Clipping PAL’s ‘too many wings’

MANILA, Philippines – When San Miguel Corporation (SMC) acquired 49% ownership of Philippine Airlines (PAL) two years ago, the conglomerate committed to turn the national flag carrier into a profitable business.

Part of returning the legacy carrier to black was to add passenger aircraft into its fleet.

So in 2012, PAL ordered 44 units of Airbus A321, and 10 A330-300 twin-aisle jets. It intended to implement the re-fleeting plan to reduce fuel and operating costs, according to its former president, Ramon Ang. The 54 wide and narrow-bodied Airbus aircraft had a $7-billion price tag.

Two years later and in a disclosure to the Philippine Stock Exchange (PSE), PAL’s parent firm PAL Holdings Inc. posted a net income of P1.49 billion ($33.24 million*) in the second quarter of 2014, an upturn of P1.08 million ($24,096.39) worth from the same quarter last year.

From April to June this year, revenues jumped 47.4% to P27.3 billion ($608.75 million) compared to P18.52 billion ($412.98 million) in the same period last year as passenger revenues surged 51% while cargo revenues grew 33%. (READ: PAL is back in the black)

“But that’s normal because it’s the (April-June) peak season,” said Jaime Bautista, who assumed PAL’s presidency role from Ang in a board election held Thursday, October 23.

Tycoon Lucio Tan was also reelected as chairman of the board and chief executive officer.

Ang resigned effective October 23.

The ‘real’ figures

Bautista said the first and third quarters of 2014, were “almost break even or a loss.”

In the last two years, he said Philippine Airlines and budget carrier Air Philippines reported a loss of $500 million, the same amount San Miguel spent to buy minority shares of PAL in 2012.

In an unaudited January to August 2014 financial statement of Philippine Airlines and Air Philippines (the latest financial statement has yet to be released) shown to Rappler, it revealed a combined earnings of $11 million from that period. In comparison, PAL Holdings reported earnings of P45.40 billion ($1,013 billion) from March to December 2013.

However, another $13.75 million of “other income” has to be deducted from its $11-million January-August earnings because the amount accounted for the lease charges of the aircraft Ang acquired under the airline’s fleet renewal program.

In that case, PAL had an excess of liabilities of more than $2 million.

In 2013, the airline’s parent company, PAL Holdings Inc., reported a net loss of P11.85 billion ($264.24 million) ending December – over 4 times its P2.74 billion ($61.15 million*) net loss in the same period in 2012, while its comprehensive net losses was at P2.7 billion ($60.25 million).

From April to December, passenger volume fell to 5 million, while total expense reached P61.5 billion ($1.37 billion).

PAL Holdings Inc., the parent company of Philippine Airlines and Air Philippines Corporation (which operates PAL Express), currently finances for its leased aircraft with terms ranging from 6 to 12.3 years.

A combination of low passenger demand during off-peak seasons, fuel price fluctuations, economic slowdown, competition, security and safety risks, plus the continuous expenses due to re-fleeting caused PAL’s break even or loss periods.

Too many wings

In an exclusive interview with Rappler, Bautista lamented that Ang had bought “too many” airplanes, adding capacity beyond what the airline needs.

This has contributed to PAL’s losses, with the company’s total long-term obligations at P26.63 billion ($594.29 million) as of June 2014.

“Before his entry to PAL, we only had around 40 airplanes. Now we have 60 airplanes. And then we’re taking another delivery of 32 airplanes in the next 3 to 4 years,” Bautista said.

In its latest quarterly report though, PAL listed 85 aircraft in its fleet. Out of the 85, it owns 33 airplanes, while the rest of the 52 airplanes either under finance lease or operating lease.

The re-fleeting program involved acquiring a mix of brand new A330s and second-hand A340s. It was meant to decrease cash flow for the airline. Instead of retaining old aircraft, operating newer airplanes would save PAL from spending more on maintenance. That, Bautista said, was Ang’s idea.

The ambitious fleet renewal program aimed at increasing PAL’s fleet to 100 planes. In May, PAL completed an order for over 70 planes, even after booking multibillion net losses.

In September last year, PAL negotiated with banks and export credit agencies to finance its $9.5-billion fleet modernization program. The airline’s financial consultant that time, Ian Reid, then declined to provide details of how much are being negotiated for the financing.

The effects of such aircraft purchases are expected to take a toll on PAL’s income for the third quarter, where PAL is anticipating to report losses. PAL has not yet released its latest quarterly report yet.

Lacking pilots

Acquiring too many wings, however, won’t help PAL fly to profitability. Bautista explained that an airplane must have 6 sets of pilot comprised of a captain and a first officer, making it 12 pilots per aircraft.

“They lack pilots when I asked how many do they have,” he said.

Every month, a leasing company also charges PAL for the excess planes – which would not have been the case if the planes had been used in its operations, said Bautista.

Financing on aircraft leases is the bulk of PAL’s capital spending, Bautista said. Lease rates are pegged at around 1%. Therefore, a $100-million aircraft’s lease rate is worth $1 million. Whether PAL uses the planes or not, leasing companies charge the airline for all leased aircraft in its fleet.

As of June 30, PAL has 3 Boeing 777-300ER ($330 million) and Airbus 320-200 ($221.7 million) under finance lease. Its 3 Boeing 777-300ERs ($330 million); 10 Airbus 330-300s ($245.6); 7 Airbus 321-231s ($120.5 million); 18 Airbus 320-200s ($221.7); and an Airbus 319-100 ($94.4 million) are under operating lease. (The prices cited are based on Boeing’s and Airbus’ latest commercial pricing.)

“If you don’t use it, you’re wasting millions. We wanted to use (them), but we can’t find destinations,” he said.

Bautista described the re-fleeting lacking deliberation, costing the carrier money.

Realizing it added too many wings for its fleet, the Ang-led management in March 2014 negotiated with Airbus to reduce its A330 order from 20 to 15. It compensated the cutback by ordering 8 additional A321 NEO aircraft, but it did not proceed with the transaction. The Airbuses were meant to be used for PAL’s long-haul flights.

Also, part of the deal with Airbus was to purchase a $16-million Rolls Royce-made spare engine for every 5 airplanes, Bautista said, who credited Ang for sealing a deal with the airplane engine maker as Rolls Royce’s performance is said to be superior than other brands.

PAL is also negotiating with Rolls Royce whether they could return the deposit of the excess spare engines, but Bautista said, since the transaction has been booked as a sale, Rolls Royce is reluctant to do a refund.

PAL’s fleet utilization is also low.

Their new aircraft has an average utilization of 4 hours per day, Bautista said, which is far lower than the ideal usage of 14-16 hours per day. Apart from the low usage, Manila’s congested runway has put a break on their ambition to mount additional destinations, on top of the fact that budget airlines such as Cebu Pacific, TigerAir, and AirAsia have already eaten up their share in the market.

Because of the re-fleeting program, PAL’s liabilities have reached $1.5 billion, said Bautista.

Botched deals

On top of the aircraft buying spree, there are those unprofitable ventures that PAL got into.

Ang, who is president and chief operating officer of San Miguel Corporation, hinted in 2012 that they were considering a deal with a regional airline. It would have been PAL’s first overseas venture since it commenced operations on March 15, 1941.

Then in 2013, PAL struck a $10-million deal with Cambodia’s hotel and telecommunications empire Royal Group to revive Cambodia Airlines, but it did not push through.

According to Bautista, Ang’s interest was rooted in an intention to use some of PAL’s aircraft for Cambodia Airlines. The revival of Cambodia Airlines was seen to compete against other domestic airlines in Cambodia. With the Royal Group of Cambodia, Cambodia Airlines would serve regional destinations to become the fastest growing airline.

The deal was supposed to make PAL a 49% shareholder of Cambodia Airlines. Royal Group would own the majority 51% shares.

It was reported that PAL was bound to pay a $1-million down payment in July 2013. However, Bautista said the botched deal had already cost PAL $5 million.

The Center for Asia-Pacific Aviation (CAPA) warned PAL in February 2013 against investing in Cambodia Air, describing the venture as “risky.”  CAPA said, “the group is better off focusing on reducing expenditure and improving profitability of its Philippine operation.”

Bautista said PAL has fixed expenses worth $5 million payable in the next 5 years. This is because a company that has been tapped to develop the reservation system for its Cambodia operations have been contracted despite securing an airline operator’s certificate before pushing for a joint venture agreement with the Royal Group of Cambodia.

Thanks to long-haul ventures, PAL’s profit saw an upturn, except for the Manila-London service which was last serviced 15 years ago.

The slot PAL got though as it started flying again in November 2013, required the airline to arrive in London at 3:30 pm. For passengers, it meant departing from NAIA Terminal 2 at 7 am, on top of a 3-hour wait or check-in time for international departures.

“Is that a good timing for departure? It’s not,” Bautista said.

CAPA had earlier warned PAL, including Garuda Indonesia, that they would face “intense competition” from Singapore Airlines, Thai Airways, Malaysia Airlines, Vietnam Airlines, and Royal Brunei Airlines.

Apart from competing with large carriers, PAL is not a member of global airline alliance SkyTeam, which makes their European service inferior even when competing with Garuda, which joined the alliance in March this year.

Manila’s under-maintained international airport, as well as its geographical location weakens the demand for such flight.

Non-disclosure

Apart from the airplane buying spree and the unprofitable ventures, there were also other transactions that apparently, Ang did not disclose to the Lucio Tan group, Bautista said.

“In the beginning it was OK because Ang would always report to the board. After a few months when he started buying planes, he had many transactions not reported to the board,” Bautista said.

For instance, Ang terminated PAL’s contract with a call center and procured a contract with a San Miguel Corporation subsidiary, San Miguel Information Technology Systems.

In 2010, PAL outsourced its non-core airline functions such as call center reservations operations to a Philippine Long Distance Telephone Company subsidiary.

 “The San Miguel call center he put up is a little bit expensive, which he promised to be cheaper,” Bautista said.

Future

Bautista said their return “means more work.”

“We need to see how we can reduce the impact of over purchasing airplanes. We have to do something about it,” Bautista said.

To address the issues causing PAL to hemorrhage money over the expensive re-fleeting program, Bautista said an aircraft leasing company has been engaged to help sublease the excess jets.

However, as potential buyers know why PAL is selling the unutilized Airbuses, Bautista said the airplanes would be subleased at a lower price. PAL has already subleased some of its airplanes to VietJet, he added.

Another 10 units of Airbuses for PAL will arrive next year. Another 10 units will arrive in 2017, and another 8 units in 2018. For the hard-pressed airline, it means another chain of challenge.

The Japan International Cooperation Agency (JICA) has showed the Philippines that it would need to pour P436 billion ($9.72 billion) to replace the old and congested Ninoy Aquino International Airport.

A better airport, one that could accommodate more aircraft and passengers, is what the flag carrier is wishing for.

“That’s the reason why we are not able to maximize utilization of airplanes because of the limited infrastructure facilities,” Bautista said.

The ambitious re-fleeting program would have not jeopardized PAL’s business performance only if the volume of aircraft ordered per year harmonized with the rate of how the market grows annually.

“It’s just [about] timing. The market grows an average of 6% to 7% a year. But the increase in our capacity is almost double in the last two years. So that’s the challenge,” Bautista said.

The challenge to expand their market, however, will be a turbulent ride.

One of its operations, the Cebu hub which served flights between Cebu and other destinations in Visayas, have been stopped because budget carriers that have turned into formidable rivals in the industry have eaten up PAL’s market share.

“We have to stop it to reduce losses or else we continue to lose money. We have to be very careful in mounting more flights,” he said.

PAL’s long-haul service will also experience a slight shrink, as Bautista said the incoming management is not keen on expanding in Europe.

This time, PAL wants to make its presence strongly felt in the US and the Middle East.

Now 57, Bautista, a certified public accountant who started his career with the country’s largest auditing firm Sycip Gorres Velayo & Co., and helped Tan in many of his major business deals, is looking to improve the airline’s cash flow.

“How can we operate without acquiring more equity from the owners or borrowing money from the banks? How can we have a positive cash flow? We have to be very creative in thinking of plans to generate cash,” he said.

Despite what happened with the San Miguel group, Bautista thinks a partnership is still an option.

“I personally think there’s a need for PAL to look a strategic partner. And we will recommend to the owners that we should go toward that direction of getting a strategic partner,” he said.

A strategic partner could be a carrier anywhere in the world as long as it “should have airline operations,” Bautista said.

The aviation business in general is a difficult one, especially for Asia’s oldest commercial carrier which history included the Asian financial crisis, its $2-billion debt that led to its closure in 1998, and the rehabilitation plan it sought for in 1999.

In 2000, PAL made a drastic turnaround from an unfortunate streak of 6-year loss. But a year later, the September 11 attacks happened and demand for flights dropped. Few years later, it went through turbulence again, including the global recession in 2009, which spiked jet fuel prices, hurting its operations. In 2010, PAL announced it would let go of its non-core airline services, which earned ire among its more than 3,000 affected employees.

“This year should be a good year only if we’re not burdened by the overcapacity of our planes. That’s the problem that we [are dealing with],” said Bautista.

Analysts have continued to point out that PAL would still be a risky venture: it’s capital-intensive, with jet fuel prices and competition among budget airlines already a serious trouble. Ramon Ang’s exit was a right move, they said, and many have wondered: why, despite previous pronouncements that Tan would leave its airline business, would it want to have a troubled airline back?

“Mr. Tan thinks PAL is a very important asset of the country …. And it will take a guy like Mr. Lucio Tan, who is willing to risk a big amount of his fortune [to make it work],” said Bautista. – with reports from Mick Basa and Lynda C. Corpuz/Rappler.com

 

 

 

 

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