Cargolux and the Chinese connection June 2014

Following the recent acquisition of a major stake in Cargolux by a Chinese company, a new dual-hub strategy appears to have caused division among the airline’s senior management. What does the future hold for Europe’s largest cargo-only carrier?

Cargolux was established in 1970 by flag carrier Luxair and a number of private companies, including Icelandic Airlines and the Salen Shipping Group. Since then, however, the airline has had an eventful history; both Lufthansa and SAir bought and then sold minority stakes, and in 2010 the airline was fined €80m by the European Commission for price-fixing (which the airline is still appealing against), with Ulrich Ogiermann – the CEO at the time – given a prison sentence.

In September 2011 Qatar Airways bought a 35% stake in Cargolux, making it the second largest shareholder at the time after Luxair, which owned 43.4%. Qatar was eager to make Cargolux one of the world’s top cargo carriers by 2015, but just a year later Qatar announced it would sell its stake after differences with other shareholders over the carrier’s strategy.

In 2012 Qatar’s stake was sold to the Luxembourg state for $117.5m, before in turn being sold to China-based Henan Civil Aviation Development and Investment Co. (HNCA) in April 2014 in a deal worth $120m. Today the other shareholders are Luxair, with 35.1%; the Banque et Caisse d’Epargne de l’Etat (BCEE), 10.9%; the Société Nationale de Crédit et d’Investissement (SNCI), 10.7%; and the Luxembourg state (8.3% – a stake bought from Luxair in April 2014 in order to give the state an ongoing role in Cargolux).

At the same time as the HNCA deal was closed, Cargolux announced that shareholders had approved a $175m increase in its share capital in order to strengthen the balance sheet and provide funds for freighter orders and expansion of the route network. As well as the $120m it paid for the 35% stake, HNCA is providing $15m to Cargolux’s “development fund” and up to $61.5m towards this capital increase. The balance sheet certainly needs strengthening – as at the end of 2013, Cargolux’s non-current liabilities stood at $1.5bn, up considerably from the $1.2bn level of 12 months earlier.

Chinese intentions

State-owned HNCA was only established in 2011 and its remit is to “accelerate the growth of the Henan civil aviation industry”, and to develop the Zhengzhou airport economic zone. Zhengzhou is the state capital of Henan province, which is located to the west of Shanghai.

The deal is resulting in major changes to Cargolux’s strategy, with the airline now changing to a dual-hub operation at both Luxembourg and Zhengzhou. This change of strategy though is known to have faced opposition by several senior executives at Cargolux.

The alleged unpopularity of the impending deal and its implications for strategy directly led to the resignation of both Peter van de Pas, COO, and Robert van de Weg, the SVP for sales and marketing, earlier this year. Weg had been with the airline for 14 years, and both executives have now started new positions at AirBridgeCargo, Russia’s largest scheduled cargo operator (with 12 747Fs) and owned by the Volga-Dnepr Group.

And Robert Song – briefly Cargolux’s SVP, head of Asia Pacific – left the company a few weeks after “brokering” the deal with HNCA, with unconfirmed reports implying he clashed with senior executives at Cargolux. Song previously advised HNCA and only joined Cargolux in March.

The Volga-Dnepr Group – which van de Weg and van de Pas have joined – was one of the companies that had (unsuccessfully) bid to buy the state’s 35% stake in Cargolux. Other rumoured bidders included Nippon Cargo Airlines and Silk Way Airways, but sources suggest that all other companies fell away early in the process, leaving HNCA as the only serious bid left. In addition the Luxembourg government may have been attracted by selling its stake to a company that would clearly improve trade ties between China and Luxembourg – rather than a trade buyer that made most strategic and commercial sense for Cargolux itself.

Based at Luxembourg’s Findel airport, Cargolux currently operates a fleet of 20, comprising 11 747-400Fs and nine 747-8Fs. It was the launch customer for the 747-8F back in 2005 and has ordered 14 of the model in total (the latest order for another aircraft – costing $358m at list prices – coming in February this year). The first aircraft arrived in October 2011 and five are still to be delivered. Two will be delivered in 2014 and all will arrive by 2017; they are gradually replacing all the ageing 747-400Fs in the fleet. The airline’s fleet has grown steadily but slowly over the last few years, and this pace is not set to change anytime soon.

In 2013 Cargolux reported a 14.5% rise in revenue to US$1,989m, based on a 16.7% rise in tonnes sold to 0.8m. However, load factor fell 0.9 percentage points to 67.7% in 2013, and daily aircraft utilisation also decreased marginally, from 15:07 block hours in 2012 to 14.57 hours in 2013.

Cargo overcapacity

Nevertheless, Cargolux turned a S35.1m net loss in 2012 (following a $18.3m net loss in 2011) into a $8.4m net profit in 2013, with operating profits increasing from $8m to $59.5m, though the airline said that “the airfreight industry continued to operate in a difficult environment for the most part of 2013 – capacity growth still outstripped demand, which resulted in an industry-wide decline in yields and load factors”.

Much of that capacity growth came from the Gulf Super-Connectors, who added considerable belly capacity as their passenger fleets grew (see Aviation Strategy, November and December 2013, and January/February 2014). Though other airlines took freighters out of service through the year this only partially compensated for the greater cargo capacity of the Big Three in the Gulf region.

Cargolux also competes against the so-called “integrators” – companies such as DHL, FedEx and UPS. Germany-based DHL, for example, has five aviation subsidiaries under DHL Aviation that operate more than 100 aircraft between them across the world, including 44 757-200Fs and 29 A300Fs. But even DHL is tiny compared with the might of Fedex, which operates 650 aircraft, of which 100 are Airbus models and 260 Boeing models.

Despite industry overcapacity Cargolux increased its own capacity through 2013, and “successfully increased volumes in order to maximize contribution to fixed costs”. As well as extra capacity on existing routes, in 2013 Cargolux added 12 new destination all over the world – to Buenos Aires, Santiago de Chile, Dallas, Columbus, Tripoli, Bamako, Port Harcourt, Ouagadougou, Muscat, Munich, Vienna and Zaragoza – and the airline now operates to around 100 destinations globally.

According to IATA statistics on international scheduled FTKs, Cargolux’s global market share grew to 3.5% in December 2013, making it the eighth largest airline in the air cargo airline rankings. Cargolux will keep growing this year, although to a lesser extent than in did in 2013; at the end of April, Dirk Reich – CEO and president of Cargolux – said: “We don’t expect market conditions to improve significantly in 2014, but our priority is to expand our global network while focusing on efficiency and performance improvements.”

Reich became CEO in March, replacing Richard Forson, who had been interim CEO (as well holding down his regular position, CFO) since August 2012. Reich was previously an EVP at Kuehne & Nagel International, a Swiss transportation and logistics company, and prior to that worked at Lufthansa.

However, just where Cargolux’s continued growth will come is now open to question following the investment by HNCA. Cargolux initiated a five-year business plan in February 2013, which was updated in early 2014 in preparation for the HNCA deal, and core to the new plan going forward is the adoption of a dual-hub strategy.

In practice this means that Cargolux will operate two times a week between Luxembourg (and via Baku, Azerbaijan) to Zhengzhou initially, rising to at least four times, although those initial operations hit regulatory clearance problems, and the launch of the route had to be pushed back from April to June.

HNCA has an initial target of 20,000 tonnes a year between Luxembourg and Zhengzhou, which is at the centre of a region known for the manufacture of technology and IT products that are exported into Europe. The longer term plan is for Cargolux to build up routes from Zhengzhou to other Asian cities, and even transpacific routes, although what the implications for Cargolux’s existing network to China has yet to be revealed; the carrier currently operates a daily service to Shanghai and other flights to Beijing and Xiamen.

Apparently Cargolux has suspended a route between Luxembourg to Taipei and Singapore in order to free up capacity for the new Zhengzhou flights, and some reports say the plan is to base around six to eight of Cargolux’s current fleet permanently in Zhengzhou – though this has been denied by one member of Cargolux’s management.

What is known is that Cargolux is currently analysing the possibility of a joint venture airline based in China, and if the initial route to Zhengzhou is successful that joint venture will certainly be launched, though this is not likely until the first quarter of 2015 at the earliest.

It’s something that Cargolux has done before, as in December 2008 it set up Cargolux Italia, a joint venture with Italian investors (and owned 40% by Cargolux). Based near Milan Malpensa airport, Cargolux Italia operates a single 747-400F on routes to Dubai, Hong Kong, Osaka, Almaty, São Paulo and Luxembourg. In 2013 the airline carried 93,106 tonnes of freight, 29.5% higher than in 2012, with revenue increasing by 16% year-on-year in 2013 to US$143m.

But the worry that some people have – both within and outside Cargolux – is that HNCA’s long-term aims are incompatible with a sensible strategy for Cargolux. HNCA’s rationale for the acquisition and the adoption of a dual hub strategy is clear – Zhengzhou was the fastest-growing cargo airport in China last year, with a 70% increase in tonnes passing through the airport thanks to being part of the government’s cargo development plan – and the Cargolux stake will undoubtedly accelerate that growth.

Veto power

Controversially, it has been reported than HNCA – despite having just a 35% share – has been granted a veto over all decisions at Cargolux, effectively giving it control over the strategic direction of the carrier. This has caused concern among unions, who already have a long-running dispute with management over job guarantees and proposed replacement of existing work contracts – last year unions and the company clashed over these proposed staff cost savings, with many rounds of negotiations breaking down several times.

The two unions representing most of the airline’s 1,600 employees are wary of the intentions of the Chinese shareholders and its vision for the strategic future of Cargolux, and the Luxembourg Chamber of Employees has also criticised the deal, saying that it will divert aircraft from profitable parts of the Cargolux network.

Unfortunately for both HNCA and Cargolux, in December 2013 the Chinese cargo company Navitrans launched a two times a week freighter flight between Zhengzhou and Liège, which is just 165km away from Luxembourg. 747-400Fs are operated on Navitrans’ behalf by TNT Airways with the company saying it is targeting at least 20,000 tonnes a year on the route, carrying equipment such as smartphones into Europe – which us exactly the same market that Cargolux/HNCA is targeting for the Zhengzhou to Luxembourg route.

Nevertheless, Cargolux will press on with its new dual-hub strategy, and whether unions and some senior management like it or not, Cargolux’s future is now closely tied to the desires and intentions of HNCA.