For decades, Cathay Pacific has dominated the skies over Hong Kong, unchallenged by local airline competition. That could soon change

Andrzej Jeziorski/HONG KONG


Hong Kong's skies are still clearly divided as far as the region's indigenous airlines are concerned and are dominated by well-established long-haul giant Cathay Pacific Airways. Cathay also has a controlling 75% stake in cargo carrier Air Hong Kong and a 17.8% stake in the only other Hong Kong passenger airline, regional carrier Dragonair. But when China National Aviation Corporation (CNAC) - a unit of the Civil Aviation Administration of China - came in as Dragonair's major shareholder in 1996, Cathay's share in Dragonair fell dramatically from the 43% it had held until then, together with its parent Swire. Since then, Dragonair has moved steadily towards independence. Some industry executives believe this independence will turn into rivalry.

Until now, this has been prevented by regulations that assign each route out of Hong Kong to a single carrier. But senior industry figures in Hong Kong say that recent statements by the government of the Chinese Special Administrative Region suggest this is changing.

"The economic services bureau has come out into the open saying it will adopt a flexible policy, opening up as necessary," says Peter Lok, non-executive director of CNAC and holder of several senior posts in the Chinese commercial aviation industry.

"In the past, the administration has gone too far in protecting the home-grown airline - this policy is shifting and opening up." Lok adds, however, that this could take some time, given the conservative culture in the government. Other Hong Kong airline executives describe the idea of home-grown competition on airline routes as "political dynamite". Lok concedes: "Cathay won't like it."

Hong Kong competition

It certainly will not, if the reaction of Cathay corporate development director Antony Tyler is anything to go by: "No one can say that [the one airline-one route policy] has been anything other than successful. There are 60-plus airlines operating here, and three of these are Hong Kong carriers. How many cities of 6 million [inhabitants] support three airlines? If Peter Lok says there's no competition in Hong Kong, my immediate reaction is, 'So what?'."

Tyler says it is more fruitful for Hong Kong's airlines to focus on competing with foreign carriers, as the Hong Kong Government has encouraged them to do.

But Dragonair is nevertheless cautiously cultivating ambitions to challenge its one-time parent. Although analysts doubt that it will rush into the fray - and certainly not on long-haul routes - industry sources say the airline believes there is potential in competition.

"In the region, there could be a case for parallel services, and that might not get up Cathay's nose so much [as long-haul competition]," says one senior official. But airline analysts point out that abandoning the one airline-one route system would cut both ways. Dragonair's mainland Chinese routes are a major source of revenue, which would be diminished by competition from Cathay at the same time as Dragonair benefits from access to Cathay's routes.

Dragonair was established as Hong Kong Dragon Airlines in May 1985, with one Boeing 737-200. It began as a subsidiary of Hong Kong Macau International Investment on the initiative of current Dragonair honorary chairman K P Chao and flew its first service to Kota Kinabalu, Malaysia, in July 1985.

Cathay and Swire bought a 35% stake in the airline in January 1990, by which time the 737 fleet had expanded to four aircraft, joined later that year by a single Lockheed L-1011 TriStar. China International Trust and Investment (CITIC), which already held 12.5% of Cathay (and now has a 25.4% stake), bought a further 38% of the regional carrier. Later that year, the Swire/Cathay shareholding grew to 43%, while CITIC became a 46% stakeholder.

In 1991, Dragonair decided to replace its 737s with Airbus A320s, with deliveries starting from March 1993. Two widebodied Airbus A330s joined the fleet in 1995.

CNAC bought into the company in 1996, taking an initial 35.86% stake in exchange for abandoning plans to set up its own Hong Kong carrier, which was tentatively called China Hong Kong Airlines. CITIC retained 28.5%, Swire and Cathay a total of 25.5%, and the Chao family remained as 5.02% shareholders. Then, when CNAC listed on the Hong Kong stock exchange in December 1997, its shareholding was boosted to 43.29%, leaving the CITIC, Cathay and Swire stakes untouched.

Dragonair operates an all-Airbus fleet, which comprises five 156-seat Airbus A320s, two 190-seat A321s and five 322-seat A330-300s. A third A321 is due for delivery next year. The airline has leased one A320 to Taiwan's TransAsia Airways since June this year, and returned a sixth A330 to International Lease Finance in September as part of its cost-cutting efforts in the economic crisis plaguing Asia since 1997.

"There was no confidence that we had sufficient need for a sixth A330," says airline general manager Felix Hart. As soon as the sixth A330 arrived in October 1998, Dragonair tried to lease it out. The carrier was eventually forced to put it into service on routes that did not generate enough revenue to be sustainable, and finally decided to return the aircraft early.

Hart says there is still a gap in the fleet between the A321 and the A330-300, and that Airbus Industrie has spoken to the airline about the reduced-capacity A330-100, being proposed as a replacement for older A300s and A310s. The 250-seat A330-200 would also be a possible contender to fill this size gap. The airline is not contemplating Boeing types. "We are an Airbus carrier, and there's no reason to change our allegiance," says Hart.

The first six months of 1999 continued to be difficult for the airline, although traffic figures across Asia have shown signs of recovery. According to CNAC, Dragonair's first-half operating profits were 50.3% below the figure for the same period the previous year, despite the fact that overall revenue fell by only 4.4%. At the same time, available seat kilometres (ASKs) rose 7%. Dragonair does not publish its financial results, but is known to have been highly profitable in the past.

One Hong Kong-based analyst concludes: "With revenue holding up pretty well and ASKs quite stable, it's clear that yields are down and their financing charges are up because they've got more aircraft." He says the airline has not done enough to cut its costs over the past few years, unlike Cathay.

"The first quarter was not good for us at all,"Dragonair concedes. Nevertheless, the carrier says the year to date has been "a reasonable performance considering the recession". Up to the end of October, passenger traffic on routes in China has risen by 9% (from 1.2 million to 1.31 million people)compared with the same period in 1998, has increased by 18.3% (488,000 to 578,000) on routes outside China, and by 11.6% overall. Airlines all over Asia found 1998 was a depressed year, however.

Cargo increase

Cargo traffic has shown a more dramatic increase of 50.1%, from 35,000t in the first 10 months of 1998 to 52,500t in the same period this year. Dragonair chief executive Stanley Hui says: "Our cargo operation continues to grow at a fast pace, with the amount of cargo we're carrying setting new records every two months on average." The airline set up a dedicated cargo-services team in Shanghai in June as part of its effort to boost its operations, and says similar teams will be operating in Beijing, Xiamen and Hangzhou before the new year.

Dragonair set up its cargo department in mid-1997, consolidating all cargo services into the department in March this year. Of the airline's total of 25 destinations, it has cargo traffic rights on 11 mainland Chinese routes and eight other Asia-Pacific routes. With a full passenger load, the airline can carry 2.5t of cargo in an A320, 4t in an A321 and 15t in an A330.

"With the gradual removal of its cargo uplift restrictions in China, the airline has been able to focus on developing this business to counterbalance the weakness in the passenger cabin," says equity research firm Salomon Smith Barney. "In fact, weak passenger volumes make incremental cargo space available, which the airline has also attempted to fill."

Since it was founded in 1946, Cathay Pacific has become one of Asia's biggest carriers, with an all-widebody fleet of almost 60 operational aircraft with an average age of just over 4.7 years. The fleet is based primarily around Boeing 747-400s, 777-300s and -200s and Airbus A330-300s and A340-300s.

Last year was disastrous for the airline, which reported a HK$542 million ($70 million) loss - Cathay's first full-year loss since 1963. The poor performance was blamed on a combination of the region's economic woes and the chaos that accompanied the opening of the new Hong Kong International Airport at Chek Lap Kok.

Cathay says almost all routes suffered through the economic downturn, particularly those to Japan and South-East Asia. "Long-haul services to Europe and North America performed better, but even these were affected," says the airline.

Tyler describes the airline's first-half performance this year as "rather indifferent". Cathay endured a messy industrial dispute with its pilots, which disrupted operations for two weeks from the end of May when the pilots - whom Tyler describes as "difficult to manage" - reported in sick en masse. The airline finally extracted a reluctant acceptance of pay cuts for some pilots from the Hong Kong Aircrew Officers Association, as part of a package of new contract terms that the airline claims will save HK$1.4 billion over the next 10 years.

Apart from the impact of this action, passenger numbers fell by 1% compared with the first half of 1998, when the airline suffered a HK$175 million loss. Despite this, turnover rose by 1.4% to HK$13.17 billion in the six months up to the end of June this year, and a net profit of HK$108 million was reported.

"Things have picked up rather snappily [in the second half]," says Tyler. "Loads are strong. Yields are weak, but we have not seen a dramatic collapse like last year. Some markets are recovering quite strongly: the inbound market [to Hong Kong] is beginning to pick up again, Seoul and parts of South-East Asia have been strong, [and] it's nice to see Japan coming back." Japan used to account for 25% of Cathay's revenue, but made up only 8% in 1998.

"Cargo has had a very good year - exports from Asia have been strong," says Tyler. This was underlined in mid-October when Cathay revealed it had ordered two Boeing 747-400 freighters to meet growing demand. The airline already owns nine freighters: two 747-400Fs, four 747-200Fs, and three more -200Fs operated by Air Hong Kong. Cargo business accounted for 28% of the airline's first-half turnover.

Return to profit

The first-half return to profit has led Cathay to consider bringing forward plans for new aircraft orders, as well as leasing three Airbus A340-300s from Air China at the beginning of October, and starting in November to hire new flight attendants for the first time in over a year.

Cathay has also just announced a new order for three A330-300s for delivery in the first quarter of 2001 and is understood to be considering leasing more A340s. The airline is examining new aircraft types for future ultra- long-haul transpacific routes, as well as future large aircraft types to replace its 19 747-400s.

"We have got the fleet planning group looking at new aircraft, but the types are still in the melting pot," says Cathay engineering director Derek Cridland. On potential North Pacific routes, Cridland says the proposed Airbus A340-500/600 four-engined types are under consideration, as are the Boeing 777-200X/300X twinjet proposals.

"One obvious issue is that we are Rolls-powered, and the 777Xs are General Electric," says Cridland, adding that Boeing is working with Cathay to find a resolution. Boeing and GE will have to convince the airline that it is worth bringing the GE90 powerplant into Cathay's fleet, while Rolls-Royce and its partners will have to demonstrate that the Trent 500, which powers the Airbus types, will perform as promised and meet reliability standards.

In November, the airline formally opened its new, HK$4.9 billion, headquarters at Chek Lap Kok Airport, consolidating 19 corporate offices and operations centres in the building, called Cathay Pacific City. Close by, Dragonair is approaching the completion of its own HK$1.4 billion facility, Dragonair House.

Dragonair is still dwarfed by its neighbour and shareholder, but the day may be coming when the Cathay Goliath faces a less-than-welcome challenge on its own doorstep.

Source: Flight International