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Malaysia Airlines pursues rapid expansion but yields and profits are under pressure

21st November, 2013

Malaysia Airlines (MAS) plans more rapid expansion over the short to medium term albeit at a slower rate compared to the torrid 20% capacity growth recorded for 3Q2013. The carrier – which has been expanding its domestic, short-haul international and long-haul international operations at similar rapid clips in 2013 – will focus in 2014 primarily on regional international growth.

MAS has been able to grow passenger traffic so far this year by 28%, including a 37% jump in 3Q2013, easily outstripping the large increase in capacity. But the load factor improvements have come at the expense of yield, pushing MAS back into the red in 3Q2013.

The flag carrier hopes it can eventually improve yields across both cabins, leveraging the improvements in its product and new membership in oneworld. But the intense competition in Southeast Asia could make it difficult to achieve higher yields, clouding the carrier’s outlook.

MAS incurs 3Q2013 loss despite impressive traffic growth

MAS has had an impressive year from a traffic perspective, recording some of the fastest growth in Asia among both LCCs and full-service carriers. In 3Q2013 the growth trend continued, with system-wide RPKs up 37% on a 20% increase in ASKs, resulting in a 10.3ppts improvement in load factor to record 84.8% (see background information). Domestic RPKs were up 45% in 3Q2013 while international RPKs were up 36% year-over-year.

But passenger revenues were up only 14% as yields dropped, fuel costs increased and the Malaysian ringgit weakened. As a result MAS incurred a MYR373 million (USD117) loss for 3Q2013, compared to a MYR38 million (USD11 million) profit in 3Q2012, signalling a disappointing setback in its path to recovery.

Malaysia Airlines financial highlights: 3Q2013 vs 3Q2012 and 9M2013 vs 9M2012

In 2Q2013 MAS was able to squeak out a small profit despite lower yields. This had provided another positive indication – following profits in 3Q2012 and 4Q2012 as well a reduced loss in 1Q2013 – the new business plan implemented in late 2011 was starting to bear fruit. Now the outlook is more mixed. But MAS is hardly alone as most of its Southeast Asian full-service peers have seen similar declines in yields as competition in the region has intensified.

After a year of consolidation and rationalising its network in 2012, MAS responded to market conditions by increasing domestic capacity by 20% through the first three quarters of 2013 and international capacity by 16%. Domestic RPKs have risen 27% and international RPKs by 28% as MAS has tried to stimulate demand with lower average fares.

Monthly passenger numbers and RPKs have been tracking higher all year, accelerating after new Lion Air Group's Malaysian hybrid carrier Malindo launched in March. The gains more than offset the declines from 2012, when MAS was in restructuring mode for most of the year.

MAS monthly passenger numbers: Jan-2011 to Sep-2013

MAS monthly passenger RPKs: Jan-2011 to Sep-2013

Malaysia market grows rapidly in 2013

The push at MAS along with the entry of Malindo and accelerated expansion at AirAsia and AirAsia X has led to rapid growth in the overall Malaysian market. Overall domestic passenger growth in recent months has exceeded 20%, making Malaysia one of the fastest growing domestic markets in the world.

See related report: Malindo Air launch drives 20% surge in Malaysia domestic traffic as MAS and AirAsia also expand

Malaysia Airports reported 17% traffic growth for the first three quarters of 2013, with similar growth for both the domestic and international markets. Passenger growth rates reached 22% in 3Q2013 for Malaysia Airports, which manages almost every airport in Malaysia, and Aug-2013 marked the first time that over 7 million passengers were handled in a single month.

At the Kuala Lumpur International Airport Main Terminal, where MAS and Malindo are based, passenger numbers were up 24% through the first three quarters of 2013. (The airport’s low-cost terminal, where AirAsia and AirAsia X are based, recorded 12% year-over-year growth.)

MAS executives expect passenger traffic for the full year 2013 to be up approximately 35%. But they do not expect the carrier to be able to achieve similar growth figures in 2014. Year-over-year comparisons will start to change in 4Q2013 as MAS started to add back capacity in late 2012, reversing some of the cuts made in early 2012.

While 20% capacity and 30%-plus passenger growth is not sustainable, MAS executives expect capacity growth will remain in the double digits in 2014 and through at least the medium term. The carrier is bullish on the Asian market and its improved positioning following a re-fleeting and product improvements. “We will build the same momentum,” MAS CEO Ahmad Jauhari told CAPA on the sidelines of the 14-Nov-2013 Association of Asia Pacific Airlines (AAPA) Presidents Assembly in Hong Kong.

MAS focuses on stimulating traffic with low fares

Mr Jauhari says the carrier will try to improve yields in 2014. In 2013 the carrier has employed a different tactic, significantly increasing the number of tickets sold at lower fare buckets in a bid to stimulate demand, improve load factors and raise its profile. This decision was partially driven by the launch of Malindo and intensifying competition from foreign carriers.

“We decided with the markets the way they were and some of the weakness in the global economy it’s better having the passenger on board the plane than try to hold out and get the extra $10 from the consumer,” explains MAS commercial director Hugh Dunleavy. “We believe that with the market conditions that we were at it’s better to fill the planes. We may not have gotten maximum yield but we certainly maximised the revenue from the assets we had deployed.”

Mr Dunleavy also points out that MAS is keen to have more passengers try out its newly improved product. The carrier has renewed most of its fleet in recent years, with new 737-800s replacing ageing 737-400s, its new flagship A380s replacing ageing 747-400s and new A330s replacing older model A330s. MAS also joined oneworld in early 2013, bringing in a new range of benefits for its customers.

“We need to get back and be recognised,” Mr Dunleavy told CAPA. “You want more people to see your product. You don’t do that by charging the highest possible fares. You want more people to trial the Malaysia Airlines product, see what we are offering and then come back and fly us more often. … As an airline we hadn’t been a significant player in the market over the previous several years. We wanted to make a big impact.”

The promotional prices have impacted both economy and premium yields as MAS is keen to capture the attention of government and corporate passengers. Winning back premium customers who have defected MAS over the years for its Asian or Middle Eastern rivals is a key component of the new MAS business plan. But competition for premium passengers is intensifying, particularly in markets such as Australia-Southeast Asia where MAS has been expanding aggressively along with several other carriers. (MAS is now in the process of adding a third daily flight to Melbourne and Sydney and recently launched service to Darwin, its sixth Australian destination.)

MAS to further thicken key regional routes in 2014

The focus in 2014 will be on adding more frequencies on popular routes within Asia. MAS this year has added frequencies on several regional routes as part of a plan to serve key business cities in Asia with four to six daily flights and key leisure destinations with three to four daily flights. There will be more opportunities to “dense up the schedule” on regional international routes as MAS plans to take another nine 737-800s in 2014. “We are dense-ing up the schedule because we want to improve the efficiency and connectivity of the hub,” Mr Dunleavy explains.

About 40% of MAS traffic now consists of transit passengers, up from 30% to 35% a year ago. While MAS has been able to stimulate local demand, particularly in the domestic market, the carrier has increased its reliance on sixth freedom traffic to drive the overall 35% increase in passenger traffic. The improved schedules and membership in oneworld have enabled the carrier to pursue more transit passengers – although yields have suffered as MAS needs to compete in this segment against very aggressive Gulf and Asian carriers.

2014 will also be a key year for MAS as the carrier plans to finally phase out its 737-400 fleet, driving further efficiency improvements. Fleet renewal has been a key component of the MAS turnaround plans as it has improved the carrier’s product and efficiency levels through higher utilisation.

The carrier’s total fleet size has remained relatively unchanged in 2013 as aircraft have been joining and exiting the fleet at an equally rapid pace. The 20% capacity increase has been driven primarily by utilisation improvements. MAS expects to take 18 aircraft in 2013, including 12 737-800s, four A330-300s and two A380s. (One 737-800 and one A330-300 have not yet been delivered.)

MAS is now utilising its 737-800 fleet an average of over 11 hours per day, compared to about nine hours with its previous narrowbody fleet. MAS still has 11 737-400s in service, according to the CAPA Fleet Database. But these aircraft will be phased out over the next year on a 1:1 basis, providing an opportunity to significantly increase capacity as the 737-800 is larger and has significantly higher utilisation rates.

Malaysia Airlines fleet summary: as of 21-Nov-2013

aircraft In Service In Storage On Order*
Total: 99 30 24
Airbus A330-200F 4 0 0
Airbus A330-300 0 3 0
Airbus A330-300E 13 0 2
Airbus A380-800 6 0 0
Boeing 737-400 11 19 0
Boeing 737-800 48 0 22
Boeing 747-400 0 7 0
Boeing 747-400F 2 0 0
Boeing 777-200ER 15 1 0

MAS looks at acquiring more widebody aircraft

MAS is currently only slated to take one widebody aircraft in 2014, the last of 15 A330-300Es. This is the last widebody that MAS currently has on order. Mr Jauhari says this aircraft will be placed on the Kuala Lumpur-Dubai route, which MAS resumed in Aug-2013 and for now is being operated with 777s-200ERs. (MAS cut Dubai along with six other long-haul destinations in early 2012; only Dubai has been reinstated.)

Widebody capacity growth will also be limited in 2014 as MAS has to remove its A380s from service, one at a time, for wing retrofits. Mr Jauhari says it will take about 10 months to complete retrofits on all six of the carrier’s A380s, leaving it with an in-service fleet of five aircraft from Feb-2014. MAS is hoping to continue operating two daily A380 flights to London and one daily A380 flight to Paris with the reduced five-aircraft fleet but will likely temporarily down-gauge its daily A380 flight to Hong Kong.

MAS is now looking at replacement options for its 777-200ER fleet, which are 14 years old, making it by far the oldest aircraft type in the carrier’s now otherwise modern fleet. MAS could start taking delivery of new widebodies to replace its 16 777s as early as 2015.

Malaysia Airlines fleet age by aircraft type: as of 21-Nov-2013

Mr Dunleavy says MAS will likely source 777 replacements from leasing companies as placing an order would require longer lead times.  Additional A330s could be acquired for part of the requirement but a new widebody type will be needed as A330s do not have the range to take over all the routes MAS now operates with 777s.

Replacements for the 777s are the last remaining component of the carrier’s fleet renewal programme. “The 777s are our next target,” Mr Dunleavy told CAPA. “But that has to tie into the lease expire conditions. That will be over the next two or three years.”

In tandem, MAS is now working on a new long-term widebody fleet plan that will take into account both growth and replacement aircraft. “Before we rush into that [leasing 777 replacements] we will do a long-term fleet plan and plan what we want to do over the next 10 to 15 years. That’s something that will be rolled out over the next three or four months,” Mr Dunleavy says.

New-generation narrowbodies could also be acquired

MAS will also eventually look at new-generation narrowbody aircraft but widebodies are for now the priority. The carrier has not yet ordered the 737 MAX or A320neo but is committed to taking from Boeing another 17 737-800s between 2014 and 2016.

The currently delivery schedule for 737-800s on order from the manufacturer includes nine 737-800s in 2014, followed by two in 2015 and a final six aircraft in 2016 (excludes separate commitments with leasing companies). Mr Jauhari says that “at the moment we have enough to tide us over” and that eventually MAS will look at new-generation narrowbody aircraft for growth and subsequently replacement as the current 737-800 fleet, which is still very new, starts to age.

MAS could potentially use leasing companies to access early slots for the 737 MAX, which enters service in 2017. Another option would be to acquire additional current generation 737-800s for growth at the end of the production line. MAS would likely receive a good deal for a top-up 737-800 order but is wary of low residual values for end of production line aircraft.

MAS has made progress but the biggest hurdles still remain

MAS has come a long way in a relatively short period, renewing one third of its fleet with over 30 deliveries since the beginning of 2012. Ascension into oneworld and the introduction of A380s have also been key milestones.

See related reports:

Over the past year MAS has grown passenger traffic at record levels. In the first 10 months of 2013 MAS had already carried more passengers than it did in all of 2012, a growth rate not matched by any flag carrier in Asia.

But MAS still has a long road ahead and challenges to overcome. Competition is intense and market conditions are not improving. Its pricing strategy is not sustainable and will only succeed if passengers are ultimately prepared to pay more to fly with MAS.

The carrier has shiny new aircraft, membership in a global alliance, an improved service, a bigger network and a more efficient hub. Now MAS has to execute the most difficult part of its strategy and turn all of those investments into higher yields and long-term profitability.

Background information

Malaysia Airlines operational highlights: 9M2013 vs 9M2012

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