HONG KONG A Cathay Pacific Airways Boeing 747 flying low over the roofs of high-rises in the crowded district of Kowloon City is a typical picture-postcard image of colonial-era Hong Kong. Last October, dozens of nostalgic fans flocked to see the last flyover of the double-decker, dubbed the "Queen of the Skies," as the Hong Kong-based airline phased out older planes for lighter, more economical models.
Some commentators spoke sentimentally of the end of an era -- when the jumbo jet propelled international travel, transforming Hong Kong from a regional seaport into a global hub of finance and trade. It was also a time when the homegrown airline wowed international rivals and impressed shareholders with its growth prospects and earnings.
"It only made losses in two out of 70 years of operations," wrote Mohshin Aziz, an aviation analyst at Malaysia's Maybank Kim Eng, in a report on Jan. 17. "No other airline has a better track record."
Cathay Pacific has reigned over the skies of Hong Kong since 1946. The airline is a core business of Hong Kong-listed parent Swire Pacific, which owns a 45% stake. Swire Pacific is active in property, beverages, marine services, retail and trading. It is one of the largest Coca-Cola bottlers in the world.
Cathay's ultimate parent is John Swire & Sons, a London-based family conglomerate that is over 200 years old and has more than 130,000 employees worldwide. It owns 55% of Swire Pacific and in 2014 appointed John Slosar, an American, as that company's first non-British chairman. He also chairs Cathay Pacific.
END OF THE RUN Cathay's winning streak is likely to be broken. Some analysts expect the airline to post its third-ever full-year loss in March, its first since 2008. A major reason for its problems: Cathay's business model is looking outdated, with a full rebound in demand for its premium service perhaps impossible given shifts in corporate and individual travel spending. At the same time, fuel costs are rising after several years of weakness, and budget airlines and state-backed carriers from China and the Middle East are challenging Cathay on far more routes than before.
The impact of these pressures has been gradually rising, as seen in the Hong Kong airline's earnings. After churning out an all-time record net profit of 13.86 billion Hong Kong dollars ($1.78 billion) in 2010, earnings have hovered at less than half that level ever since. Even though revenue from both passenger and cargo services increased until 2014 as Cathay expanded its network, faster growth in operating costs prevented the bottom line from rebounding.
On Jan. 18, Cathay announced job cuts and hinted at a leadership reshuffle in what it said would be its largest restructuring in two decades. "2017 is going to be a year of significant change" in an "increasingly competitive aviation landscape," the airline said in a statement, after a meeting of its leadership team.
Cathay said the overhaul would create new positions, but "some jobs will no longer be needed." Citing the need for a "leaner, simpler structure," it said key changes would "start at the top" and take effect by the middle of the year.
Cathay gave few details on how many positions would be cut from its global payroll of 33,800 as of November, according to a company fact sheet. But it appeared that front-line workers would be less affected due to the recent addition of new flights to Barcelona and Tel Aviv, extra flights to Toronto and new lounges in Hong Kong and Singapore. "Most losses [will] be in the back office," said Dora Lai Yuk-sim, head of Cathay's flight attendants union, who attended the leadership meeting.
The market responded negatively to the announcement. Cathay's share price lost 4% the next day, nearly erasing its gains since news of the restructuring surfaced on Jan. 16. The stock is at an eight-year low and one of the worst-performing airline issues in the region.
"Cathay's new strategy stands out for not [having] a single mention of growing partnerships. It's a big world to be alone in," said Will Horton, a Hong Kong-based analyst at consultancy CAPA Centre for Aviation, adding, "Eight hundred and five words don't say what is actually going on and what they are actually going to do."
The bigger challenge for Cathay's earnings outlook is too much capacity in both its cargo and corporate travel business.
Last October, the airline stopped forecasting that the second half of 2016 would be better than the first. Net profit dropped 82% on the year to HK$353 million in the first six months of last year compared with a year earlier on sales of HK$47.5 billion, down 9.3%.
The airline blamed dwindling cargo traffic and corporate downsizing, which has hurt demand for its premium-class seats. About a third of its fleet's seat capacity is configured for first- and business-class passengers, according to CLSA, a brokerage.
"We've seen softer traffic demand, with customers trading down from front-end to back-end, from long-haul to short-haul," Cathay chief executive Ivan Chu Kwok-leung said at the company's earnings briefing in August. "And there is a lot of capacity in Asia."
CROWDED SKIES Cathay is being squeezed by budget airlines at one end of the market and by state-owned Middle Eastern and Chinese airlines at the other. China's "big three" -- China Eastern Airlines, China Southern Airlines and Air China -- offer competitive fares on both regional and trans-Pacific flights.
Some Asian players have pulled out. Malaysia Airlines suspended flights to Amsterdam and Paris last year and has no plans to resume them in the near future, as round-trip economy flights from Europe are going for as little as $500.
Deutsche Bank estimates that state-owned Chinese airlines and budget carriers, including Shanghai-based Spring Airlines, will increase capacity by 9-12% annually in 2017 and 2018, nearly three times as fast as Cathay.
The bank placed a "sell" recommendation on Cathay's stock, a day before the airline unveiled its new strategy. "Competition and overcapacity in the region [have] put pressure on Cathay's [passenger] yields" -- an indicator of profitability in the industry calculated by dividing revenue by mileage -- pushing it down to its lowest levels in seven years, analyst Joe Liew said.
Indeed, Cathay's passenger yield peaked in 2013 at HK$0.685 per mile. In the first half of 2016, it dipped to HK$0.543, approaching the low of HK$0.511 recorded in 2009. A similar trend was seen in cargo and mail yields as well; they were most recently reported at HK$1.59, down from a recent peak of HK$2.42 in 2012 and breaking past the low point hit in 2009.
Rival Singapore Airlines is in a similar quandary. Majority-owned by Singapore's state investment arm Temasek Holdings, the full-service airline saw its market capitalization fall to $8.3 billion as of Jan. 19, compared with Cathay's $5.3 billion that nearly halved from 2010. Both are dwarfed by Air China, valued at $12.6 billion.
Cathay, unlike Singapore Airlines, does not have an affiliated budget carrier. Rather than build one, its strategy has been to try to keep others out of its Hong Kong hub. In June 2015, city authorities sided with Cathay, blocking Australia's Jetstar from setting up an affiliate in Hong Kong.
Falling Asian currencies are putting pressure on regional rivals, which are burdened with high U.S.-dollar costs, but Cathay and short-haul sister carrier Cathay Dragon are not immune despite the Hong Kong dollar's peg to the greenback. "Cathay derives half of its revenues in foreign currencies and that means any weakness in these revenue currencies is negative for Cathay," said CLSA analysts Rajani Khetan and Michael Luo in a recent report. Previously known as Dragonair, Cathay Dragon's focus is on markets in China and Southeast Asia.
This weakness also makes it harder for Cathay to push up prices in foreign markets and cover its own dollar-based costs.
It also bet the wrong way on oil prices, blowing a hole in its balance sheet. While most airlines had benefited from lower fuel costs, Cathay's hedging strategy locked in fuel at higher prices, leading to a loss of HK$13 billion in the 18 months through June 2016.
Cathay has vowed to curtail its hedging program, but short-term losses are unavoidable. With hedging positions at roughly 30% above the spot oil price, the airline is expected to lose HK$6 billion to HK$7 billion this year, according to Daiwa Capital Markets Hong Kong. That is on top of looming cost headwinds -- again-rising fuel prices and higher landing fees in Hong Kong aimed at paying for construction of a third runway at the airport.
"Weak profitability is more of a structural issue and therefore [we] do not expect it to be resolved in the near term," said Kelvin Lau, Daiwa's aviation analyst, adding that Cathay is a "top sell idea." He cited excessive expansion over the past few years as the major reason for its profit slump, although much of that impact was temporarily "hidden" due to fuel-cost savings, he said.
Lau called Cathay's strategy "nothing new," and said the impact would be limited without aggressive cost reductions. "We doubt how much Cathay can do," he wrote in a Jan. 20 note. Drastic staff cuts will be difficult with the addition of new routes, he said, "which we believe is something Cathay should consider stopping."
Of the 18 analysts polled by Thomson Reuters, none has a "buy" recommendation on Cathay's shares. Nine have a "sell" recommendation and five have a "strong sell" recommendation on the stock, which has tumbled more than 40% over the past two years.
Maybank's Aziz is one of the few who maintains a "hold" rating on the stock. He said hopes for a turnaround rest on Cathay's ability to prioritize quality growth over size. This means downsizing its operations and reducing reliance on transit traffic, which has shrunk over time as Chinese airlines increase their international links. Its outdated business model needs to be replaced with a "point-to-point strategy," he added, with a focus on strong niche markets.
"Cathay has an illustrious history," Aziz said. "However, this legacy has caused it to be too complacent with regards to embracing the changing profile and trends of air passengers."
Nikkei Asian Review deputy editor Zach Coleman in Hong Kong contributed to this report.