April 2006

Dragonair - The Joys of Uncertainty

It’s been a year of superlatives for Hong Kong’s Dragonair Cargo services. But during the next few years, a major jump in fleet size and trying to stay ahead of rapid advances in potential competition in China mean the longer-term future will be a giant step into the unknown. A report by Michael Westlake

With record amounts of cargo carried in November and December last year, five more Boeing 747-400 freighters to join the fleet over the next three years and 15 percent-20 percent growth expected this year, executives at Hong Kong-based Dragonair should be very happy with the freight side of the airline’s operations. In 2005, cargo accounted for 42 percent of total revenue.

Stanley Hui

And happy they are. But this success is all based on growth in the China export market as the People’s Republic continues its Long March to be the world’s workshop. And the chiefs at Dragonair are very much aware that operators, airports and exporters next door in the Chinese mainland are eager to acquire more of that airfreight business for themselves instead of watching large and growing lumps of it funnel through Hong Kong.

Apart from the neighbours, there’s also uncertainty about relations between China and the United States over the burgeoning trade deficit on the U.S. side, which will almost certainly lead to more pressure on Beijing to revalue the renminbi, thus possibly changing at least some of the economics of the market as a whole.

Then there’s the vexed issue of traffic rights, regarding which for historical reasons China and Hong Kong negotiate with third countries in effect as separate territories, despite Hong Kong’s sovereignty having reverted from Britain to China’s control in 1997.

China’s fourth-largest carrier in revenue terms, Hainan Airlines, is seeking to buy control of tiny Hong Kong start-up CR Airways, which at present operates regional charter flights. No one has yet mentioned cargo in relation to this possible deal, which is exercising concern about it being a possible Trojan horse for Hainan Airlines to make use of Hong Kong’s hard-won traffic rights – if it is allowed to proceed.

In the meantime, Dragonair chief executive officer Stanley Hui proudly points to record figures for the last quarter of 2005, with November’s cargo total at 35,529 tonnes and says December’s figure was more than 37,000 tonnes. He expects the grand total for 2005 to be around 390,000 tonnes, or around 13 percent up on 2004’s total, while cargo tonne kilometres will show a more than 30 percent gain over the 2004 figure.

Not bad for a cargo operation that only really began five years ago. As an airline that started as a narrow-body passenger aircraft operator in 1985, Dragonair continued with a mostly all narrow-body fleet until 1993, when Airbus A320s began replacing Boeing 737s that had been the airline’s mainstay.

With only about 2.5 tonnes of cargo capacity on each of the 737s and A320s (and since 1999, 2.8 tonnes on A321s as well), Dragonair’s focus was obviously on the passenger market. Even operations with one and then two wide-body Lockheed TriStars to Beijing and Shanghai in 1990-95 didn’t change this focus.

Airbus A330 wide-body passenger aircraft began joining the fleet in 1994.

With a full passenger load the A330 offers 15 tonnes of cargo capacity – though Hui says Dragonair’s 12 A330s can each carry up to 30 tonnes in general service, depending on the length of the route. As the airline’s network expanded and frequencies increased, this sort of capacity generated a rising level of interest in cargo in its own right.

Hui says Dragonair’s A330s can carry up to 30 tonnes in general servicei

All this had taken place in a background of ownership changes, from being the independent creature owned by Hong Kong shoe magnate K.P. Chao in 1985 to Hong Kong’s Wharf Group taking control, and then Hong Kong’s much larger carrier Cathay Pacific Airways and its parent, the Swire Group, buying 35 percent of Dragonair in 1990 and China’s official overseas investment arm in Hong Kong, the China International Trust and Investment Corp., buying 38 percent at the same time. CITIC already held 12.5 percent of Cathay.

There was another change later in 1990, when Swire and Cathay upped their joint stake to 43 percent and CITIC’s share rose to 46 percent.

In 1996, the shareholding structure changed again: the mainland’s China National Aviation Corp. (Group) bought a 35.86 percent holding to become the largest shareholder; CITIC’s shareholding became 28.5 percent and Swire/Cathay held 25.5 percent, leaving the Chao family with 5.02 percent.

In late 1997, after the return of Hong Kong’s sovereignty to China, CNAC (Group) subsidiary CNAC Ltd. took over the Group’s shares, was listed on Hong Kong’s stock exchange and increased its holding through new shares to 43.29 percent.

The other shareholding percentages remained unchanged. Dragonair remains in private hands and does not publish its financial results.

With the corporate changes came several leadership changes culminating in February 1997 with the present incumbent, Stanley Hui, becoming Dragonair’s CEO.

Hui joined Cathay as a management trainee in 1975 and worked for Cathay until 1992, then switching to being Swire’s top man in Beijing until 1994, when he joined all-cargo airline Air Hong Kong as CEO for three years.

Since Hui’s arrival, Dragonair’s fleet has tripled in size. His time as an air-freight man led to the start of all-cargo services in late July 2000 using a wet-leased Atlas Air 747-200, with a 100-tonne capacity, operating between Hong Kong, Dubai, Amsterdam and Manchester, and later that year to Shanghai and Osaka.

In August 2001, Dragonair bought its own freighter – a 747-300, with a capacity of 100 tonnes. This entered service on the Osaka route in September that year. Another 747-300 arrived in October 2001, and a third in October 2002.

In May 2004 the airline announced plans to buy five 747-400 passenger aircraft from Singapore Airlines and have them converted into freighters with a capacity of 110 tonnes each; in June the same year an A300B4 wet-leased from Express.Net Airlines of the US and a 747-200 purchased by Dragonair joined the fleet. The final current freighter to join the fleet is a 747-400 wet-leased from Taiwan’s China Airlines, which launched services to New York in April last year.

With the last of five B747-400BCFs joining the fleet in 2008, Dragonair will operate a freighter fleet of 11 B747s. Photo: Rob Finlayson

The first 747-400BCF (Boeing Converted Freighter, formerly know as the Special Freighter – the title signifies that the type doesn’t have the upward-opening nose section that the production line model has) is due to arrive in October this year from Taikoo Aircraft Engineering Co. in Xiamen, China. The remaining four are to be converted by SIA Engineering Co. The second will arrive in December, and the two newcomers will contribute to Dragonair’s cargo capacity increasing by 15 percent this year.

The plan is to replace the “Classic” 747-200 and the -300s on Asian regional routes so that flight crews can gain experience on the 747-400s on shorter sectors for several months. The Classics will therefore shift over to the long-haul routes to the Middle East and Europe. Two more 747-400BCFs are to arrive in August and December 2007, and the fifth and last in the current plan in November 2008, bringing the total freighter fleet to 11. Rounding out present fleet expansion plans, three more A330s are to come this year.

Long haul has been and still is the major goal: Dragonair now runs 10 services a week to Europe and wants three or four more. As the 747-400s push the Classics onto the European routes, Hui foresees seven flights a week to Amsterdam and Manchester (up from the current six) and six or seven to Frankfurt (up from three) and onward – though perhaps not all of them – to Manchester. Dubai is currently served by 10 ex-Hong Kong flights a week on the way to Europe, and this might be increased.

For New York, Hui wants to jump from three a week to daily service, as well as adding Chicago and Los Angeles to the network, so that all three have daily flights by 2008. The arrangement with China Airlines for the wet-lease of a 747-400 for New York flights is due to end in March 2007, but may be extended – no decision has been made yet. But Hui wants one of Dragonair’s own 747-400s to fly to New York early in 2007, and his team is still analysing various combinations and permutations of aircraft and routes.

Says Hui about the market to the U.S., “There’s a lot of competition. They’ve got so many big, very strong airlines and they come into the market in a very big way.”

To and from Shanghai, Dragonair now runs 16 freighters a week, five with 747-300s carrying up to 100 tonnes of cargo and 11 with the A300B4, which has a capacity of 43 tonnes – three of the 747 services also serve Xiamen. Hui points out that Dragonair also flies 10 A330 services a day to Shanghai, which offer combined cargo space equivalent to around two or more 747s. Also on the Chinese mainland, Nanjing receives one Dragonair A300B4 service a week.

Japan is served by a mix of five 747-300 flights and one A300B4 flight a week to Osaka, while to Taiwan, Dragonair operates a 747-300 to Taipei five times a week.

Bellyhold s of A320/A321/A330 fleet feed cargo for international routes.

There are no firm new destinations or further fleet additions planned for the near future. Hui comments: “We’ve enough to do until 2008. The aircraft we’re taking in will give us enough to handle.”

Naturally, for an airline that was initially set up to take advantage of opportunities arising from China’s development, China remains the core of Dragonair’s routes and the source of a huge amount of its business. As Hui says, “China will continue to be our prime focus for passengers and cargo.”

But while the carrier has managed to keep pace with the massive and accelerating pace of change just over Hong Kong’s border with the mainland, there’s a sense that the good, easy times may be coming to an end in the not too distant future.

Not just Dragonair but many other Hong Kong companies and indeed Hong Kong itself have profited handsomely from China’s growth and its shortages of skills, facilities and infrastructure in general as it modernises itself.

But the political will in Beijing is for the giant country to catch up with the West in technology, trade and standard of living as rapidly as possible, so Hong Kong’s much-vaunted advantages in commercial, financial, legal and infra-structural terms, and its much worshipped reputation for efficiency, are bound to be eroded over time.

As Hui points out, “Some time down the road, China’s improvements will be a major factor for Hong Kong to worry about.” And Albert Yau, Dragonair’s general manager cargo, adds: “No one knows what will happen after five years.”

Yau, another Cathay alumnus, began as a management trainee before serving in various Cathay management positions before joining Dragonair as manager, cargo in 1997. After two years he moved to senior Dragonair management roles in China. He took up his present post in 2004.

Yau sees Hong Kong remaining the major cargo hub for southern China for at least four more years – it used to be the hub for all of China, but of the three major Chinese regional industrial clusters centred on Guangzhou in the south, Beijing in the north and Shanghai in the east, a lot of Beijing’s export air cargo now heads out via Seoul, and much of Shanghai’s goes direct to the U.S.

Yau also points out that China has some self-inflicted problems that limit its ability to help itself. Shanghai, for instance, is congested – Pudong’s relatively new airport needs a third runway, its cargo village won’t be ready until 2008 and road access is tight, so a lot of Shanghai export cargo comes via Hong Kong on Dragonair flights. Also, Beijing has capacity constraints.

Albert Yau

Another problem for China is security concerns, which mean that cargo pallets have to be built up after cargo has been X-rayed air-side at airports, instead of being built up in agents’ warehouses. This is a major source of congestion problems.

In Hong Kong, for instance, there is a “Known Shipper” system under which consignments from registered agents can be built up on pallets and cleared without an airside X-ray check – similar regimes operate in the U.S. and Europe. Taiwan doesn’t have a “Known Shipper” system, but works through four franchised agents.

With China accounting for roughly 60 percent of Hong Kong’s airfreight (total throughput in 2005 in Hong Kong was 3.4 million tonnes), at present the real concern is with trying to build up the backhaul.

Cargo flights from China and Hong Kong outbound are usually 80 percent-100 percent full, depending on the season; going into China, they’re lucky to hit 50 percent load factors.

Both Hui and Yau point to trucking services as a good way of extending Dragonair’s reach in Europe, the U.S. and in China, with subcontracted trucks using the airline’s flight numbers.

As roads improve within China, so will the range of these services – rail won’t be competitive for a long time as there are no high-speed trains of the kind used in Japan and Europe, and, as Hui notes, rail freight tends to be bulk or heavy cargo anyway.

There is, of course, the potential for a sudden change of cargo flows if and when the mainland and Taiwan decide to allow regular direct flights across the Taiwan Strait – at present, cargo and passengers travelling between the mainland and Taiwan have to go via Hong Kong or Macau, except for special flights arranged for important holidays. Hui merely says that direct flights don’t seem likely “too quickly,” so the current system should continue for the foreseeable future.

But the foreseeable future is becoming shorter. Neighbouring Guangzhou has a big new airport built well outside the city with plenty of room for expansion, and airfreight giant Federal Express has signed an agreement to open a cargo hub there, leaving the fate of its current Subic Bay hub in the Philippines open to question.

Guangzhou’s plan includes up to six runways to accommodate expansion, and says Hui: “Once they build up a major operation they’ll be a major threat to Hong Kong.”

The other major area of doubt is traffic rights, as China is liberalising fast and Hong Kong is running to open up as well. Hainan Airlines’ announced intention of buying a clutch of still on the drawing board Boeing 787 Dreamliners, of flying to Boston and of buying control of Hong Kong’s CR Airways have the pundits and lawyers guessing.

Dragonair operates one wet-leased A300B4 freighter from US-based Express.Net Airlines.

Says Hui, “We don’t know what will happen with that. We embrace competition but we want a level playing field. We are small and weak, but Hong Kong is opening up. Arrangements in the Asian region are becoming much more open.”

There are, of course, other parts of the world Dragonair is looking at, even if there are no firm plans for them at present. Yau says, “India is definitely an interesting country,” and is looking too at Bangladesh, currently served by four A330s a week but with 18-20 tonnes of cargo capacity available that is almost always filled.

But in the meantime, he’s looking at more A300B4 freighters (new A300-600s are too expensive, he says).

Yau says he wants “to thicken our service to China and to add feed from Asia. We have concentrated on our long-haul fleet, but we are now looking at more regional feed.”

And that’s one of the few certainties Dragonair can count on.

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Copyright for texts and pictures: Payload Asia, Singapore. This report is brought to you in partnership with Payload Asia, the air cargo/express magazine for the Asia-Pacific and Middle East regions. To learn more about Payload Asia, please visit their website.