On the Verge of Something Big

Philippine Airlines and Cebu Pacific
face off against each other amid a
world of opportunity

As 2010 opened, airlinesin thePhilippines had reason to look to the future with some measure of optimism amid the first signs of recovery appearing on the radar. This is a country where the geography and demographics are ideal for the growth of air transportation. In fact, it consists of  7,107 islands that are home to the world’s 12th largest population, 90 million, with a growth rate of 2%.

According to the Sydney-based Centre for Asia Pacific Aviation, “the Philippines is one of the fastest-growing air travel markets in the world . . . driven by strong domestic air travel growth rates as LCCs, especially locally based Cebu Pacific, provide a boost for the industry, entering domestic markets previously not served with affordable air services.”

However commercial aviation has been through some turbulence over the past two decades. Philippine Airlines in particular has experienced some significant setbacks. It is still repaying debt from its near-death experience after the Asian currency crisis in 1997. And in November 2007 US FAA downgraded the country’s safety rating from Category 1 to Category 2, stating that the then-Philippines Air Transport Office failed to satisfy ICAO standards relating to safety inspections of the 47 airlines in the country. That downgrade means PAL has not been able to increase services to the US and is subject to heightened FAA scrutiny.

Following on the heels of that action and an ICAO Significant Safety Concern issued on the Philippines in October 2009, the EU on March 31 banned all of the nation’s carriers from flying to its member states, a move that has been criticized by Philippine political leaders. Presidential spokesperson Ricardo Saludo expressed befuddlement over inclusion of the country on the blacklist and challenged the safety record of some airlines allowed to fly to the EU.

PAL also protested the decision, noting that it “came about notwithstanding PAL’s safety record, as borne out by its compliance with internationally accepted safety standards, including the IATA Operational Safety Audit and audits by major foreign aviation regulatory authorities.” In fact, it is the only IOSA-certified Philippine carrier. While no Philippine airline operates to the EU, the global implication is a dampening of business, and some other countries are influenced by the bans.

Key to rectifying the safety concerns, according to Saludo, is the March 10 appointment of Gen. Alfonso Cusi as DG of the country’s Civil Aviation Authority, which replaced the ATO after FAA’s downgrade. Cusi has an extensive transport management background and was GM of the Manila International Airport Authority. Responding to the EU backlist, he said, “There is urgency in our current position to demonstrate that we have strong oversight of the air carriers active in the Philippines and that our regulations and practices are aligned with international civil aviation standards.”

Not influenced by EU bans is Australia, which hosted the launch of Manila-Brisbane service with PAL’s new flagship 777-300ER in March. The Australian Civil Aviation Safety Authority has “no intention to revoke the airline’s landing rights,” according to a spokesperson.

The expectation is that the country will regain its FAA Category 1 rating this year and PAL CEO Jaime Bautista says PAL’s growth plans for North America “will then take off. The plan is to grow progressively from the present 25 frequencies per week to North America to 31 per week by 2015. We also plan on adding San Diego as a new destination on the West Coast.”

Concerning Europe, the EU ban notwithstanding, he says there are “encouraging signs and the traffic indicators seem to point positively toward Europe. We are studying the countries in Europe where the Filipino component of the traffic is huge and where the potential tourist traffic to the Philippines is strong. The UK, Germany and Italy are leading candidates.” In the meantime, “we plan to expand our network in China and Australia, and gain access to the NewZealand and Indian markets.”

PAL serves 20 domestic and 26 international destinations with 367 weekly domestic and 203 international flights. For the year ended March 31, 2009, it carried 8.95 million passengers, 17.1% up on the previous period. It expected to carry more than 9 million for the 2010 year with a fleet of 41 planes comprising 22 A320 family aircraft, eight A330s, four A340s, five 747-400s and two 777-300ERs, with another four -300ERs on order. According to CAPA, it has a 35.8% share of the domestic market behind Cebu Pacific’s 47.1% and a 27.4% share of international capacity.

More robust passenger numbers are contributing to a contraction in losses, with Bautista saying that although PAL will post a loss for the 2009-10 fiscal year ended March 31, it will be a significant improvement on the $301.4 million deficit for the 2008-09 year. “For the first three quarters of the current fiscal year, PAL reported a comprehensive net loss of $40.2 million,” he tells this magazine.

The FY09 loss prompted plans for a major shakeup at the airline, with extensive restructuring and an “extraordinary” array of cost-cutting measures including offering early retirement packages to employees and outsourcing passenger, ramp and cargo handling and catering by last November. However, a howl of protest over the 2,000 job losses caused those moves to be put on ice.

Bautista will have to balance announced plans to cut staff by up to 10% with the rebounding economic conditions and more aggressive unions. In February, hardliners won a landslide victory in a ground staff union election on a platform of job security—12 years after a 10-year moratorium on collective bargaining was imposed in 1998 to aid the airline’s recovery process. The PAL Employees Assn. is now headed by Gerry Rivera, who assumed the position of president on March 29. Rivera was VP of PALEA during the strike of 1998, the country’s biggest labor dispute of the decade, which forced owner Lucio Tan to shut down the airline, causing employees to agree to the moratorium, which has had two one-year extensionssince 2008.

Part of the solution for PAL is a drive to improve yield and attract more traffic with cabin upgrades that recently have been completed in its premium long-haul fleet. A focal point is new Recaro lie-flat cocoon seats and Thales IFE systems throughout the 747-400 fleet. Bautista notes that “passengers nowadays are well informed and have lots of options. With greater access to communication and data, they know if they are getting their money’s worth. So if you have a better product and you communicate it well to your public, you will be able to get the yield it deserves.” The 777-300ERs are being delivered fully equipped.

PAL’s domestic A320s are fitted with overhead television monitors while the A330s and A340s on international routes have personal IFE systems for business class passengers and overhead monitors for economy.

Winning Ways

As PAL strives to attract more long-haul traffic, on short-haul routes it faces significant challenges, with Cebu Pacific seemingly kicking winning goals year after year. According to CAPA data, the JG Summit Holdings-owned airline operates 1,400 weekly domestic flights on 49 routes to 33 destinations from its two primary bases at Manila and Cebu and smaller bases at Clark and Davao. Its model is a combination of point-to-point and hub. The 15 largest routes in the Philippines all involve Manila and the top two are to Cebu in the center of the country and Davao in the south. Cebi is Asia’s third-largest LCC and it has carved out a 13.6% share of the international market with 300 weekly flights on 21 routes to 14 destinations with a heavy focus on Hong Kong, Macau, Osaka, Shanghai and Busan.

Domestically, Cebu Pacific, which was launched in 1996 following deregulation, continues to strengthen its markets, launching a number of routes in the past year, many of which are monopolies. To support these operations it has a fleet of 21 A320 family aircraft and eight ATR 72s. It has 15 A320s and two ATR 72s on order.

PAL has resisted going down the LCC road. Bautista explains, “On domestic routes, it is not the practice of PAL to follow its competitors. PAL will set its own fares according to how it sees market demand for travel and is committed to delivering honest value to its passengers.” Like Cebu Pacific, its routes are dominated by Manila and are a combination of network and point-to-point.

Officials at the LCC were unable to discuss the virtues or specifics of their operations with ATWowing to a pending IPO set to occur after the Philippines election in May. It is expected to raise PHP25.7 billion ($566 million) and is being launched on the back of a PHP1.82 billion profit in the first half of 2009 that put the airline on course to improve upon the PHP15.7 million loss suffered in 2008. Half-year revenue rose 21.3% year-over-year to PHP11.39 billion. 

According to CAPA, Cebu Pacific has bigger expansion plans that spell trouble for PAL, with an aim to cross the Pacific to the US West Coast, Houston and Chicago. Closer to home it launched routes to Kuala Lumpur in November, Bangkok in December and Jakarta in January.

On the domestic front, despite having no business class it is targeting more corporate accounts to lift yield with its CEB Corporate and Government Accounts program that enables members to book, change and cancel flights directly and avail themselves of seat sales. In 2008 it had 238 accounts and the number shot up to 438 in 2009.

According to CEB President and CEO Lance Gokongwei, the airline’s extraordinary growth can be put down to its “aggressive pricing strategy, continuous expansion and opening of new routes, as well as its high-quality product offering.”

A key to its success, says CAPA, is creativity. “Cebu Pacific has approached its operations in an innovative way, from its distribution strategies to its ancillary revenue streams to its product offering.” It was the first Philippine airline to introduce e-ticketing, pre-paid excess baggage, and seat selection. Most recently it launched a payment center option, allowing all passengers to book flights online or through the reservations hotline and pay via the carrier’s partner banks.

While CEB and PAL dominate Philippines aviation, three smaller airlines have a combined 12.8% market share. The largest is Zest Airways, formerly Asian Spirit, which operates scheduled domestic and international tourist services, predominantly feeder flights between Manila and Cebu and 24 domestic destinations using three A320s and three MA60s. Air Philippines operates PAL Express on behalf of parent PAL with one 737 and eight Dash 8s serving 19 destinations. South East Asian Airlines flies to 15 destinations with six Do.228s/328s and eight L-410s.

Opportunities

The Philippines suffered a 40% decline in tourism receipts in the first half of 2009 owing to the global financial crisis. The signs of a recovery bode well for the country and its carriers as did the government’s planned accession to the ASEAN open skies agreement in April, which is expected to increase tourist arrivals and trade between member countries dramatically.

Problems notwithstanding, Bautista is bullish on PAL’s future: “I have been fortunate enough to have been involved in the airline’s transformation from pre-rehabilitation, rehabilitation and post-rehabilitation and am witness to the resilience of the airline and its employees. Yes, I expect PAL to grow its fleet, its market and its presence in the Philippines, Australasian regions as well as in its North American operations. PAL will likely post another loss in FY10 but expects to be profitable in the coming years.”

And he insists that the last debt repayment from the 1998 restructure due in 2012 will be met. “PAL has consistently fulfilled its debt payment obligations despite the strain caused by the global financial crisis. Moving forward, we are confident that PAL will continue being able to service its debt, especially in light of the gradual recovery from the economic slump.”

CAPA founder and Chairman Peter Harbison agrees with Bautista’s assessment, saying that PAL has responded well to its tribulations of the late 1990s. But he warns that if it falters, this time “the environment is very different” with a real alternative in Cebu Pacific (which has markedly lower costs) for both domestic and long-haul travel. But there is still a long-haul market for PAL, he says. “Rising economic growth in the Asian region and the continued needs of a large Filipino Diaspora in medium- and long-haul markets should provide PAL with the opportunities it needs to restore health and emerge from the current crisis.”

Harbison suggests that alliance linkages will be crucial for PAL in the future. “The global alliances landscape will change dramatically in Asia over the next couple of years. For carriers like PAL updating its long-haul fleet, new opportunities will beckon.”