Asia-Pacific LCCs third force at Paris Air Show

It is not often an air show introduces structural change. Yet Asia’s low-cost carriers did just that in Paris last month, reports Will Horton.

July 1st 2019

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By changing their cost base and growth outlook by up-gauging orders and setting industry records for seating density Asia’s LCCs produced a third important result at the European show after the headlines of the A321XLR launch and Boeing’s 737 MAX deal with the International Airlines Group (IAG). Read More »

At the show AirAsia revealed it had up-gauged 253 A320neos to the A321neo, leaving only 14 A320neo in its order backlog, a dramatic winding down of the A320 that has powered AirAsia’s growth for more than a decade.

As well, Cebu Pacific, the most profitable carrier in the Philippines, chose 16 A330neo to replace and increase its leased fleet of eight A330ceo. The deal included 10 A321XLR and five all-economy 194 seat A320neo, an 8% increase on the 180-seat configuration of the type only a few years ago. Cebu’s A330neo will have 460 seats. Airbus will modify exit doors to surpass the A330’s certified maximum of 440 seats.

The A320 and 737-800 have been the backbone of the region’s fleet, striking a balance between operators’ preferences and lessor considerations and the wider aftermarket. It created an ongoing cycle with airlines favouring new A320s and 737-800s since residual values and aftermarket demand were high. Second-hand customers came to expect A320 and 737-800 availability.

Larger narrow bodies had been supplementary, ranging from Eastar Jet’s two 737-900s to Jetstar Australia’s eight A321s. “While there is a readily available supply of A320s and 737-800s, the up-gauges are less common,” said NYU Shanghai Adjunct Professor of Finance and an aircraft appraiser, David Yu. “There is fluctuation in pricing on A321s and 737-900s because there are less of them. They come in waves.”

The biggest exception to the pattern has been Lion Air, the launch customer for the 737-900ER. Lion received its first -900ER in 2007, but its first -800 did not arrive at the carrier until 2012. Lion Air still operates more -900ERs than -800s. It has more A320neo on order than A321neo. The composition of its 737 MAX backlog is undisclosed.

AirAsia’s 2016 order for 100 A321neo aircraft cemented the willingness of LCCs to use larger narrow bodies. Some might argue AirAsia’s deal was late as Spring Airlines had ordered the A321neo, VietJet had received its first A321ceo and HK Express was a few months away from accepting its first A321ceo. Way before all of them, Cebu Pacific ordered the A321neo in 2011.

Last year AirAsia flagged it was re-evaluating its group order book. Up-gauging was expected, but in moderate numbers. No one said the A321 would become its core asset, and the Centre for Aviation, in a September 2018 report, expected AirAsia to use A321s on trunk and slot-restricted routes.

“It was a bit of a surprise,” said the founder of Endau Analytics, Shukor Yusof. Wider up-gauging appears justified. Despite various market challenges, AirAsia’s Southeast Asian units reported improvement in the first quarter with 87%-91% load factors and Revenue Available Seat Kilometres (RASK) momentum.

Underlying demand strength has been evident, but so too have infrastructure constraints. Yu believes airlines put off confronting slot challenges. “They would not want to react until they had to,” he said. “The constraint overhang has been around for a while but has not kicked in until recently.”

The turning point for AirAsia was partially due to external considerations, Yusof said. “AirAsia appears to be taking its cue from some of its lessor partners,” he said.

There is an argument LCCs are up-gauging in tandem with full-service airlines. China Airlines will replace 737-800s with A321neo. Cathay Dragon is removing A320s and A321s for only A321neo. SilkAir’s A319s and A320s will be replaced by 737-800s and MAX 8s. All Nippon Airways short-haul re-fleeting is tilted towards the A321neo.

Full-service airlines appear to be up-gauging due to regional congestion but also because their smaller variants did not always offer favourable economics for sizeable premium and economy cabins. So while full-service up-gauging leans more towards necessity, LCCs are up-gauging system-wide out of opportunity.

In the last decade, more airlines have become publicly listed. Investors tend to first look at market growth, so up-gauging provides an opportunity to quell concerns about outlook by arguing up-gauging is smart growth, with low Cost per Available Seat Kilometre (CASK) or even CASK-neutral growth.

Switching from old generation baseline models such as the A320 or the 737-800 in favour of a next generation neo or MAX provides a range of benefits that vary from the A320neo to the A321XLR.

Asia-Pacific airlines typically up-gauge for additional seats. Range is a secondary benefit. Jetstar’s domestic network largely features flights of less than three hours while AirAsia typically only flies routes of no more than four hours - as part of an agreement with sister AirAsia X, which takes longer flights. Both of those airlines are linked to longer-range variants.

Jetstar is a customer for the A321LR, which can fly from Australia to Bali Denpasar. AirAsia X is considering adding the A321neo or A321LR to thinner markets or off-peak frequencies that do not require its 377-seat A330s. Seating 192-236, the A321neo would give 16% savings on variable costs and could operate 64% of AirAsia X’s Malaysia network as of 2018. AirAsia X has said it would use A330s to “defend markets”, subtly highlighting AirAsia X’s shift from start-up to established carrier.

Jetstar parent, the Qantas Group, has announced 36 of the 243 commitments so far for the A321XLR. The type’s launch and even key orders, such as from American Airlines, were well reported before the Paris Air Show.

More of a surprise was IAG’s announcement for 200 737 MAXs. The significance was multi-fold as the MAX is still grounded and subject to intense regulatory and industry scrutiny. It was the first MAX deal since the fatal March crash of Ethiopian Airlines flight 302. IAG’s European airlines do not operate the 737. IAG CEO, Willie Walsh, gave a sweeping endorsement of the MAX’s technical capabilities.

Walsh pointed out he had given an earlier interview that discussed a likely MAX order. He also drew on IAG’s history, noting British Airways (BA) had been a 737 operator, including from London Gatwick until 2015. The MAXs will be operated by BA, but also at all-Airbus Vueling and Level, an IAG statement said.

Before the air show, Boeing arranged for Walsh to visit a 737 MAX simulator with the proposed software fix installed. Airbus indicated IAG had not asked Airbus for a formal request for proposal.

Perhaps what the IAG MAX deal underscores is buying at the bottom of the cycle and balancing OEMs. When asked if his timing secured an especially good discount, Walsh said he thought the deal was good for IAG and Boeing.

Ryanair CEO, Michael O’Leary, has a history of buying 737s at the bottom of the market. While other airlines spoke about compensation for the MAX grounding, O’Leary told CNBC: “I don’t need cash compensation. I’d like to see some movement from Boeing on the pricing of aircraft and on future orders.”

Lufthansa Group CEO Carsten Spohr jokingly claimed credit for IAG’s MAX deal, saying at the group’s Capital Markets Day: “I only mention it once and Willie runs to buy 200.”

Under Spohr, the group has changed its aircraft procurement approach. “It’s way more effective to play the competition and to ride specific market cycles,” said Lufthansa Group Chief Officer Airline Resources & Operations Standards, Dr. Detleft Kayser. “We want to strike a better balance when it comes to the OEM balance – Boeing versus Airbus.”

Lufthansa Group CCO Network Airlines, Harry Hohmeister, said the group could have a few A321XLRs to take advantage of range. Asia’s airlines would be interested in Hohmeister’s justification for not having a larger fleet of A321XLRs: “This aircraft is not a cargo provider.”