Delivering on his dynastic destiny

Cebu Pacific Air started life in 1996 with four mature aircraft that flew 24 times a day between Manila, Cebu and Davao. This year, as he celebrates the carrier’s 20th anniversary, the airline’s founding president and CEO, Lance Gokongwei, is in charge of the biggest airline in the Philippines.

by TOM BALLANTYNE IN MANILA  

April 1st 2016

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Twenty years ago, Philippines tycoon, John Gokongwei, bought four DC9 passenger jets and told his only son Lance, then aged 28, “to go start an airline”. Two decades on, Lance Gokongwei has done exactly that – and then some. Read More » Cebu Pacific Air is one of the region’s most successful low-cost carriers and is now the largest airline in the Philippines. In March, the publicly listed company celebrated its 20th anniversary.

“We have continued on our growth path,” Gokongwei told Orient Aviation in an exclusive interview at the carrier’s headquarters overlooking Manila’s Ninoy Aquino International Airport (NAIA). “We are one of the 20 largest LCCs in the world. We carried more than 18.4 million guests last year. We have a fleet of 57 aircraft with an average age of below five years.”

Photos: Ryan Peters

President and CEO Cebu Pacific Air, Lance Gokongwei: “This year we will be solidly profitable as a long-haul operator, not just a short-haul LCC, because of the maturity of the routes and fuel prices.”

The highlight of 2015, he said, was the successful expansion of Cebu’s long-haul network with the addition of routes to the Middle East and Sydney. “We are now the largest carrier on the Manila-Sydney route, with about 40% of the market share. Overall, last year was quite a successful one financially, barring some hedging and foreign exchange losses that we experienced.”

In a fiercely competitive market, Cebu has reported a net profit of $76.5 million for the first nine months of 2015, up 71% from a year earlier. Revenue increased by 10%, to $909.4 million, with the carrier’s full year results to be announced at press time.

Cebu’s net margins of more than 8% are well above the industry average and its load factor has hit 86%. Growth in passenger numbers, which increased 9% in 2015, was driven largely by the carrier’s low-cost long-haul services, launched in 2013, and increased frequencies in key domestic markets. Cebu has 59.5% of the Philippines domestic air market.

Passengers flown on long-haul routes grew by 146% year-on-year, on the back of its increased presence in Australia and the Middle East. Its Manila-Gulf network is to Riyadh, Kuwait, Dubai and Doha, of which the latter was launched in June. The carrier also reported notable passenger growth in international destinations including Hong Kong, Tokyo (Narita) and Nagoya in Japan and Beijing and Shanghai in China.

Now operating a network of more than 90 routes to 64 domestic and international destinations, Cebu’s fleet consists of eight A319s, 35 A320s, six A330s and eight ATR 72-500s. In the next five years it is scheduled to accept delivery of three new A320s, 30 A321neos and 16 ATR 72-600s.

In 2018, the fleet will number 69. The ATR order was announced last year at the Paris Air Show, along with options for another 10. The new aircraft is part of a fleet renewal program that will replace the airline’s eight ATR 72-500s with the -600s to meet growing demand in the Philippines for inter-island services.

Gokongwei is committed to growth, but there is an issue. NAIA is one of the most congested airports in the region and handles only 40 aircraft movements an hour. “It is a constraint,” he said. “It certainly affects our on-time performance in many ways, especially in the Philippines which often has severe weather events.

“There have been some significant improvements at the airport with new terminals being built or renovated. The single biggest issue is runway capacity and air traffic flow management. There is a very serious study underway with NATS (the UK air traffic service provider) to identify improvements.” Nevertheless, it is likely to add only a handful of new slots at the airport, observers said.

There is one benefit from the congestion at Manila. Gokongwei’s rival LCCs in the region may have huge numbers of aircraft on order “but they can’t fly them to Manila”, he said. “Given the opportunity we would like to grow a lot faster, but we face this constraint so we have to develop elsewhere.

“One way is to up-gauge all our capacity to the A321neos from 2017. The A320 seats 180 while the neo seats 220 in a single class configuration. We also are beginning to use our A330s on shorter haul routes to add incremental capacity into the slot constrained airport.

“The second strategy is not to be totally dependent on Manila. You have to build hubs outside of Manila and I think that will mean Cebu, Davao, Clark and elsewhere eventually. It will have to happen. As we receive more aircraft we will be able to put more resources behind those new hubs.”

The airline operates a substantial hub in Cebu and it has begun developing its other hubs. Last year it launched Kalibo-Hong Kong, Cebu-Narita, Cebu-Taipei and Davao-Singapore.

But congestion or not, the market is fiercely competitive. When Orient Aviation was in Manila, AirAsia announced it would put three million one peso (US$0.02) tickets on sale. It did not phase Gokongwei. “We started the one peso fare here so in fact today if you look at the newspapers we have a one peso fare ongoing,” he said.

“In the passengers’ minds it’s an expectation. The passengers’ first choice for travel is Cebu Pacific AIr. If they are looking for a good deal they check our site first.”

He pointed out average yields in 2015 were eroded relative to previous years, but he said that is primarily because fuel surcharges have been removed. “On average, the industry has been fairly disciplined here. I don’t think we have – I hope not anyway – the beginnings of a disastrous price war,” he said.

“There will be capacity constraint and with the economy continuing to grow, there is a supply balance. It’s very hard to add a huge amount of capacity when ultimately it will be disruptive to the yields.

“I’ve always believed that as an industry either you all make money together or you all lose money together. It’s very rare to see a situation where one airline is making lots of money and the other airline is making no money because the one that makes no money will go bankrupt and will be replaced by somebody who knows how to compete. So for me the growth of industry capacity is still the single most important factor [at Cebu Pacific Air].”

Gokongwei is comfortable with the financial situation. “Our assets are long term assets and they have been financed in mainly US$. The peso has weakened in the last year by 7%-8%, but fortunately the currency has not suffered as much as our neighbouring countries like Malaysia and Indonesia where they have had a 15%-20% devaluation against the US dollar.

“Historically, we have hedged about 30% of our fuel. Last year I guess was very reminiscent of 2008-2009 when oil went from $110 to $40 per barrel in the year. We would have locked in maybe 25%-30% of our fuel last year at the higher prices and we had to bear those hedging losses.

“But we continue in that vein. We have hedged about 25% of our fuel this year at low $70s jet price, so not that bad, and about 30% at low $60s for next year. We really don’t know where the fuel price is going.

“Most analysts predict the price should normalize around the $50s so jet would be about $60. If that is indeed true – and you take these forecasters with a grain of salt because nobody ever forecast a drop of $100 to $40 – then we will be in good shape.

“We are risk managing by getting some certainty for the future regarding the level we will be paying. Our airline is built to be profitable, even at $100 for fuel and we have benefited, so anything below that is really a blessing.”

In the next 12 to 24 months Cebu Pacific Air will consider more fleet replacement. It has no wide bodies on order and its six A330s are leased. “over the next 12 months, we will probably have a process to renew our long-haul fleet and this time we will probably purchase the aircraft,” he said.

“The reason we did not buy the aircraft the first time around was that we expected there would be a change in technology and did not want to invest in the asset. We thought leasing was the best proposition at that time,” he said.

“The current long-haul network requires four to four-and-a-half of the six A330s, with the remainder being used on shorter haul routes. The long-haul destinations on the radar are Melbourne and Honolulu, which can be handled by the six A330s. Additional aircraft can be leased if necessary.”

When the time comes, Gokongwei said Cebu will have “a complete process to anticpate the structure of the network five or ten years from now” before making a decision. The airline will evaluate the A330neo and the B787 Dreamliner.

Ultimately, Cebu wants to fly to the U.S. Mainland to cities including Los Angeles or San Francisco, but it won’t do it one-stop through Hawaii.

“My experience of one-stop is that it is probably not the best thing to do, especially with Philippine Airlines there. They have pretty modern aircraft, the B777, and they have ordered A350s,” he said.

“You really have to think it through. What kind of competitive advantage do you have? You may just end up splitting the route and that doesn’t help anyone. Scale is important in driving cost and efficiencies, but market share in itself doesn’t do anything.

“It’s not market share in itself, but how profitable [a route] is. That is my fundamental belief. You need a certain market share to drive economies of scale and we don’t enter a market just because the other guy is there.”

'Looking back, I am very proud of the way we pull together, always with our mission in mind, which is to make flying affordable for all Filipinos. So far, we have stayed true to that mission. We have changed people’s perceptions and lives in a way'

Lance Gokongwei President and CEO Cebu Pacific Air

As for competition between Cebu and Philippine Airlines (PAL) Gokongwei said: “we have a healthy respect for each other, but we compete like hell in the market place. They still dominate the corporate end of the market, but in several ways they have had to adjust their product, especially in the domestic market, to copy us. In many of the shorter haul markets they have had to duplicate our product.”

There has been one unusual outcome from their competition. “I noticed this trend over the past 10 years,” Gokongwei explained. “If you look at the total traffic 10 years ago, there were about 11 million international passengers and the Philippine carriers share was only four million, or about 40%.

“In the most recent year, because PAL and Cebu Pacific Air are aggressively re-fleeting and competing hard, Philippine carriers have more than half of the international traffic. It’s very rare to find countries like that. It’s really private sector ownership and competitive tension that has enabled this to happen.”

One market, however, has not taken off for Cebu. “The Philippines is not experiencing a boom in Chinese visitors. Cebu’s Chinese traffic accounts for only 2% of its passengers, he said. “Chinese tourists are the main drivers of growth in most other markets, particularly Thailand, whereas in the Philippines it’s still Koreans and Japanese.”

“The reason is the delicate political situation between the two nations over the Spratly islands in the South China Sea. While there is no “official” bar on Chinese travelling to the Philippines, there is a perception that the Mainland government does not encourage its tourists to visit the country.”

There is, however, huge potential in Southeast Asia. In February, the Philippines finally ratified the ASEAN (Association of Southeast Asian Nations) open skies treaty. “It is a big win for the aviation industry,” said Gokongwei. “It’s a big win for the customer. Now there are basically no constraints on capital city to capital city flights.

“Instead of spending management time negotiating air rights, we can spend all our time developing new routes. That is going to be great for tourism throughout ASEAN. The first opportunity is to increase capacity on certain routes which can take more capacity, such as Bangkok and Bali, assuming you can get slots. And given the situation in Manila, to talk about more direct flights to these places from other Philippine hubs.”

If there is one aspect of Cebu’s long-haul flying that has raised industry eyebrows it is that unlike other budget long-haul operators such as AirAsia X and Jetstar, it has not introduced a “premium” cabin on its aircraft to attract corporate customers.

Typically, an A330 with a two class configuration carries around 300 passengers. Cebu’s A330s are single class with 436 economy seats, an extremely high density in anyone’s language.

Gokongwei stressed the airline has been flying long-haul for two years. “Last year our losses significantly diminished [on long-haul] because we have been on these routes longer and the brand is better known to distributors. We are up to speed and oil prices in the back half really helped,” he said.

“This year we will be solidly profitable as a long-haul operator and that is because of the maturity of the routes and fuel prices.” But he said people needed to look at the offering and where Cebu is flying. “This is all worker traffic to the Middle East. Sydney might have room for some premium seats, but I am not going to have one aircraft just for Australia and all the other aircraft for the Middle East. So we stick with the model,” he said.

“A lot of this business is saying no to these little changes which add a lot of complexity to the business. The conditions might be different if you were doing a San Francisco or a Los Angeles route because the plane may be too heavy and you’d probably put in some lie-flat beds. You would have the scale to have some of your aircraft in a two-class configuration. But there is no immediate need.”

Given Cebu’s market strength has Gokongwei given thought to doing a Virgin Blue, the Australian budget carrier that has transformed into full service Virgin Australia. “The plan is working, why change it? In other words, if it’s not broke, why fix it? Per capita income here is $3,000 a year, not $30,000. I am perfectly suited for 99% of the market. They are happy to take Cebu Pacific Air.”

There has, however, been transformation. In 2015, the airline introduced a new livery and last month, new cabin crew uniforms. “It just signifies the change in the Philippines in the last 20 years. The country has become much more cosmopolitan and vibrant and much more international because of our IT economy boom. Our brand had to change with the times and portray a more confident Philippines brand,” he said.

There may be many challenges ahead, but Gokongwei said one of them, as Cebu expands, is to stay disciplined and committed to the model while maintaining the airline’s corporate culture.

“As you get larger and larger it gets harder and harder to do things and keep that underdog fighting spirit going. Looking back, I am very proud of the team. I’m very proud of the way we pull together, always with our mission in mind, which is to make flying affordable for all Filipinos. So far, we have stayed true to that mission. We have changed people’s perceptions and lives in a way.”