Industrials

David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

Cathay Pacific Airways Ltd. is in a state.

Its shares have fallen 27 percent since Chief Executive Officer Ivan Chu took over in 2014, and the carrier Wednesday reported a HK$575 million ($74 million) loss, its first on an annual basis since 2008. Five months after the company junked its earnings forecast and announced a "critical review" to turn the business around, there were no details about how this would be achieved beyond an alarmingly banal aspiration to increase revenue and reduce costs.

There is one thing the airline is getting right: When it comes to filling up seats on its planes, it's among the best in the business. Of the world's top 15 carriers by revenue , only Air France-KLM and Delta Air Lines Inc. have a better load factor -- passenger traffic as a percentage of available seats.

Fill 'Em Up
Cathay Pacific's load factor is one of the best among major airlines
Source: Bloomberg
Note: Includes only top 15 airlines by revenue. Load factor is revenue passenger kilometers as a percentage of available seat kilometers.

In theory, that should be good news. An empty plane costs almost as much to fly as one that's full of paying passengers, so the difference between a load factor north of 80 percent and one south of 70 percent is typically the dividing line between profit and loss.

Unfortunately for Cathay Pacific, there's another issue to consider: revenue and expenses. One easy but dangerous way to fill extra seats is to sell tickets below cost. That will certainly induce more passengers to book, but they may also come to see your unprofitable prices as normal and switch to competitors if you try to get things back on a more viable footing.

Selling tickets below cost is exactly what Cathay Pacific has been doing for several years. Work out an airline's revenue per passenger kilometer as a percentage of its operating costs per available kilometer and you get its break-even load factor -- the share of seats it needs to fill if it's to make a profit on ticket sales. Have a look at the chart below and you'll see Cathay Pacific's problem:

Out of Reach
Cathay Pacific needs to fill more seats than it actually has if it wants to make a profit on passenger flights
Source: Bloomberg
Note: Shows break-even load factor. Latest fiscal year figures.

You read that right. Thanks to its stubbornly high costs and plummeting ticket prices from the overcapacity in greater China's aviation market, Cathay needs to fill about 124 percent of its seats to break even on its passenger services. You don't need a math Ph.D. to spot the fundamental obstacle to achieving anything above 100 percent.

So how, exactly, does Cathay Pacific make money?

Cargo isn't the answer. Though Cathay is the world's fourth-largest air-freight carrier and makes about a quarter of its revenue from the business, costs tend to exceed yields there too, so it's unlikely to be plugging the hole from passenger aviation.

Money Machine
Catering and other ancillary services comprise a tiny proportion of Cathay Pacific's revenue, but likely account for an outsized share of profits
Source: Company reports

The real answer lies in things that passengers could be forgiven for barely noticing -- catering, fees and other ancillary revenue, as well as equity-accounted profits from investments in associates such as state-controlled Air China Ltd. Ancillary and other revenue has exceeded net income in every year since 2012, and shares of associates' profits made up 40 percent of Cathay's total in 2014 and 2015, according to data from the company's annual reports.

Capital Gains
Almost half of Cathay Pacific's profit comes from investments in other companies
Source: Company reports

Making money from things other than selling airline tickets -- charging for window seats and baggage, or running an aircraft-leasing business, for instance -- is a surprisingly sustainable business model in aviation. But reality has a habit of catching up with you. While associates' profits in the 2016 fiscal year were the best since 2010, they weren't enough to compensate for the HK$3.36 billion loss from the core business.

Cathay Pacific's problem is that its operating costs are consistently above its competitors'. With the big three mainland Chinese airlines fighting for market share and driving down ticket prices, Cathay's high cost structure leaves it most vulnerable to being caught in the crossfire. The absence of decisive moves to address this problem in Wednesday's annual results announcement should be deeply troubling.

Premium Economy
Cathay Pacific's operating costs are the highest among its competitors
Source: Bloomberg
Note: ASK = available seat kilometers, the total distance flown by a carrier's aircraft multiplied by the number of seats.

Aircraft are pretty safe as long as they know the route to their desired destination and keep plenty of fuel in the tank. Cathay Pacific, at this point, appears to have neither. Investors should assume the brace position.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. Measure excludes many budget carriers like Ryanair Holdings Plc and Spring Airlines Co., which tend to have the very best load factors in the skies.

  2. Calculated by multiplying the number of revenue-paying passengers aboard a plane by the distance traveled. Available seat kilometers are the distance flown by an airline's fleet multiplied by the number of seats on board the respective planes.

  3. Cathay Pacific doesn't break down the profitability of its different units.

To contact the author of this story:
David Fickling in Sydney at dfickling@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net