13-Jun-2015 6:00 PM

Philippine Airlines will renew its long haul fleet with more 777-300ERs and potentially A350-900s

Analysis

Philippine Airlines (PAL) is leasing two additional 777-300ERs and is looking to acquire four to six new-generation widebody aircraft, most likely A350-900s. The group's new widebody fleet plan envisions phasing out six recently acquired A340-300s over the next three years while also potentially pursuing relatively modest long-haul growth.

PAL is keen to offer a standard product across its long-haul operation, which currently consists of one destination in Europe and five in North America. Los Angeles and San Francisco could transition to an all-777-300ER operation by the end of 2016, while A350s could be used to introduce non-stops to New York, which was launched in Mar-2015 with service via Vancouver.

PAL is also planning to standardise its A330-300 fleet by retrofitting the eight aircraft which currently are in all-economy configuration. PAL may sublease two of its 15 A330-300s but growth of the medium-haul network could still be pursued using A321neos.

Summary

Philippine Airlines (PAL) is leasing two additional 777-300ERs and is considering acquiring four to six new-generation widebody aircraft, most likely A350-900s.
PAL plans to phase out six recently acquired A340-300s over the next three years while also potentially pursuing modest long-haul growth.
PAL aims to offer a standard product across its long-haul operation, potentially transitioning Los Angeles and San Francisco to an all-777-300ER operation by the end of 2016.
PAL is planning to retrofit its eight A330-300s, which are currently in an all-economy configuration, and may sublease two of them.
PAL is looking to acquire at least four and as many as six new-generation widebody aircraft for delivery in 2017 and 2018, most likely A350-900s.
PAL is considering using A321neoLRs to expand its medium-haul operation, potentially introducing non-stop flights to Brisbane, Melbourne, and Sydney.

PAL took delivery of 23 widebody aircraft in 2013 and 2014

PAL's widebody fleet currently consists of 27 aircraft, including 15 A330-300s, six 777-300ERs and six A340-300s. All the A330s and A340s were delivered in 2013 or 2014 and were acquired under the fleet plan that was developed by Philippine conglomerate San Miguel, which controlled PAL from Apr-2012 to Oct-2014. PAL phased out its ageing fleet of 747-400s in 2014 along with older model A340-300s.

The 777-300ERs were acquired under the original fleet plan by the Lucio Tan Group, which sold a controlling stake to San Miguel in early 2012 but reacquired the stake in 2014. PAL initially placed an order with Boeing in 2007 for two 777-300ERs and two options and at the same time agreed to lease two of the type from GECAS. The two options were subsequently exercised.

The first batch of two 777-300ERs were delivered in 2009. Another two 777-300ERs were delivered in 2012 and the final batch of two aircraft were delivered in 2013. All six aircraft have 370 seats, including 42 angle-flat seats in business in two-three-two configuration and 328 economy seats in three-four-three configuration.

The A340-300s are ex-Iberia aircraft that are leased from Airbus and are currently between 13 and 16 years old, according to the CAPA Fleet Database. They are in 254-seat two-class configuration including 36 recliner seats in business and 218 seats in economy.

Philippine Airlines average aircraft age by fleet type: as of 12-Jun-2015

The A330s are all less than two years old and include eight aircraft in 414-seat all-economy configuration (375 regular economy and 39 premium economy) and seven aircraft in 368-seat three-class configuration (18 business, 27 premium economy and 323 regular economy). The premium economy cabin features extra legroom but the same seat as economy with the same nine-abreast configuration.

PAL currently has a mismatch of products on long-haul routes

PAL uses its A330-300s on medium-haul routes within Asia as well as to Australia, Hawaii and the Middle East. The single-class A330s are generally used on select Middle East routes.

The 777-300ERs are currently used to operate seven weekly flights to Vancouver (including four of which continue onto Toronto), seven weekly flights to San Francisco and six weekly flights to Los Angeles, according to OAG schedule data. The A340-300s are currently used to operate five weekly flights to Los Angeles, four weekly flights to London Heathrow, four weekly flights to Vancouver (all of which continue onto New York) and three weekly flights to San Francisco.

PAL began using 777-300ERs to Los Angeles and San Francisco in May-2014. While the 777s were initially acquired for the US market, PAL was previously unable to change gauge on existing US flights or launch new US flights because of Category 2 restrictions.

The US FAA restored the Philippines Category 1 rating in early 2014, enabling PAL to finally phase out its 747 fleet. But PAL had to place A340s on Heathrow to free up 777-300ERs for Los Angeles and San Francisco. PAL also did not have sufficient 777-300ERs to use 777 on all Los Angeles and San Francisco flights, leading to the current less than ideal mismatch of products and a search for more 777-300ERs.

PAL will add two 777-300ERs in 2015

PAL president Jaime Bautista told CAPA at the 8-Jun-2015 IATA annual general meeting in Miami that the carrier recently committed to leasing two additional new 777-300ERs for delivery in 2016. The additional aircraft will be delivered in the same 370-seat configuration as the existing six 777-300ERs.

PAL will most likely use the two additional 777-300ERs to transition Los Angeles and San Francisco to an all 777-300ER operation. PAL is also considering placing the additional 777-300ERs on the Manila-Vancouver-New York route but if this was pursued it would not also be able to upgrade all its Los Angeles and San Francisco flights.

Providing a uniform product in the California market would be logical and could help boost sales. Los Angeles and San Francisco are PAL's two largest international markets. While Manila-San Francisco has slightly less ASKs than Manila-Vancouver a large portion of the Vancouver capacity is allocated to New York and Toronto while all the San Francisco capacity is for the local San Francisco market.

Philippine Airlines top 10 international routes based on ASKs: 8-Jun-2015 to 14-Jun-2014

PAL will continue to operate the A340 to London and probably New York

The 777-300ER offers a far better and newer product than the A340 in both cabins. The A340 only has overhead in-flight entertainment monitors in economy. Individual monitors are provided upfront but the business cabin has old recliner style seats and lacks power outlets.

If Los Angeles and San Francisco are upgraded to an all-777 product, Manila-London and Manila-Vancouver-New York will be left as the only remaining A340 routes. The other Vancouver flights, which include three turnaround flights and four which continue onto Toronto, are already operated with 777-300ERs.

While the use of the A340 on the recently launched Manila-Vancouver-New York route creates a mismatch of products in the Vancouver market this is more manageable than the mismatch in the California market because a majority of Manila-Vancouver passengers continue onto New York. PAL has fifth freedom rights to pick up local passengers between Vancouver and New York but has experienced strong local demand on Manila-New York.

PAL eyes A350s and more Heathrow flights

PAL is still in the process of finalising a new widebody fleet plan but most likely the new plan will see the A340s being phased out entirely in 2018. PAL has been evaluating the 787-9 and A350-900 as potential replacements for its last four A340s.

Mr Bautista told CAPA that PAL is looking to acquire at least four and as many as six new-generation widebody aircraft for delivery in 2017 and 2018. Six aircraft would give PAL an opportunity to expand its network in North America and Europe and/or operate additional frequencies to its six existing long-haul destinations. PAL is particularly keen to upgrade its London service to daily.

As CAPA previously outlined, PAL has been able to improve its performance on the London-Manila route since moving to a later arrival and departure slot at Heathrow in Mar-2015. The new timings improve connections on the Manila end as previously the flight departed Manila too early to facilitate connections. PAL is now looking for more evening slots at Heathrow to accommodate a daily service.

London and New York could potentially be served with new-generation widebody aircraft. The A350-900 has emerged as the strong favourite as Airbus has informed PAL that it could use the type to operate non-stop services to New York. PAL was able to get a close look at the A350-900 in May-2015, when Airbus had a demonstration flight in Manila, and will have further discussions with Airbus during the Paris Air Show, which starts on 15-Jun-2015.

PAL cosiders non-stops to New York but will continue to serve Toronto with one-stops

PAL is eager to provide a non-stop product for the New York market. PAL does not believe any variants of the 787 or its existing fleet of 777-300ERs have the range to operate this route without payload restrictions. PAL also does not want to wait for the 777-8X, a new ultra long-range aircraft that would be able to operate Manila-New York but is not slated to enter service until around 2020.

While PAL is eager to serve New York non-stop it plans to continue to serve Toronto on a one-stop basis. PAL briefly operated from Manila to Toronto non-stop with 777-300ERs after launching services to Toronto in late 2012 while stopping in Vancouver on the return sector. A lack of demand rather than operating issues prompted PAL to end the eastbound non-stops in favour of one-stops in both directions.

Canada is currently PAL's third largest international market after the US and Japan based on ASKs.

Philippine Airlines largest international markets (countries) ranked by weekly ASKs: 8-Jun-2015 to 14-Jun-2014

North America overall accounts for over 40% of PAL's international ASKs but only about 17% of its total international seats.

Philippine Airlines international capacity share (% of ASKs) by region: 8-Jun-2015 to 14-Jun-2014

PAL plans adjustments to its under-utilised A330 fleet

PAL aims to eventually pursue expansion of its long-haul operation using a larger and more efficient long-haul fleet. For the short to medium term PAL will be limited to regional and medium-haul international expansion using its A320 family and A330 fleets.

PAL is not considering any expansion or renewal of its A330 fleet as part of its current fleet review. PAL instead is looking at reconfigurations and a possible slight reduction of its A330 fleet to better match supply with demand on medium-haul routes.

Mr Bautista said PAL would be interested in subleasing two of its A330s. As CAPA has previously outlined, PAL has been under-utilising its A330 fleet since taking the last batch of aircraft in late 2014. PAL is currently only utilising its A330 fleet an average of about nine hours per day.

The Lucio Tan Group initially determined after taking back control of PAL that the carrier had about seven too many A330s. But the number of excess aircraft has reduced to a more manageable two as PAL decided to use the A330 to replace the A340 on the Honolulu, Melbourne and Sydney routes.

The new fleet plan however envisions reconfiguring the eight all-economy aircraft within the next few years, or six if two aircraft are subleased. PAL is considering new 311-seat and 329-seat configurations for its 414-seat A330-300s.

This would provide a new less dense option, resulting in capacity reductions on some routes. The seven PAL aircraft which already have business class will stay in the current 375-seat configuration.

PAL A330 reconfiguration provide differentiation from Cebu Pacific

The reconfigured A330s will enable PAL to again offer a premium product across all its medium-haul routes. This should enable PAL to better differentiate its product compared to rival Cebu Pacific, which operates six A330s in single-class configuration. Cebu's new long-haul division and PAL currently compete on several routes to Australia and the Middle East.

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San Miguel's decision to pursue a dense all-economy configuration for eight A330s was seen as a response to Cebu's early 2012 decision to establish a medium/long-haul unit. Lucio Tan is now keen to reverse the San Miguel decision and focus on providing a higher end product, rather than simply following Cebu Pacific.

This is a sensible approach given Cebu's lower cost structure and the fact there is some premium demand on all the routes PAL serves with A330s. PAL particularly points to its success in the Dammam market, where it has added capacity while Cebu Pacific has withdrawn.

PAL considers the A321neoLR

PAL also sees opportunities to expand its medium-haul operation using new-generation A321neo aircraft. PAL has 30 A321neos on order for delivery from 2017.

The A321neos provide significantly improved range over the A321ceo, opening up new medium-haul routes. Mr Bautista said PAL is also considering converting some of its A321neo orders to the A321neoLR, a newly launched long-haul version that is capable of flying on routes of up to eight hours.

PAL is considering outfitting A321neoLRs with lie-flat business class seats and operating the aircraft to Australia. Launching non-stop flights to Brisbane, which is now served via Darwin, is a likely route for the A321neoLR. PAL also believes using the new type for Melbourne and Sydney would be a possibility.

PAL launched Manila-Darwin-Brisbane and Manila-Darwin-Perth services in 2013. Perth quickly proved to be unviable and was dropped. Brisbane has been a stronger market than Darwin but PAL does not currently have a suitable aircraft to operate Brisbane non-stop.

PAL is also using the A320ceo to launch on 1-Dec-2015 four weekly flights to Auckland via Cairns. But Auckland would not be within range of the A321neoLR.

PAL's A320s are currently configured with 156 seats including 12 in business and 144 in economy. The PAL Group also has A320s in single-class configuration but these are all operated by sister carrier PAL Express.

PAL's newer A321s are configured with 199 seats including 12 in business, 18 in premium economy and 169 in economy. As is the case with the A330s, PAL's premium economy product on the A321 features the same seat as regular economy but extra legroom.

There are no A321s at PAL Express, which currently operates only A320s and Bombardier Dash 8 turboprops. PAL Express operated two of the single-class A330s until late Mar-2015, when it handed its only long-haul route, Manila-Dubai, to PAL mainline.

All of PAL's A321s have been delivered over the last two years and were ordered by San Miguel in 2012. PAL currently operates 19 A321ceos, including five which have been delivered since the beginning of 2015, and has five more on order.

PAL Group fleet: as of 12-Jun-2015

Aircraft	In Service	On Order
Total:	77	35
Airbus A320-200	22	0
Airbus A321-200	19	5
Airbus A321-200neo	0	30
Airbus A330-300E	15	0
Airbus A340-300X	6	0
Boeing 777-300ER	6	0
Bombardier DHC-8Q-314	4	0
Bombardier DHC-8Q-402	5	0

PAL's new fleet plan will result in more modest capacity growth

Lucio Tan has slowed down growth by deferring five of the 10 A321 deliveries originally slated for 2014 as well as five of the 10 A320 deliveries originally slated for 2015. These 10 aircraft will now be delivered as neos in 2020 to 2024.

PAL also sold two A320ceos in 1H2015, resulting in a net gain of three narrowbody aircraft (as five A321ceos were delivered). PAL is not planning any aircraft deliveries or retirements in 2H2015.

In 2016 it plans to return two A320s while taking five A321neos, again resulting in relatively modest net growth of three narrowbody aircraft. As discussed earlier in this report, PAL plans to take two 777-300ERs in 2016 but will retire two A340-300s.

The new fleet plan gives PAL an opportunity to take a breather after rapid fleet and capacity growth in 2013 and 2014. The Lucio Tan Group seems to be taking a more disciplined approach to capacity which should enable PAL as well as its two local competitors, Cebu Pacific and Philippines AirAsia, to continue to improve profitability. PAL posted an annual profit in 2014 for the first time in four years and was again in the black in 1Q2015.

New widebodies should improve PAL's position in long-haul markets

PAL is clearly benefitting from lower fuel prices, particularly on A340-operated routes. But PAL cannot bank on continued lower fuel prices. Transitioning to a more efficient long-haul fleet will improve the carrier's long-term position and also unlock growth opportunities.

North America has traditionally been PAL's largest and most profitable market. But PAL will eventually face competition in this key market against Cebu Pacific, which is now looking at acquiring A350s to serve the west coast of North America. Quickly acquiring more 777-300ERs and locking in early A350 delivery slots should improve PAL's long-term position in the Philippine long-haul market as competition intensifies.

A further encouraging sign is that PAL is not being overly aggressive and is looking to acquire only a modest number of new long-haul aircraft. This is a refreshing change after the overly ambitious buying spree from San Miguel in 2012.

A long-haul fleet of 14 aircraft should easily be sustainable, even with increased competition, as the Philippines is now seeing healthy demand and economic growth.