Tokyo Airport Route Case Foreshadows Massive And Risky Route Shifts

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Includes: AAL, DAL, HA, UAL
by: Tim Dunn
Summary

The Japanese government is in the process of ending its segregation of domestic and international traffic between Tokyo’s two major commercial airports.

Four U.S. airlines are in the process of applying for a limited number of new flights at Tokyo Haneda airport.

Three of four U.S. airlines have deep commercial relationships with two international Japanese airlines.

There will be a likely shift in market share from U.S. to Japanese carriers.Up to $2 billion dollars in U.S. airline revenue is at risk in the move from Narita to Haneda.

Nearly three years ago, I published an article regarding the addition of the first daytime international slots in decades at Tokyo’s Haneda airport that would be available for U.S. airlines in this Seeking Alpha article.

Haneda airport source: Japanese Ministry of Land, Infrastructure and Transport

Background

In preparation for the 2020 Tokyo Olympics, the Japanese government is making 12 additional roundtrip flights between the U.S. and Tokyo Haneda available to U.S. airlines, with an equal number of flights available to Japanese airlines.

This article re-examines the U.S.-Tokyo as well as the larger U.S.-East Asia airline markets. In addition, I will examine the potential impact as a result of the latest route award on each of the four U.S. airlines that serve the market: American Airlines (NASDAQ:AAL) , Delta Air Lines (NYSE:DAL), Hawaiian Airlines (NASDAQ:HA), and United Airlines (NASDAQ:UAL).

World source: Delta application p.35

Since my 2016 article provides a detailed history of US airline operations at Tokyo’s two largest airports – Narita and Haneda, I will refer readers to that article for complete information. As a brief review, Haneda was Tokyo’s commercial airport until Narita was opened in 1978. Japan attempted to segregate intercontinental flights at Narita and leave domestic flights at Haneda but Narita was limited by runway capacity, lack of domestic connecting traffic, and most importantly its much greater distance from downtown Tokyo than Haneda. Few cities in the world segregate intercontinental and domestic flights by airport and Japan realized it needed to shift those flights back to the much larger Haneda airport in order to compete with larger Asia-Pacific hubs including nearby Seoul-Incheon and Peking. As a result of Japan government decision to re-open Haneda to longhaul international flights, Japan has slowly increased the number of timing of flights between the US and Japan over the past 10 years.

U.S. to Japan capacity

Source: United application, page 26

Two Tokyo Airports Have Outsized Importance to U.S. Airlines’ Asia revenues

Currently, the four U.S. airlines offer approximately 17 flights per day (depending on season) between the U.S. and Narita in addition to service to Guam which is also governed by the U.S. air services treaty. There are also six U.S. carrier flights to Haneda; Japanese carriers have the same number of flights from Haneda to the U.S. but approximately 24 flights per day from Narita. In addition, Delta operates one daily flight from Narita to each of Manila and Singapore, the last intra-Asia vestiges of predecessor Northwest’s Tokyo hub which Delta has slowly been replacing with service to other points in Asia that overflies Japan.

The latest route case allows U.S. airlines to add 12 flights per day to Haneda meaning that two-thirds of the remaining U.S. flights and one-half of Japanese carrier flights at Narita could be moved to Haneda, although some new Haneda flights could be added that are not replacements for Narita flights.

Even though U.S. airlines have expanded service to other Asian cities including in China, S. Korea, and Hong Kong, 40% of U.S. airline E. Asia capacity in 2019 is to/from Tokyo’s two airports, down from 50% five years ago. Notably, American, Delta and United all have smaller Tokyo operations today compared to five years ago and Delta and United’s total U.S. to East Asia capacity is down as well, with Delta falling the most as its Narita hub has become less and less relevant and as it and United’s 747 jumbo jets have been retired.

While the size of Delta’s Pacific network has shrunk, its profits have increased dramatically. In the early years after the Northwest merger and the acquisition of the Tokyo hub, Delta’s Pacific operation was marginally profitable but most recently is generating low double-digit operating margins, according to US DOT data which itself is based on carrier filings with the DOT. Now, Delta is the most profitable U.S. airline operating across the Pacific, with profits twice as large as United, even though Delta earns half of the transpacific revenue of UAL. While United has aggressively grown its transpacific network, it has not been profitable operating across the Pacific on a cumulative basis for the past three years. American, the smallest of the three U.S. global carriers across the Pacific has operated its transpacific system on a breakeven basis for the past five years on a cumulative basis and has lost money in that region in every one of the past nine quarters. Hawaiian’s Pacific network also is not profitable on a consistent basis. Despite the financial black hole that the Pacific is for three of the four U.S. airlines, there continues to be a desire to stick it out and even grow in hopes of a turnaround.

The Pacific represents 4% of American’s total system passenger revenues and 6.4% for Delta but double-digit percentages for both United and Hawaiian.

Current U.S. to Haneda flights source: Delta application, p. 28

2019 Haneda Route Applications

The Japanese government’s previously stated goal is to shift longhaul premium revenue flights from Narita to Haneda and make Narita a primarily leisure/low cost carrier airport. The current Haneda route case supports that goal.

The Japanese government has had to negotiate revised air service treaties with multiple countries as a result of opening Haneda to longhaul international flights; while U.S. carriers split one of the larger international markets from Japan, the Japanese government has had to create scores of new slots at Haneda in order to accommodate the desire of airlines from dozens of countries to shift flights to Haneda.

The U.S. Dept. of Transportation has long allocated international route awards to limited access destinations to U.S. airlines via a written, publicly accessible process in which the DOT ultimately weighs the merits of each route case based on the submissions of each proposal from the airlines and makes route awards based on the perceived maximization of public benefit.

The route award process has been largely dismantled as a result of Open Skies agreements which the U.S. has put in place with more than 100 countries around the world. The intent of Open Skies agreements is to allow carriers from either country to add service and price their product based on market forces rather than government control and route decisions. Nearly all of the U.S.’ largest international air travel markets now are governed by Open Skies agreements. The U.S. has an Open Skies agreement with Japan for all airports except Haneda.

American, Delta, Hawaiian, and United combined requested 19 new Haneda flights. There are 12 new flights available for each of the U.S. and Japanese airlines. Every U.S. carrier flight has to be authorized by the DOT, meaning that a carrier that wishes to add a second flight in a market they already serve must receive authorization just as for a new route.

American Airlines requested two flights from Dallas/Ft. Worth to Haneda, one from Los Angeles (they already operate one daily flight in that market) and a new route from Las Vegas. American’s flight to Las Vegas is the only U.S. carrier route request from a city that does not already have service to one of the two Tokyo airports.

American Airlines Haneda application

Delta requested one flight each to Haneda from Atlanta, Detroit, Portland, Oregon, and Seattle as well as two daily flights from Honolulu. Delta currently operates flights to Haneda from Minneapolis/St. Paul and Los Angeles.

Delta Air Lines Haneda application

Hawaiian requested three daily flights from Honolulu to Haneda. HA currently operates one daylight and one nighttime only flight to/from Haneda; HA operates the only nighttime flight to Haneda by U.S. carriers. The first set of Haneda flights for U.S. carriers involved flights that could only operate after 10 p.m. Tokyo time; American and Delta both tried to operate flights from the U.S. mainland, leaving Hawaiian as the only U.S. carrier that could support nighttime flights because of the smaller time difference between Hawaii and Tokyo.

United requested daily flights to Haneda from Newark, Washington Dulles, Chicago, Houston, Los Angeles and Guam. United currently operates a single flight to Haneda from San Francisco.

United Airlines Haneda application

Joint Ventures

The U.S. DOT and Dept. of Justice permit U.S. airlines to enter into antitrust immunized joint ventures with foreign carriers in countries with which the U.S. has Open Skies. Joint ventures allow airlines to cooperate on capacity and route and schedule planning as well as pricing. To ensure that the collaboration between a US and foreign airline under a joint venture does not adversely impact consumers or other airline competitors, the US does not allow joint ventures with countries with which there is not open access to competitors.

The U.S. – Japan Open Skies agreement excludes Haneda airport but allows unlimited access to Narita. The U.S. – Japan Air Services Agreement is the only agreement that the U.S. has with a country that restricts access to one or more airports in the country’s largest market.

While there is not unlimited access to Haneda airport for all U.S. carriers, American and United were allowed to form joint venture agreements with Japan Airlines (JAL) and All Nippon Airways (ANA), respectively. Hawaiian Airlines has a joint venture application with JAL before the U.S. DOT.

Under previous Haneda route awards, the Japanese government awarded two daytime flights to Japan Airlines and three daytime plus one nighttime flight to All Nippon Airways. As part of their joint ventures, United and All Nippon share revenues and jointly market their Japanese flights as one entity while JAL and American do the same. Hawaiian will coordinate its Honolulu to Tokyo flights with JAL when its joint venture application is approved; they already cooperate under other commercial terms.

Delta has a joint venture with Korean Airlines which includes Delta’s flights to Japan but Korean cannot use its own flights at Haneda to serve U.S. destinations.

Japan - US Joint Venture connecting passengers source: United application, p. 42

Potential Route Award Considerations

The DOT generally favors awarding routes to cities which do not have service over allowing additional flights in the same market by the same carrier. The DOT also considers geographic balance across the U.S. of route proposals as well as the ability to serve other cities via connections. The DOT also tries to balance the competitive landscape to/from a limited access market through awards to multiple airlines. Since the U.S. does not allow joint ventures in countries which do not provide unlimited access to U.S. airlines, this route case is unique in that there is a route application process in a country with which the U.S. has Open Skies. Less than a decade ago, the U.S. and U.K. had a very restrictive treaty that limited access to London Heathrow airport and the U.S. refused to sign an Open Skies agreement until the U.K. included Heathrow in the Open Skies agreement. Although operating slots at Heathrow are some of the most expensive in the world, U.S. airlines can acquire or trade slots, allowing them to expand based on economic justification of the new flight rather than governmental restrictions on expansion.

Japanese carriers do not have to go through a route application process. The Japanese government simply awards the number of flights to each of the two Japanese international carriers. Those carriers are free to add service to the cities they deem best and are also free to move routes to other cities or airports, something which the U.S. DOT does not permit U.S. airlines to do.

Delta filed a request with the DOT that the current round of Haneda awards be transferable to any city based on the freedom the Japanese government gives its airlines. Delta also argued that American and United through their joint ventures can have JAL and All Nippon Airways shift flights to cities that American and United are not awarded. The U.S. DOT denied Delta’s request, citing the inability of the Department to award routes based on geographic considerations.

American lost a previous Haneda route case for a route to Dallas/Ft. Worth, its largest gateway to Asia, so would like to receive awards for two flights even though it has not operated any flight on that route. Based on American’s own data, the amount of local Tokyo passengers can be fully accommodated on one flight with the remainder of its DFW-Tokyo passengers connecting in Tokyo to flights with JAL. American has operated a flight from Los Angeles to Haneda and requests a second, likely to replace its currently operating flight to Narita, although American has not said which of its potential new Haneda flights will be used for replacement of Narita service and which will be used for additional service. American proposes new service to Las Vegas, a market it has served during the Consumer Electronics Show in January.

Delta has stated before and states again in its current application that all of the awards it receives will be to replace service from the same U.S. city to Narita. Delta is requesting enough flights at Haneda to move its entire Tokyo operation from Narita to Haneda, dismantling the connecting hub that it inherited from Northwest. Delta provides the only transpacific service regardless of nationality from Detroit and Portland, OR and the only U.S. carrier transpacific service from Atlanta and Seattle; Delta has stated it needs to receive awards for all four of those cities in order to provide a competitive balance to the American/JAL and United/All Nippon joint ventures. Delta has also requested two flights to Honolulu, saying that it needs to have a large enough presence as the only carrier without a joint venture with one of the two Japanese carriers to protect consumer interests.

Hawaiian is requesting three new flights from Haneda to Honolulu, all at times earlier than its current flights, facilitating connections beyond Tokyo to the rest of Japan and elsewhere in Asia.

United is requesting flights in sets of priority with its first set of flights including Newark, Washington Dulles and Chicago. Its second priority flight is a new flight from Los Angeles while its third priority flights are from Houston and Guam. United states that it intends to retain mainland U.S. to Narita flights from Newark, Denver, Los Angeles and San Francisco. United notes that its hubs are in the largest metro areas in the U.S. which combined have the largest Japanese descended population.

Possible Award Outcomes and Implications

While it is far from clear how the DOT will decide, the likelihood is that each carrier will receive a route award to Haneda. Although the DOT did not award a flight to United in the first round of Haneda flights because of its joint venture with All Nippon, the number of flights available means that all carriers are likely to receive some awards.

Hawaiian’s request for three additional flights in a market where it already operates one daytime and one nighttime flight makes it unlikely that they will receive all of the flights they have requested. No carrier – U.S. or Japanese - currently operates two or more flights in any other market and HA’s request exceeds the number of flights it currently operates from Narita airport.

The DOT on two separate occasions has awarded more Haneda flights to Delta than to American and United and that is likely to be the case again. All of Delta’s requests amount to half of the available flights. If the DOT gave Delta all six of its flight requests and gave one flight to Hawaiian, American and United would split the remaining five flights. Since three of American’s four routes involve second flights in the same market, the DOT is not likely to award all of American’s awards. United’s request is unique in that it is requesting service from Chicago which its joint venture partner already serves. The DOT has also considered Newark and New York/JFK as a single market in the past and ANA currently serves the JFK-Haneda market.

Given that ANA and JAL will each likely receive six flights of their own, they can easily cover whatever flights their U.S. joint venture partners do not receive.

Given that Narita is significantly further from downtown Tokyo than Haneda, it is a given that Haneda will be the preferred airport – with associated higher fares – than Narita in any market where both services are offered. In its route application with the DOT, United shows that there has been a shift in passengers from Narita to Haneda in the San Francisco market, where United offers service to both Tokyo airports. DOT data shows the same phenomenon has occurred in Los Angeles; the two California airports are the only two continental U.S. airports with U.S. carrier service to both Tokyo airports.

Delta supports its position regarding the long-term viability of Narita by citing the case of London Gatwick, the secondary London airport that certain airlines and U.S. cities had to serve before the U.S. and U.K. agreed to Open Skies and opened access to Heathrow. Delta notes that, like Heathrow, Haneda is the preferred airport for U.S. travel. Delta notes that no U.S. airlines serve Gatwick now and the only flights to the U.S. are to leisure destinations or by low cost carriers, neither of which are the profile for any current U.S. carrier flights other than to Hawaii and Guam. Delta terminated its previous service from Narita to Micronesia, likely recognizing that they could not be sustained from Haneda and could not solely support an operation at Narita.

Gatwick to U.S. service post U.K. Open Skies source: Delta application, p. 37

Europe to Tokyo airport shifts source: Delta application, p. 37

United is the only U.S. carrier that has stated it intends to continue to operate flights from Narita airport regardless of the outcome of the Haneda route awards. Delta specifically has said it intends to close its Narita operation if it receives enough awarded flights at Haneda. With even limited awards, American and Hawaiian would be left with small Narita operations which they might or might not choose to retain.

Given the DOT’s historic preference for increasing awards to U.S. carriers that are not part of joint ventures with Japanese carriers which in the past were Delta and Hawaiian, there is a strong likelihood that Delta will receive a high percentage of its route requests given that Delta will be the only U.S. carrier without a joint venture in the future with a Japanese airline.

While the terms of joint venture agreements are highly confidential, in general, the amount of revenue that is shared is based on the amount of capacity that each carrier adds to the joint venture. In addition, many U.S. airline labor agreements include restrictions on the amount of capacity that a U.S. carrier can sell on a foreign airline to ensure that U.S. carriers do not give away their flying and U.S. airline jobs to foreign carriers.

There is a distinct possibility that American to a smaller extent and United to a greater extent might end up with smaller Tokyo operations than they had going into the joint ventures precisely because of the limits on the ability to add capacity at Haneda and because of the U.S. DOT’s attempt to balance capacity between carriers that do not have joint ventures with those that do.

The second major consideration is that All Nippon and Japan Airlines are attempting to do in Tokyo what no other airline – let alone two airlines – are doing at any other airport in the world which is operate duplicate hubs from two separate airports in the same region alongside their joint venture partners. ANA and JAL might be able to operate to nearly every city they serve in the US from Haneda while AAL and UAL might be left with some flights from Narita, the success of which is dependent on connecting traffic which ANA and JAL have to provide. Given that the highest value passengers from the US overall and specifically in the gateways of Los Angeles and San Francisco are gravitating to Haneda, there is a distinct possibility that ANA and JAL’s Narita operations will become economically obsolete given that 80% plus of the capacity to Tokyo will be operating from Haneda. While ANA and JAL as well as AAL and UAL will attempt to maximize the revenue they can gain from their Haneda flights – which means likely using seats for local Tokyo passengers – the absence of higher value local demand on U.S to Narita flights as well as reduced connectivity at Narita could doom the U.S. carriers’ remaining operations at Narita.

Potential Financial Exposure For U.S. Airlines Serving Tokyo

American Airlines has approximately 24% of its transpacific available seat miles (ASMs) deployed at Narita. For 2018, AAL reported $1.6 billion in transpacific revenues. Since U.S. carriers (and AAL) get higher average fares than for other destinations in East Asia, AAL has approximately $380 million/year in Narita revenues at risk. Currently American’s continental U.S. to Narita network draws a revenue premium to its Haneda network based on DOT data although the distribution of traffic from U.S. cities for American and each of its competitors is not constant between Tokyo airports.

Note that the Pacific region for both SEC and DOT reporting requirements includes the S. Pacific which is not part of E. Asia traffic flows for U.S. carriers and is also not part of any E. Asia related joint ventures.

Delta reported $2.5 billion in transpacific revenues for 2018; Narita represents approx. 24% of its Pacific ASMs on routes from the U.S. mainland to Narita, putting nearly $500 million at risk. Delta operates flights from Narita to Singapore and Manila via Narita and it cannot move those routes to Haneda. If Delta obtains all of its mainland U.S. to Haneda route requests, the revenue to Manila and Singapore (including what it generates locally from Tokyo to Manila and Singapore which it is allowed to do) is at risk unless Delta is able to start new service to those cities via another gateway at margins as high as or higher than what it currently obtains through Narita. Like American, Delta gets a revenue premium on its Narita flights compared to its Haneda flights, likely the result of Delta’s historic strength at Narita and its smaller relative size at Haneda. Delta does receive a revenue premium in the Los Angeles to Haneda market although American should have an advantage because of its joint venture with Japan Airlines. Los Angeles is the only current market where two U.S. carriers operate service to Haneda. If Delta receives all of its mainland U.S. flight requests, it will have the largest U.S. carrier presence at Haneda, potentially giving it the ability to offset some or all of its current yield weakness relative to Narita.

Delta is accelerating deployment of new generation (more efficient) aircraft as well with increased numbers of premium seats on all of its transpacific aircraft which will likely offset the potential revenue risk. Delta has the highest average fares of any U.S. carrier on its existing flights from Tokyo to Honolulu so is likely to increase revenue relative to its peers if it obtains one or both of its requests for Honolulu flights.

It is possible that Delta will take a special charge to close its operations at Narita if it succeeds in obtaining enough flights at Haneda.

Hawaiian reported $765 million in Pacific revenue for 2018 and approximately 20% of its ASMs are to/from Honolulu. HA receives a small single digit revenue premium on its Haneda flights relative to Narita and currently has the highest percentage of its Tokyo network at Haneda. Hawaiian’s route requests, if granted in any part, is likely to be revenue additive, unlike its mainland U.S. based legacy carrier peers.

United reported $5.2 billion in Pacific revenue in 2018 and approximately 27% of its ASMs are deployed at Narita, meaning potentially $1.4 billion is at risk. United’s risk is greater than any other U.S. airline because it assumes that Narita can remain a viable airport at similar yields. In addition, it will shift a higher percentage of its capacity in Tokyo to its joint venture partner via new Haneda awards. Given United and Delta’s own data in their presentations, it is likely that yields from the U.S. to Narita will fall given that 75% or more of the U.S. to Tokyo capacity will operate from the preferred, close-in Haneda airport. United’s route application specifically states that it will retain Narita service from Newark, Los Angeles, and San Francisco even if it wins all of its route requests. It is not likely that UAL will receive all of even its mainland U.S. route requests, meaning that some of its U.S. gateways could be required to serve Narita while competitors’ routes to/from the same region will serve Haneda. ANA could operate its own flights to Haneda from United hubs that do not receive Haneda service, potentially shifting more of United’s capacity to its partner.

United also faces more risk than other U.S. carriers because its joint venture partner ANA will receive more new flights at Haneda than United, meaning that UAL will shift some of its capacity in Tokyo to a joint venture partner. Not only does United have limitations on the amount of seats it can sell on ANA flights due to UAL’s labor agreements, but United is dependent on ANA to maintain its current level of connecting flights at Narita in order to keep UAL’s remaining Narita flights viable.

United, like Delta and American, is adding more premium cabin seats to its transpacific fleet and is adding some newer generation aircraft but will add new aircraft at a smaller rate than other carriers.

The Haneda route case involves a high risk swap of capacity from Narita to Haneda airport and involves potentially $2 billion in U.S. airline revenues. More capacity will move from Narita to Haneda airport than in any other international airport move in U.S. airline history. Not only will connecting dynamics for all four U.S. change but United particularly is dependent on the assumption that Narita will remain a viable airport at comparable yields to today when data shows that is not likely to be the case. American and United particularly could see shifts in their Tokyo revenues from their own aircraft to their partners’ aircraft with revenue sharing potentially limited by labor agreements.

While the route changes are to take effect in the second quarter of 2020, the DOT will likely issue its decisions in the next few months, allowing U.S. carriers to apply for operating slots later this fall. Once schedules are published, marketing efforts by each airline along with associated shifts in revenue will take place.

Bejing Will Join Tokyo with Two Large International Airports

The Haneda route case is one of just two major airport related stories affecting U.S. airlines in the next year. Later this year, China is expected to open a new Beijing area airport at Daxing, shifting some of the capacity in the Beijing area to the new airport from Beijing Capital airport, one of the world’s busiest. Unlike in Tokyo, the Beijing airports are expected to be divided by airline alliance so two airlines will not be attempting to operate duplicate longhaul routes from two airports in the same metro area. Combined with changes to China’s aviation policies, the expectation is that U.S. and Chinese airlines will be able to add significant amounts of new capacity to the Beijing area. Because Beijing like Tokyo and Seoul compete for many of the same connecting passengers traveling deeper into Asia, there will be value in assessing outcomes between the Beijing and Tokyo dual international airport strategies.

Daxing airport New Daxing (Beijing) airport

Conclusion

The U.S. DOT is in the process of deciding new routes for U.S. carriers to Tokyo in what will result in the largest shift in traffic between airports in the history of U.S. transpacific aviation.

Because of the combination of joint ventures, the likely closure of the Delta intra-Asia hub at Tokyo, and the limits on U.S. carrier access to Haneda, there will be a likely shift in market share from U.S. to Japanese carriers.

Up to $2 billion dollars in U.S. airline revenue is at risk in the move from Narita to Haneda with United most exposed followed by Delta and then American. Additional route awards for Hawaiian could be revenue positive.

All four U.S. airlines which serve Tokyo have price targets above their current stock prices; however, reduction of revenue or a shift in revenue from one carrier to another could change the revenue projections underlying that price guidance.

I will update this article when the DOT makes its final decisions.

Disclosure: I am/we are long DAL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.