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China Eastern Airlines: rebranding, strategic revival, new 777 deliveries and an investor hunt

It is not often that a lick of paint is so momentous. When China Eastern Airlines – China’s second largest carrier and the world’s eighth largest by seats – unveiled its new livery, it marked an important step. The details of the branding are the minor part; the major fact is that in China’s slow-moving legacy environment of national carriers where the state has a heavy hand, China Eastern was able to implement change. Competitors, still wearing their old coats, are jealous. This is China Eastern's first re-branding since its establishment over 20 years ago, and the first major one among China's airlines.

The branding itself is the visible signal of strategic change. A more material one is due to arrive with the 24-Sep-2014 delivery of the first of China Eastern’s 20 777s for long-haul growth, mainly to North America. China Eastern’s lagging performance has made its Shanghai hub vulnerable, albeit one of China's most important. Further, China Eastern is the first – and so far only – state carrier to launch an LCC. Even more disruptive, in its low key way, is China Eastern’s discussion of finding a strategic investor.

The strategy may be relatively fresh but it needs time (perhaps years) to incubate. China Eastern has some way to go before becoming fully commercial; for example, its 1H2014 financial results included domestic load factor gains at the expense of yield - while operating profit was boosted by state subsidies.

 

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China Eastern's new livery is designed to convey modernity – and the fact of change itself is the most important feature

China Eastern’s livery change consisted of, most noticeably, removing the colour on the aircraft fuselage, which was deemed old fashioned. China Eastern’s dislike of the colour has resulted in the extreme outcome of an all-white fuselage. The logo has been simplified to show its swallow symbol in two colours, rather than in white against a two-toned circle.

The swallow is also supposed to convey the letters "CE", the initials of China Eastern. The new logo also features more curves, which China Eastern intends to convey modernity. Chinese airlines are sensitive over their (not always inaccurate) reputation of not being modern and internationally minded. The extreme change shows how serious China Eastern is to improve its standing. The visual change however must be the start of a new process and not the culmination.

China Eastern logo evolution: As of Sep-2014

Until Sep-2014 From Sep-2014

While the design may garner mixed views, other state-owned carriers seem jealous that China Eastern at the very least was able to make change. The state’s ever-present hand apparently extends to choice of paint.

Perhaps Air China is circumventing this inertial force by having an increasing number of special liveries on its 777s, seen as its flagship aircraft serving high-profile international routes. Most of Air China’s new special liveries feature a simple white fuselage with a mark promoting whatever concept arises (including “Smiling China”, "Love China" and another promoting the 50th anniversary of Sino-French relations – ironically on a US-made Boeing aircraft).

Shanghai-based China Eastern is seemingly trying to reduce the role of Beijing's intervention. Besides the livery change, China Eastern is trying to shorten the CAAC-mandated introduction period of its new 777s, which China Eastern sees as beyond conservative and beyond international standards. China Eastern has also spoken of welcoming a foreign investor to accelerate its internationalisation.

These developments are significant within the realm of Chinese aviation, but there is still a long way to go for China Eastern to be more market-oriented and make changes that will have a deep structural impact, such as workforce simplification. Much of the change at China Eastern is driven by chairman Liu Shaoyong, who was plucked from China Southern to turn China Eastern around.

Mr Liu soon may face a higher calling in the central government – which could potentially give China Eastern a friend in the right place. 

See related report: China Eastern Airlines once again seeks a strategic investor to welcome it onto the world stage

The Shanghai market is at an inflection point

China Eastern’s changes are important in their own right, but also as its Shanghai hub threatens to become a more competitive place to operate. It could be argued Shanghai has granted competitive moves by other airlines partially out of frustration with China Eastern's slow expansion.

For example Hainan Airlines/HNA is converting Shanghai Pudong-based freight operation Yangtze River Express to a passenger airline, while China Southern is enlarging its presence, keen to secure long-haul traffic rights, having failed to gain key long-haul traffic rights out of Beijing. As CAPA previously wrote:

The competitive and fragmented aviation market of Shanghai will become more complex with China Southern Airlines' Jun-2014 establishment of a branch while HNA seeks to have locally-based Yangtze River Express transition from freight services to freight and passenger services. China Southern's enlarged Shanghai presence will follow its notable presence in Beijing and hub in Guangzhou. The long term could see China Southern attempt to launch long-haul routes from Shanghai, which have been lacking, although China Eastern Airlines is seeking to change this. Yangtze River Express holds some prime slots that could be used for passenger service, finally giving the HNA Group a presence in Shanghai.

China Eastern's market share in Shanghai has declined faster than Air China's in Beijing or China Southern's in Guangzhou, and this is likely to continue. Shanghai's Hongqiao and Pudong airports collectively handled 82.8 million passengers in 2013, just shy of Beijing Capital's 83.7 million. Over the next year, a slot expansion at Shanghai Pudong will increase the number of slots for existing and new entrants.

See related report: China Southern Airlines and HNA's Yangtze Express attack China Eastern's market share at Shanghai

Arrival of the 777s marks the start of long-haul growth, which China Eastern expects to be profitable

Long-haul growth is not always a welcome development from Chinese airlines since international routes tend to be unprofitable. But China Eastern expects its new 777s to deliver its long-haul market to profitability, and also grow. China Eastern’s limited long-haul network compared to its peers has been a sore point for the local government.

On the cost side, China Eastern has made improvements in recent years, but believes profits cannot be achieved until it switches from A340-600s to 777s. China Eastern has 20 777-300ERs on order, with the first to arrive on 24-Sep-2014. China Eastern will take four of the type in 2H2014 and a further five in 2015, allowing for its five A340-600s to be retired by the end of 2015.

Further 777 orders are expected as China is a likely market for “production bridge” 777s built prior to the commencement of 777X production. Most 777s are expected to be used on North American routes.

China Eastern Group planned fleet development: as of 30-Jun-2014

China Eastern Airlines Fleet Summary Hulls: as at 22-Sep-2014

On the revenue side, China Eastern hopes to capture a premium for demand to/from Shanghai, although onward domestic connections will be hampered by the carrier’s split Pudong/Hongqiao hub operation.

As noted by CAPA at the start of 2014, China Eastern will also be the first Chinese carrier to give every business class seat direct aisle access. China Eastern is using the popular Zodiac Cirrus seat. This brings China Eastern into the same hard product category as its peers. It is uncertain if China Eastern can capture a yield premium for these more spacious seats, or simply would not be able to capture traffic without them. China Eastern will use the Cirrus seat on its long-haul A330s. China Eastern will also have 10-abreast economy seating, the second Asian airline to do so on a long-haul 777 (after ANA). China Eastern will stick with a traditional eight-abreast configuration in economy on its A330s.

China Eastern is also hoping to gain service marks for its 777 having walk-up snack bars, toasters, rice cookers, duty free showcase and renewed emphasis on the serving of tea and coffee. These developments follow other hard product improvements from Chinese airlines that have often gone under-appreciated, although soft service and the passenger experience in other areas still has room for improvement – as Chinese airlines often admit themselves.

See related report: 777-300ER gains three North Asian operators in 2014: China Airlines, China Eastern & China Southern

China Eastern is first of the Big 3 to establish an LCC, China United Airlines

China Eastern has become the first of the Big 3 (the other two being Air China and China Southern) to establish a low cost carrier. Perhaps learning from Qantas/Jetstar, with whom it has a JV to establish Jetstar Hong Kong, China Eastern certainly has a better basis now to embark on low cost operations.

Hainan Airlines has already converted West Air (and, in Hong Kong, HK Express) with plans to transform Beijing Capital Airlines. China Southern has mooted transforming its subsidiary Chongqing Airlines (based in Chongqing, as is West Air) while Air China is likely to convert one of its smaller subsidiaries.

China Eastern gained an LCC by converting Beijing-based wholly-subsidiary China United Airlines to an LCC in Jul-2014. This followed almost a year of market speculation, but the immediate change to China United on LCC appears limited.

There is new management, from within China Eastern, and adoption of some well-understood principles. An announcement that China United was removing first class suggested a positive development, that as an LCC it would sensibly move to a single-class configuration (not that its first class was ever filled with many (paying) passengers).

But the details of the announcement clarified that China United was merely re-branding first class as business class. Deeper, structural changes clearly await. Some changes do need to come from management thinking, but also some from regulators (clearer views on policies) and suppliers (being able to accommodate airlines' changing product needs within a reasonable timeframe).

China United seems ideal to function as an LCC given it serves more regional markets (where there is greater price sensitivity) and has low frequency on its major markets, reducing its appeal to business travellers.

See related report: China Eastern to transform China United Airlines into a LCC; first of China's Big 3 to have a LCC

China United Airlines top 10 routes ranked on return weekly frequency: 22-Sep-2014 to 28-Sep-2014

Incremental benefits from Shanghai Disneyland, Shanghai FTZ and in-flight wifi

China Eastern expects incremental benefit from the opening of Shanghai Disneyland, the first Disney theme park in mainland China, as well as the Shanghai Free Trade Zone. China Eastern expects both to boost interest in Shanghai, and in particular the area around Pudong airport, where China Eastern’s yields and load factors are often weaker than at more convenient Shanghai Hongqiao airport.

Disneyland in particular could help stimulate weekend traffic around Shanghai, which is not as large a domestic tourism point as Beijing. As CAPA previously wrote:

China Eastern is hoping to ride on – and also contribute to – Shanghai’s increasing profile as a tourism destination, one set to grow with the 2015 opening of a Disney Resort in Shanghai, the first in mainland China.

Shanghai is a common tourist destination for foreigners who come to see the city and its rapid growth encapsulated in the Bund skyline but also historical colonial heritage – rare in China (and indeed, Asia). But for domestic tourism, which comprises the majority of arrivals, Shanghai garners considerably less interest than Beijing, the capital with official sights but also a representation of the “old” China.

Domestic visitors to Shanghai are common during the week for business reasons, but not at weekends. Shanghai’s hope is that Shanghai Disney will keep weekday tourists in Shanghai while also bringing in new ones on weekends. Shanghai Disney will complement existing Disney parks in Tokyo and Hong Kong, although the latter has under-performed with visitor statistics. 

The tie to aviation and China Eastern specifically is furthered with Shanghai Disney’s location in the Pudong area, in proximity to Shanghai Pudong Airport, southeast of the city centre. Most passengers find Shanghai Hongqiao far more convenient being placed just outside the western part of the city. Hongqiao Airport is also connected to an extensive ground transportation hub comprising buses and high-speed trains, allowing for easy connections beyond Shanghai.

Whereas Hongqiao is mainly a domestic airport, Pudong has a larger international focused. But the full utilisation of Hongqiao combined with the need for domestic feeder flights for international services means there are substantial domestic services at Pudong.

Pudong yields however are typically lower than out of Hongqiao, reflecting the incentive airlines need to offer for passengers to make the trek to Pudong. China Eastern hopes growing interest in Pudong from Disney and the free-trade zone will gradually boost Pudong yields.

See related report: China Eastern Airlines seeks to revitalise its position with 777 long-haul growth and new brand

Further, China Eastern says that in Jul-2014 it completed a trial of the first in-flight wifi flight in China. This may be optimistic, as other airlines (including Air China and Hainan Airlines) have reported trialling in-flight wifi. Whatever the specifics, the signs nonetheless are that China Eastern is (1) trying to be ahead of (or in line with) Air China and Hainan on what will surely be eventual in-flight connectivity; and (2) is trying to improve the flying experience.

The inflight experience has been particularly battered on the key Shanghai-Beijing route. Eventual in-flight connectivity may enhance the appeal of flying versus the high speed rail option on this route. Far more significant an improvement will be punctuality. When on time, flights have a slight advantage over rail. But with ever-increasing delays – which are unpredictable and frustrating – high speed rail quickly becomes a real factor. However, airspace appears to be a matter out of the hands of all but the top echelons of government.

China Eastern's 1H2014 results: subsidies boosted operating profit

While there may be strategic change at China Eastern, its 1H2014 performance showed a result in line with peers.

Among the key points: net profit fell due to foreign exchanges while the operating profit was boosted by government subsidies. China Eastern has not stated the exact change but its “other” revenue increased RMB1,187 million (USD193 million) to RMB1,842 million (USD300 million). China Eastern attributed most of the rise to greater subsidies.

China Eastern financial summary: 1H2014

Without the subsidies, China Eastern would have posted a higher operating profit than in 1H2013, but the result would still effectively be break-even. Other positive factors were a 3.6% increase in transport revenue outpacing a 2.8% increase in costs.

China Eastern’s fuel price was down 5.3%, leading to a 0.2% reduction in its fuel bill despite capacity growth. Staff cost increases (10.6%) once again significantly outpaced capacity growth (system growth of 5.5% ASKs and 4.7% ATKs).

China Eastern overall market indicators: 1H2014

The domestic market remains China Eastern’s core with subtle change to international/regional markets. Regional and international markets were difficult to manage in 1H2014.

As has been observed at other airlines, expanded cross-Strait capacity between mainland China and Taiwan drove yields down (a 10.6% decrease offset by 2.1ppt load factor gain). In the regional international market, Southeast Asia deteriorated while Korea maintained strong momentum with Japan rebounding.

China Eastern passenger market key indicators: 1H2014

Outlook: The second half is usually stronger. For the long term, positive change and perhaps an investor

In the short term, the second half of the year is traditionally stronger and China Eastern should benefit from these operational benefits, although foreign exchange will continue to impact the net level.

Looking beyond, the fact that China Eastern is making changes is positive in itself. There will be costs associated with these, such as re-shaping China United and new long-haul route start-up costs.

Introduction of the 777s will offer a real litmus test of where China Eastern will be headed, in the US market particularly.

China Eastern is convinced it will generate profits from these adjustments, but also of the strategic necessity to make these changes - and do so earlier rather than later.

As for further hints of an equity investor, China Eastern has been there before, with a Singapore Airlines investment that was in the main part foiled by Beijing. The mere revival of the suggestion is interesting timing; perhaps the environment is now more welcoming. There will be more than one foreign airline alert to the possibilities.

While these may be momentous changes, there are still far deeper ones to be made. For now, the early signs of positive change are welcome.

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