27-Aug-2013 10:00 AM

AirAsia faces challenges throughout Southeast Asia as competition continues to intensify

Analysis

AirAsia's remarkable track record of success over its first 12 years has come at a price - more competition as others look to duplicate the group's formula. While AirAsia still reaps the benefits of first mover advantage in several of its markets and continues to outperform nearly all of its peers, competition is intensifying.

The Malaysian market, the group's original and by far its most profitable market, has been shaken up this year as rival low-cost carrier group Lion has launched Malindo Air and as rival Malaysia Airlines (MAS) has exited a restructuring phase by pursuing aggressive expansion aimed primarily at fighting off Malindo. While AirAsia's Malaysian short-haul operation continues to report industry-leading operating profit margins of about 20%, its yields have dropped in recent months and the carrier's profitability could eventually be impacted.

AirAsia's short-haul operation in Thailand also reported a drop in yields for 2Q2013. Like its Malaysian sister carrier, Thai AirAsia was still able to improve operating profits. But with new competition around the corner as two new LCCs plan to launch in Thailand, market conditions will only become tougher.

Indonesia AirAsia reported both a yield and operating profit improvement for 2Q2013 but it remains by far the least profitable of the group's original three affiliates. Competition in Indonesia is intense, particularly in the domestic market where AirAsia is trying to establish a meaningful presence.

Meanwhile the group's newest surviving affiliate, Philippines AirAsia, has struggled almost as much as the new failed affiliate, AirAsia Japan. AirAsia is banking on its fortunes in the Philippines changing after new partner Zest Air adopts the AirAsia brand, but the group still faces an uphill battle against market leader Cebu Pacific.

This is the second in a two-part series of reports looking at AirAsia's position in its home markets. The first part looked at Malaysia, where the group's original airline operates alongside long-haul sister carrier AirAsia X. This part looks at AirAsia's position in its three other current home markets - Thailand, Indonesia and the Philippines.

Thai AirAsia and Indonesia AirAsia launched in 2004, following the late 2001 launch of AirAsia in Malaysia. The group finally broke an eight year dry spell without launching any new affiliates in 2012, when Philippines AirAsia and Japan AirAsia, the group's first venture outside ASEAN, began operations. But the group decided to dissolve its joint venture in Japan with All Nippon Airways (ANA) in Jun-2013. AirAsia is now preparing to establish a new joint venture in India, which is expected to launch services in 4Q2013 and become the group's fifth affiliate and only carrier outside Southeast Asia.

Thai AirAsia records higher profit but drop in yields

Thai AirAsia turned an operating profit of THB517 million (USD16 million) in 2Q2013, an increase of 124% compared to the THB231 million (USD7 million) operating profit in 2Q2012. The carrier's net profit also doubled from THB246 million (USD8 million) in 2Q2012 to THB499 million (USD16 million) in 2Q2013 (see background information).

Revenues were up 21% to THB5.36 billion (USD168 million) as passenger traffic increased by 25% to 2.4 million. Thai AirAsia's seat load factor improved by 3ppt from 79% to 82%, outperforming its Malaysian sister carrier which typically has had the highest loads in the group. RPKs were up 25% while ASKs were up 18%. Thai AirAsia ended the quarter with an operating profit margin of 10% compared to 5% in 2Q2012. Unlike the group's other affiliates, Thai AirAsia has been consistently profitable in recent years although its operating margin has never approached the margin seen in Malaysia.

But passenger unit revenues were down 3% year-over-year in 2Q2013 and average fares dropped 4% to THB1,877 (USD58.82). These were not as steep as the 8% unit revenue and 10% average fare drops at the group's Malaysian short-haul operation but are alarming as Thailand has not seen the same kind of dramatic changes to the competitive landscape that Malaysia has witnessed this year.

Thai AirAsia operating highlights: 2Q2013 vs 2Q2012

Thai AirAsia faces new competitive threats in Thai Lion and Thai VietJet

Thailand's market currently has just two local LCCs, Thai AirAsia and Nok Air. Orient Thai previously competed as a third LCC domestically but has essentially withdrawn from this market, initially shutting its LCC brand One-Two-Go in 2008. Over the last couple of years Orient Thai has steadily cut back domestic capacity and now only operates two domestic routes with a total of 23 weekly flights, according to Innovata data. It has a larger international operation, with two scheduled routes and several charter routes (primarily to China), but this follows a leisure carrier rather than LCC model.

Thai AirAsia, Nok and Thai Airways each currently account for approximately a 27% share of seat capacity in the Thailand domestic market, according to CAPA and Innovata data. Full-service boutique carrier Bangkok Airways accounts for about an 18% share and Orient Thai accounts for less than 2%.

Thailand domestic capacity share (% of seats): 19-Aug-2013 to 25-Aug-2013

LCC competition in Thailand's domestic market is poised to increase significantly as Lion and Vietnam's VietJet are preparing to launch new joint venture carriers in Thailand in late 2013 and early 2014 respectively. This will likely put further pressure on Thai AirAsia's yields. Thailand's domestic market, which is currently smaller than the domestic markets in Malaysia and the Philippines, is unlikely to support four LCCs over the long term.

See related reports:

The Malaysian domestic market, which Malindo has only served thus far (it will launch its first international route on 28-Aug-2013), has driven the yield declines at AirAsia's Malaysian short-haul carrier. Lion's entry in Thailand with Thai Lion will likely have a similar impact - initially domestically and eventually also in the international market. This impact will be compounded if Thai VietJet follows through and launches domestic services.

Thailand's international market is less competitive as AirAsia currently accounts for over 57% of all international LCC capacity in Thailand, according to CAPA and Innovata data. But Nok has just launched international services and Thai Lion and Thai VietJet are both expected to pursue international expansion after initially launching in the domestic market.

Thai Lion is expected to serve within the first few months the Thailand-Malaysia and Thailand-Indonesia markets, both of which are big markets for AirAsia. (Lion currently does not serve Thailand from Indonesia while Malindo has no plans to serve Thailand as part of the first phase of its international expansion and is instead leaving the Malaysia-Thailand market to Thai Lion.)

LCCs currently account for about 20% of international capacity in Thailand. The AirAsia Group accounts for over half of this capacity and has about a 12% share of total international capacity in Thailand.

Thailand international capacity share (% of seats): 19-Aug-2013 to 25-Aug-2013

Thai AirAsia pursues rapid expansion

Thai AirAsia is pursuing ambitious expansion in 2013, which can be viewed as a move to establish a larger presence in the local domestic and international markets before competition increases. The rapid expansion, however, is likely putting pressure on yields.

Thai AirAsia added two aircraft in 1H2013, giving it a fleet of 29 A320s as of 30-Jun-2013. The carrier is slated to add another six aircraft in 2H2013, one of which has already been delivered.

Another six A320s are slated to be added in 2014, giving Thai AirAsia the capacity to maintain its share of the market as new LCCs enter.

Thai AirAsia fleet plan: 2004 to 2017

1H2013 saw a relatively even mix of domestic and international growth - both of which expanded at clips exceeding 20%. Thai AirAsia transported 3.0 million domestic passengers and 2.0 million international passengers in 1H2013, up from 2.4 million and 1.6 million respectively in 1H2012.

During 2H2013 Thai AirAsia plans to focus on further domestic expansion as well as international expansion within Southeast Asia and to China. The carrier in Nov-2013 plans to re-open a base in Chiang Mai, where it is looking at starting flights to China to supplement its rapidly expanding Bangkok-China operation.

Thai AirAsia new and expanded routes for 2013

AirAsia also plans to diversify its international product in Thailand by launching a new Bangkok-based long-haul low-cost carrier under the AirAsia X brand. Thai AirAsia X is now in the process of being certified with Thai authorities - as is Thai Lion and Thai VietJet - and will likely launch services in early 2014.

Thai AirAsia X will be well positioned as it will be the first local LCC in Thailand's medium/long-haul market, where there are huge growth opportunities. But the short-haul market, where publicly listed Thai AirAsia competes, could see over-capacity as several LCCs expand.

AirAsia Group currently owns a 45% stake in Thai AirAsia, which in 2012 became the first AirAsia carrier to have a separate listing. AirAsia X, which will own Thai AirAsia X in partnership with Thai AirAsia's largest shareholder, completed its IPO in Jul-2013. Indonesia AirAsia, which is now 49% owned by the AirAsia Group, is now preparing for its own IPO. The IPO, originally planned in 2013, is now slated for 4Q2013 although a further postponement until 2014 is possible.

Indonesia AirAsia reports drop in operating margin but higher yields

Indonesia AirAsia turned a modest operating profit of IDR87.7 billion (USD8 million) in 2Q2013, an improvement of 13% over 2Q2012. Its net profit increased by 72% to IDR51.7 billion (USD5 million).

Revenues were up 42% to IDR1.398 trillion as passenger traffic increased by 33% to 1.9 million. Seat capacity was up 32%, translating into a 1ppt improvement in load factor to 79%. ASKs were up 28% year-over-year as the carrier pursued aggressive expansion while RPKs were up 31%.

Unlike its sister carriers in Malaysia and Thailand, Indonesia AirAsia has been able to increase its yields despite intensifying competition. Unit passenger revenues were up 8% as average fares increased by 3% to IDR576,507 (USD53.16). Ancillary income per passenger also increased by 29% to IDR151,040 (USD13.93).

Revenues per ASK were up 11% in both IDR and USD but costs per ASK were also up 13% in both currencies. Excluding fuel costs per ASKs increased by 17%.

Indonesia AirAsia operating highlights: 2Q2013 vs 2Q2012

Indonesia AirAsia's operating margin slipped from 8% in 2Q2012 to 6% in 2Q2013. The carrier has traditionally had the lowest margins and load factors among AirAsia's original three carriers. With the Malaysian and Thai short-haul operations reporting improved operating margins in 2Q2013, the gap between Indonesia AirAsia and its sister carriers has again increased. While the improvement in profitability is encouraging the reduction in operating profit margin and higher unit costs is discouraging, particularly as the carrier tries to move forward with its delayed IPO.

AirAsia has a long way to go in improving its position in Indonesia's domestic market

Competition in Indonesia is fierce, particularly in the domestic market. AirAsia over the last year has attempted to make a bigger push in the domestic market, recognising it needs to have a larger presence in Southeast Asia's largest market to meet its group goal of being the leading LCC in ASEAN. The group says Indonesia AirAsia captured 5% of the Indonesian domestic market in 2Q2013, compared to only 2% in 2Q2012.

But the domestic gap between AirAsia and the Lion Air Group, which accounts for about 50% of Indonesia's domestic market, is still huge. While Indonesia AirAsia continues to expand domestically and aims to capture 7% of the market by the end of 2013, it will once again allocate a majority of its additional capacity in 2H2013 to the international market as it adds five more aircraft. Capacity will be added in several existing international markets, including Australia, Malaysia, Singapore and Thailand.

Indonesia AirAsia added two aircraft in 1H2013 and operated 24 aircraft as of 30-Jun-2013. The carrier is slated to add another five aircraft in 2H2013, two of which have already been delivered and deployed from its bases at Bali and Medan.

Indonesia AirAsia has traditionally focused more on Indonesia's international market, where it accounts for a leading 18% share of capacity. AirAsia Group accounts for 26% share of total capacity in Indonesia's international market.

Indonesia international capacity share (% of seats): 19-Aug-2013 to 25-Aug-2013

The focus on further growing its international operation in 2H2013 is logical as Indonesia's international market still remains relatively under-served and Indonesia AirAsia is able to leverage AirAsia's strong international brand. But eventually Indonesia AirAsia will need to establish a more meaningful domestic presence. While it has expanded from a very small domestic base it will be challenging to secure more than a 10% slice of the market given the domination of Lion and the more rapid growth of Garuda LCC subsidiary Citilink.

AirAsia continues to face challenges in the Philippines

AirAsia faces even bigger challenges in the Philippines as it entered the market later. Cebu Pacific dominates the Philippine LCC market, accounting about 50% of total domestic capacity. Cebu Pacific also has a strong and rapidly growing international presence.

Philippines AirAsia incurred a net loss of MYR24 million (USD7 million) in 2Q2012, representing only a very slight improvement compared to a net loss of MYR25 million (USD8 million) in 2Q2013. The carrier has struggled since launching services in Mar-2012 with a fleet of two A320s. Philippines AirAsia is still currently only operating two A320s, an indication of its failure to gain traction in the competitive Philippine market.

The carrier made a big strategic move in trying to improve its position by forging a partnership in Mar-2013 with Zest Air, an independent LCC which had been struggling financially. Philippines AirAsia now holds an 85% economic stake and a 49% voting stake in Zest while Zest now owns a 15% stake in Philippines AirAsia. AirAsia Group owns 40% of Philippines AirAsia.

AirAsia was attracted to Zest because of Zest's slots at Manila International Airport. Philippines AirAsia currently only operates at Manila alternative airport Clark, where it has struggled to attract passengers particularly in the domestic market. As CAPA reported in Feb-2013 (before the Zest deal was forged):

AirAsia Philippines has quickly discovered it is difficult to serve the domestic market from Clark. International services can potentially work with the right low fare stimulation. But there are not many potential international markets to serve given the tensions with mainland China and the fact the two other key North Asia markets - Philippines-South Korea and Philippines-Japan - are currently not open to additional Philippine carriers.

Southeast Asia is open but AirAsia already has affiliates in three other Southeast Asian countries, making the new Philippine operation unnecessary except in the Philippines-Singapore market. But the Philippines-Singapore market is already served by several LCCs, making it tough for AirAsia to carve out a profitable niche. In hindsight, establishing a Philippine affiliate was probably not the smartest move.

Zest changes the outlook for Philippines AirAsia considerably, particularly if the two carriers are able to fully integrate their operations. AirAsia started selling Zest-operated flights on its website in May-2013 but the carriers remain separate and have two different products. For example Zest does not currently offer a pre-assigned seat option except for the front row and does not offer web, mobile or kiosk check-in. But Zest is working on adopting the AirAsia product and the AirAsia Group is hopeful it will soon secure Philippine authority approval to have Zest assume the AirAsia brand.

A single brand and product across the Philippine market, including both Manila and Clark, should improve AirAsia's position in the Philippines. In its 2Q2013 results presentation, the AirAsia Group stated that it expects Philippines AirAsia to be profitable in 2014 as the carrier's network is expanded and utilisation is increased.

But it will still face an uphill battle as Cebu Pacific remains a strong competitor. Tigerair Philippines, which has encountered similar problems as Philippines AirAsia, is also trying to establish a bigger presence and turn around financially. Philippine Airlines is a large and tough competitor with relatively low fares even though it has transitioned its former budget subsidiary AirPhil Express into more of a full service or hybrid regional carrier, now known as PAL Express.

AirAsia in 2Q2013 only accounted for 0.6% of domestic passengers in the Philippines while Zest accounted for about 11%, according to Philippines CAB data. In the Philippines international market the AirAsia Group (including Zest) currently account for only about 8% of seat capacity. Cebu Pacific accounts for about 17% while the PAL Group accounts for about 27%.

Philippines international capacity share (% of seats): 26-Aug-2013 to 1-Sep-2013

Philippines AirAsia to finally pursue fleet expansion

Philippines AirAsia is finally slated to take delivery of an additional aircraft in 4Q2013 - the first time it has expanded its fleet since its Mar-2012 launch. AirAsia says AirAsia Philippines and Zest will end 2013 with a combined fleet of 16 aircraft. Zest currently operates a fleet of 11 A320 family aircraft.

The additional aircraft will likely be used to launch services from the Philippines to Japan, a market the group says both Philippines AirAsia and Zest is looking to serve from Manila, Kalibo, Cebu and Clark. The AirAsia Group also has said the two carriers will pursue expansion in Kalibo to China, Taipei and Korea, leveraging its leading position in the Kalibo market. Kalibo is the fourth largest airport in the Philippines and is the international gateway to the popular resort island of Boracay.

Japan becomes an option as Japanese authorities are expected to soon lift restrictions which have prevented any new Philippine airline from launching services to Japan or any existing carrier in the market from increasing capacity. But the Philippines-Japan market could see a flood of new LCC activity as the current restriction is lifted. Cebu Pacific is expected to add significant capacity to Japan, where it is now limited to only operating three weekly flights to one destination (Osaka). The Japan's new LCCs have also been looking at serving the Philippines.

AirAsia's pursuit of rapid growth in Southeast Asia could lead to further yield declines

The AirAsia Group plans to add 16 aircraft in 2H2013, including four in 3Q2013 and 12 in 4Q2013. Some of these aircraft are coming out of the fleet of AirAsia Japan, which currently operates five aircraft and is winding down its operation over the next two months. The carrier plans to re-launch as Vanilla Air in Dec-2013 under new ownership and with a new fleet as AirAsia's stake has been sold back to ANA. AirAsia Japan incurred a net loss of MYR54 million (USD16 million) in 2Q2013 compared to a loss of MYR23 million (USD7 million) in 2Q2012.

See related reports:

Of the 16 A320s being delivered, 15 will be allocated to Southeast Asian markets with AirAsia India slated to take the remaining aircraft. The rapid expansion across Southeast Asia will ensure AirAsia maintains is leading position in the region's LCC market as the overall market continues to grow at a high double digit clip. The AirAsia brand currently accounts for about 35% of LCC capacity to/from and within Southeast Asia.

Market conditions in Southeast Asia remain favourable for further LCC growth as the region's economies remain robust and middle class populations continue to rise rapidly. But several markets could see over-capacity as nearly every LCC in the region pursues rapid growth and new LCCs prepare to enter. While AirAsia is well positioned and has the cash to fight back, inevitably profits and yields will come under pressure as competition continues to intensify.

Background information:

Thai AirAsia financial highlights: 2Q2013 vs 2Q2012

Thai AirAsia passenger traffic, load factor, average fares and ASKs: 2Q2013 vs 2Q2012 and 1H2013 vs 1H2012

Indonesia AirAsia financial highlights: 2Q2013 vs 2Q2012