Cathay Earns Second-Half Profit

Madhu Unnikrishnan

March 15th, 2020 at 5:44 PM EDT

  • Somehow, Hong Kong’s Cathay Pacific managed to earn a profit during the second half of 2019, despite ongoing cargo weakness and a severe demand shock caused by political unrest. It wasn’t a big profit; operating margin was less than 2%. But that’s a triumph under the circumstances. The key, it seems, was Cathay’s ability to remove costs, not quite to the extent that revenues were falling but pretty close. H2 revenues in fact declined 8% y/y, while operating costs fell 5%. Luck helped, for sure, in that Cathay’s fuel bill plummeted 16%. But labor costs also fell, by 3% despite 4% more capacity.

    The surprisingly healthy H2 results meant the company wound up with a 3% operating margin for all of 2019, which is exactly what it earned in 2018. Again, that’s quite an achievement given all the duress the Hong Kong market experienced last year. The trouble spots were many: cargo, mainland China routes, premium demand, etc. But there were some bright spots too. Connecting traffic, though low yield, filled seats. For that thank strong demand to Europe from leisure travelers in Australia and Taiwan, most notably. Australian routes also benefitted from capacity reductions by mainland carriers among others.

    Indian routes, often filled with sixth-freedom traffic to North America, benefited from the demise of Jet Airways. Japanese routes boomed during the Rugby World Cup, especially from the U.K. and South Africa.

    At the same time, rival Hong Kong Airlines struggled to stay alive, dismantling big chunks of its network in the process. Cathay’s 18% ownership stake in Air China, meanwhile, earned better returns last half. Now for a reality check. Yes, 2019 was better than feared — still not great but well short of disaster. Now, disaster is probably too soft a word. Cathay was an early victim of Covid-19’s demand decimation, forcing draconian capacity and job cuts, first to mainland China, as early as the last week of January. One of the mainland routes it served was Wuhan, the origin of the pandemic. By February, its worldwide flight schedule, including both Dragonair and HK Express, had shrunk by nearly one-third y/y, according to Cirium.

    As of Friday, with the pandemic spreading across the planet, its scheduled flight departures for March were down a once-unimaginable 64%. About three-quarters of staff are on unpaid leave, the South China Morning News reported in late February. So no miracles this half — Cathay made clear last week that it would suffer a “substantial loss” for the January-to-June period. Hong Kong is still seeing new cases of Covid-19, prompting a mandatory 2-week quarantine last week for all visitors from most of Europe.

    At this point across the global airline industry, no airline is safe from running out of money. But Cathay is at least in the position of having a government that would surely not let it die. It also entered the crisis relatively healthy, if not very profitable. So assume it will come out of the crisis, and when it does, it will be ready with a business plan that includes, among other things, new planes. Indeed, it plans to continue to take plane deliveries this year, from its orders of A321 NEOs, A350-900s, and A350-1000s. For now, B777-9s are currently scheduled to arrive next year. “Our plan to take delivery of 70 new and more fuel-efficient aircraft by 2024 remains unchanged,” the company said.

    Cathay’s acquisition of HK Express was completed in July. At that time, it expected the LCC to earn a small profit for the remainder of 2019. Instead, it lost $32m, even as it filled 92% of its seats. As for the bigger picture, Cathay says it’s ready to add back capacity “as soon as we are able to.”  

Azul Posts Strong Q4, Optimistic About Future

  • For airlines just now reporting their Q4 results, the discussion is divided into two parts: 1) How they did in the quarter, before the world started falling apart; and 2) Their current predicament amid an industry crisis of epic proportions. In Azul’s case, the look backward was a celebration of phenomenal success. And the examination of current affairs was less awful that what most carriers are reporting.

    During Q4, Azul’s operating margin was a breathtaking 24%, topped only by its rival Gol’s 26%. Azul grew a lot faster though, expanding ASK capacity a monstrous 30% y/y. It’s another testament to how lucrative the Brazilian market became following the death of Avianca Brasil, which coincided with an uptick in corporate travel and lower fuel prices. For all of 2019, Azul’s operating margin was 17.5%, fifth-best of any airline that’s reported thus far (only Allegiant, Air Arabia, Gol, and Pegasus did better).

    Azul’s Q4 results, like Gol’s, would have been even better were it not for the expiration of payroll tax relief. This meant labor costs rose 42%. But fuel costs, even with all that new flying, and even with further real depreciation, increased just 8%. Total operating costs rose 22%, far less than the carrier’s 32% revenue gain. Azul has grown capacity almost 60% since 2016, largely by upgauging to larger planes including A320 NEOs. As things stood at the start of this year, the fleet consisted of 166 planes, including eight A330 CEOs, two A330 NEOs, 41 A320/21 NEOs, four E195-E2s, 70 E1-EJets, 39 ATRs, and two cargo-only B737s. The move from E1s to E2s is especially helpful, in terms of both ownership and operating costs.

    An accelerated E1 phaseout continues, facilitated by deals with LOT Polish and Breeze, the new U.S. startup created by Azul’s founder David Neeleman. In other developments, Azul obtained more São Paulo Congonhas slots by buying a regional carrier called Two Flex. The airline’s cargo and loyalty businesses are growing rapidly and appear to be strong profit generators. So now to the Covid crisis.

    Encouragingly, Azul said on Thursday, the day it reported earnings, that it’s hardly seeing any impact at all on domestic markets. That makes Brazil a rare market that’s apparently thus far spared from ravaging demand destruction. That said, international demand has dropped by 20% to 30%, which could be partly related to another sharp fall in the Brazilian real-dollar exchange rate. It’s not seeing any increase in no-shows however.

    Azul quickly cut international flying by about the same amount as its demand decline, with additional measures under consideration — it might postpone the launch of its planned New York JFK flights, for example. Management didn’t expressly say it had been negotiating a sale of its 47% stake in TAP Air Portugal. But that was implied as it talked about how any such matters were suspended for now (Lufthansa was a rumored buyer).

    Azul is now cutting even its domestic capacity, just in case. It’s also implementing a hiring freeze and preparing an unpaid leave program if needed. The point is, it’s ready to do more: “I have no intention of flying empty airplanes and definitely not flying when demand is low,” said chief revenue officer Abhi Shah. “We’re going to be okay,” added CEO John Rodgerson, who mentioned that he personally bought shares in the airline that morning.

    Management also said it’s hopeful that Brazil will be spared the worst given its warm climate and “vast experience in dealing with tropical diseases such as Dengue and Zika.” Brazil, it added, has one of the youngest and healthiest populations in the world. Its best guess is that the crisis will last for four months.

    Separately in Brazil, Gol late last week suspended its planned takeover attempt of Smiles, its loyalty plan.

Pegasus Results Strong, But Pandemic the Big Unknown

  • The Turkish LCC Pegasus, which recorded extremely strong summertime results thanks to strong inbound tourist demand, followed that with a solid offpeak fourth quarter. Its operating margin for the period was 6%, up sharply from negative 4% in the same quarter a year earlier. Revenues rose 24% y/y while operating costs rose just 11%, all on 13% more ASK capacity. As was a common theme throughout the industry in late 2019, lower fuel prices were a big tailwind, in the case of Pegasus rising just 5%.

    On the revenue side, ancillaries per passenger jumped 19% and now account for roughly one-fifth of the airline’s total revenues. In euro terms, unit revenues rose 11% while unit costs declined 5% — even unit costs ex fuel dropped 2%. It was, simply put, a fantastic year overall for Pegasus. Its 19% operating margin for all of 2019, in fact, was fourth-best in the world among carriers reporting so far, as mentioned above in Azul’s review. Key to the strong performance was shrinking its domestic footprint and expanding internationally, which for Pegasus means mostly Europe, central Asia, and the Middle East. In 2019, it added Baku, Basra, Venice, Riyadh, Manchester, Eindhoven, Casablanca, and Ras al-Khaimah.

    Also helping were newly arriving A320 NEOs; it now has more than 30. Late in the year, it started taking A321 NEOs as well. It didn’t hurt that chief rival Turkish Airlines was held back by lost MAX capacity. But what about Turkey’s flimsy currency? It’s not really a big problem for Pegasus, which gets roughly as much revenue in euros and dollars as it does in lira. Its cost base is pretty close to matching its revenues too, alleviating forex risk.

    Pegasus separately sold a 39% stake in Air Manas of Kyrgyzstan. Things were looking good in early 2020 when local rival AtlasJet collapsed. What now, with the world in an economic freeze? Pegasus didn’t provide any information on current trends. But obviously, things are getting rough.   

Transat Says Air Canada Deal Still On

  • Canada’s Transat doesn’t break out earnings for its airline. But the company as a whole, reporting for the months of November, December, and January, managed to go from an operating loss a year ago, to operating profits this time. A double-digit gain in travelers to its Caribbean and Florida sunshine destinations was a big factor. So was cheaper fuel and the arrival of A321 NEOs, including some LR versions capable of reaching Europe.

    Looking back at the full year however, “our results for the year 2019 did not live up to our hopes.” The disappointment stemmed from factors like tough competition, higher fuel prices during much of the year, a weak Canadian dollar, the collapse of its partner Thomas Cook, and costs related to modernizing its fleet. It was in these difficult circumstances that Transat agreed to sell itself to Air Canada.

    Is that transaction now in jeopardy with the industry’s revenue base in flames? No, insists Transat. It should close this quarter, pending approval from European and Canadian competition regulators. Next week (March 23), Canada’s competition bureau will make a recommendation, which Transat anticipates might be hostile to the merger. But it advised investors to pay more attention to the final ruling by Transport Canada, which it thinks should be favorable. That ruling needs to happen before May 2.

    Air Transat hasn’t made any major schedule adjustments yet in response to the Covid crisis (as of the weekend), aside from suspending flights to Italy. But bookings have indeed dropped sharply since the last week of February, and by roughly 50% y/y in the days leading up to its earnings call on Thursday. It says some people are pushing back their vacations to July and August but it’s still taking bookings. Interestingly, it’s working with Google to understand what travel searches Canadians are conducting right now — younger travelers, it says, are more likely to be shopping and booking near-term trips.

    Similar to other airlines, Air Transat is waiving change fees, offering staff reduced work schedules, and taking measures to protect its cash. Not having any debt helps. If need be, the airline can ground older A330s or ask lessors for payment deferments. A310s are already gone. B737s will be too. Might it delay A321 NEO deliveries? No, they’re already late, management said, and can use these planes to downgauge and save money.

    Other aspects of its business plan remain intact, including efforts to increase ancillary revenues, improve revenue management, generate more connecting  traffic, pursue more partnerships like the one it has with easyJet, and increase direct sales. This plan of course, could change if and when Air Canada takes the reigns. The latter plans to retain the Air Transat brand.

    Bottom line: Last year was tough for Transat. This year started out well. But the rest of 2020 will be extremely tough given the Covid crisis. Seeking to calm nerves, Transat pointed to its long experiencing dealing with major demand shocks, including 9/11, SARS (which hit Canada hard), and the global financial crisis. Remains Upbeat

  • gave a relatively upbeat update on Wednesday. First of all, it said earnings excluding special items for its fiscal year that ends this month will be “significantly ahead of current market expectations.” Then it said summer 2020 bookings were well ahead of expectations as of late February, though of course weaker in recent weeks. Some customers booked for July and August might be waiting to see how the virus outbreak transpires before cancelling their trips.

Correction/Clarification: In last week’s issue, we wrote that JPMorgan was planning a conference last week in Atlanta. It was actually scheduled for New York, though later changed and held virtually.

Madhu Unnikrishnan

March 15th, 2020 at 5:44 PM EDT