China Eastern's new-generation partnerships provide a unique platform for its long-haul network

Long-haul, not the most pressing concern, could use friends

International services contributed 30.6% of China Eastern's revenue in 2012, up slightly from 29.4% in 2011. But the long-haul component of that operation remains on the backburner as China Eastern focuses on more pressing developments with its limited managerial resources - and most of these moves are in the domestic market.

China Eastern international seat capacity by region: 24-Jun-2013 to 30-Jun-2013

Source: CAPA - Centre for Aviation & Innovata

Yet significant opportunities await - and await quite literally: Qantas is eager for a deeper partnership (now that the Qantas-Emirates deal is established) and Etihad would be willing to expand its arrangement, which for now is a simple codeshare, along with frequent flyer reciprocity. China Eastern is still working through what greater scope a deal with Etihad could eventuate and in Apr-2013 is still in active negotiations with Qantas. The two are first putting efforts into launching their joint venture LCC Jetstar Hong Kong, due to launch in the second half of 2013.

As CAPA previously wrote of the potential scope for partnering with Qantas:

It is not just sheer scale that a Qantas-China Eastern relationship would deliver (likely starting as a deep codeshare and frequent flyer arrangement, and progressively expanding). There would be network benefits to both sides. China generally operates on a one route, one airline policy that sees international sectors limited to having one Chinese carrier on them, a policy designed to limit competition against Chinese carriers and instead let them build experience against international carriers.

The exception to this rule, to the chagrin of peers, is Air China. Although Air China, China Eastern and China Southern are all state-owned, Air China is the flagship, the government-preferred carrier that curries considerable favour in the power halls of Beijing, its base. The administrator of China's airline regulatory body, the CAAC, is a former Air China chairman. Air China is allowed to fly on routes already occupied by competitors, such as Shanghai-Sydney, which China Eastern serves. But in turn, China Eastern is not permitted to fly between Beijing and Sydney. The result is Air China has a wider spread for non-stop flights, serving Sydney from both Beijing and Shanghai.

China Eastern will not be able to fly to Australia from Beijing, save for secondary Australian cities Air China does not serve and would not object to China Eastern serving. Partnering with Qantas, however, gives China Eastern a friend that is unrestricted in its Chinese ports. Qantas had previously operated a Sydney-Beijing service but culled it in 2009; with feed from China Eastern, that service could be sustainable again. Qantas' sole passenger service into mainland China is a daily Sydney-Shanghai service. In 2009 Qantas ended a Melbourne-Shanghai service.

And of course there are the regular benefits from a tie-up: greater connections in home markets, combination of each other's frequent flyer programme members, reciprocal lounge access and the like.

The current Qantas-China Eastern relationship sees Qantas codeshare on China Eastern domestic services between Shanghai and Beijing, Chengdu, Dalian, Fuzhou, Guangzhou, Harbin, Kunming, Qingtao, Shenyang and Xian and also between Shanghai and Singapore. In turn, China Eastern codeshares on Qantas services including: 11 Australian domestic routes; five trans-Tasman routes; and between Singapore and Sydney, Melbourne, Brisbane, Perth and Adelaide.

See related article: Qantas & Virgin Australia look for new Asian partners: China Eastern for Qantas, Cathay for Virgin?

Since this report was published, China Eastern and Qantas have concluded the first phase of their partnership. Qantas will codeshare on China Eastern's Melbourne-Shanghai, Sydney-Nanjing-Beijing as well as Nanjing-Shanghai services.

And for Etihad:

China Eastern says it is interested in codesharing on Etihad's services to Saudi Arabia and potentially Africa. Saudi Arabia for many countries is an under-served market, partially a result of conservative growth at national carrier Saudia. While Saudia in May-2012 joined SkyTeam, its sole service to China - and the only route by any carrier between Saudi Arabia and China - is a three times weekly flight from Riyadh to Guangzhou.

China Eastern does not have a base at Guangzhou, and in any event the carrier has been more open to partnerships outside of alliance lines, partaking in a joint venture with Jetstar for a Hong Kong affiliate (Jetstar Hong Kong) as well as codesharing with Hong Kong Airlines. Etihad in Sep-2012 expanded its commercial team in Saudi Arabia, saying the moves reflect the "growing importance of this market for Etihad Airways".

See related article: China Eastern-Hong Kong Airlines partnership bolsters them in a market dominated by Air China-Cathay

...

Links between Africa and Asia, and China in particular, hold wide potential. That market segment is forecast to see the highest growth rate (albeit from a low base) of services to Asia, even eclipsing the intra-Asia growth rate. Ethiopian Airlines and Kenya Airways are bullishly betting on China with expansion plans.

See related articles:

• Ethiopian eyes 787 service to Hong Kong and new Asian services as Africa-Asia market booms
• Rapidly expanding Kenya Airways charts growth with plan to serve every inhabited continent by 2017

South African Airways in Feb-2012 launched non-stop services between Johannesburg and Beijing and Air China has raised the possibility of serving South Africa after 2013. Even Air Seychelles, following a strategic investment from Etihad Airways, is looking to use its hub at Mahe as a connecting point for Africa-China flights. Its initial connecting service will be from Johannesburg to Beijing, a market it reckons incumbents are too comfortable in.

See related article: Etihad Airways stake in Air Seychelles gives 'realistic way forward' to the island carrier's future

The challenge for a Chinese carrier is feed across Africa. Ethiopian and Kenya Airways are strategically positioned and benefit from being able to connect across Africa (Kenya Airways has set a medium-term goal of serving every African capital city). Nigeria in particular is a large market for African passengers bound for China. Etihad's Abu Dhabi hub, with connections to eight African cities, presents a new and more viable opportunity.

See related article: Etihad-China Eastern codeshare starts small but with enormous potential

Although bedding down these partnerships sooner rather than later would be ideal, China Eastern does have time on its side. In 2014 the carrier will receive the first four of 20 777-300ERs to expand its long-haul presence. These will initially be used to replace the carrier's five A340-600s. Net long-haul/ultra-long-haul widebody growth will occur in 2015, but even then China Eastern has flagged its intentions to first bring Los Angeles, New York JFK and Paris CDG from a daily to double daily operation before exploring new destinations. These are decisions which could be influenced by its partnership strategy.

Financials give an impetus to fast-track partnerships: although China Eastern does not break down exact losses, North America and Europe are loss making. In 2012, North American routes improved by about RMB100 million (USD16 million) while Europe declined by RMB100 million (USD16 million). China Eastern could consider funnelling traffic through Etihad's Abu Dhabi hub for onward carriage to Europe (and other markets). Hainan Airlines in late 2012, nearly a year after reaching an initial partnership with Etihad, switched its UAE service from Dubai to Abu Dhabi to leverage its partnership with Etihad.

For North America, China Eastern has no small partner in SkyTeam leader Delta. The two already codeshare, although anti-trust immunity is not on the cards in absence of a US-China open skies air service arrangement (a prerequisite for US approval). Delta inherited a large Japan network from its acquisition of Northwest, but maintains a historical focus on the US market, with international strategies still mainly directed towards trans-Atlantic services (and there Delta is bedding down its stake and pending JV with Virgin Atlantic).

As its network changes, China Eastern needs to improve its international marketing and sales capability. Flights remain heavily Chinese-origin/VFR and heavily leisure, an imbalance that challenges profitability. Despite financial pressure, China Eastern is planning frequency increases on services to New York JFK, Rome and Sydney, necessitating changes if these services are to be profitable.

Growth continuing at hubs of Shanghai, Kunming and Xi'an

Chinese carriers continue to build their hub strategy, and China Eastern's hubs are at Shanghai (Hongqiao and Pudong), Kunming and Xi'an as well as a notable presence at Beijing Capital. But this is mainly due to capacity from China Eastern's Kunming, Shanghai and Xi'an hubs, which account for 50% of China Eastern's arriving seats at Beijing Capital.

China Eastern top 10 hubs/bases/focus cities based on available seat capacity: 24-Jun-2013 to 30-Jun-2013

Source: CAPA - Centre for Aviation & Innovata

China Eastern has the largest presence at its main hubs, but not a majority position: of all seats, it accounts for 31% at Shanghai Pudong, 30% at Hongqiao, 43% at Kunming and 31% at Xi'an.

Shanghai Pudong system seat capacity by carrier: 24-Jun-2013 to 30-Jun-2013

Source: CAPA - Centre for Aviation & Innovata

Shanghai Hongqiao system seat capacity by carrier: 24-Jun-2013 to 30-Jun-2013

Source: CAPA - Centre for Aviation & Innovata

Kunming system seat capacity by carrier: 24-Jun-2013 to 30-Jun-2013

Source: CAPA - Centre for Aviation & Innovata

Xi'an system seat capacity by carrier: 24-Jun-2013 to 30-Jun-2013

Source: CAPA - Centre for Aviation & Innovata

Kunming is a significant airport for China's southwest region and also provides important hub access to Southeast Asia. An integral part of Chinese carriers' hub strategy is to have a base in various parts of China that facilitate traffic flows to different regions, domestically and internationally. China Eastern is building up its Southeast Asian presence with additional services to the region. Juneyao and Spring are also building up Southeast Asia, albeit from their Shanghai hubs.

China Eastern additional international services from Kunming in northern summer 2013 season: effective 31-Mar-2013

• Kunming-Chiang Mai: Frequency increase from daily to twice daily. Boeing 737 to operate this route, instead of existing three times weekly CRJ200 and four times weekly 737 operation;
• Kunming-Chiang Rai: Three times weekly service operated by 737, replacing CRJ200/737 equipment;
• Kunming-Kathmandu: Frequency increase from six to seven times weekly with 737;
• Kunming-Phnom Penh: Frequency increase from twice to four times weekly with 737;
• Kunming-Siem Reap: Frequency increase from five to seven times weekly with 737;
• Kunming-Vientiane: 737 operates daily service, replacing five times weekly CRJ200 and twice weekly 737 service;
• Kunming-Yangon: 737 operates daily service, replacing five times weekly CRJ200 and twice weekly 737 service.

Source: CAPA - Centre for Aviation & Innovata

See related articles:

• Kunming Airport star of China's southwest, but already demand is outstripping slots
• Juneyao Airlines continues international expansion in North & Southeast Asia, and seeks partners

China Eastern also has a significant operation at Beijing's secondary airport, Nanyuan, through its wholly-owned China United Airlines subsidiary. China United has historical ties to the military and so is allowed to operate from Nanyuan, a military airport, even though other carriers are not. Critically, China United also has a large growth opportunity in contrast to carriers at Beijing Capital. Its weekly operation of about 120,000 seats compares to Air China's 830,000 at Beijing Capital, but China Eastern plans to grow China United from its 23 aircraft at the end of 2012 to 50 by 2015.

China Eastern also holds 50% of pending start-up Jetstar Hong Kong, an LCC it plans to benefit from as it learns about the LCC model, also securing a greater foothold in the Hong Kong-mainland China market - where China Eastern has decreased capacity since 2008 as cross-Strait flights opened up to Taiwan, bypassing the former Hong Kong transfer operations.

See related articles:

• Hong Kong Airlines continues expansion; Jetstar HK appoints CEO & Dragonair to grow closer to Cathay
• Jetstar Hong Kong is group's largest launch challenge yet but with a tremendous potential upside

High Speed Rail partnerships should be easier with the breakup of the Railways Ministry

China Eastern should benefit in the long-term from the country's new government's dismantling of the Ministry of Railways, a kingdom that became bloated, corrupt and inefficient - and certainly not commercial. China Eastern's efforts to expand a partnership with HSR were impeded by the carrier having to negotiate with each provincial office of the railway. In 2012 it collaborated with the railway on five destinations and in 2013 has so far expanded that to 13, covering 300 routes per day. The potential for cooperation as these rail links grow is substantial.

The breakup of the Ministry into a commercial and operational division signals to China Eastern that the government supports greater market responsiveness by the railways (which have large debts due to expansion and uncertain profitability on HSR). China Eastern is eager for a more comprehensive network that gives it access to more cities, expanding its reach.

For the current construction phase the threat from HSR has largely passed and China Eastern does not expect significant negative impacts over the next few years. While airlines have reduced capacity on some routes because of high-speed rail, the capacity decrease was either minor or the route already very small to begin with. Instead the opportunities are becoming more evident as connectivity prospects emerge.

See related articles:

• Chinese airlines have high-speed rail as a friend and foe despite early dire survival questions
• Chinese airlines start developing mutually beneficial solution through air-rail codeshare agreements

Operating profit is flat as yields decrease, staff costs increase and Japan challenged

China Eastern's 2012 operating profit (prepared under IFRS) increased marginally by 1.3% but the operating margin declined slightly from 4.9% to 4.8% as revenue grew 4.2% but costs increased 4.4%, led by staff (salary increases rather than headcount increases), fuel and takeoff and landing charges. Chinese carriers in 2013 will no longer receive a subsidy on charges for international flights, in accordance with the World Trade Organisation protocol, but will receive a discount on domestic charges to make up for the difference. Air China is projected to incur an additional cost while China Eastern's overall charges will be lower.

China Eastern revenue and operating costs: 2011-2012

Source: China Eastern

China Eastern's decline in operating profit margin is in contrast to Air China and China Southern. Air China's operating margin increased from 6.4% to 8.1% while China Southern's increased slightly from 4.8% to 5.1%.

Yields deteriorated overall except on regional services to Hong Kong, Macau and Taiwan - this market was helped by a 2.1% decrease in ASKs whereas other markets grew (overall, China Eastern's ASKs were up 6.9%). Traffic on regional routes grew, leading to a 2.4% increase in load factor. International load factors picked up 4.4% while domestic load factors fell 0.6%.

China Eastern yield by region (2012 in bold): 2011-2012

Source: China Eastern

China Eastern load factor (2012 in bold): 2011-2012

Source: China Eastern

International operational statistics were up despite the political situation in Japan leading to a significant downturn in passenger numbers. China Eastern increased capacity between China and Japan from January to August compared to 2011 but then decreased from September to December after the political spat over remote islands.

Although a rebound is in sight, traffic is still down. Japan is the largest international market for China Eastern and typically profitable. 57% of China Eastern's northern summer 2013 international seat capacity is in North Asia, pending capacity changes in Japan.

China Eastern revenue by region: 2011-2012

Source: China Eastern

China Eastern international capacity by region: 24-Jun-2013 to 30-Jun-2013

Source: CAPA - Centre for Aviation & Innovata

China Eastern's long-haul strategy can be a major asset and strong, willing partners are available

Despite growth in capacity and revenue, and the work associated with it, 2012 was not a distinctive year for China Eastern. It managed to shield top-line figures at its international operation from the impacts of the Japanese market, which were strong in the last three and four months of 2012 but could have a more lingering impact in 2013, depending on how quickly the rebound eventuates.

Yield deterioration is always a concern, but more so for China Eastern owing to the decline in domestic and its poor performance compared to Air China and China Southern.

And then there is international long-haul, a small but unprofitable portion of China Eastern's portfolio.

As the airline progressively improves its management efficiencies, international strategy must take on a larger role in its portfolio. Until it has a sufficient long-haul fleet of its own, partnerships are the unavoidable direction to follow. These also have the advantage of exposing the airline on the operational and marketing fronts to international best practice, something that is badly needed.

Almost as a by-product of its emerging relationship with Qantas, the Hong Kong JV experiment with Qantas/Jetstar also gives China Eastern the opportunity to learn first-hand the intricacies both of LCC operation and of managing a low cost subsidiary within a group; the airline will be the first of the Big Three to venture into that brave new world. It will not be too much longer before Beijing succumbs to establishing a more LCC-friendly domestic environment, at which time China Eastern should be well-positioned.

But it is long-haul where both opportunities and challenges abound. China Eastern, based in the commercial centre of China, is fortunate in that there is no shortage of willing airline partners. Making the right choices will nonetheless be important; integrating them into a broad long term strategy will not be a simple task (and there are few signs yet of such an integrated approach), but the rewards could be pivotal for an airline that is not currently performing as well as its peers.