22-Feb-2016 12:31 PM

Philippine Airlines to expand long haul operation after completing A350-900 acquisition

Analysis

Philippine Airlines (PAL) is planning significant expansion of its long haul operation as it takes delivery of new widebody aircraft, including A350-900s. PAL's long haul fleet is slated to expand from only 12 aircraft currently to 14 by the end of 2016, and to at least 17 aircraft by mid-2019.

After several months of negotiations PAL has finally committed to acquiring at least six A350s, three of which are tentatively earmarked as growth aircraft. The new high gross weight A350-900s will enable PAL to operate nonstop flights to the east coast of North America, as well as to add capacity to the west coast of North America and to Europe.

The Philippine flag airline currently has six long haul destinations, only four of which are served nonstop from Manila. PAL plans to add new long haul destinations, upgrade one-stop routes to nonstop, and launch new long haul routes from its secondary hub at Cebu as it expands its long haul fleet.

Philippine Airlines to take six A350-900s in 2018 and 2019

PAL currently has 12 long haul aircraft, including six A340-300s and six 777-300ERs. Its total widebody fleet consists of 27 aircraft including 15 A330-300s, which are used on medium haul routes to Australia, Hawaii and the Middle East and on some regional services within East Asia. (Honolulu and Sydney have been served over the last year with a mix of A330s and A340s.)

PAL has only four nonstop long haul routes (over 10 hours) - Manila to London Heathrow, Los Angeles, San Francisco and Vancouver. London is currently served with four weekly A340 flights; Los Angeles with seven weekly 777-300ER and four weekly A340 frequencies; San Francisco with seven weekly 777-300ER frequencies; and Vancouver with seven weekly 777-300ER frequencies and three weekly A340 frequencies. Of the seven 777-300ER Vancouver flights, four continue to New York and three continue to Toronto.

Philippine Airlines long haul routes ranked on seat capacity: 22-Feb-2016 to 28-Feb-2016

Rank	Origin		Destination		Total Seats
1	MNL	Manila Ninoy Aquino International Airport	YVR	Vancouver International Airport*	6,704
2	MNL	Manila Ninoy Aquino International Airport	LAX	Los Angeles International Airport	6,284
3	MNL	Manila Ninoy Aquino International Airport	SFO	San Francisco International Airport	5,180
4	MNL	Manila Ninoy Aquino International Airport	LHR	London Heathrow Airport	2,540

At the 2016 Singapore Airshow on 17-Feb-2016 PAL signed a memorandum of understanding with Airbus to acquire six A350-900s, with options for an additional six aircraft. PAL President Jaimie Bautista said at a press conference announcing the deal that the first four A350-900s are slated be delivered in 2018, with one aircraft arriving each quarter followed by the final two firm deliveries in 1H2019.

Mr Bautista said that PAL plans to retire three of its A340s as the A350s are delivered, while the other three are earmarked as growth aircraft. PAL plans to retire its last three A340s later, which suggests that at least some of the A350 options will likely be exercised. PAL owns all of its A340s, which are 14 to 16 years old, whereas it plans to lease its new fleet of A350s.

A350 deal supports PAL long haul expansion plan

In mid-2015 PAL committed to leasing two additional 777-300ERs for delivery in late 2016. The additional 777-300ERs will enable PAL to grow its long haul operation as its long haul fleet expands from 12 aircraft currently to 14 aircraft by the end of 2016.

The commitment for six A350-900s has been anticipated for several months to support further long haul expansion, as well as fleet renewal. CAPA stated in a 13-Jun-2015 report that along with the two additional 777-300ERs for delivery in 2016 PAL was seeking to acquire four to six new-generation widebody aircraft for delivery from 2017. "The A350-900 has emerged as the strong favourite as Airbus has informed PAL that it could use the type to operate nonstop 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," CAPA wrote in Jun-2015.

In a 20-Nov-2015 report CAPA stated that PAL was close to committing to six A350-900s for delivery from 2017. CAPA wrote at the time:

PAL is looking to acquire a new high gross weight (HGW) version of the A350-900 which is available from 2017 and will enable nonstop Manila-New York flights in both directions without payload limitations. Airbus has informed PAL that it does not need the recently launched A350-900ULR, which will be available from 2018 and has been ordered by Singapore Airlines for nonstops to the US.

Trans-Pacific flights from Manila are about three hours shorter than flights from Singapore. But flights from eastern North America to Manila are still slightly too long for the current version of the A350-900 or the 777-300ER.

PAL is also looking at using A350-900 HGW aircraft to potentially upgrade Toronto to nonstop and launch a fourth destination in the mainland US. Chicago is the most likely new destination for the A350-900 HGW.

PAL has also been evaluating other potential US markets in both the east and west coasts. New destinations in the western US can be launched using the existing widebody fleet, potentially as early as late 2016 as the two additional 777-300ERs are delivered. PAL previously served Las Vegas and at one point was considering San Diego, which has a large Filipino community.

PAL to launch Manila-New York nonstops in 2018; Toronto nonstops seem unlikely

PAL was ultimately unable to secure late 2017 delivery slots, which would have been preferable since that would have enabled it to expand in the US market, including an upgrade of New York to nonstop, prior to the peak 2017 Christmas season. However, PAL should be able to launch nonstops to New York by mid-2018, at which point two A350-900s will be delivered.

Serving New York nonstop is a priority for PAL as its evaluation of new-generation widebody aircraft specified the ability to operate Manila-New York in both directions without payload restrictions. A new higher gross weight version of the A350-900 also enables PAL to upgrade Toronto to nonstop, but Mr Bautista says a decision on Toronto will not be made until later.

Manila-Toronto is a smaller local market than Manila-New York and therefore may not be able to support a nonstop service, particularly on a year-round basis. PAL briefly operated Manila-Toronto nonstop with the 777-300ER in one direction (eastbound only) after launching Toronto in late 2012, but poor performance prompted PAL to implement a stop in Vancouver in both directions. New York was launched in Mar-2015 with a stop in Vancouver in both directions.

The A350-900 is a smaller and more economical aircraft than the 777-300ER, making it an ideal fit for New York nonstops.

PAL to offer a premium economy option on A350

PAL plans to configure its A350-900 with approximately 300 seats across three classes - economy, premium economy and business. PAL configures its 777-300ERs with 370 seats across two classes - economy and business.

PAL currently only offers a premium economy product on its A330-300 fleet. The PAL premium economy product provides extra legroom but has the same seat width as economy. This makes the PAL premium economy product more like the product offered by US airlines rather than that of its Asian competitors, which offer a wider seat and a differentiated service.

The higher-capacity 777-300ER is ideal for PAL's biggest long haul markets, Manila to Los Angeles and San Francisco. Although PAL plans to use the A350-900 to add frequencies on these routes, the A350 is generally a better fit for thinner markets including London, New York, Toronto and Vancouver. For Vancouver a smaller aircraft would be sensible, particularly as it is decoupled from New York, leaving Vancouver with more dedicated flights even if Toronto remains tagged.

PAL to use A340s initially to launch new long haul routes

The A350-900 is also a good fit for potential new long haul routes. PAL is launching service from Cebu to Los Angeles in Mar-2016 and plans to consider other long haul routes from Cebu as its widebody fleet expands. PAL is also considering the launch of a destination in continental Europe, potentially by the end of 2016.

Cebu-Los Angeles and the other potential new long haul routes will be launched with A340-300s as the 777-300ER is too large. PAL's A340-300s have 254 seats in two-class configuration (economy and business only), making them even smaller than the A350-900s. However the A340s are inefficient, resulting in higher per seat costs even in a low fuel price environment.

As CAPA stated in the Nov-2015 report, PAL intends to keep operating each of its six A340-300s, which were acquired in 2013 and early 2014, until the engines require overhaul. For three of the aircraft the engines will come up for overhaul as the A350-900s are delivered in 2018 and 1H2019.

PAL has the flexibility to operate the other three A340s slightly longer, although it could accelerate their retirement if fuel prices increase. If the retirement of the last three A340s were accelerated, PAL would need to quickly exercise A350-900 options or adjust its long haul capacity plans.

PAL's long haul ASKs to grow by approximately 50% over next three years

PAL's current fleet plan envisages 17 long haul aircraft at the midpoint of 2019, including eight 777-300ERs, six A350-900s and three A340-300s. This represents an expansion of 42% compared with the 12 long haul aircraft in the current fleet. However, long haul ASK growth will likely expand at even faster rate - potentially above 50% - as three of the A350s are being used to replace smaller A340s. The A350s will also be utilised more than the A340s.

PAL plans to use most of the additional capacity to expand in its existing long haul destinations - with a mix of additional frequencies, upgrading one-stop services to nonstop and setting up new links from Cebu. However there will also be an opportunity to add new destinations in Europe and the US. As CAPA has highlighted, PAL previously served Las Vegas and has been evaluating several potential new US destinations including Chicago, Miami and San Diego.

The approximately 50% capacity increase may seem steep, but should be manageable given PAL's strong position in the North American market. PAL faces relatively limited competition between the Philippines and North America as the Gulf airlines are unable to offer convenient connections in this market. PAL also has a loyal customer base in North America, where there is a large Filipino community.

PAL has the opportunity to expand in US market

For several years PAL was unable to expand in the US because the Philippines was under a Category 2 safety rating from the US FAA. PAL has only increased capacity slightly to the US since the Philippines was upgraded to Category 1 in Apr-2014. There are clearly opportunities for further expansion, particularly when taking into account the need to catch up on growth after not being able to expand its US operation for six years.

PAL has between 6,500 and almost 9,000 weekly nonstop one-way seats to the US depending on the time of year. The launch of Cebu-Los Angeles will add approximately 10% more seats. New York is not included in these figures as it is served one-stop via Vancouver, but the planned new nonstop service to New York would generate approximately 10% seat growth for PAL in the Philippines-US market.

PAL Philippines to US nonstop capacity (one-way seats per week): Sep-2011 to Jul-2016

PAL's load factor to the US is generally high, an indication that the market can support an increase in capacity. Its average load factor to Los Angeles and San Francisco is generally above 80% most of the year, and in peak months is often above 90%.

PAL monthly average load factor for Manila-Los Angeles: Jan-2013 to Aug-2015

PAL monthly average load factor for Manila-San Francisco: Jan-2013 to Aug-2015

Load factor data for New York is only available for the first three months of the New York operation. But in Aug-2015, the last month of available data, PAL recorded a load factor of 87% on the Vancouver-New York sector. In Aug-2015 PAL recorded an average load factor of approximately 89% on Manila-San Francisco and 86% on Manila-Los Angeles.

The Philippines-US market will likely grow at least modestly over the next several years. PAL should also be able to increase its Philippines-US market share as it adds nonstop capacity.

PAL should be able to increase its share of the Manila-Los Angeles and Manila-San Francisco markets as it adds frequencies. However, the biggest opportunities for market share gains could be on routes where it launches a new nonstop option - such as Cebu-Los Angeles and Manila-New York - because on these city pairs PAL now offers similar one-stop products to those of its competitors.

European expansion could be more challenging for PAL

Expansion to Europe is much riskier as PAL faces intense competition from Gulf airlines in the Philippines-Europe market, as well as from several other Asian airlines. PAL may be better off forging new or expanded partnerships to cover Europe.

The A350 will make any potential new European route more attractive, but PAL may generate better returns by using the expanded long haul fleet to expand in North America. North America is already PAL's main long haul market accounting for approximately 34% of its international ASKs, compared with less than 4% for Europe.

Philippine Airlines international capacity share (% of ASKs) by region: 22-Feb-2016 to 28-Feb-2016

PAL should continue to focus on where its strength is - and where competition is less intense.

PAL fleet renewal initiative to focus next on regional aircraft fleet

Completing the A350 deal represents a major milestone for PAL since it enables the group to phase out its oldest aircraft type - the A340 - and provide capacity to grow its long haul operation.

The group has already renewed its medium haul widebody fleet by taking 15 A330s since 2013. PAL is also already committed to renewing its narrowbody fleet, with orders for 30 A321neos for delivery from 2017.

Philippine Airlines Group fleet summary: as of 21-Feb-2016

Aircraft	In Service	In Storage	On Order*
Total:	76	2	43
Airbus A320-200	21	0	0
Airbus A321-200	19	0	5
Airbus A321-200neo	0	0	30
Airbus A330-300E	15	0	0
Airbus A340-300X	6	0	0
Airbus A350-900XWB	0	0	6
Boeing 747-400	0	2	0
Boeing 777-300ER	6	0	2
Bombardier DHC-8Q-314	4	0	0
Bombardier DHC-8Q-402	5	0	0

The group will now turn its attention to renewing and expanding its regional aircraft fleet, which currently consists of nine Bombardier Dash 8 turboprops operated by full service regional subsidiary PAL Express. The PAL Express Dash 8s now have an average age of approximately 12 years, making them the second oldest type in the PAL Group fleet after the A340s.

Philippine Airlines Group fleet by average aircraft age: as of 21-Feb-2016

PAL is now evaluating new turboprops from ATR and Bombardier, as well as regional jets from Bombardier and Embraer. PAL had meetings with all three manufacturers at the 2016 Singapore Airshow and is expected to make a selection by the end of 2016.

New turboprops will almost certainly be acquired as not all the domestic airports that PAL Express serves can accommodate jets. Regional jets are a possibility to supplement the turboprops on some existing domestic routes, and could potentially be used to launch new point-to-point domestic and regional international routes. However PAL may ultimately opt to acquire turboprops only, because the Philippine market, which is extremely price-sensitive with limited premium demand, may not provide sufficient yields to support smaller jets economically.

A350 supports upgauging strategy at Manila, while growing Cebu

PAL and its main competitor Cebu Pacific are also focusing on upgauging at their main hub in Manila because of slot constraints. PAL and Cebu Pacific will both be replacing A320ceos with A321neos in the coming years, while moving most of their turboprops from Manila to secondary bases, primarily Cebu.

The A350-900 is another example of upgauging as PAL phases out smaller A340-300s. PAL can continue to grow its long haul operation at Manila by upgauging aircraft and redeploying slots now used for short haul flights.

PAL is also planning to grow the Cebu hub with more new long haul routes along with Los Angeles, and potential regional international routes. However, the biggest opportunities will continue to be at Manila, particularly in the key North American market.