23-Mar-2013 9:11 AM

Hong Kong's low-cost airline presence could triple to 15% of seats in 2015

Analysis

Hong Kong is no Singapore for low-cost carriers - in early 2013 LCCs account for 5% of all seats at Hong Kong, compared with 27% of seats in Singapore. But Hong Kong is on the verge of a possible rapid structural change that could see LCCs account for approximately 15% of seats in Hong Kong in 2015.

The spike in LCC presence is predicated on a number of factors, including the successful launch of Jetstar Hong Kong, the continued expansion of mainland China's Spring Airlines and the mooted re-launch of Hong Kong Express into an LCC. The fast ascent of LCCs will level off around the middle or latter part of the decade when almost all slots at Hong Kong airport will likely become utilised, leading to the possibility of a period of almost no growth until the completion of a much-needed third runway, which will not open until around the turn of the decade. Singapore in contrast has enjoyed many years of rampant LCC growth.

As the Hong Kong slot shortage comes closer into view, airlines are participating in an effective slot grab, growing routes or maintaining unprofitable capacity in order to secure slots and hope the services will later be sustainable.

Summary

Hong Kong is on the verge of a possible rapid structural change that could see low-cost carriers (LCCs) account for approximately 15% of seats in Hong Kong in 2015.
The spike in LCC presence is predicated on the successful launch of Jetstar Hong Kong, the continued expansion of mainland China’s Spring Airlines, and the re-launch of Hong Kong Express into an LCC.
Hong Kong ended 2012 with an average LCC penetration rate of 5.2% of available seat capacity, which is low compared to other regions in Asia.
LCCs have recorded a higher seat capacity growth rate than full-service carriers in Hong Kong, except for 2006.
The growth of LCCs in Hong Kong is based on the successful launch of Jetstar Hong Kong, the conversion of Hong Kong Express into an LCC, and the expansion of Spring Airlines.
The limited availability of slots at Hong Kong airport will limit LCC growth in the medium term, leading to a slot grab by airlines to secure slots for future growth.

Hong Kong lags Asia in LCC growth

Hong Kong ended 2012 with an average LCC penetration rate of 5.2% of available seat capacity, according to CAPA and OAG. This is low on many counts: LCCs had a penetration rate of 9.5% of traffic within Northeast Asia, contrasting steeply with 52% within Southeast Asia. The large LCC presence in Southeast Asia has impacted the LCC figure for all traffic (including intercontinental flights) to/from Southeast Asia, where they accounted for 13.5% of traffic in 2012.

AirAsia X, Jetstar and Scoot operate low-cost, long-haul services to/from Southeast Asia, but this represents a minority (but not uninteresting share) of capacity.

Hong Kong LCC penetration rate of available seat capacity: 2003-2012

Singapore LCC penetration rate of available seat capacity: 2003-2012

Hong Kong's lack of notable LCC presence is not, as detractors may argue, due to the city being unsuitable for the low-cost model. Rather, there has been an absence of formidable LCCs in North Asia, including in Hong Kong. Countries where LCCs are based have a higher share of low-cost seats than the average in Hong Kong: LCCs account for 18% of capacity between Hong Kong and Singapore (home to Jetstar Asia and Tiger Airways) and 32% of capacity between Hong Kong and Malaysia (home to AirAsia Berhad), even if - as a defensive Cathay Pacific is eager to repeatedly point out - AirAsia withdrew from Penang-Hong Kong.

The Hong Kong-Thailand market in Mar-2013 is served by 13 carriers, six of them fifth freedom carriers, but still manages an LCC rate of 7%, above the Hong Kong average. This is due solely to Thai AirAsia. South Korea is home to some of the first LCC growth in North Asia but the market is deprived of innovation and the LCCs there have a blurred business model that delivers a cost base lower than full-service peers but well short of their own potential. Two of the Korean LCCs - Air Busan and Jin Air - play second fiddle to their full-service owners, Asiana and Korean Air, respectively. This has further limited growth.

Despite these factors, the Hong Kong-Korea market has an LCC penetration rate of 8%, also above Hong Kong's average. Spring Airlines is the sole LCC between Hong Kong and mainland China, and its capacity - only recently increasing as the carrier turns its eye towards the Hong Kong market - singularly represents the 4% LCC penetration rate. LCC limitations in Hong Kong are not the result of nuances to Hong Kong but rather, amongst other reasons, a lack of LCC capacity in general.

LCCs have had a higher growth rate than full-service airlines

Over the past decade, LCCs have recorded a higher seat capacity growth rate than full-service carriers in Hong Kong in all but one year: 2006, when Cebu Pacific decreased capacity and Valuair exited the Singapore-Hong Kong market following its acquisition by Jetstar Asia. For early 2013, LCCs are once again growing faster than FSCs. Comparing 2012 to 2003, full-service carriers grew 56% in Hong Kong, but LCCs grew 1,465%, albeit from a very low base. LCCs grew in 2009 when FSCs decreased capacity as they bore the brunt of the global financial crisis. Not even the 2008 collapse of Oasis Hong Kong caused negative LCC growth.

Growth at Hong Kong by type of carrier: 2004-2012

In Singapore, with a more developed LCC network, LCCs have had a higher growth rate in every year of the past decade. Full-service carriers have recorded negative growth in three of those years compared to only one year in Hong Kong.

Growth at Singapore by type of carrier: 2004-2012

LCCs are not, contrary to the view of some incumbents, a passing fad. Instead they represent a new order and a development peers will struggle to reconcile if they refuse to acknowledge the presence and potential of LCCs.

Jetstar Hong Kong, Spring and Hong Kong Express to lead LCC growth

The growth of LCCs in Hong Kong that could see them triple their presence of all seats in the market to 15% is based on a number of factors. Jetstar Hong Kong is still aiming for a 2013 launch, although the date has moved from mid-2013 to being firmly in the second half. The delay is a result of government changeovers in Hong Kong and mainland China that have slowed processes down, but also a result of the carrier's joint-ownership between Australia's Qantas Group (which owns Jetstar) and mainland China's China Eastern Airlines.

Although Qantas has sought to emphasise the historical relationship between the two, implying smooth cooperation, this relationship is relatively limited historically and the two have not been proceeding as one at all times. China Eastern took some time to finalise the establishment paperwork, and at the IATA AGM in Beijing in Jun-2012 China Eastern chairman Liu Shaoyong said the carrier could even launch before the end of 2012 - a prospect that was fanciful at best.

Jetstar Hong Kong has since appointed a CFO and CEO and also received regulatory approval from Beijing. As CAPA previously wrote:

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.

Jetstar Hong Kong had targeted a launch in 2013 with three A320s, quickly building the fleet to upwards of 18 A320s in 2015. The fast growth plan was designed to secure slots quickly as the slot shortage increases. Jetstar Hong Kong, as a new entrant, will receive priority in requesting slots.

Hong Kong Airlines has toyed with converting subsidiary Hong Kong Express into an LCC. Hong Kong Express has its own AOC but is run by Hong Kong Airlines and the two operations from a market perspective are interchangeable.

Hong Kong Airlines announced in 2011 it would convert Hong Kong Express into an LCC but delayed the project in 2012 and then re-announced it towards the end of 2012. It has not provided a public update since then. Hong Kong Airlines and Hong Kong Express account for just over 8% of available seat capacity in Hong Kong and have, in the short-term, 17 A320s and four A330s on order. Using new aircraft for a Hong Kong Express LCC (if it is still to proceed), or converting the existing fleet, or a combination of both, would see Hong Kong Express contribute at least a few percentage points of LCC market share in Hong Kong.

Hong Kong Airlines Fleet Summary: as at 19-Mar-2013

Aircraft	In Service	In Storage	On Order
Total:	21	1	52
Airbus A320-200	9	0	17
Airbus A330-200	6	0	0
Airbus A330-200F	3	1	0
Airbus A330-300	3	0	4
Airbus A350-900XWB	0	0	15
Airbus A380-800	0	0	10
Boeing 777-F	0	0	6

Hong Kong Airlines projected delivery dates for aircraft on order being purchased directly from manufacturers* as at 18-Mar-2013

Mainland China's Spring Airlines is turning its attention to the Hong Kong-mainland China market, although the domestic mainland market remains its key focus - but there restrictions are greater and there could be more appetite from the government to let Spring grow on less high-yielding international and regional routes.

Spring in late 2012 added four new routes from mainland cities to Hong Kong and additional cities, as well as frequency upgrades of existing services, are likely in due course. Spring, like Jetstar Hong Kong (pending launch) but to a lesser degree, receives priority handling for slot requests.

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LCC growth is not confined to these carriers. Jetstar Japan will likely launch some services to support Jetstar Hong Kong's network, delivering synergies and frequency advantages. Fellow new Japanese LCC Peach Aviation would like to have a second daily Osaka Kansai-Hong Kong service but it is limited by slots; as its fleet grows and it has more space in its schedule it may be able to consider second-tier slot options.

Philippines' Cebu Pacific in 2013 will start taking delivery of A330s, its first widebody aircraft, and while it will use the A330s on long-haul routes, it will also use them regionally around Asia. Cebu would like to deploy them to Hong Kong to grow in absence of frequency, but it is constrained by bilateral restrictions.

Indonesia is a relatively quiet market full of potential, but like China the carriers there are focusing on domestic services ahead of international ones, although Tiger Mandala may consider a service from Indonesia to Hong Kong. The massive A320 and 737 orders from Indonesia's Lion Air will find their way onto AOCs in other Asia-Pacific countries (such as Malindo in Malaysia) that could be used to open a route to Hong Kong.

These scenarios are moderately conservative. Very aggressive expansion from the three, possibly combined with more flat FSC growth, could bring an optimistic 20% LCC rate into the picture for 2015. This view also excludes the possibility Cathay Pacific would respond with an LCC, a view it has not warmed to, despite the seeming logic.

The collapse of Oasis Hong Kong, a long-haul LCC, last decade has been used to argue LCCs have no home in Hong Kong. The case of Oasis was exceptional. It was focused on long-haul routes, which have different economics, and at the time of if its collapse it is understood that, despite fierce competition, its London service was operationally profitable while its nascent North American presence was incurring losses amidst a shareholder dispute that ultimately shut the carrier down.

Others argue Hong Kong Airlines exists to either import aircraft into mainland China for Hainan Airlines (Beijing must approve aircraft orders) or pull mainland China-Hong Kong traffic that Hainan is unable to handle. While there are questions surrounding Hong Kong Airlines' order for the A380 (which may, in a positive development, be cancelled), an aircraft cannot simply be brought into China - let alone registered - without Beijing's blessing. Hong Kong Airlines is targeting the mainland China network, but in its own right and profit objectives. While financials are very limited, the carrier reported a USD32 million profit in the first nine months of 2011 and then a 50% drop in profit (but still a profit) in 1H2012. Full year 2012 figures have not yet been released.

Slots will limit LCC growth in Hong Kong in the medium term

While Singapore has enjoyed 10 years of LCC growth with relatively limited slot restrictions, Hong Kong is already facing notable slot restrictions, and this will only increase in the next few years. There is a strong possibility Hong Kong could see limited or almost no annual movement increases until a third runway is completed around the turn of the decade. Singapore had far more slots available when its LCC rate was at 5% than Hong Kong does, limiting LCC growth.

Hong Kong runway movement restrictions: summer 2013

Time	Movements
0000-0059L	42 movements per hour with no more than 20 arrivals and 24 departures
(1600-1659Z)
0100-0659L	37 movements per hour with no more than 20 arrivals and 20 departures
(1700-2259Z)
0700-0759L	37 movements per hour with no more than 22 arrivals and 26 departures
(2300-2359Z)
0800-2259L	64 movements per hour with no more than 33 arrivals and 33 departures
(0000-1459Z)
2300-2359L	59 movements per hour with no more than 32 arrivals and 32 departures
(1500-1559Z)

Based on summer 2013 capacity, Hong Kong can theroetically see up to 481,800 annual movements.

Provisional 2012 movement figures indicate Hong Kong had 351,675 movements, a 79% increase since 2001 but only a 5% increase from 2011.

Hong Kong annual aircraft movements: 2001-2012*

While there may appear be plenty of available slots, these are primarily during the less than ideal midnight hours, although airports like Beijing Capital and Shanghai Pudong have seen some movements up to 02:00 as they are restricted during other parts of the day.

Thus, while Hong Kong may not reach capacity on paper, it will effectively become almost entirely constrained during the day.

Hong Kong airport available slots: summer 2013

Hong Kong airport hourly aircraft arrival histogram projection: 12-Aug-2013 to 18-Aug-2013

Hong Kong airport hourly aircraft departure histogram projection: 12-Aug-2013 to 18-Aug-2013

Securing slots a greater priority over profitability

With decreasing numbers of slots available, local carriers are effectively participating in a slot grab, utilising as many slots as they can, even if this is ahead - and sometimes well ahead - of demand.

The rationale is two-fold: use a slot rather than let a competitor have it, and have a slot now so it is available when demand is ready for a service to be sustainable. It is a mostly rational approach provided there is no exceptional event by the end of this decade (when a new runway should be in place) that would see slots rapidly free up for an extended period of time. Movements decreased in Hong Kong during SARS in 2003 and the global financial crisis in 2009, but rebounded and recorded growth in the following years.

This slot grab is a game of which owner has deeper pockets and is willing to sustain this approach. Shareholders will bear the short-term brunt with promise of long-term benefits, but airline investors are generally more interested in the short-term, given the industry's cyclical nature. Airlines have tried to avoid suggestions they have over-capacity.

For example, North Asia in 2012 was the only region to see a decrease in yield (despite fuel surcharges) for the Cathay Pacific Group. North Asia may be seen as a market to easily deploy loss-making services in order to secure slots as the distances are short and competition less.

Cathay Pacific and Dragonair year-over-year yield change: 2012

Overall Yield: +1.2%;

India, Middle East, Pakistan and Sri Lanka: +2.4%;
Southeast Asia: +0.9%;
Southwest Pacific and South Africa: +1.7%;
Europe: +1.9%;
North Asia: -3.4%;
North America: +3.1%.

Short-term pain can be justified. Singapore Airlines in 2009 during the global financial crisis reduced its Singapore-Shanghai service during the winter but consequently lost the slot. While the market has since rebounded, SIA is today forced to reduce its frequency during the winter.

The slot grab at Hong Kong does not mean LCCs, foreign or local, should be written off. They will muscle their way in and make the most of the available slots - and, as part of a familiar pattern in other markets around the world, cause pain to those who ignore them while capturing new demand and some of the existing demand too. In an industry riddled with constraints on open competition, airport slots are only one of many market distortions that new entrants must navigate. Somehow, they usually seem to manage to do so, as attitudes change.