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Cathay feels pressure from competition from over the border

SHARES in Hong Kong's flagship carrier, Cathay Pacific, recently slumped to its lowest level in seven years after the company lowered its second-half profit forecast blaming overcapacity and competition from the mainland.

The airline said in a statement to the Hong Kong Stock Exchange that it was carrying out a "critical review" of its business, which it said had "deteriorated" since an interim report in August.

On the other hand, mainland China's big three state-owned airlines have been adding planes and routes at a rapid clip in recent years.

Along with HNA-controlled Hainan Airlines, they've been chasing a domestic market that Airbus forecasts will grow almost fourfold between 2015 and 2035 and an international one that has already turned China into the world's biggest exporter of tourists, Bloomberg reported.

If that sort of market growth sounds like good news for Cathay, think again. Boom times can be as fatal to airlines as busts, because when the competition raises capacity too quickly it drives down everyone's prices.

As Bloomberg's Gadfly warned in August, airlines in China and Hong Kong are suffering from a brutal bout of ticket price deflation. Passenger yield, which measures how much a carrier earns for flying a single passenger one kilometre, has slumped across the board.

In their most recent reporting periods, the 7 cents and 6.8 cents revenue per passenger kilometre that Cathay and Hainan Airlines were getting was barely more than the 6.7 cents received by Shanghai-based Juneyao, an upmarket budget airline that by rights should be making considerably less.

In theory, that deflation should be offset somewhat by the rapidly falling price of jet fuel, but Cathay's been hit on that front as well. Its state-owned rivals have enjoyed the full benefit of plummeting oil prices because they don't hedge, while Cathay's hedging policy has been an expensive failure.

However, Cathay still has some cards up its sleeve. Shuffling its aircraft orders would stop the bleed from capital spending while a restructure of the fuel hedge book, or possible higher oil prices, could turn some of those losses back into profits.

The carrier could raise cash by selling off stakes in its catering, ground-handling or frequent-flier programmes, though its substantial cargo business isn't likely to attract investors in a weak market for air freight.

It might also have some supporters in the form of controlling shareholder Swire and Hong Kong's government, which showed its willingness to go into bat for the local hero in rejecting Qantas' attempt to set up a low-cost carrier in the territory last year.

Either way, Cathay can't remain aloof from the market share war playing out in China. Transit passengers make up about half its traffic, according to HSBC analyst Jack Xu, so Cathay is embroiled in this battle whether it wants it or not.