Making A Splash

The wheel has turned… spectacularly.

Last year CSA snared 21 per cent of Australia-China business, with Cathay holding 16 per cent, CEA 15 per cent and Air China 11 per cent. Qantas’s share plunged to just 12 per cent. It is a sign of changing times, particularly for the Flying Kangaroo and the competitive challenges it faces on long-haul routes. But it is also misleading. The Chinese juggernaut still has a long way to go before it really challenges international rivals for a major portion of Australasia’s long-haul passenger traffic.

When it comes to how the spoils of Australia’s international market are shared out, none of China’s operators even make the top 10. The latest figures, for the year ended July, show Qantas (with 17. 2 per cent of traffic) and its budget subsidiary Jetstar (7. 9 per cent) out in front. The big guns battling it out behind are Singapore Airlines with 9. 1 per cent, Emirates Airline with 8. 9 per cent, Virgin Australia with eight per cent and Air New Zealand with 7. 9 per cent. The likes of Thai Airways and Malaysia Airlines and even budget AirAsia X are all ahead of their Chinese counterparts.

In the marketshare pie chart, they slot into the ubiquitous “others” section, a large group of carriers accounting for a little more than a quarter of all traffic. China Southern’s share of the total market: just two per cent. That will change.

CSA’s rapid growth in capacity into Australia from a low base leaves no doubt it has every intention of catching up. The A380 alone, replacing A330 services, adds more than 160,000 seats annually. Now operating 48 weekly flights into Australia and New Zealand, it is planned to increase this to 55 by 2015.

And it’s not only in Australia that CSA is driving expansion. Last year, its revenue passenger kilometres (RPKs) for domestic operations grew 7. 6 per cent, while internationally they increased 24. 9 per cent. Domestic passengers rose 6. 5 per cent, while international passengers rose 15. 7 per cent. Domestic cargo lifted just 3. 9 per cent, but international freight rose 22. 7 per cent.

If anyone thinks these rates are unsustainable, future plans are as ambitious as the much publicised

China Southern is hell bent on catching its big Western rivals.

and spectacular development of the Gulf carriers.

“We currently have 540 aircraft in our fleet, with an annual growth rate of 10 per cent, so we have 50 additional aircraft joining our fleet every year,” CSA chief executive Tan Wangeng explained during welcoming ceremonies for the first A380 service into Sydney. It doesn’t end there.

“We are interested in new aircraft types. After some time operating the A380 and Boeing 787 we have realised these ‘evolved aircraft’ are game-changers. ” In the middle of next year the first of 10 777-300ERs it has on order will arrive to launch Guangzhou-New York flights. Although no decisions have been made, Tan said he is open to considering more A380s and 787s, and won’t rule out the possibility of A350s. On the agenda: consolidation of existing routes and new destinations in Africa, the Middle East, South America and Europe. In other words, China Southern is hell bent on catching its big Western rivals. Yet, like all of China’s major operators, it is confronted by a range of issues that threaten to dampen progress. They include: >> The rapid development of China’s high-speed rail network, which has already forced airlines to reduce frequency and even cancel flights on certain routes.

>> Infrastructure issues. Despite a massive airport modernisation and construction program, congestion, as well as airspace problems caused by the military’s control of vast areas of sky, continue to cause flight delays and spark angry customer complaints.

>> A slowdown in China’s economic conditions has put the brakes on previously high rates of domestic market growth.

>> The current dismal state of the freight sector has hit Chinesecarriers particularly hard.

This volatile landscape has seen them report mixed results in the first half of 2013. CSA saw its net profit fall 19 per cent in the six months to $59. 5 million, down from $73. 4 million a year ago. That missed estimates and was the worst result in three years. Holding the largest share of the domestic market, it particularly cited fierce competition from the expanding domestic high-speed rail network. China Eastern, the country’s second biggest carrier by passengers, saw its half-year net profit fall 23 per cent on weaker domestic air travel demand. It fell from $172. 5 million in the 2012 first half to $132. 1 million this year.

On the other hand, Air China saw its first half earnings rise 7. 3 per cent to $193. 8 million, from $163. 4 million a year earlier. The airline said it had gained from a rapid expansion in its international network that now provides 40 per cent of its revenue. In the last three years, Air China has launched some 18 new international routes, lifting its overseas services by more than 20 per cent. China’s fourth largest operator, Hainan Airlines, also reported robust profit, lifting its net income in the first half by 29. 3 per cent to $111. 6 million, attributing the growth to an increase in its fleet to 120 aircraft from 109 and rising passenger traffic, which was up 13. 4 per cent to 12. 5 million in the six months.

The truth, however, is that these results would have been far worse if it were not for one income-boosting factor: foreign currency gains. In CSA’s case it reaped a foreign exchange windfall of $245 million thanks to the appreciation of the Yuan against the US dollar. Analysts are unanimous this has helped prop up China’s airlines and hide tough trading conditions, a factor that can’t be relied on to continue.

As Citigroup analyst Vivian Tao put it in a report, Chinese airlines “faced many challenges from the economy, politics and high-speed rail competition”.

One of the reasons CSA fared relatively badly against its competitors is its heavy reliance on domestic operations, a market in which competition has been far tougher than on international routes. Among the big three Air China, the country’s official flag carrier, gets 40 per cent of its revenue from international services. China Eastern gets 30 per cent while China Southern gets only 19 per cent. CSA’s ambitious international expansion plans are aimed at eventually bring a better revenue balance to its books.

Its first half results, released in September, clearly show the pressure this is creating. Total passenger revenue was $7. 2 billion, down 1. 6 per cent from the same period last year, even though passenger traffic volume increased by 10. 2 per cent. Passenger yield per RPK decreased by 10. 6 per cent $0. 11 to $0. 10, the first decline in four years. Domestic passenger revenue was $5. 8 billion, down 3. 5 per cent from the same period last year, accounting for 81. 0 per cent of overall passenger revenue.

Cargo results were also poor. Freight revenue was down 6 per cent to $506. 2 million. While CSA carried 590,000 tonnes, up 2. 3 per cent, the yield per tonne kilometre dropped 8. 1 per cent from $0. 28 to $0. 17.

There is another potential issue domestically. While there is pricing competition airfares are still regulated, with minimum and maximum levels. It means Chinese carriers can’t make maximum use of sophisticated revenue management systems to maximise their income.

The government is considering deregulating airfares, but that may raise another problem. Low-cost

(China Southern) is banking on its ‘Canton Route’. . . to be one of the major building blocks of its international growth.

carriers (LCCs) have not seen the sort of domestic growth in China that has occurred elsewhere in the region simply because regulations don’t allow them to operate as true no-frills airlines. Airfare deregulation could change all of that, sparking a domestic LCC boom which would potentially be extremely damaging to the legacy airlines.

Influenced by domestic and international economic conditions, and with unfavorable factors including a slowing down in market demand coupled with rapidly increasing capacity and high-speed rail, competition in the domestic market is already tough.

“This put the company’s operation under greater pressure. We would like to maintain our competitiveness, but we also need to realise that labour costs are increasing in China. We are working diligently to cut down operating costs,” said Tan.

High-speed rail is undoubtedly one of the major issues. China opened the world’s longest high-speed rail line at the end of last year between Beijing in the north and Guangzhou in the south, cutting train travel time between the two cities to eight hours from almost a day. Si Xianmin, CSA’s chairman, who was also in Sydney for the A380 route launch, said demand for air travel in China reduced sharply earlier this year, leading to a drop of 10 per cent year-on-year in airfares.

“Another reason is the impact of high-speed railway. For example, Beijing-Guangzhou high-speed railway has shunted the air traffic flow, especially on Beijing-Zhengzhou route and Guangzhou-Wuhan route. Furthermore, with the decrease of business travel, it has led to the decrease of premium passenger flow, which directly affects the passenger load factor and traffic flow this year. ” The head of the Civil Aviation Administration of China (CAAC), Li Jiaxiang, has suggested that 50 per cent of domestic flights under 500km in length and about 20 per cent of flights between 800km and 1,000km could become unprofitable due to high-speed rail. That is significant because 14 per cent of CSA’s domestic ASKs are on routes in that range, compared with 16 per cent for China Eastern and just seven per cent for Air China.

Si says with further structural changes within the company and focus on international expansion, he expects profitability through the remainder of this year to be far better. However, even with its offshore operations CSA has hurdles to overcome to improve efficient utilisation of its aircraft. For example, three of its five A380s are still flying domestically with the others used for Guangzhou-Los Angeles and now Sydney. This is because there are very few international routes from Guangzhou that can support a daily A380 service. CSA has applied for permission to operate the big jets from a second hub in Beijing but so far this has not been forthcoming, probably because of objections from Air China. If it succeeds it would be a major breakthrough because it would then be able to make the A380s viable by flying them from the Chinese capital to the US and Europe, linking there with its Skyteam alliance partners and offering a far more attractive international network.

In the meantime, Si says the use of an A380 to Sydney underlines the airline’s commitment to Australia as one of its key overseas markets.

“China Southern Airlines will take this opportunity to enhance the cooperation with Australia, improve the quality of services and gradually make Guangzhou an exciting bridge connecting Australia with China, Asia, the Middle East and Europe,” he added.

The airline is banking on its ‘Canton Route’, launched last year to link Australasia with Europe through Guangzhou, to be one of the major building blocks of its international growth. It has been touting the fact that the route iseven shorter than flying through Singapore or Dubai. Si likes to point out that Sydney to London via Singapore is 17,152km, through Dubai 17,519km but through Guangzhou just 16,995km.

Its Australian flights have been performing well, with 85 per cent load factors, although a great deal of that may be explained by the fact it is selling tickets up to 30 per cent cheaper than its major competitors. Also helping are new visa rules introduced earlier this year allowing Australian travellers a 72-hour visa-free stopover in Guangzhou.

CSA chief executive Tan also says the airline, which carried 90 million passengers last year, is “doing a great deal” to upgrade its product and service levels. It recognises international travellers still cite concerns about the level of service, lack of English language skills and quality of food on China Southern flights.

“I attach high importance to the service quality of our products. More importantly, on the Australasian routes, passengers can fly on the most state-of-the-art, newest aircraft. We would like to focus on the skill of the airline and the quality of our service, so as to develop into a world-class carrier. I’m sure the Chinese aviation industry will be one of the biggest players in the world soon. ” The airline is upgrading its inflight dining and wine and has begun employing Australian cabin attendants.

It has also been building a reputation for innovation. For example, in China earlier this year it began deploying an onboard retail technology platform, including point-of-service (POS) handheld devices that for the first time will accept China UnionPay bank cards onboard its aircraft. From GuestLogix, a global provider of onboard retail and payment technology solutions, the system includes a world-first facility that lets passengers purchase seat upgrades inflight.

He points out that China’s tourism industry is growing at 20 per cent every year and last year alone, more than 100 million Chinese tourists travelled abroad.

While Sydney, Melbourne and Auckland are the most attractive destinations (CSA also flies to Brisbane and Perth) for Chinese in Australasia, the airline has its sights set on adding services to Adelaide and Christchurch.

“But our priority right now is to strengthen current destinations before we try other destinations. If we target 20 per cent annual growth, our current load factor on Australian routes is 85 per cent, so our next step will be to fill up that unsold 15 per cent first. ” The hubbing statistics for CSA’s base at Guangzhou’s Baiyun International Airport are impressive, though the numbers begin from a low base. The number of passengers transiting on to other destinations (including domestic) reached more than two million last year, up from 800,000 a year earlier. Sixth freedom traffic right transiting passengers (international) increased by nearly 1. 5 times from 147,900 in 2011 to 346,000, with an increase of more than 20 times compared with 2009.

While there has been a slowdown in activity domestically the government is attempting to jump-start renewed growth by offering big incentives to airlines to open up new routes to underserved cities. The CAAC recently announced rebates to airlines operating new regional services. The big three havealready received some $45 million for doing just that. This year alone the CAAC has allocated $90 million to help finance some 134 smaller inland airports. China is on an airport construction boom but even that may not be enough. Some 70 airports are scheduled to be built by 2015 with the total number of airports in the country projected to reach 244 in 2020, up from 180 at the end of 2011. It’s just a start. The US had around 5,000 civil airports at the end of 2011 for a population less than a third of China’s 1. 3 billion, according to a report by consultancy Frost & Sullivan.

China Southern dominates this vast domestic market but others are fighting hard. Carriers are battling to forge tie-ups with regional operators to extend their reach. In July, China Eastern chairman Liu Shaoyong flew to Henan province to seek expansion opportunities in Zhengzhou, a central city of more than eight million people where Apple iPhones are made. CSA already has a joint venture in Zhengzhou and holds stakes in Xiamen Airlines, Chongqing Airlines and Sichuan Airlines.

HNA Group, parent of Hainan Airlines, wants to set up five new subsidiaries in the remote provincesof Xinjiang, Heilongjiang and Guangxi, among others. HNA also has a stake in regional carriers such as Tianjin Airlines and Kunming-based Lucky Air.

The strength of long-term growth projections is not in question. Currently operating some 2,600 aircraft, the Chinese fleet is expected to grow to 4,500 by the end of2015 with more than 75 per cent of the new jets being for expansion rather than replacement. The country’s airlines carried more than 300 million passengers last year, expected to rise to 450 million by 2015, 700 million in 2020 and 1. 5 billion by 2030. On these trends, the domestic Chinese market alone is expected to double in size every eight years.

International expansion is forecast to be just as robust. Indeed, during the current winter-spring season, running to the end of March, 31 new international air routes will be added in China, the CAAC has announced. They include 23 passenger and eight cargo routes. During the season, 17 Chinese airlines will operate 4,798 international weekly flights, with 109 foreign airlines from 56 countries operating 4,786 flights to China each week. In the domestic market, the number of flights will increase by 7. 1 per cent compared to the same season last year and 84 new routes will be launched.

The big question, for China Southern and all its local competitors, is whether they can deal profitably with this growth, the challenge from high-speed rail and volatile economic conditions at home and abroad.

The domestic Chinese market alone is expected to double in size every eight years.