A New Airline Storyline in the Philippines
Tear up the script. The storyline is flipping.
For years, the Philippines featured a classic airline narrative: A bright young low-cost carrier making life miserable for a stodgy old money-losing legacy carrier. The protagonist was Cebu Pacific, quietly one of the world’s most profitable airlines during the 2010s. In 2019, its 15 percent operating margin placed it within the top ten of all carriers industrywide. Its hapless victim? Philippine Airlines, or PAL, a chronically overstaffed basket case that lost $188 million in 2019, excluding special items.
But oh, how the tables have turned. In 2022, it was Cebu that wore the red ink. Cebu’s operating margin for the year was a gruesome negative 20 percent, even as PAL managed a strong profit — its operating margin was positive 12 percent. Cebu’s result was negative even during the fourth quarter, after Asia’s demand recovery began to revive. PAL by contrast took advantage of the upturn, earning a 12 percent operating margin in the fourth quarter.
Cebu’s struggles came despite a strong recovery in domestic traffic as early as last year’s second quarter, followed by the gradual reopening of destinations throughout East Asia and Australia. One market that didn’t open until late in the year, however, was Hong Kong, Cebu’s most important international market prior to the pandemic. Of all the outbound international seats it flew in 2019, 21 percent were bound for Hong Kong, home to many Filipino workers. Mainland China was an important market too; Cebu served Beijing, Shanghai, Guangzhou, and Xiamen in 2019. Service to all but Beijing has been restored but with many fewer seats than before. Macao is another important market where Cebu is now flying just a fraction of the capacity it was prior to the crisis. In the meantime, competition from some key rivals has intensified, notably Singapore Airlines and its low-cost affiliate Scoot. Their combined capacity to the Philippines is up by almost a third from 2019. Capacity to the Philippines flown by Taiwan’s airlines, including newcomer Starlux, is up by more than 50 percent. Several LCCs from Korea have boosted their capacity to the Philippines as well.
Domestically, the Philippines restricted travel more than many other countries in the regions throughout the pandemic — domestic markets were a refuge for many carriers worldwide, but not so much for Cebu. It did receive some modest government support, including fee waivers and loan deferments. Critical to its survival, furthermore, was its successful effort to raise new funds (more than $1.6 billion) through additional borrowing, share issuance, and sale-leaseback activity. Naturally, it took steps to cut costs as well, by reworking labor contracts, restructuring aircraft lease payments, closing call centers, and adopting more self-service options for customers.
No less critical was the robust performance of Cebu’s cargo operations. In 2019, cargo accounted for a meaningful 7 percent of the company’s total revenues. In 2021 the percentage rose to nearly 40 percent, before declining to 13 percent last year. Cargo revenues continued to increase last year but diminished in importance as passenger volumes returned. In addition, management said in its fourth-quarter earnings presentation that cargo volumes were now flattening, with yields falling due to more competitive pricing. Perhaps most importantly, Cebu’s cost-cutting efforts were in large part negated by spiking fuel costs last year, made worse by the depreciation of the Philippine peso.
Cebu hopes 2023 will better. Fuel prices have dropped. The Philippine peso has strengthened. At the same time, tourism trends are strong throughout Southeast Asia. And many of the fundamentals that helped Cebu become so profitable in the past haven’t changed. These include the fact that its country has 115 million people but only three airlines, one of them — AirAsia’s Philippine venture — has a long history of lossmaking.
The other though is PAL. In 2021, it entered U.S. Chapter 11 bankruptcy restructuring, cutting about $2 billion in debt, according to Bloomberg. It also cut operating costs while in bankruptcy, positioning it to take advantage of the demand recovery as it began to take shape in 2022. While battling Cebu and AirAsia at home, and with other Asian carriers within its region, PAL had the North American market to itself. PAL serves Los Angeles, San Francisco, New York, Honolulu, Toronto, and Vancouver. Some of these markets are benefitting from PAL’s new Airbus A350s, and all are seeing a strong increase in passenger demand following several years of strong cargo demand. PAL faces nonstop competition in the Australian market from both Cebu and Qantas. But that hasn’t stopped it from adding a new Perth flight. Competition is more intense on Middle Eastern routes serving overseas Filipino workers in the Gulf region. Cebu, for example, flies ultra-dense Airbus A330s to markets like Dubai. Multiple Gulf carriers serve Manila as well.
Can PAL sustain its newfound post-bankruptcy, post-pandemic success? It’s now looking to add back more capacity and further improve its fleet, contemplating, for example, acquisition of larger A350-1000s. Besides its core business of transporting overseas workers — approximately 12 million Filipinos live or work abroad — PAL is hoping to generate more business from domestic tourism, adding new routes to Cebu and elsewhere. That said, it doesn’t plan on reaching 2019 levels of capacity until around 2027 or 2028.
Cebu, for its part, told Bloomberg in January that it was “on its way to full recovery and profitability in 2023.” Both carriers face some common challenges, including woefully inadequate airport infrastructure in Manila. But both enjoy advantages as well, not least the location and population size of their home country; only 12 other countries in the world have more people than the Philippines. The economy is growing rapidly again too. Maybe going forward, the Philippines will have two airline success stories, not one.