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TEMPO SLOWS FOR ASIA’S LCCs
Asia-Pacific budget carriers are facing a new reality. Capacity growth and market penetration no longer translate into profits. Is this a temporary hiccup or a long-term flattening of regional LLC growth?
April 1st 2015
When times were tough for full-service airlines after the global financial crisis, money poured into the region’s budget carriers. Now, many Asia-Pacific LCCs are reporting losses, a trend that is continuing in 2015. Read More »
In February, Asia’s largest budget airline by passenger numbers, Malaysia’s AirAsia, reported its first quarterly net loss in two years, at $117.1 million, for the three months to December 31, 2014. It made a profit of $46 million for the same period last year. The result was recorded against a revenue increase of 15%, to $410 million.
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The group’s long-haul LCC subsidiary, AirAsia X, has had four consecutive quarterly losses. As a result, the CEO was disappeared and AirAsia co-founder, Kamarudin Bin Meranun, commenced restructuring the carrier with the support of acting CEO, Benyamin Bin Ismail.
As the reporting season continues, eight AirAsia branded airlines have announced losses. The most serious issues revolve around Indonesia AirAsia, which was thrust into the spotlight after the crash of flight QZ8501 on December 28. Formerly Awair, the AirAsia group bought 49% of the carrier in 2005, with 51% of its equity held by Indonesian investors. It has lost money ever since. Long-haul budget carrier, Indonesia AirAsia X, established last year, is expected to also suffer from the passenger fallout, by association.
Industry statistics reveal the budget carrier business in Southeast Asia alone has grown to 200 million seats in the last decade. But this growth slowed last year and is predicated to continue to flatten in 2015 as LLCs delay aircraft deliveries to reduce overcapacity.
The empire of the region’s budget king, AirAsia group boss, Tony Fernandes, is hardly alone when it comes to bad news. In Thailand, Nok Air, part-owned by Thai Airways International (THAI), was in the red in its last full financial year, ending December 31. It posted a net loss of $14.6 million, compared with profits of $15.6 million in 2012 and $32.7 million in 2013.
Also among the region’s loss-makers are the budget arms of Australia’s Jetstar and Singapore Airlines’ (SIA) Tigerair. Another SIA subsidiary, long-haul, low-cost Scoot, is losing money. In India, the fiscal bloodbath that has beset the nation’s LCCs is well recorded.
In a poll conducted by Orient Aviation among analysts and airline management, overcapacity tops the list of woes for the region’s LCCs. The direct result of that, vicious and often unrealistic price-discounting, was a strong second.
Other factors eroding profitability included higher operating costs such as airport charges, difficulty in securing suitable slots as a result of infrastructure congestion, foreign exchange losses - as local currencies depreciate against the U.S. dollar - fuel hedging losses triggered by the dramatic drop in the oil price and rising financing costs.
Mainland Chinese tourists, an important market for many LCCs, were turned off by the long period of political upheaval in Thailand and the two Malaysia Airlines accidents in March and July last year.
Nok is a prime example of several of the above problems. Its chief financial officer, Nuanwan Bhuprasert, attributed its losses to Thailand’s sluggish economy, a fall-off in international visitors, a weakened currency, but most importantly, overcapacity and the intense price war seat oversupply generates.
He said there had been an 18.6% increase in LCC capacity into Thailand, exceeding the country’s domestic passenger growth of 10.1%. In Thailand, airline executives have privately voiced concern about the particularly aggressive pricing of the Thai budget arm of Indonesia’s Lion Air group, which they argued has wreaked havoc in the LCC market.
Fares of 300 baht ($9.26) for a one-way Bangkok-Chiang Mai flight, against the 1,500 baht ($46.30) charged by other airlines, is “dumping” said its rivals. And Thai Lion Air is adding 10 new B737-900ERs to its fleet this year, which is likely to make matters worse.
None of this comes as a surprise. Analysts and industry observers have been warning for some time that trouble was brewing. Former Cathay Pacific Airways and British Airways chief executive, Rod Eddington, who is now out of the airline business, recently pointed out Asian airlines have endured tough periods before, usually because of external events such as the 1997 Asian financial crisis or the outbreak of severe acute respiratory syndrome (SARS) in 2003.
“But this is different because it appears a lot of carriers are buying a lot of aircraft and putting them into the market at the same time, particularly no-frills carriers,” he said. “This is clearly a tough time and the operating numbers for the airlines reflect that.”
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The problem is most severe in Southeast Asia. At a conference in Bangkok in March, senior Asean (Association of Southeast Asian Nations) official, Tran Dong Phuong, head of the group’s Finance, Industry and Infrastructure Directorate, told delegates budget airlines’ combined seat capacity in the 10-member ASEAN group jumped to 57% last year from 13.2% in 2003, a major contributor to the double-digit growth in ASEAN’s air traffic in the four years to 2013.
At the same gathering, AirAsia’s Fernandes pointed out the three biggest ASEAN LCCs alone flew 110 million passengers last year and that six of the world’s 10 busiest LCC routes are in ASEAN, including Singapore-Jakarta, Singapore-Kuala Lumpur and Singapore-Bangkok. The latest count by aviation research body, CAPA, showed that 22 of the Asia-Pacific’s more than 50 LCCs are operating in Southeast Asia with around 550 aircraft. The problem is likely to worsen before it improves. Two carriers, AirAsia and Lion Air, have more than 800 aircraft on order. Across the region, the budget order book exceeds 1,000 new single-aisle jets.
And it’s not simply the problem of the number of aircraft arriving in the region’s fleets, it’s the ability of the infrastructure to handle the increased capacity. Shukor Yusof, principal of Kuala-Lumpur based aviation analysts, Endau Economics, believes overcapacity is a major issue.
“In my opinion, with the number of aircraft due to come in this year alone, airports can’t cope with the numbers. If you look at KLIA 2, Kuala Lumpur’s LCC airport, it can’t cope with adding one or two aircraft every month for the next one or two years,” he said.
Yusof did point out that not everyone is having a bad time. “I understand Lion Air is profitable. They are still making money. I spoke to someone from Lion recently and I have looked at the numbers and their loads and I think they are doing OK,” he said.
He also said Vietnamese no-frills operator, VietJet, is “doing well”, although it is another carrier with a big aircraft order, some 63 A320s worth $9 billion. “Airlines in Vietnam are generally doing very well, including Vietnam Airlines,” he said.
“It is one of those countries in Southeast Asia that is bucking the trend. It has the right demographics, with a lot of young people, and a big population of around 90 million. A prevalence of LCCs is perfect for a country of that size and geography.”
China’s most successful LCC, Spring Airlines, which was listed in Shanghai in January, has reported a full year profit, to December 31, last year of 884.2 million yuan (US$142.4 million) compared with a profit of 732 million yuan in 2013. However, it is important to keep in mind that Spring benefits from a number of subsidies from provincial governments and other sources which could distort its results.
Analysts, including Yusuf, question why carriers such as Tigerair and Scoot are not making money, given the current level of fuel prices. In the case of Scoot, they believed it had a lot to do with the business model and the equipment at the carriers.
“Although Scoot has begun replacing its B777s with B787 Dreamliners, the improved economics of the new aircraft are going to take a while to have an effect,” Yusuf said. “I don’t see the load factor on Scoot to be anywhere near the level that can make the carrier money in the next three to six months at least.”
Scoot started operations in June 2012 and by the end of last year had reported cumulative losses of $25.2 million. Yusuf also believed that AirAsia X “has always” had an issue with its business model. “I have always felt it is not easy to run a long-haul, low-cost carrier. It’s tricky. It’s do-able, but you have to work within certain parameters that are going to be very tight. They have not got it quite right,” he said.
Several forecasters also argue it is difficult to be optimistic about the profitability of budget operators across the region because of the slowdown in China’s economy, a country which is a major target of LCCs and where many of them expect to make good profits. That market is becoming more competitive as Beijing strongly supports increasing the numbers of Mainland budget startups.
Eddington also cautioned that Asia isn’t always the source of riches many prospective airlines perceived it to be. “People are mesmerized by the size of the market and the growing middle class, but that doesn’t mean airlines that get started are going to be profitable,” he said.
“There are a lot of airlines that have launched and most of them have lost a substantial amount of money. Your passengers can disappear quite quickly. The low-cost carrier market basically targets people who are discretionary spenders. Those who follow the dominant players, thinking it’s an easy game, are often doomed for disappointment.”
It is not all doom and gloom, however. Hedging losses for some carriers aside, the lower price of fuel should begin to flow through to the bottom line of LCCs in the coming year, lifting their income, according to analysts.
Also, carriers have recognized their over-ordering and reduced or sold off part of their order book. For example, AirAsia has deferred 24 of 29 A320s airliners scheduled for delivery in 2015 and Tigerair has suspended capacity growth. “This year and for the next couple of years, the group will not be taking in a larger number of aircraft every year like before, hence allowing the company to preserve cash,” AirAsia group boss Fernandes said.
Last year, Qantas froze expansion of its Singapore-based LCC, Jetstar Asia. It will limit deliveries to five aircraft in Thailand, India and Japan.
Some rationalization is also occurring. A number of airlines have stopped flying, including Indonesia’s Mandala. Conversely, Thailand’s Nok and Singapore’s Scoot are launching a new joint venture carrier, NokScoot, in May.
Yusof suggested NokScoot is two struggling airlines getting together in the hope they can achieve something as a joint venture they can’t do alone. An opposite view is that a partnership of a short haul LCC and a long haul LCC, with its headquarters in Southeast Asia’s largest international market and second biggest domestic market (CAPA figures), is a good way to go.
In Indonesia, Garuda Indonesia’s budget subsidiary, Citilink, said it would be profitable for the first time this year. Its new chief executive, Albert Burhan, appointed in February, said the environment in 2015 is better.
“In 2014, sometimes competitors disrupted us with a campaign of low fares,” he said, while also pointing out Citilink has benefitted from the exit of LCC Tigerair’s Indonesian affiliate airline last year and the grounding of indebted State-owned Merpati Nusantara Airlines.
Overall the outlook for Asia-Pacific LCCs is positive. Buoyed by lower fuel prices, analysts said success in the LLC sector may be dictated by collaborations. Carriers needed to rationalize their operations and forge partnerships to provide them with a cross-feed of passengers and savings in base costs, such as joint maintenance agreements.
Demographics and the increasing prosperity of the region also bode well for budget airlines as increasing numbers of emerging market consumers have the discretionary income to become first time flyers. Their airline of choice is usually an LCC. And once they fly, they fly again when they can.
Nevertheless, there is a universal belief the sector will see more casualties in the coming years and that the high double digit growth of the past decade will not return. The market has matured and, like elsewhere in the industry, only the best will survive.
