Cathay Pacific is set to use newly-acquired low-cost airline HK Express to reduce competition by limiting fleet expansion and re-positioning the airline to facilitate transfer traffic, shrinking local supply for visitors and Hong Kong residents. In the short-term that should increase yields, boosting Cathay’s under-performing restructuring. Long-term, Cathay’s greater control of Hong Kong capacity will make it harder for competitors to have a meaningful presence in the city.
“I suspect by 2024 or so when the third runway system opens up in Hong Kong, we’ll have 26 to 30 aircraft” at HK Express, Cathay Pacific chairman John Slosar told the Wings Club before the transaction was completed this month. Cathay did not respond to follow-up queries.
HK Express has 24 aircraft but projected a fleet of 50 in 2018. That growth was paused after Hong Kong’s new government negatively reacted to HK Express pre-emptively cancelling 18 flights in 2017.
The higher range of Slosar’s projection means HK Express will take only one additional aircraft a year. Cathay hinted at a limited remit for HK Express, saying the LCC would serve a “niche” market segment despite low-cost demand flourishing across Asia.
Even if the 50 aircraft target was overly-optimistic, Cathay’s plan for HK Express is well below peer LCC growth. Congestion at Hong Kong International Airport is not to blame. “Guess what? That doesn’t mean growth turns to zero,” Slosar said of slot constraints.
Korea’s lively LCC sector has seen some airlines add more aircraft in a single year than HK Express will add in the medium-term. Growth occurred despite constraints in Seoul, Busan and Jeju.
Cathay is shunting low-cost growth in favour of its full-service brands. Cathay Pacific is adding 18 A350s from 2019 to 2021, mostly for expansion. From 2020, regional full-service arm Cathay Dragon will start taking delivery of 32 A321neos while Cathay Pacific in 2021 will start taking delivery of 21 777-9s, for growth and replacement.
Slosar is confident there will be sufficient slot increases in Hong Kong for Cathay’s large fleet expansion. “The airport and the Civil Aviation Department in Hong Kong, who see this as a real issue, are working very hard to find a little bit more capacity,” he said. “When I reflect back on the last few years of Kai Tak, which was absolutely maxed out, every year we found a little bit more capacity somehow by being a little bit more efficient. So I think over the next five years there’s a good chance there’ll be just enough to keep some growth possible, that will be fine.”
Cathay having a greater share of its home market means it will be harder for competitors to make inroads or even establish a new airline in Hong Kong. “When the third runway opens up we will have if you’d like a kind of running start,” Slosar said.
“It would be a totally different picture I think to be trying to set up something from scratch at that point,” he said. “It’d have been a lot harder if you started from zero.” Before the HK Express acquisition, Cathay was open-minded about having a LCC, but only after the third runway opened. HK Express will help propel its strategic development while reducing competition.
Cathay will also curtail local capacity by having HK Express carry more transfer passengers, a change from its current point-to-point business model. Slosar said HK Express would transfer passengers with Cathay Pacific and Cathay Dragon. This implies that by having HK Express focus more on transfer passengers, it will de-emphasise local traffic.
A constrain on supply should increase fares in Cathay’s popular home market. Hong Kongers spend US$2,959 on travel e-commerce per capita, higher than any other Asian market, including second place mainland China at $1,935 per capita, according to a report from travel technology provider Amadeus.
Fare increases will drive yield growth at a critical time for Cathay. The restructuring it started in 2017 differs from most other airline overhauls by focusing on yield growth rather than cost cutting. Airlines typically target double-digit unit cost reductions, but Cathay only plans to keep unit costs flat. There is cost cutting, such as on staff, to offset uncontrollable cost growth like increases in Hong Kong airport parking charges.
Cathay showed strong passenger yield growth of 6.7% in 2018 by holding back on discounted tickets, proving its point it was selling too cheaply and could command the elusive goal of a yield premium. That has become short-lived with yields weakening and Cathay warning in June of “tremendous pressure.”
That yield decrease started before a series of protests and travel warnings for Hong Kong. The protests had been in commercial and tourism hubs, and on Friday spread to the airport for the first time. Aviation bounces back from short-term events, ranging from MERS to swine flu to territorial disputes. Unknown is the long-term impact for Hong Kong tourism and critical high-yielding business demand. Growth in overnight visitors after 2014 protests subsided was one of the key underlying market conditions for Cathay in recent times.
The Cathay-HK Express acquisition was not subject to formal competition oversight in Hong Kong. This is standard for the territory; an earlier Cathay-Qatar Airways joint venture did not need regulatory approval.
