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Cebu Pacific and Philippine Airlines are poised to expand in US following Category 1 upgrade

The US FAA upgrade of the Philippines to a Category 1 safety rating opens up short-term expansion opportunities for Cebu Pacific Air and Philippine Airlines (PAL), brightening the outlook for both carriers. The upgrade removes the previous freeze on new entrants or adding capacity.

The Category 1 rating enables PAL to immediately replace ageing A340s and 747-400s with more efficient 777-300ERs on existing services to Los Angeles and San Francisco. PAL also plans to add within the next year new destinations in the continental US, giving it a potential alternative to the more risky planned expansion of its European network.

Cebu Pacific is likely to launch services by the end of 2014 to Guam and Hawaii with A320s and A330s, matching PAL on each route. Hawaii and potentially Europe, which is also now an option for Cebu Pacific as the carrier has joined PAL in being removed from the EU blacklist, gives the LCC an opportunity to slow down Middle East expansion and diversify its new long-haul operation.

Philippine authorities secure Category 1 rating after long wait

The US FAA announced on 10-Apr-2014 the upgrade of the Philippines from a Category 2 to Category 1 safety rating. The Philippines has been stuck in Category 2 since early 2008, prohibiting PAL from adding flights or changing gauge on any existing frequencies in one of the carrier’s most important markets.

Transitioning trans-Pacific flights to more efficient widebody aircraft and expansion in the US has been a key component of the PAL business plan for over six years. PAL initially committed in 2007 to acquiring six 777-300ERs with the expectation of operating the type to the continental US, including existing and potential new routes. But just a few months later the US FAA downgraded the Philippines to Category 2.

Frustratingly for PAL, the Philippines remained in Category 2 when the 777-300ERs were delivered, starting with two aircraft in 2010 and followed by another two in 2012 and the final two in 2013. As a result PAL was forced to find other markets for its 777-300ERs, some of which like Australia proved to be less than ideal.

In 2011 PAL, under its prior management and ownership, even took the unusual step of hiring and paying for a consultant to help Philippine authorities meet Category 1 standards. While Philippine authorities over the last few years have repeatedly expressed confidence in an upgrade, a Category 1 rating particularly appeared imminent since Mar-2013, when ICAO concluded that Philippine oversight authorities were again in compliance with international safety standards.

The ICAO conclusion led to the EU removing PAL from its blacklist of carriers in Jul-2013. Japanese authorities also quickly lifted restrictions that had blocked PAL and all Philippine carriers since 2008 from expanding to Japan. The Philippines had to wait longer for the US to follow as the FAA first needed to schedule and conduct a new audit of Philippine authorities, which was completed in Mar-2014.

PAL will finally be able to operate 777-300ERs on US routes

PAL stated on 10-Apr-2014 that 777-300ERs will take over within the next month its existing flights to Los Angeles and San Francisco. PAL now operates ageing 747-400s on its daily flight to San Francisco and a combination of 747-400s and A340-300s on its 11 weekly frequencies to Los Angeles. PAL also operates five weekly flights to Guam and three to Honolulu, which the carrier says will continue to be operated with A320s and A330-300s respectively.

PAL currently uses its six 777-300ERs to operate three of its 14 weekly flights to Tokyo Haneda, its five weekly flights to London and its seven frequencies to Vancouver with three continuing to Toronto, according to OAG data. Sydney had also been flown with 777-300ERs until early Feb-2014, when A340-300s were placed back on the Manila-Sydney route.

The 777-300ER will significantly improve the efficiency of PAL’s operation to Los Angeles and San Francisco and also enable the carrier to eliminate a fuel stop on the westbound leg. The 747-400 and A340 are able to operate non-stop from Manila to California but often have to make a stop on the longer return leg.

PAL needs to acquire more widebody aircraft

The 777-300ER is the ideal aircraft for PAL’s trans-Pacific operations, as the carrier envisioned in first selecting the type in 2007. But PAL will not have enough 777-300ERs to cover all its North American flights. Based on current schedules all 25 weekly frequencies to Los Angeles, San Francisco and Vancouver would require a fleet of at least seven aircraft.

PAL will also need more 777-300ERs to add new destinations in mainland US, which it plans to launch within the next year. The carrier served Las Vegas until 2012 and previously looked at serving San Diego, which has one of the largest Filipino populations in the US. But at this point PAL’s management team seems more keen to go further east with Chicago and New York both likely destinations by early 2015.

PAL has been looking at acquiring more widebody long-haul aircraft, including additional 777-300ERs. With the green light now to change gauge and expand in the US, the acquisition of additional 777-300ERs through leases or new orders becomes more likely as it remains the preferred type for US routes. (787s or A350s could also be acquired but PAL would likely need to wait longer for delivery slots, making these types potential replacements for A340s on European routes.)

Category 2 prevented PAL from completing renewal of its widebody fleet as the carrier had no choice but to continue operating 747-400s and A340s on its US routes. PAL currently operates five 747-400s, which are 19 to 20 years old and are only used for Los Angeles and San Francisco. PAL also has been operating some of its US flights since 2008 with four long-standing A340-300s, which are 16 to 17 years old.

Philippine Airlines average fleet age by type: as of 12-Apr-2014

In addition to taking its last two 777-300ERs, over the last year PAL added five ex-Iberia A340-300s under a lease agreement with Airbus. The newly acquired A340-300s, which are 12 to 15 years old, will likely be used to operate to London (and at least some of the Vancouver frequencies) as PAL looks to free up 777-300ERs for the US market.

PAL also has taken delivery over the last year of eight A330-300s (including one at PAL Express) which were part of a large order placed in 2012 with Airbus. PAL has another 12 A330-300s on outstanding order, all of which are slated to be delivered by the end of 2015, according to the CAPA Fleet Database.

PAL has been using the A330s to expand regionally within Asia-Pacific and to the Middle East. PAL recently reduced its A330-300 order book by five aircraft in a swap for eight more A320neos, raising it A320neo commitment to 18 aircraft.

Philippine Airlines fleet summary: as of 12-Apr-2014

Aircraft In Service In Storage On Order*
Total: 61 0 58
Airbus A319-100 4 0 0
Airbus A320-200 16 0 0
Airbus A321-200 6 0 28
Airbus A321-200NEO 0 0 18
Airbus A330-300 8 0 0
Airbus A330-300E 7 0 2
Airbus A330-300X 0 0 10
Airbus A340-300X 9 0 0
Boeing 747-400 5 0 0
Boeing 777-300ER 6 0 0

The PAL group has been ambitiously pursuing expansion in the Middle East, where it added five destinations in 4Q2013 using new A330-300s. PAL also launched the Manila-London Heathrow route in Nov-2013, quickly taking advantage of its removal from the EU blacklist.

See related reports:

US expansion could be more attractive to PAL than continental Europe

PAL has also been preparing over the last several months to add services in continental Europe, with Amsterdam, Frankfurt, Paris and Rome all cited as potential routes. PAL had been looking at launching multiple European destinations in 2014 and still has a sufficient number of A340-300s to potentially launch one or two. But new US destinations could become the priority over continental Europe.

It would be logical for PAL to focus on the US and catch up on the six years it has not been able to grow in the US market. (In fact PAL slightly reduced capacity to the US as in 2012 it dropped Las Vegas, which it served as a tag with Vancouver on three of the seven weekly flights to Vancouver. Dropping the tag allowed PAL to switch its Vancouver service to an all-777-300ER operation and add Toronto. Service to Las Vegas is not likely to be restored as the focus is instead now on the eastern US.)

The US represents a better opportunity than Europe as the US has by far the world’s largest population of overseas Filipinos. There are over 3 million Filipinos living in the US while there are about 700,000 Filipinos living in Europe. The European population is also spread out, making it easier for Gulf carriers to penetrate the Philippines-Europe market as they are able to offer a wider array of destinations in Europe, particularly as PAL does not currently have a European partner.

The Philippines-US market is also competitive but PAL does not have to contend with the Gulf carriers and has an advantage as it is the only carrier with non-stop service. Delta and United serve the Philippines but neither operates non-stops. Delta currently serves Manila via Nagoya and Tokyo in Japan while United operates from Guam, where it has a small base.

Several North Asian carriers also serve the Philippines-US market on a one-stop basis including All Nippon Airways, Asiana, Cathay Pacific, China Airlines, EVA, Korean Air and Japan Airlines. But PAL has a strong position with its exclusive non-stop product along with brand loyalty as overseas Filipinos generally prefer flying with PAL.

Despite offering an outdated product on ageing aircraft, PAL’s load factor to Los Angeles and San Francisco in recent years has been consistently above 75% except during the off peak months of September to December.

Philippine Airlines average monthly load factor from Manila to Los Angeles: Jan-2011 to Sep-2013

Philippine Airlines average monthly load factor from Manila to San Francisco: Jan-2011 to Sep-2013

PAL’s position in the US should strengthen further as its transitions its California flights to its flagship product, the 777-300ER. About half of the Filipinos living in the US reside in California.

Expansion of the network to the east should allow PAL to be able to further grow its overall share of the Philippines-US market. There are currently about 200,000 Filipinos living in the New York City area and about 100,000 in the Chicago area. This segment of the community is generally flying with North Asian carriers as there is no convenient PAL option.

Cebu Pacific poised to enter Guam and Hawaii markets

Cebu Pacific also is keen to serve the US market but currently does not have the aircraft with the range to reach the mainland US. The LCC is expected to initially focus on Guam and Honolulu with both routes likely to be launched by the end of 2014.

Cebu Pacific has long been interested in serving Guam with its A320 fleet but has been precluded by Category 2 restrictions. The carrier even previously looked at wet-leasing aircraft from a US carrier to serve Guam but ruled out that option as it was cost prohibitive.

Manila-Guam is currently served by United with 10 weekly 737-800 flights along with the five weekly A320 flights from PAL. With LCC stimulation the Manila-Guam should be able to support a significant increase in capacity.

Guam has been keen for some time to attract LCC service from the Philippines. The Guam airport has seen the Korea-Guam market grow following the entrance of Jeju Air, which is the only LCC currently serving Guam.

Manila to Guam capacity by carrier (one-way seats per week): 19-Sep-2011 to 28-Sep-2014

The Honolulu-Manila market has only been served by PAL since Hawaiian Airlines dropped Manila in mid-2013 after five years on the route. Cebu Pacific should be able to be more successful than Hawaiian at stimulating demand as the Honolulu-Manila market is price sensitive - as are most Filipino expatriate markets.

Hawaii has the second largest Filipino community after California among US states, with about 300,000 residents.

Manila to Honolulu capacity by carrier (one-way seats per week): 19-Sep-2011 to 28-Sep-2014

The opening up of the US market comes at an ideal time for Cebu Pacific as the carrier has not yet decided on routes for the three A330-300s it is adding in 2014. The carrier’s new long-haul unit took delivery of its first two A330s in 2013, one of which was used to launch service to Dubai in Oct-2013 with the other aircraft used for regional services to Seoul and Singapore. Cebu Pacific has been using its third A330 in the domestic market since taking the aircraft in Feb-2014.

Hawaii gives Cebu Pacific the option of slowing down Middle East expansion

With another A330 delivery expected in May-2014 followed by one more in 3Q2014, Cebu Pacific needs to quickly move forward with selecting additional long-haul routes. Australia is under consideration and Sydney will likely be launched by the end of 2014. As CAPA previously reported, Cebu Pacific also has been considering two destinations in Saudi Arabia as well as Kuwait, Qatar and Oman.

Hawaii represents a potentially more appealing option. The Middle East market has become extremely competitive as PAL also has launched services to Saudi Arabia, Qatar and the UAE. In addition several Middle Eastern carriers have large operations at Manila.

As Cebu Pacific’s initial performance in Dubai has been somewhat disappointing, the carrier’s long-haul unit could be better off focusing on a more balanced network featuring a mix of Australia, Hawaii and two or three Middle Eastern destinations. Previously the long-haul plan was for five to six destinations in the Middle East and one in Australia by the end of 2014. Cebu Pacific will still likely launch one or two additional Middle Eastern routes in 2014 but now has the option of deferring some of its Middle Eastern expansion until at least 2015 in order to free up capacity for Honolulu.

See related reports:

Cebu Pacific also now has the option of serving the EU as it was removed from the EU black list on 10-Apr-2014, ironically the same day it received good news with the US FAA announcement. But Hawaii is a more likely option for 2014 with services to Europe and potentially the continental US to be added later as new generation widebody aircraft are considered. Most European destinations are not within range of Cebu’s A330s without payload limitations although Moscow is an option and has been considered.

The outlook for PAL and Cebu Pacific also improve as Japan opens up

US Category 1 along with the removal from the EU blacklist significantly improves the outlook for both main Filipino carriers. PAL and Cebu Pacific are also now pursuing rapid expansion in Japan, taking advantage of the lifting of restrictions by Japanese authorities.

See related report: Cebu Pacific, AirAsia Zest, Tigerair and Philippine Airlines race to add flights to Japan

For Cebu Pacific the opportunities in Japan and the US are particularly key as the carrier was previously limited to operating only three weekly flights to Japan while it was completely shut out of the US. PAL benefited in Japan and to a lesser extent the US as it was already in both markets with relatively significant operations.

Japan is currently PAL’s largest market, accounting for about 25% of its total international seat capacity while the US is its fourth largest market accounting for about 10%. On 30-Mar-2014 PAL significantly expanded its Japanese operation as it launched two daily flights to Tokyo Haneda, introduced a second daily frequency to Osaka and added two weekly frequencies to Fukuoka for a total of seven.

Philippine Airlines capacity share (% of seats) by country: 7-Apr-2014 to 13-Apr-2014

PAL can now look for US airline partners

While it benefited from limits on Cebu’s expansion, PAL needed to grow in both Japan and the US as the carrier enters a new expansion phase under San Miguel, which acquired a majority stake in PAL in 2012 and has invested significantly in new aircraft. The Category 1 rating also allows PAL to pursue codeshares with US carriers, which would give it domestic connections beyond its gateways.

While attracting a partnership with a US major may be challenging, Hawaiian Airlines, Alaska Airlines and Virgin America are all potential suitors which would provide sufficient offline access beyond the main PAL gateways of Los Angeles, San Francisco and Honolulu. JetBlue could also be a potential partner if PAL opts to launch services to New York.

PAL also has been discussing a potential partnership with ANA, which could provide access to some US points beyond Tokyo as well domestic connections in Japan.

Category 1 will offer a huge boost for PAL as it opens up online and offline opportunities in the US. While an ambitious PAL is still keen to grow further in the Middle East and Europe, where it did not have a single destination just six months ago, the US should now get priority.

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