Cathay Pacific's new CEO faces bloated costs, upstart rivals

Friends and executives clinked their champagne flutes for Rupert Hogg late last week at a sky lounge offering a view of Hong Kong’s Victoria Harbour, wishing him success as he assumes the CEO role on May 1 at Cathay Pacific Airways.

A can of Red Bull might have been more appropriate.

The 55-year-old veteran executive with the Swire Group, the Hong Kong conglomerate and Cathay’s largest shareholder, is about to take on one of the toughest turnaround jobs in Asian commercial aviation.

Once a dominant player in Asia’s premium air travel market with few serious rivals, Hong Kong’s marquee carrier has hit an air pocket, despite the booming travel demand in the region.

Last month, the airline reported its first loss in eight years, in part from a fuel hedging bet gone bad.

That was a one-off misstep, but far bigger challenges loom, including intensifying competition from budget carriers and deep-pocketed, state-owned Chinese carriers for cost-conscious passengers and incursions into Asia from Mideast rivals such as Emirates Airline and Etihad Airways for the business traveler.

In recent years, Cathay has had to sell tickets below cost to keep its planes full and its operating costs are higher than most rivals.

Sales per employee at Cathay in the latest fiscal year was about US$352,614, while it was US$473,268 at Delta Air Lines and US$414,610 at Qantas Airways.

Cathay’s stock has tumbled 25 percent since the incumbent CEO Ivan Chu took over on March 14, 2014, while analysts tracked by Bloomberg currently have zero buy ratings on the company.

Into the breach enters Hogg, who joined the Swire Group in 1986 and steadily rose through the ranks with overseas stints in Southeast Asia and Britain, before being tagged as Cathay’s chief operating officer in 2014.

As part of the senior management team under Chu, Hogg helped pull together a restructuring plan announced earlier this year to help cut as much as $514 million in costs over three years -- a strategy he intends to stay with now that he’s boss.

“We’ve got a plan,” Hogg said at the event on April 21. “It’s the three-year business transformation program. We’ll work through this.”

Hogg, considered by many employees as charismatic and approachable, is a consummate Swire insider with a strong track record, but some analysts wonder if Cathay might be better off with an outsider at the helm who’s less beholden to established ways and more willing to engage in some shock therapy to get the carrier back on track.

Hogg and three of his immediate predecessors -- Chu, John Slosar and Tony Tyler -- worked as the chief operating officer of the airline just before taking up the top job.

The worry is that Swire group think contributed to the strategic mess Cathay now finds itself in and may hamper the kind of bold thinking needed to adjust to the changing competitive landscape in the region.

“All the guys are from the University of Swire Group,” said Maybank Investment Bank Bhd. analyst Mohshin Aziz.

“They graduate with honors, meaning, they are identical to each other. The way they think, the way they do things. It’s different faces, but it’s the same content. It’s way overdue for someone from outside to come in.”

The counter-argument is that the business cultures of Swire and Cathay are so intertwined and unique that only an insider can navigate them, according to Singapore-based independent aviation analyst Corrine Png.

“Cathay’s corporate culture is so strong, it may actually be difficult for someone from outside to integrate and to work well with the existing management team and also the middle managers and the staff," said Png, the CEO of Crucial Perspective.

Born in a Manila bar

American Roy Farrell and Australian Sydney Hugh de Kantzow founded Cathay Pacific Airways in 1946. Initially based in Shanghai, the two men eventually moved to Hong Kong and established the airline. Farrell and a group of foreign correspondents thought up the airline’s name in the bar at the Manila Hotel, according to Cathay’s website.

Now, it is one of the nine carriers in the world with a 5-Star Airline Rating by Skytrax, which measures cabin service, staff and product offerings both at the airport and aboard the aircraft for the top grade.

Swire and Air China., Cathay’s two largest shareholders with a combined stake of 75 percent, provide the airline the financial flexibility to map out long-term strategy, said Will Horton, a Hong Kong-based senior analyst at CAPA Centre for Aviation.

“Cathay’s shareholding structure allows it to focus on the long term, which is what’s dictated by the cyclical nature of aviation with too many external factors,” Horton said. “There’s no need to focus on quarterly improvements like the way North American and European airlines have to.”

The Swire Group started out in Liverpool in 1816, when John Swire set up an export-import business focused on textiles between the U.K. and the U.S, an entity that his sons advanced over the years.

As the outbreak of the American Civil War disrupted American cotton imports, John’s son set up a business in Shanghai in 1866 and later expanded to Hong Kong.

Swire's Cathay stake

Shipping, sugar refinery, ship repair and aircraft engineering businesses followed and the entity was one of Hong Kong’s biggest employers. The group then bought a controlling stake in Cathay in 1948 while the exiting of sugar and dockyard businesses gave Swire the land to become a property developer in Hong Kong.

With losses looming, Hogg and Chu put in motion the HK$4 billion (US$514 million) three-year cost reduction plan. Half of that will be executed this year itself, according to Xiao Feng, the chief financial officer of Air China, which holds 30 percent of Cathay.

“These are challenging times and we are up for that challenge,” Hogg told the gathering. “Obviously we’ll be listening closely to our customers. We’ve always been and we always will. We have the customer right at the center of everything we do.”

Booming bemand

Asia Pacific is seeing robust growth in air passenger traffic, helped by a rash of budget airlines that started in the past two decades offering cheap fares and connectivity that has lured the train and bus travelers.

Much of that booming demand bypassed Hong Kong, which has few budget airlines that call the city home. So Cathay had to rely on business travel and inter-continental traffic that fed into Chinese cities.

After years of benefiting from China’s growth, Cathay is being hurt by its strong ties to the mainland. Travelers are bypassing Cathay and flying directly between Chinese cities and the U.S. or Europe. The city has also been slow to see the trend and a new runway aimed at easing airport congestion is still years out.

Cathay has played a role in promoting Hong Kong as a global tourism destination in the past, but the city is going through an identity crisis, said John Carroll, a professor in history at the University of Hong Kong.

"Between government and the industry, nobody has really figured out a good way to sell Hong Kong," Carroll said. The economic rise of the mainland makes the distinction with Hong Kong hard to tell. "Why invest in Hong Kong when you can invest directly to the mainland?"

The restructuring Hogg will oversee won’t be easy, but others have shown that a large-scale transformation is possible. In 2008, Qantas named the then head of its discount unit Alan Joyce as the CEO of the airline and he successfully steered the carrier out of trouble through a restructuring plan, that included job cuts and deferral of aircraft.

“The global precedent suggests a tough transition period, but as Qantas showed, it can be done,” said Joshua Crabb, head of Asian equities at a unit of Old Mutual.