Philippine Airlines: long haul adjustments - first, drop London?

Summary

• Philippines Airlines is considering suspending services to London Heathrow and instead launching Paris.
• Philippine Airlines is hoping to forge a partnership with a European airline to provide offline connections from Paris to London and several destinations in continental Europe.
• Philippine Airlines has shelved plans to launch a new US destination and will instead focus on maintaining its existing North American operation, which has experienced a significant increase in capacity over the past year.
• Philippine Airlines recently took delivery of the last A350 from its 2016 six aircraft order and is now considering ordering more A350s or 777Xs.
• Philippine Airlines has a requirement to start replacing 777-300ERs in 2022 but may be better off reducing its long haul fleet by not replacing its oldest two 777s as they are returned.

Philippine Airlines has 16 long haul aircraft and six long haul routes

PAL's long haul fleet currently consists of six three class 295-seat A350-900s and 10 two class 370-seat 777-300ERs. PAL only operates six long haul routes (over 10 hours) - Manila to London, Los Angeles, New York, San Francisco, Toronto and Vancouver.

Los Angeles, San Francisco and Vancouver are served with the 10 777-300ERs while London, New York and Toronto are served with the six A350-900s. PAL also operates a limited number of regional flights within Asia Pacific using the A350s and 777-300ERs, which helps boost utilisation as the aircraft would otherwise sit all day in Manila.

PAL currently uses A350s on some Bangkok and Hong Kong flights and uses 777s on some Bangkok flights as well (based on OAG schedules for the week commencing 17-Jun-2019). The A350s and 777s are typically used on more regional flights during the offpeak months for the North America market, when frequencies are reduced.

PAL's widebody fleet also includes 15 A330-300s, made up of eight aircraft in 309-seat three class configuration and seven aircraft in 363-seat two class configuration. The A330s are used regionally within Asia Pacific, as well as to the Middle East and Hawaii. The longest A330 routes are Auckland, Honolulu and Riyadh - all of which are approximately 10 hours (for the purposes of this report these are not considered long haul).

PAL completes long haul fleet growth with recent delivery of sixth A350

PAL completed a widebody renewal and expansion programme in May-2019, when it took delivery of the sixth A350-900 from a six-aircraft order placed in 2016. PAL has options for another six A350s as part of the 2016 order but does not currently have any additional widebody aircraft on firm order.

All six A350s were delivered in the span of less than one year (the first delivery was Jun-2018). The A350s have been used partially as replacements for PAL's remaining A340s, which have been phased out, and partially for growth.

See related report: A340 fleet: last Asian operator, Philippine Airlines, bows out

PAL currently operates 57 weekly long haul return flights (over 10 hours) compared to 38 weekly flights a year ago. Los Angeles, New York, San Francisco, Toronto and Vancouver have all experienced a significant increase in capacity. However, London has been reduced.

London has been a difficult market for PAL, despite several adjustments

London is PAL's least profitable long haul route and has struggled since it was launched in Nov-2013. PAL has tried to improve the route's performance by implementing schedule, frequency and aircraft changes, but while some combinations have done better than others, the losses have continued to mount.

PAL initially launched Manila-London Heathrow as a five times weekly nonstop service with 777-300ERs. It downgauged the route to A340-300s in Aug-2014 and initially maintained five weekly flights. A cut to four weekly A340-300 flights was implemented in early 2015.

PAL switched to a new schedule for London in Mar-2015, moving from an 07:10 departure from Manila and an 18:25 departure from Heathrow to a 13:10 departure from Manila and a 22:20 departure from Heathrow. The new timings opened up connections from Australia and domestic points in the Philippines and were also more appealing for local Manila-London passengers.

PAL added back a fifth London frequency in late 2015 and for the first time in mid-2016 introduced a daily service, using A340-300s. In Sep-2017 PAL briefly reintroduced the larger 777-300ER on London, with only four weekly flights, but reinstated five frequencies in Oct-2017 and a daily service in Dec-2017.

The daily 777-300ER schedule represented an all-time capacity high for the London route, forcing PAL to try to increase reliance on low yielding sixth freedom traffic (particularly on the kangaroo route to/from Australia). The daily 777-300ER schedule was maintained for nine months, with some brief offpeak reductions to six frequencies.

A350 fails to improve PAL's London performance

PAL slashed London capacity once again in Sep-2018 when it downgauged to the A350-900.

The airline initially operated only four weekly frequencies after switching to the new A350s, before reinstating five weekly frequencies in Oct-2018. It briefly had a daily A350 frequency in Dec-2018 and Jan-2019, but has since been operating a consistent schedule to London of five weekly A350-900 flights.

Philippine Airlines Manila-London one-way frequencies since launching the route in Nov-2013

Source: CAPA - Centre for Aviation & OAG.

The A350-900 is more efficient and has a significantly better inflight product than the 777-300ER, which enabled PAL to offer lie-flat seats for the first time in the London market, as well as premium economy. However, the performance of the London route has not improved, and PAL is now finally considering axing London.

PAL president Jaime Bautista told CAPA on the sidelines of the 3-Jun-2019 IATA AGM in Seoul that "admittedly we are not making money and we are looking at other possibilities".

He added that PAL may instead launch Paris and forge a partnership with a foreign airline to provide feed to London as well as to other destinations in Europe, such as Italy and Spain.

"We are studying that very carefully," Mr Bautista said.

Garuda suspends London - this time for good (hopefully!)

PAL's experience in London mirrors that of Garuda, which recently announced plans to suspend its Heathrow service in Aug-2019 after five years of trying multiple different routings. CAPA first reported on Garuda's suspension of London in early Sep-2018 after the airline announced it would exit the market in Oct-2018.

See related report: SE Asia-London market: Garuda Indonesia learns a difficult lesson

In a surprising U-turn, a couple of months later Garuda decided to reinstate London, bowing to political pressure.

Since Jan-2019 Garuda has operated a Jakarta-London Heathrow-Bali service, which has been just as unsuccessful as the three prior routings (Jakarta-Amsterdam-London Gatwick-Amsterdam-Jakarta, Jakarta-Singapore-London Heathrow-Jakarta, and Jakarta-London Heathrow-Jakarta).

The latest suspension decision appears to be permanent - a sensible move, given the huge losses incurred since Garuda began serving London in Sep-2014.

See related report from Blue Swan: After four attempts in five years, Garuda Indonesia is set to finally pull the plug on its unprofitable London link

PAL drops ambitions for multiple European routes

PAL was previously considering launching Paris or other destinations in continental Europe (such as Rome or Frankfurt) while maintaining London. The new plan is to replace London with Paris using the same A350 now used for London, and not to grow the airline's European network beyond one destination.

Mr Bautista explained that the airline had decided to focus - at least for the next few years - on one online destination in Europe and on serving the rest of the region through partnerships. A second online destination will only be considered after profitability is achieved with the first destination.

"We want our European flights to be profitable first", Mr Bautista said.

PAL also drops plans for expanding North American network

PAL has also shelved plans for expanding its US network. It had been considering launching services from Manila to Chicago, Houston, San Diego or Seattle with the A350 as well as potentially resuming Cebu-Los Angeles, which it briefly served with A340-300s in 2016 and 2017.

The original plan was to add at least one and possibly two US destinations - as well as a second European destination - after all six A350s were delivered. However, PAL has decided instead to focus on its existing North American network of five destinations, recognising that any new long haul route would be challenging.

PAL's North American operation has historically been profitable - particularly the core Manila to Los Angeles and San Francisco routes. Los Angeles and San Francisco have huge Filipino communities that are relatively loyal to PAL, and PAL is the only nonstop competitor in these markets.

However, one-stop competition has intensified in recent years in the North America-Philippines market, impacting yields and profitability. It is not uncommon for multiple airlines to be offering fares below USD1000 return to Manila from Los Angeles, San Francisco and several other North American points.

PAL's new nonstop services to New York and Toronto also have not yet matured. PAL began operating nonstops to Toronto in Dec-2017 and to New York JFK in Oct-2018, replacing one-stop services via Vancouver.

PAL quickly upgraded both new ultra long haul nonstop routes to daily, providing significantly more capacity than the prior less than daily one-stop flights. Although PAL is encouraged with recent booking trends, New York and Toronto, along with the overall North American operation, remain unprofitable.

"We would like to make our operation to the US profitable", Mr Bautista said, adding that PAL has decided against pursuing network expansion in the US because those would be "new routes we wouldn't make money on".

PAL should reduce North American capacity

The decision to halt US expansion is sensible, given that all of the potential new destinations are competitive and have significantly less local traffic to the Philippines than its existing destinations. PAL would have to rely heavily on sixth freedom traffic, which is very low yielding and hard to secure, since PAL does not have strong brand outside the Filipino community and its transit product at congested Manila is significantly inferior compared to the transit product of most other Asian airlines.

However, without any new destinations it becomes questionable whether PAL will be able to support all 16 of its long haul aircraft over the long run.

Although PAL is now using the aircraft sufficiently (Mr Bautista says its A350 utilisation rate is among the highest in the world), yields are under pressure, in part because of the recent capacity increases. PAL has had to price aggressively and carry more low yielding sixth freedom traffic as its North America capacity has increased by nearly 50% over the past year.

See related report: ANA invests in Philippine Airlines as PAL expands

PAL recognises that it cannot maintain the current year-round schedule of 52 weekly one-way flights to continental North America (or 57 when Hawaii is included).

PAL is reducing its North America schedule to 39 weekly one-way flights (43 including Hawaii) from mid-Sep-2019 to mid-Nov-2019. During this two-month offpeak season PAL will have 14 weekly flights to Los Angeles (a reduction from 17), 10 to San Francisco (a reduction from 14), and five to New York, Toronto and Vancouver (a reduction from seven to each city).

Philippine Airlines weekly one-way nonstop frequencies to North America (including Hawaii): Nov-2011 to Nov-2019

Source: CAPA - Centre for Aviation & OAG.

PAL will restore its full North America schedule in Dec-2019 and Jan-2020 but is planning another set of seasonal reductions for Feb-2020 and Mar-2020, a second offpeak period for Philippines-North American travel before Easter.

Based on the full schedule, North America accounts for approximately 13% of PAL's international frequencies, 18% of international seats and 45% of international ASKs.

Philippine Airlines ASK share (%) by region: week commencing 10-Jun-2019

Source: CAPA - Centre for Aviation & OAG.

PAL could be better off with a reduced year-round schedule to North America. For example, a 10% to 15% cut would still result in significantly more North America capacity than in prior years and provide impetus to improve load factors and yields.

PAL is unable to cut back on North America without reducing aircraft utilisation, which it understandably wants to maintain because of the aircraft leasing costs. However, it could cut its long haul fleet by two aircraft by early 2022, when its two oldest 777-300ERs turn 12 years old and are due to be returned.

PAL is considering acquiring replacements for its oldest 777-300ERs

Of PAL's 10 777-300ERs, six are older model aircraft that were delivered in late 2009 to late 2013 and four are newer model aircraft that were delivered in late 2016 and late 2017. All 10 aircraft are leased, according to the CAPA Fleet Database.

PAL has an opportunity to replace its entire 777-300ER fleet by 2025 as the four newer model aircraft have leases with an eight year exit clause. The initial batch of two 777-300ERs have leases expiring in 2022. The other eight aircraft can all be returned in 2024 and 2025 (the first four 12 years after delivery and the last four eight years after delivery).

PAL has starting considering potential replacements for these 777-300ERs and is currently evaluating the 777X, A350-900 and A350-1000. The A350-900 or larger A350-1000 (which is closer in size to the 777-300ER) could be acquired using options from its 2016 order, and the 777X (777-8X or 777-9X) would be a new order that could be placed as early as this year.

The A350-1000 is particularly appealing as it would enable PAL to improve seat economics on its thickest North America routes and reap the benefits of an all Airbus fleet. PAL is looking at a 414-seat three class configuration (lie flat business, premium economy and 10 abreast economy) for the A350-1000, which would result in a significant improvement in efficiency and seat costs compared to the 777-300ER as well as a 12% increase in capacity.

PAL needs to improve the consistency of its long haul product

Replacing the 777-300ER would make sense from a product standpoint as it would give PAL an opportunity to provide a consistent long haul product. PAL's 777-300ERs have 42 angled flat seats in 2x3x2 configuration and do not have a premium economy cabin, whereas its A350-900s have 30 lie-flat business class seats in 1x2x1 configuration and 24 premium economy seats.

PAL also has lie-flat business class seats on all 15 of its A330-300s (and a premium economy cabin on eight of the aircraft), and even has lie-flat business class seats on its six long haul configured A321neos.

Mr Bautista said the current product gap is being managed by dedicating the 777-300ERs to three long haul markets (Los Angeles, San Francisco and Vancouver) to ensure that passengers are aware and know what to expect, but acknowledges that the current situation is not ideal.

PAL has been considering retrofitting its 777-300ERs with lie-flat business seats and premium economy. However, so far the airline has decided against a retrofit project due to the high cost.

Due to the high costs of retrofits PAL is better off returning the 777-300ERs and replacing them with A350s (or 777Xs) that could feature the same premium products as its six existing A350s.

PAL should consider reducing its long haul fleet

It would also be sensible for PAL to use the 777-300ER lease returns to re-examine its widebody needs.

PAL should consider returning the first two 777-300ERs without replacing them - and therefore postpone a selection of new widebodies for another two years, when it will have to decide on the eight 777-300ERs that can be returned in 2024 and 2025.

Operating fewer long haul aircraft would enable PAL to cut capacity to North America and/or drop Europe entirely. Without a reduction in the fleet, it is difficult for PAL to cut back in North America or axe London without launching Paris (as is tentatively planned).

While Paris may seem like a better option than London, particularly if PAL can secure feed, Paris will likely not be profitable. The Philippines-Europe market is extremely competitive, due to aggressive competition from the Gulf carriers and from other Asian airlines. PAL is best off retreating from Europe entirely.

Competition in the Philippines-North America market is not about to ease. Asian carriers continue to pursue expansion in North America and will continue to rely on the Philippines for providing filler traffic, despite the low yields.

PAL should expect new competition from Cebu Pacific on US routes

Cebu Pacific may also start competing in the Manila-Los Angeles and Manila-San Francisco markets within the next few years.

Cebu Pacific signed an MOU at the 18-Jun-2019 Paris Air Show for 16 A330-900neos. While the A330-900neo is not capable of operating nonstop from Manila to the US west coast in Cebu Pacific's 460-seat configuration the airline has the flexibility to convert to the A330-800neo, which would be able to operate to the US west cost in high density all economy configuration without payload restrictions.

Cebu Pacific's longest route is currently nine hours - Manila-Dubai, which is served with 436-seat all economy A330-300ceos. Due to slot restrictions at Manila and several of its regional international destinations, Cebu Pacific plans primarily to use the new fleet of A330-900neos on trunk routes within Asia, where its existing eight A330ceos are mainly now deployed. However, PAL should assume that at some point it will have to contend with a nonstop low cost competitor on its two largest (and historically most profitable) long haul routes.

PAL will obviously not want to retreat when Cebu Pacific enters but should recognise that it is not realistic to expect to maintain current capacity levels to Los Angeles and San Francisco once there is a second nonstop competitor in these markets. Following the recent increases, PAL's capacity in these markets is already probably too high.

PAL has slipped into the red in the past two years, due mainly to losses in the long haul segment. Its domestic and regional international operation have generally remained profitable, whereas Australasia, Europe, the Middle East and North America have all been loss-making.

Suspending London and shelving the launch of new US destinations is a sensible initial move by PAL as it tries to restore profitability.

A sensible subsequent move for PAL would be to be drop Europe entirely (by not moving forward with Paris when London is terminated), to reduce US capacity, and to cut its long haul fleet by not replacing its two oldest 777-300ERs as they are returned.