Plunging Cathay profits: What went wrong?

Photo courtesy Cathay Pacific Airways

Photo courtesy Cathay Pacific Airways

WITH Cathay Pacific Airways – one of the world’s leading airlines – announcing an 83-per-cent plunge in annual profit, one must begin to wonder what went wrong.

Almost five years since the onset of the global economic crisis, the fortunes of the airlines can be best alluded to the unpredictable movements of the yo-yo. It was only at the end of last year that the International Air Transport Association (Iata) could with some confidence finally revise its profit forecasts upwards instead of downwards: from US$4.1 billion to US$6.1 billion for 2012, and from US$7.5 billion to US$l4 billion for the current year.

Could Cathay be an exception to the rule? For all the hype about product improvement all round including the new Premium Economy class and a new regional business class, the Hong Kong-based airline posted a net profit of HK$916 million (US$118 million), down from HK$5.5 billion a year ago.

Cathay has attributed its poorer performance to a number of factors.

First, higher fuel costs. Cathay reported that throughout much of 2012, fuel prices were at sustained high levels and the Cathay Group’s fuel costs increased by 0.8 per cent compared to 2011. What’s new anyway, when this should similarly affect all airlines across the industry? Yet, in spite of that, some airlines such as Japan Airlines are reporting improved performances. The volatility of the fuel price has been an easy target to blame no matter what degree its impact is on performance. It may not apply to Cathay, but in fact the average jet fuel price had been falling from Sep to Dec 2012 before rising again.

What is more of a concern is the reason for the decline in the fuel price, as explained by Iata chief Tony Tyler: “The reduction in fuel prices is a great thing for the airline industry but they are coming down because of concerns over world economic activity. If the world enters an economic slump, that will be even worse for the industry than the higher fuel price was on its own.”

Second, a drop in demand for corporate travel. This is a more cogent argument as the industry continues to be hard hit by the economic stagnation or slow recovery if at all it is happening, particularly in Europe and the United States. Cathay, which banks on its premium product, is naturally affected more than other airlines that thrive on the low-end traffic.

In a statement issued by the airline, Cathay chairman Christopher Pratt said: “Premium class yields were affected by travel restrictions imposed by corporations.”

Again, this is not a new lesson gleaned only yesterday but widely recognized during the global financial crisis which all but favours cheaper alternatives. Cathay is not alone in this predicament; rivals such as Singapore Airlines (SIA) and Qantas face the same threat.

In a counter-move, Cathay introduced the premium economy class to retain downgraders and attract those who are prepared to pay a little more but not that much more to upgrade to enjoy the frills of an in-between class. It is tempting to conclude that this strategy – perhaps to the relief of SIA which has until now snubbed the idea – is not working judging by the results posted by Cathay, but its full impact is yet to be realised. If the global economy continues to weigh down, it may well prove to be Cathay’s lifeline.

That brings us to the third point as to what went wrong then. Cathay attributes it to increased competition. Mr Pratt said: “An increasingly competitive environment added to the difficulties.” That may be true, but when an airline such as Cathay which is among the world’s most successful carriers resigns to that, it comes across as being somewhat less plausible and lame, and smacks of something amiss.

Competition is a given in this industry. So what has Cathay done or is doing to check the competition? To be fair, it has done much more than most airlines. It has rolled out new product improvements and improved its in-flight service. The airline is ranked consistently among the industry’s favourites, particularly its business class, by air travellers. By all account, its strategy should place it in the forefront of the competition, so what is missing that it should ascribe its falling performance to increased competition? If there’s such a thing as a success formula to suit different environments, has it got the equation not quite right?

Fourth, the weak cargo demand in major markets, particularly from Asia to Europe. No doubt this has affected Cathay’s overall profitability. If it is any consolation, close rival SIA is also similarly afflicted. There are no clear signs that the situation will improve substantially in the near term. In light of the weaker outlook, Cathay has cancelled an order for eight Boeing 777-200 freighters but instead placed an order for three Boeing 747-8 freighters which will carry 16 per cent more revenue-producing freight than predecessor Boeing 747-400. Cathay chief executive John Slosar said the larger airplane would result in fuel savings for the revamped fleet.   

Fifth, high operating costs, especially of the long haul routes that according to Mr Pratt were dominated by “older, less fuel-efficient Boeing 747-400 and Airbus A340-300 aircraft”. Last year, the company announced plans to accelerate retirement of the less fuel-efficient 747-400 as it continues with the fleet upgrading programme for both airlines in its fold – Cathay and Dragonair. In January, Cathay ordered 10 Airbus A350-1000 and converted 16 of its existing order for A350-900 to the larger A350-1000. These 350-seaters will ply high-density routes which include non-stop flights to Europe and North America.

The future should look rosier. Mr Slosar said: “This is an important strategic development for Cathay Pacific. The A350-1000 aircraft will bring us world-beating fuel efficiency.” 

Last, incommensurate cost-cutting measures that include offering unpaid leave to crew and reducing capacity on some routes which unfortunately, according to Mr Pratt, “were not enough to offset in full the effects of high fuel prices and weak revenues.”

And we have come one full circle. So what makes one airline more likely to succeed than another when almost every one of them alike ascribes its failed performance to the same factors?

Mr Pratt said: “Our core strengths remain the same ever: a superb team, a strong international network, exceptional standards of customer service, a strong relationship with Air China and our position in Hong Kong. These will help to ensure the success of the Cathay Pacific Group in the long term.”

Sounds familiar, you may say, except for specific references applicable only to Cathay.

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About David Leo
David Leo has more than 30 years of aviation experience, having served in senior management in one of the world's best airlines and airports. He continues to maintain a keen interest in the business, writes freelance and provides consultancy services in the field.

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