC Spring Airlines, although this is in terms of schedule and not price, where Spring retains the edge.

Further competition at the low end of the market is set to come from Jetstar Hong Kong, which has appointed its first CFO and CEO and formally received Beijing’s blessing, indicating the rejection from Hong Kong authorities that Cathay Pacific hoped for is increasingly unlikely.

Cathay meanwhile is seeking to present a unified premium experience between itself and subsidiary Dragonair, which may grow even closer to Cathay with a re-branding exercise; a proposed “Cathay Dragon” name could be a possibility to have a stronger positioning in a changing market.

Expanding Hong Kong Airlines looks to gain scale and superior positioning

Hong Kong Airlines could be considered Asia’s fastest-growing carrier of notable size. Some of this growth has occurred haphazardly as aircraft were added before thorough route analysis could be completed or enough support given to the operation, from both a staff and front-line perspective.

That led Hong Kong’s aviation regulator, the Civil Aviation Department (HKCAD), to impose growth restrictions on the carrier in 2012, an act seized upon by detractors but internally met with favour as it forced the carrier to plan its expansion more methodically.

The HKCAD has since lifted the restrictions, allowing Hong Kong Airlines to expand its fleet from 20 to 22 with the addition of two A330s. The expansion from Feb-2013 is through the end of its schedule and thus not seasonal.

The additional growth is occurring through expanded service on existing routes, as well as the re-introduction of Hong Kong-Tokyo Narita services, culled in the wake of deteriorating Japan-China relations over uninhabited islands.

Four of Hong Kong Airlines’ expanded routes will have a frequency equal to or larger than that of Dragonair while other routes will have a lesser gap with its competitor. To be clear, the focus is not on size; Cathay and Dragonair will always be a degree larger. But the matching on frequency correlates to a more competitive schedule. On some routes Hong Kong Airlines will operate narrowbodies where Dragonair also does (Haikou), or operates widebodies (Taipei).

Hong Kong Airlines will also set itself apart from Spring Airlines, which in late 2012 opened four new routes from Hong Kong after previously having only a Hong Kong-Shanghai Pudong (up to triple daily) and Hong Kong-Shijiazhuang-Shenyang (thrice weekly) service.

Hong Kong Airlines/Hong Kong Express frequency expansion overview: Feb-2013

Route

Hong Kong Airlines Service Jan-2013

Hong Kong Airlines Expanded service: Apr-2013

Cathay/Dragonair capacity: Apr-2013

Spring Airlines capacity: Apr-2013

Hong Kong-Bangkok

3x daily

4x daily

About 6x daily

n/a

Hong Kong-Fuzhou

Daily

2x daily

2x daily

n/a

Hong Kong-Haikou

Daily

2x daily

1x daily

n/a

Hong Kong-Hangzhou

Daily 737-800

Daily A330-200

5x daily

1x daily

Hong Kong-Nanjing

Daily

2x daily

2x daily

4x weekly

Hong Kong-Sanya

Daily

2x daily

5x weekly

n/a

Hong Kong-Shanghai Pudong

2x daily

3x daily

About 16x daily

3x daily

Hong Kong-Taipei Taoyuan

3x daily

4x daily

About 19x daily

n/a

Hong Kong Airlines is not a replacement for Dragonair, but a significant competitor

The numbers are stacked in Dragonair’s favour: it serves 22 cities in mainland China compared to Hong Kong Airlines/Express’ 15 while Cathay and Dragonair in late Jan-2013 offered approximately 90,000 seats to mainland China, compared to Hong Kong Airlines/Express’ 24,000.

Hong Kong Airlines is growing fast, but it is not trying to mirror Dragonair; it knows it will be a smaller competitor yet believes a competitive service with a lower cost base and sufficient frequency will make it attractive to a large portion of the market, leaving the most frequency and service sensitive passengers to Dragonair.

See related article: Hong Kong Airlines, Asia's fastest growing carrier, looks to become reckoning force in the region

The expanded capacity is leaving Hong Kong Airlines with considerable pressure to market the new services, which on some routes involves twice as much capacity as before. Price will be a key stimulant as the carrier is willing to reduce yields in return for higher load factors - unlike Dragonair, which is generally favouring yields over load factors.

Dragonair’s North Asian load factor has dropped 10ppt in two years

Traffic results show the combined Cathay/Dragonair North Asia network load factor (measured in RPK/ASK – seat figures not provided) averaged 71% in 2012 while the system average was 80%. China accounts for the single largest share.

Long-haul services with higher load factors offset the North Asia flights with lower load factors and higher yields, a combination that appeases investors typically focused more on yield than load factor. This approach may prove short-sighted, however. While Cathay and Dragonair seem eager to use the limited Hong Kong slots available rather than see expanding competitors use them, an expected third runway due to be completed in 2015 will add slots.

Restricting competitors who will inevitably expand is threatening to erode shareholder value – if it has not already. From 2010 to 2012 Cathay and Dragonair’s RPKs in Northeast Asia (where Hong Kong Airlines mainly competes) grew only 1.5%, far outstripped by ASK growth of 15.6%. This has seen load factors fall 10ppt from the 81% achieved in 2010.

While 2010 was a record year of profitability for Cathay, the average system load factor then was 83.4%, down only 3ppt in 2012 at 80.1% indicating a wider gap. The long-haul operation may be efficient, but short-haul is not. (Nor in passing is it very environmentally friendly.)

Cathay Pacific/Dragonair North Asia RPK: 2010-2012

Cathay Pacific/Dragonair North Asia load factor (RPK/ASK): 2010-2012

Hong Kong Airlines is not without its own serious challenges. An airport bill – unpaid due to differences of “opinion”, according to Hong Kong Airlines – reportedly nearly saw the airport impound aircraft until an 11th-hour payment was made. While the carrier is gaining traction among travel agencies, it still has considerable marketing to do to a public long-exposed to heavyweights Cathay and Dragonair.

Hong Kong Airlines has suffered at times from a lack of focus. For over a year now the carrier has toyed with an LCC spin-off – announcing it, delaying it and then re-announcing it in late-2012 – and most recently has delayed it again. The change of attitude however may allow the carrier finally to concentrate its focus, which should deliver positive outcomes in terms of growth, sustainability and market perception.

Jetstar Hong Kong nears mid-2013 launch, further changing Hong Kong's competitive landscape

While Hong Kong Airlines prevaricates about an LCC and Cathay remains strongly opposed (pointing to its Hong Kong-Penang operation being sustained despite AirAsia recently pulling off), Jetstar Hong Kong is growing closer to a mid-2013 launch.

It is a 50-50 joint venture between Shanghai’s China Eastern and Melbourne-based Jetstar, a wholly-owned subsidiary of the Qantas Group.

Critically, the carrier has secured approval from Beijing, whose Ministry of Commerce gave antitrust approval. (Australian authorities have also permitted cooperation between Jetstar Hong Kong and Australia-based Jetstar Airways, although this only affects what type of tickets consumers in Australia could see, and not the existential right of the airline.)

With Beijing’s approval, a rejection from Hong Kong authorities for an air operator’s licence looks less likely. Although Hong Kong, a special administrative region of the People’s Republic of China, officially operates under its own laws, Beijing looms overhead. That is not to say Jetstar Hong Kong had any less validity without Beijing’s backing.

But, given the close links between Cathay shareholder/partner Air China and the Beijing administration, Beijing's decision to approve a China Eastern/Jetstar operation would at least appear to remove one significant potential area of opposition.

Cathay, however, has taken the view that the operation will fail to meet local ownership and control requirements and therefore should be rejected. Airlines typically have to demonstrate local majority ownership and control, both for local regulatory compliance and to conform with bilateral air services agreements with the territories where the airline will be operating. Local ownership is relatively straightforward to prove, but the latter point is open to interpretation.

It is an open secret that, in the Asian cross border joint venture operations, the parent airline hub exerts elements of control. This has arguably become a norm of the recent regulatory easing occurring in the region and one to which Hong Kong authorities themselves have acceded, in permitting foreign LCCs to fly there.

Cathay, taking the view Jetstar Hong Kong will be Australian-controlled and thus a foreign entity, has made vague references that if an Australian carrier can establish itself in Hong Kong then there should be some quid pro quo. Cathay - or any foreign carrier - can in fact establish a domestic airline in Australia under more liberal ownership laws there (Tiger Airways Australia is wholly owned by Singapore-based Tiger, although Virgin Australia has proposed to take control).

But Cathay will not launch a domestic carrier in Australia, so its talk could be simply to stir discussions and not be seen as being steamrolled; or it could concern some other matter, such as wanting expanded air services to Australia, as it is currently using almost its entire allotment. Australia, however, will take the view Jetstar Hong Kong is a Hong Kong-based carrier and thus the discussion of granting anything to Cathay is moot.

Jetstar in Feb-2013 announced the appointment of Edward Lau as inaugural CEO effective 18-Feb-2013. Representatives from China Eastern and Jetstar have been establishing the carrier since it was announced. Mr Lau was previously MD Hong Kong for TNT and held additional positions with the company. He has also worked for Hay Group, Rosenbluth International and was part of the team that established FedEx in Asia, according to Jetstar.

Mr Lau’s appointment follows the Jan-2013 appointment of Howard Cheung as Jetstar Hong Kong CFO. Mr Cheung worked for Amcor and Rio Tinto Alcan from 2006 to 2012 and held senior roles across the company, most recently CFO Amcor Flexibles. Mr Cheung also worked for 10 years at General Electric in finance and operations positions. Other appointments include the appointment of Ronnie Choi Mow Sang, former president of Hong Kong Express, to the Jetstar board as an independent non-executive director. The chairman is China Eastern V-P, Tang Bing.

The appointment of local leaders with business backgrounds but not in aviation is consistent with the approach of JVs to harness local connections – and regulatory requirements – while ensuring head office can maintain influence. Two of the six directors are Group CEO Jane Hrdlicka and CCO David Koczkar.

Dragonair could align further to Cathay after a restriction on branding expires; a Cathay Dragon?

In the days when Hong Kong's market was less dynamic, Cathay Pacific operated Dragonair (fully acquired in 2006) across multiple market segments, whlle preserving Cathay’s ultra-premium positioning. The dual-brand strategy did not curry favour with travellers, who were often subjected to using Dragonair as there was no other choice (Cathay and Dragonair overlap on only a few routes and Cathay codeshares on almost every Dragonair service).

In recent times Dragonair has received attention, first with new staff uniforms and in Jan-2013 a much-needed update to interiors that will see Dragonair use Cathay’s exact interior style. The move is to align the carriers but also to present Dragonair as a more premium carrier, both to passengers connecting off long-haul Cathay flights and to passengers who might otherwise have taken Hong Kong Airlines, which has had a more modern look than Dragonair. Cathay CEO John Slosar in Mar-2012 remarked of the need to “create a seamless experience between KA and CX to help maintain the Group’s competitive edge against other fastgrowing hubs and carriers”.

See related article: Quiet achiever Dragonair aligns with owner Cathay Pacific in recognition of its growing stature

The alignment may not be over. Following the internal re-branding, Cathay may look externally and re-name the carrier and give it a logo that ties in with its big sister, all but merging the two.

One option could be “Cathay Dragon”, according to marketing images that have been circulating. Although a decision has not been announced, the “Cathay Dragon” concept is understood to have been evaluated, amongst other options. The concept shows Dragonair adopting Cathay’s livery but with “Dragon” instead of “Pacific” and a dragon being featured on the mid fuselage.

Cathay acknowledges it has been evaluating a re-branding. As it tells CAPA, “Dragonair constantly looks at different means to improve on our product and service offerings… For some time now, as part of this effort, we have also been looking at design propositions in enhancing the airline’s image and service positioning which is a rather lengthy process and no decision on any design has yet been made. For now the liveries will remain as they are. Regardless of any future design changes, Dragonair will retain its own brand identity.”

The re-branding may occur sooner rather than later, as Cathay in late 2012 was relieved of its obligation, imposed at the time of the 2006 takeover of Dragonair, to preserve the Dragonair branding for six years. Closer alignment would give better synergies – marketing, cost – at a time Cathay needs a stronger, unified image of the group.

Arguments start to build for a full integration to achieve more synergies, but one argument against combining AOCs is that certain Hong Kong-mainland China routes have a maximum number of carriers that can operate; combining Cathay and Dragonair could open the door to new entrants, just as those possible entities are appearing. Opening the door to added competition is not what Cathay is seeking.

Even a re-branding will not be without challenges. Investors will be wary of cost creep; Dragonair has a lower cost than Cathay but it is still not an especially defensible level as new aggressive entrants circle. The new interiors and service flow introduced in Jan-2013 will cost less than if Dragonair implemented them without Cathay, but still represent a higher cost than its previous, simpler, service (the seats, for example, are now heavier).

Pay disagreements also become a stronger possibility. As CAPA previously wrote:

[Staff] can argue that if a subsidiary is effectively the same as the parent, then staff (often paid less on a subsidiary and/or with higher productivity requirements) should be treated the same as those at the parent. This equation is the same on a worldwide scale.

Qantas in Jan-2013 saw the end of a bitter battle between management and staff for pilots at LCC unit Jetstar to be employed under Qantas contracts. Iberia staff have protested the same about Iberia Express. Cathay has had run-ins with its unions – a strike was averted days before Christmas 2012 – and wages are a frequent discussion in the local press.

Consumers benefit from more competition than ever – but can airlines respond?

Additional capacity from Dragonair, along with different market profiles from Hong Kong Airlines, Jetstar Hong Kong and Spring Airlines benefits the market, but not always the airlines. Some, like Hong Kong Airlines, face short-term challenges to spool up and support the capacity while Dragonair will find itself the underdog in certain markets in its own backyard. Responding could be uncomfortable with capacity growth already well ahead of demand, resulting in load factors and bottom lines taking a hit - or in wider discounting to stimulate growth.

There will also be duelling visions for each airline’s capability.

Jetstar and Spring see themselves targeting the leisure market and capturing some corporate passengers, while Hong Kong Airlines is more in the middle; Dragonair is positioned towards the higher end but believes it can extend its reach all the way down to the LCC market. The Cathay subsidiary believes it can conduct segmentation within its business (a concept that has indifferent evidence to support it), while the other carriers believe segmentation needs to be done at the airline level as cost determines all else.

That principle is straightforward but inexperienced markets can be reluctant to admit to it, let alone make corresponding changes. Hong Kong will see not just more choice than before but more change, evolution and hybridisation of modes too. The more interesting moves may not occur until well after smaller carriers gain more size, or launch in the market. Meanwhile, as Dragonair becomes more Cathay-like, questions persist over whether Cathay will finally bite the bullet and introduce its own LCC subsidiary.


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