April 13, 2012
Philippine Airlines (PAL) and low-cost sister carrier AirPhil Express
are embarking on a new but still challenging era following the sale of
large minority stakes in the two companies to Filipino conglomerate San
Miguel. While Lucio Tan will continue to control majority stakes in both
airlines, the deal is significant as it provides USD500 million
required for fleet renewal and reinvigoration at PAL and for expansion
at AirPhil,
which will be used to fight off increasing LCC competition. It is also
significant as San Miguel will gain management control of both carriers,
which could lead to some adjustments in the group’s strategy.
The deal, which was completed last week, hardly comes as a surprise.
On numerous occasions Mr Tan has looked to sell part of his stake in
PAL, of which he took control 20 years ago after the flag carrier was
privatised. The latest round of negotiations with San Miguel and one
other potential buyer have been dragging on since late last year.
Industry sources say Mr Tan was initially reluctant to include AirPhil,
which has a brighter outlook than PAL given its focus on the faster
growing budget end of the market, and cede management control in either
carrier.
While San Miguel and PAL parent Trustmark Holdings have announced the
deal will involve Trustmark and AirPhil parent Zuma Holdings issuing
new shares in the two carriers to San Miguel Equity Investments, they
have not confirmed exactly how large a stake will change hands.
Reportedly San Miguel will end up with stakes between 40% and 49% in
both carriers. Zuma now owns all of AirPhil Express while Trustmark owns
nearly all of PAL (Trustmark’s control of PAL is estimated to be 97% to
98% as a small minority share in PAL is publicly traded on the Philippine Stock Exchange). Mr Tan controls both Zuma and Trustmark.
PAL could adopt similar strategy to Garuda
PAL is among the weakest of Asia’s major flag carriers, having seen
its share of the Philippine market steadily erode in recent years, and
was in need of a recapitalisation. With the USD500 million coming from
San Miguel, the carrier will be able to embark on a new business plan
that will likely follow a strategy similar to the one used by
similarly-sized Garuda Indonesia. As part of its Quantum Leap business plan for 2011 to 2015, Garuda is investing in rapid expansion at budget brand Citilink as well as in improving its full-service offering through fleet renewal and premium product enhancements.
Garuda is also now in the process of joining the SkyTeam
alliance, which has required a complete overhaul of the carrier’s IT
systems. Joining a global alliance, upgrading IT systems and adding more
codeshare partners will likely become an important component of the
medium to long-term strategy at PAL as the flag carrier looks to expand
its international network and improve its premium product.
PAL has said it plans to use the funds coming from San Miguel to renew its fleet, particularly its ageing Boeing
747-400s. PAL already has four additional 777-300ERs on order, which
are slated for delivery in 2H2012 and 2013. Some of the USD500 million
will likely be used to complete the acquisition of these aircraft while
new widebody and narrowbody orders, including for the A320neo, are also
possible.
PAL cannot compete directly with the country’s fast-growing LCC sector...
PAL
will also likely invest in improving its product in both cabins,
particularly business, through upgraded in-flight entertainment, new
seats and other enhancements. While the Philippine premium market is
relatively small, PAL cannot compete directly with the country’s fast-growing LCC sector
given its higher unit costs and legacy structure. It needs to
differentiate the main PAL brand from local competitors, which are all
LCCs and only offer economy class.
Like Garuda, PAL is no longer the largest carrier in its home market (in Indonesia, Lion Air now carries the most passengers while in the Philippines, LCC Cebu Pacific
carries more passengers). PAL has seen its share of the domestic market
slip to about 20%, based on current capacity, while its share of the
international market has slipped to about 25%.
According to Philippine CAB data for 2011, Cebu
carried 45% of the 19 million domestic passengers that were transported
in the Philippines last year, compared to 24% for PAL and 20% for
AirPhil Express. In the international market, PAL flew 25% of the nearly
16 million passengers while Cebu accounted for 16% (see Background
information).
While PAL plans to maintain its presence in domestic and regional
international markets to meet the needs of premium and connecting
passengers, the carrier will likely look to focus primarily on long-haul
markets as it invests in renewing its widebody fleet. Cebu Pacific
plans to launch its own widebody operation next year but this operation
will focus on medium-haul routes to Australia
and the Middle East and only offer economy class. As a result, there is
still an opportunity for PAL to capitalise on its position as the only
Philippine carrier operating long-haul routes and the only local carrier
with a premium product.
Alliance membership and an improved product with a modern fleet could
help PAL find a profitable niche, particularly as the Philippine
economy and tourism sector grow. But there are still numerous challenges
confronting PAL’s long-term viability even though it now has the cash
to survive the current crisis and invest in improving its product.
Gulf carriers limit PAL’s network opportunities in the Middle East and Europe
The Philippines
market is now very well served by Gulf carriers, which has already
forced PAL to withdraw entirely from the Middle East. PAL also no longer
offers services to Europe and is unlikely to enter the market given its
inability to compete with the Gulf carriers. KLM, the only European carrier still servicing the Philippines, also recently dropped its non-stop Amsterdam-Manila service for a one-stop Amsterdam-Taipei-Manila offering.
Emirates, Etihad, Qatar Airways
and Saudi Arabian combined account for 23% of international ASKs from
the Philippines, which is almost as much as the 30% international ASK
share held by PAL. In terms of seats, Emirates, Etihad, Qatar
and Saudi Arabian have a relatively strong 10% share of the market (all
four carriers are among the largest 10 foreign carriers serving the
Philippines; Kuwait Airways also serves Manila but with a much smaller operation).
Gulf carriers have a dominant position in the local
Philippines-Middle East market and a strong position in the
one-stop Philippines-Europe market. Both these markets are big as there
are about 2.5 million expatriate Filipinos working in the Middle East
and another 1 million in Europe. There is also growing demand from
leisure passengers from the Middle East and Europe as the Philippines
has started to emerge as a major tourist destination.
PAL’s outlook clouded by current inability to expand in the US market
The strength of PAL’s long-haul network is now North America, where the carrier makes most, if not all, of its profits. But FAA Category 2 restrictions currently prevent PAL from adding flights to the US
or even deploying its two 777-300ERs on existing US flights. There has
been some indication that the Philippines will regain its Category 1
status later this year and PAL has tried to expedite this effort by
paying for a consultant firm which is helping Philippine authorities
meet Category 1 requirements.
But Category 1 is far from guaranteed and this uncertainty clearly
reduces the value of PAL. In fact, in some respects it is surprising San
Miguel has agreed to invest in the carrier while Category 2
restrictions are in place.
Without Category 1, PAL will struggle to find homes for its four
additional 777-300ERs on order. Without Category 1, the carrier cannot
proceed with its long-delayed plans to add capacity to its three
existing US mainland destinations – Los Angeles, San Francisco and Las Vegas (it also serves Honolulu and Guam) – and add new US gateways such as San Diego. Under Category 2, PAL also cannot codeshare with a US carrier, which could dilute its attractiveness to alliances.
In Australia, which also has a relatively large population of
Filipinos, PAL faces the prospect of competing with Cebu when it
launches its A330 operation in mid-2012. There is also a possibility of
long-haul low-cost services from Jetstar.
PAL faces prospect of increased LCC competition on North Asian routes
PAL will also see LCCs eat into its relatively strong position in
North Asia as key North Asian markets liberalise. Cebu already has a
larger share of capacity than PAL on international routes within
Southeast Asia, where it has had fairly unfettered access. But the more
restricted North Asia market is a vastly different story. PAL currently
accounts for 29% of capacity between the Philippines and North Asia
while Cebu has an 18% share, according to Innovata data.
Given the Philippines central geographic position, all major cities
in North Asia and Southeast Asia are within the range of narrowbody
aircraft. Cebu Pacific has been gradually expanding in North Asia as
opportunities arise and is expected to significantly improve its 18%
market share as the region continues to liberalise.
...competition is already intense in the Philippines-Korea market with five LCCs and four full service carriers...
Cebu
Pacific particularly sees opportunities in the mainland Chinese and
Japanese markets. Some growth is also expected in Korea, which is the
largest source of tourists for the Philippines. But
competition is already intense in the Philippines-Korea market with five LCCs and four full service carriers. Cebu Pacific is already the leading LCC between the Philippines and Korea, with an 18% share of total capacity. PAL (22%), Korean Air (25%) and Asiana (21%) are all larger, suggesting there could be opportunity for further LCC growth at the expense of PAL.
To Japan,
Cebu Pacific now only operates one route (Manila-Osaka) and accounts
for less than 3% of total capacity compared to 46% for PAL. Expansion by
Philippine carriers in Japan is currently prohibited by Japan’s JCAB.
But Cebu Pacific executives told analysts last month during its 4Q2011
earnings call that there are discussions between Japanese and Philippine
regulators about removing this restriction, which is somewhat linked to
Category 2 in the US. Cebu Pacific is now confident the Japanese
restriction will be lifted, at least for carriers that already serve
Japan, regardless of the outcome with Category 2 in the US.
Cebu Pacific chief executive advisor Garry Kingshott says the carrier
has been very successful in Osaka and capacity expansion opportunities
in Japanese markets other than Tokyo could easily support full-time
allocation of two to three additional A320s. He sees sufficient demand
for more capacity to Osaka as well new services to Fukuoka and Nagoya. Securing rights to Tokyo could be more challenging but Mr Kingshott sees the launch of two new Narita-based LCCs later this year, Jetstar Japan and AirAsia Japan,
potentially opening up the Tokyo-Manila market to Cebu Pacific as
Philippine authorities would request reciprocity in the event that a
Japanese LCC asks to serve the route. Cebu Pacific is confident it can
compete well with PAL and Japanese LCCs on the Tokyo route given its
significantly lower cost structure.
This gives PAL a huge advantage that will not likely be maintained...
Cebu Pacific is now limited to three weekly flights on Manila-Osaka while Jetstar Asia late last month launched service on the route with four weekly flights that originate in Singapore. Jetstar also has just launched four weekly flights between Manila and Tokyo Narita (which originate in Darwin),
illustrating the huge untapped potential for LCCs in the
Philippines-Japan market. PAL serves four Japanese destinations –
Fukuoka, Osaka, Nagoya and Narita – but does not currently face any
competition on two and has very limited LCC competition on the other
two.
This gives PAL a huge advantage that will not likely be maintained.
Cebu Pacific is also bullish on the China
market and believes LCCs are well positioned to capture most of the
growth between mainland China and the Philippines. The carrier last
month launched service to Xiamen,
its fourth destination in mainland China. Mr Kingshott says there are
“a number of markets in China that have come on to our radar screen”.
There are generally no restrictions on the carrier launching flights to
new secondary destinations in China. But expanding in Beijing, Shanghai and Guangzhou
is challenging given the slot constraints at China’s major airports
(Cebu currently has one flight to Shanghai, four weekly flights to
Beijing and three weekly flights to Guangzhou).
PAL now has a leading 40% share of the Philippines-mainland China
market, based on current capacity. In comparison, Cebu Pacific has a 23%
share.
Cebu Pacific has a similar 22% share of capacity in the humongous Philippines-Hong Kong market, which is more than double the size of the Philippines-mainland Chinese market. Cathay Pacific has a leading 42% share of this market followed by PAL with a 25% share. (In the smaller Philippines-Macau market, Cebu is currently much larger than PAL.)
Cathay Pacific is a formidable competitor to PAL
Hong Kong-Manila is Cathay’s fourth largest route by capacity
(seats), the largest international route for PAL and the second largest
international route for Cebu Pacific. Cathay’s leading market share
between the Philippines and Hong Kong (it is 45% when including its
regional subsidiary Dragonair)
reflects the group’s big presence in the greater Philippines-North Asia
and Philippines-North America markets. Cathay is PAL’s biggest
competitor on the premium end of these markets and will remain a major
player in the Philippines.
It is by far the largest foreign carrier in
the Philippines, with an 8% share of current international capacity.
As it carries a large chunk of premium passengers travelling between
the Philippines and North Asia or North America, Cathay will likely be
the biggest target for PAL as it looks to improve its premium offering.
Korean Air, Asiana, Japan Airlines, All Nippon Airways, China Airlines, EVA Air and Delta Air Lines
(which serves Manila via Tokyo) also play in the Philippines-North Asia
and Philippines-North America premium markets but they all have a much
smaller presence in Manila than Cathay.
PAL’s key advantage in the Philippines-North American market is its ability to offer non-stops. PAL is currently the only carrier operating non-stop flights to the mainland US and Canada but currently faces restrictions on its US flights due to Category 2.
PAL is now forced to include fuel stops on some of its westbound
flights from the US due to range/payload issues. This would not be an
issue if it was able to replace 747-400s and A340-300s with 777-300ERs
on its US flights – something it desires to do but cannot due to
Category 2 restrictions.
Non-stops are particularly critical to premium passengers. With
non-stop flights and an upgraded premium product, PAL should be able to
hold its own, especially if it succeeds at joining a global alliance. An
expanded operation to North America would also help feed PAL’s routes
to Southeast Asia, which are struggling due to the intense LCC
competition.
PAL needs to expand in North America and improve its product in the
market with 777-300ERs as its current advantages in North Asia will be
eroded as LCCs start to make inroads in the Japanese and Chinese
markets. PAL primarily uses widebody aircraft on its North Asian routes,
partly because of the high demand on these sectors due to the absence
of LCC competition but also because of the current restrictions on
expanding in the US. North Asia is a huge market for PAL, accounting for
nearly half of its international seats. But on an ASK basis, North
America is already PAL’s biggest market, accounting for two-fifths of
ASKs.
AirPhil has brighter outlook than PAL
AirPhil generally has a better outlook as most of the growth in the
Philippines is at the lower end as it is a market dominated by leisure,
migrant worker and visiting friends and relatives (VFR) traffic. But the
Philippines LCC sector is also very crowded and is already seen by some
as oversaturated. With financial support from San Miguel, AirPhil is
now in better shape to withstand the war now being waged between
Philippine LCCs.
With insisting that AirPhil was included in the sale of PAL, San
Miguel recognised the value of AirPhil and the need to adopt a
multi-brand strategy. AirPhil will be the brand used to grow
domestically and in regional international markets. Growth at PAL will
be relatively limited with the exception of North America, where
significant capacity will be added if and when Category 2 restrictions
are lifted.
AirPhil has been used as PAL’s budget brand since early 2010, when the Air Philippines
name was dropped and the carrier adopted the LCC model. At the time,
Air Philippines was only operating Dash 8 turboprops on behalf of PAL.
AirPhil continues this regional domestic operation, in which it competes
primarily against Cebu’s ATR
72s to airports that cannot be accessed by jets, but after the
re-branding also started competing on domestic trunk routes using A320s
sourced from PAL.
AirPhil codeshares with PAL on its turboprop routes while on the
trunk routes it generally operates alongside PAL, with AirPhil focusing
on the lower end of the market and PAL focusing on premium and
connecting passengers. AirPhil’s traffic doubled last year to about 4
million passengers. Cebu transported just under 12 million passengers in
2011. It has more than doubled its traffic in only four years, from 5.4
million in 2007.
AirPhil now operates 11 A320s and prior to the ownership change had a
strategy in place for steady expansion of three to four additional
A320s p/a. The new funding from San Miguel will support the acquisition
of these aircraft and could potentially lead to an acceleration of the
expansion at AirPhil.
The carrier currently only operates five scheduled international routes, including daily services on Manila-Singapore and Cebu-Hong Kong plus low frequency services from Kalibo to Beijing, Hangzhou and Shanghai. AirPhil also operates international charters and has one A320 dedicated to running charters between Clark International Airport
outside Manila and China. AirPhil has been expecting to focus more on
international expansion once it has built up a larger domestic base.
AirPhil plans to expand international operation from secondary cities
Scheduled flights to several destinations in China, Korea and Japan
are in the carrier’s medium-term plan. But AirPhil’s strategy envisions
operating these flights primarily from Clark
and other secondary airports in the Philippines. This strategy is
primarily due to congestion and lack of space at Manila. But by not
operating a significant number of international flights at Manila, the
carrier will also avoid competing head to head with PAL.
AirPhil particularly sees an opportunity at Clark, which has its own
large catchment area which encompasses the heavily populated northern
suburbs of Manila. Earlier this year AirPhil began domestic operations
at Clark, where it now operates four domestic routes according to
Innovata data. AirPhil does not currently have any scheduled
international flights at Clark but is planning to launch service on the
highly competitive Clark-Singapore route next month. Clark-Singapore is
already served by Tiger Airways/SEAir and Cebu Pacific and is expected to be served by AirAsia Philippines by the end of this year.
New LCCs such as AirAsia Philippines will also have to focus on Clark
due to the lack of space at Manila. As the country’s first LCC, Cebu
has an advantage in that it already has a large presence at Manila. But
Cebu also has some international flights at Clark and has been building
up its operations in other cities, including new point-to-point domestic
routes which bypass Manila.
AirPhil/Air Philippines has been a sister carrier to PAL since the
late 1990s, when Mr Tan purchased the carrier. But the companies have
always been separate with different boards and management. More
cooperation has been pursued since the 2010 re-branding and once San
Miguel takes over management control of the carrier more ties between
the carriers could be pursued. AirPhil has been following the last two
years a strategy similar to Jetstar but AirPhil is not yet fully
exploiting synergies with PAL as is the case with Jetstar and Qantas.
AirAsia Philippines launch further intensifies competition in the Philippines
AirAsia Philippines launched services last month, becoming the country’s fifth LCC after Cebu Pacific, AirPhil, Zest and SEAir/Tiger.
The new AirAsia affiliate is now operating domestic services from Clark
and plans to launch international services later this year.
Zest currently operates both domestic and international routes.
SEAir, in addition to operating turboprops under a domestic regional
carrier model, now operates two A319s on international routes under an
LCC model and as part of a marketing tie-up with Tiger Airways. The two
carriers have been discussing extending this partnership to include
A320s, an equity stake and domestic trunk routes.
...they aim to close the gap with market leader Cebu Pacific...
AirPhil, Zest and AirAsia Philippines are all planning rapid growth this year as they aim to close the gap with market leader Cebu Pacific,
which also claims to be the country’s only profitable LCC. AirPhil,
Zest and AirAsia Philippines plan to add about seven aircraft this year,
giving the trio a fleet of 35 A320 family aircraft by the end of 2012.
Cebu plans to add four A320s, giving the carrier a fleet of 33
A319s/A320s by year-end. There are also seven foreign LCCs currently
serving the Philippines
Cebu Pacific says it plans to grow capacity by 12% in 2012 and
continue expanding at this pace over the next five years as it grows its
A320 fleet to 52 aircraft by the end of 2017. Cebu executives expect
domestic capacity to grow by 10% to 12% p/a over the next several years
while regional international capacity grows by 15% to 20% p/a. This
excludes its new medium/long-haul division, which will start operations
in 3Q2013. The first of eight A330s are slated for delivery to Cebu
Pacific in Jun-2013.
Cebu Pacific long-haul operation will likely not impact PAL significantly
While Cebu’s decision to add widebodies likely led to an immediate
decrease in the value of PAL just as the flag carrier was looking for a
new owner, the impact of the new Cebu Pacific widebody operation on PAL
may not end up being that significant. Cebu Pacific management is
adamant the carrier will not follow a hybrid model. Instead the carrier
will stick to a pure low-cost model with 400-seat A330-300s in
all-economy configuration. Cebu Pacific management also says they have
no intentions to forge codeshares and are unlikely to add interline
agreements. Currently Cebu Pacific has one limited interline agreement,
with Hawaiian Airlines.
Cebu Pacific management also does not envision Cebu Pacific launching
services to Europe or North America. Most European and North American
routes from Manila (Hawaii and Moscow would be the only logical
exceptions) would require a one-stop service given the range of Cebu’s
A330-300. Cebu Pacific says it is not interested in operating one-stop
flights as they are too complex. Cebu Pacific previously studied using
its A320s to serve Sydney or Melbourne with a stop in Darwin but concluded it is hard to make money on one-stop services under the low-cost model.
Hawaii would be within range but Cebu Pacific management say it is
unlikely the carrier will serve the Hawaii market. This is good news for
PAL and Hawaiian Airlines, both of which operate between Honolulu and
Manila.
Cebu Pacific management is primarily targeting the Middle East, particularly Saudi Arabia with three potential destinations along with the UAE
and Qatar. While all these markets are now served from Manila by Middle
Eastern carriers, Cebu Pacific says there is not sufficient capacity
given the large number of Filipinos living in the Middle East and that
most expatriate workers are opting for less expensive one-stop services.
With its low-cost structure, Cebu Pacific believes it can match or
undercut the fares on these one-stop services while offering a non-stop
product which will appeal to Filipinos. Cebu Pacific management believes
it can achieve a 35% cost advantage compared to other carriers on
routes to the Middle East but says on longer routes this is not
achievable at current fuel prices.
As Cebu Pacific is not interested in
launching routes unless it can achieve such a cost advantage, the
carrier’s new long-haul division plans to stick to medium-haul or
shorter long-haul flights, primarily Middle East and potentially
Australia.
PAL should be able to maintain its role as the only Filipino carrier in the key North America market...
Given
Cebu’s intentions with its new long-haul low-cost division (it does not
plan to apply for a separate operators certificate), PAL should be able to maintain its role as the only Filipino carrier in the key North America market.
In addition to the US, PAL also serves Canada, which has a large
Filipino population and does not suffer from Category 2 restrictions.
PAL it appears will also be able to maintain its position as the only
Philippine carrier offering a premium product and following a network
model. While premium demand in the Philippines is relatively limited,
the country’s economy and high-end inbound tourism are growing. If PAL
can improve its premium product and join a global alliance, it should be
able to compete better with foreign full service carriers serving the
Philippines.
There are huge risks facing PAL, including the possibility of the
Philippines remaining in Category 2. PAL may also have trouble
persuading a global alliance to accept the carrier. Securing a new major
shareholder with deep pockets means PAL now faces a much more certain
future. But many of its challenges remain and PAL has a lot of work hard
work ahead if it wants to leave the bottom tier of Asia’s flag
carriers.
