07-Apr-2014 10:00 AM

Nok Air will continue its domestic focus as competition within Thailand intensifies

Analysis

Thai low-cost carrier Nok Air plans to continue focusing primarily on the domestic market as it expands its narrowbody and turboprop fleets following the first orders in the company's 10-year history. Nok currently operates a fleet of 17 aircraft and has recently committed to purchasing over the next five years at least 19 aircraft, including eight 737-800s, seven 737 MAX 8s and four Bombardier Dash 8 Q400s.

Nok captured 27% of Thailand's domestic market in 2013, up from 22% in 2012. Nok and its part-owner, Thai Airways, are keen for the LCC to maintain its strong domestic position as competition intensifies.

But internationally Nok is taking a cautious approach. The airline currently only serves one international route, Bangkok-Yangon, and plans to launch only one or two more international routes in 2014, Bangkok-Ho Chi Minh and potentially Bangkok-Hanoi. This leaves the Thai Airways Group without a serious participant in the international short haul segment, something that will need to be addressed.

Nok and AirAsia now have roughly equal shares of Thailand's domestic market

Nok currently serves 22 domestic destinations (based on OAG data), giving it the largest domestic network in Thailand. The carrier has rapidly expanded its domestic operation over the last two years, closing the gap with low-cost rival Thai AirAsia, which has a smaller network of 15 destinations but higher frequencies on most trunk routes.

Nok overtook Thai AirAsia as a larger domestic carrier in 3Q2013 and in the first nine months of 2013 captured 27.2% of Thailand's domestic market compared to 26.9% for Thai AirAsia. But Thai AirAsia retook the lead in 4Q2013 as it pursued aggressive domestic expansion and for the full year captured a 27.8% share compared to 27.2% for Nok, according to Thailand DCA data.

While Thai AirAsia had a surge in late 2013, overall Nok has grown much faster domestically in recent years. Nok's share of the domestic market has increased by over 7pts since 2011 while AirAsia's share has increased about 4pts.

Thai Airways and Orient Thai have seen their shares of the domestic market drop since 2011 by about 6pts and 5pts respectively while independent full-service boutique carrier Bangkok Airways has maintained a 14% share. Orient Thai has steadily cut back its domestic operation, which follows an LCC or hybrid model, and is now predominately an international charter operator.

Thailand annual domestic market share (% of passengers carried) by carrier: 2011 to 2013

Thai Airways focused on group share of domestic market as LCCs rise

While Thai Airways continues to lose market share to LCCs its overall share as a group has increased. Thai Airways, Thai Smile and Nok combined accounted for a 56.5% share of the domestic market in 2013, up from 55.3% in 2011. (The Thai Smile figures are included under Thai Airways as Thai Smile has also been operating under the TG code; it shortly plans to start operating under its own code.)

Thai Airways currently has a 39% stake in Nok. It had a 49% stake prior to Nok's Jun-2013 initial public offering, which floated about 31% of the company's shares. The remaining 30% is held by Thai investors, including Nok executives.

While Nok is completely independent from Thai Airways, the Thai Airways Group sees Nok as an important component of its multi-brand strategy. With Nok, the group is confident it can maintain its current share of the domestic market. Thai Airways recognises LCCs are better positioned to capture the continued growth in Thailand's domestic market, which is being driven by rapid growth in the middle class and the first time flier population as more Thais trade in long bus and train journeys for budget flights.

Thailand recorded 26% domestic growth in 2013

Thailand's domestic market grew by 26% in 2013 to 22.3 million passengers, making it one of the fastest growing domestic markets in the world. Nok carried over 2 million more domestic passengers in 2013 compared to 2012 while Thai AirAsia carried about 1.7 million additional domestic passengers.

Thailand annual domestic passengers by carrier: 2011 to 2013

Thailand's domestic market is expected to continue growing rapidly over the next several years (with a likely dip in the growth rate in 1H2014 due to the continuing political instability). But the market is also becoming much more competitive as two new LCCs enter, Thai Lion and Thai VietJet.

Thai Lion launched services in early Dec-2013 and flew 22,500 domestic passengers in its first four weeks of operations, according to Thailand DCA data. Thai Lion currently operates four domestic and four international routes with a fleet of four 737-900ERs and one ATR 72 turboprop.

Thai VietJet aims to launch services in Sep-2013 and initially operate a fleet of three A320s. It plans to have a network of five routes, including two or three domestic routes, by the end of 2014.

Nok's expansion over the last two years puts the carrier in a better position to battle the new competitors. The Thai Airways Group expects Nok to continue expanding with the domestic market while its two full-service brands will roughly maintain current capacity levels.

Thai Airways expects the LCC share of the domestic market, which is already about 67%, to continue increasing. But the group does not mind this trend as long as Nok continues in a position to be one of the main beneficiaries of the growth at the bottom end of the market.

Thai Airways and Thai Smile (which operates smaller aircraft and has a lower cost structure than Thai Airways but has a full-service offering) plan to focus their domestic operations on business passengers and the connecting market. CAPA analysed the outlook for Thai Smile and Thai Airways in previous instalments of this series of analysis reports on the Thai market. In Part 1, CAPA analysed the outlook for new long-haul low-cost carriers NokScoot and Thai AirAsia X, both of which plan to launch scheduled operations in 4Q2014.

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While Thai Airways will only have an indirect 20% stake in NokScoot the new carrier is considered an important element of Thai's multi-brand strategy. Thai Airways sees NokScoot as competing primarily against Thai AirAsia X while Nok is used to compete against Thai AirAsia, Thai Lion and Thai VietJet. Thai Airways is confident there will be sufficient segmentation between the two full-service and two-low cost brands to avoid cannibalising its legacy business.

Nok Air has a weak international presence

Nok's domestic focus, however, creates a void in the Thai Airways Group portfolio because it leaves the budget end of the regional international market for competitors. Eventually Nok and Thai Airways will need to address this weakness.

NokScoot could potentially be used to serve some denser short-haul markets with its widebody fleet such as Singapore and Hong Kong. But ultimately Nok will need to start pursuing more aggressive international expansion, or a new fifth brand (which the group considered previously) will be needed to serve the regional international low-cost segment.

Thai AirAsia now has a firm grip on this segment as it serves over 20 international destinations and allocates about 40% its capacity to the international market. Thai Lion is also starting to make inroads and already has more international routes than Nok.

Thai VietJet is planning a similar relatively even mix of domestic and international services. Sister carrier VietJet Air already serves Bangkok from its bases in Hanoi and Ho Chi Minh, giving the VietJet brand more international routes in Thailand than Nok.

There are huge opportunities in Thailand's international market for LCCs - both short-haul and long-haul - as LCCs currently account for only 21% of total international capacity. In comparison the international LCC penetration in Singapore is about 33% and in Malaysia it is about 49%, according to CAPA and OAG data.

While NokScoot will ensure the Thai Airways Group has a play in the medium/long-haul segment, without a more aggressive Nok it risks losing out in the short-haul international segment to competitors. Nok currently serves only one international destination, Yangon in neighbouring Myanmar, which it launched in Nov-2013.

Nok plans to launch Vietnam service in 4Q2014

Nok's current fleet plan is predicated on continuing double digit domestic growth and does not have sufficient aircraft simultaneously to pursue significant international expansion.

Nok CEO Patee Sarasin tells CAPA the focus in 2014 is to increase frequencies on the main domestic routes. Vietnam will be the only country added in 2014 with the launch of Bangkok-Ho Chi Minh planned for Oct-2014. Nok is also considering serving Hanoi but it at this point does not want to serve any country other than Myanmar and Vietnam.

Nok has looked several times in recent years at launching scheduled services in the large and fast-growing Thailand-China market (inbound tourist numbers almost doubled in 2013) but is content at least for now on only serving China with charters. Charters accounted for just 2% of Nok's revenues in 2014 and are not likely to become a major contributor as the main focus is on the scheduled domestic market.

Thai Airways acting president and Nok board member Chokchai Panyayong points out that international expansion comes with significant investment and risk. While he acknowledges the group needs to eventually address its lack of a significant presence in the regional international low-cost segment the focus for now at Nok should be cementing its domestic position. "I think Nok needs to try to maintain their strength domestically," Mr Chokchai told CAPA, adding that Nok has been very successful and profitable over the last decade with its domestic focus.

Nok was profitable in 2013

Since launching 10 years ago Nok has been one of the most consistently profitable LCCs in Southeast Asia, despite its low profile. Nok reported a THB1.066 billion (USD35million) profit in 2013, roughly double the THB505 million (USD16 million) profit from 2012. Nok ended the year with a net profit margin of 9.4% and an operating profit margin of 9.7%, putting the carrier among the best performers in Asia.

Nok Air annual profit: 2011 to 2013

Revenues were up 37% in 2013 to THB11.315 billion (USD369 million). Passenger traffic was up 44% to 5.9 million, representing the third consecutive year of passenger growth exceeding 40%.

Nok Air annual passenger traffic: 2010 to 2013

RPKs were up 45% on a 46% increase in ASKs. Nok's load factor was 84% for the second consecutive year.

Nok's yield dropped 7% in 2013, an indication of the intensifying competition. But Nok was still able to improve its bottom line despite the flat load factor as its cost per ASK dropped 10%, driven by the transition to a more efficient fleet. Variable cost per ASK excluding fuel was down 14% year over year.

Nok grows its 737-800 fleet

Nok's rapid capacity growth and efficiency improvements in 2013 were driven by the delivery of six 737-800s. Nok took an initial batch of three 737-800s in 4Q2011 and added five more of the type in 2012. The 737-800s replaced 10 smaller 737-400s with the last three being phased out in 2013.

Nok took delivery of an additional 737-800 in Mar-2014, giving it a fleet of 15 leased 737-800s. Mr Patee says Nok has committed to leasing three more 737-800s in 2014 for a year-end total of 18 aircraft.

He says the carrier is slated to take the first four 737-800s from its commitment with Boeing in 2015 followed by another four 737-800s in 2016. Nok is now looking at potentially supplementing these eight aircraft by leasing additional 737-800s.

The carrier has some flexibility in its fleet plan as two of its oldest 737-800s will likely be returned in 2015. Among the 15 737-800s currently in Nok's fleet, 13 were delivered used and now range from seven to 14 years old. Nok's leases run for five to eight years with the first coming up for renewal in 2015.

Nok has not yet received a delivery breakdown for its seven 737 MAX 8s but expects it will receive an initial batch of two aircraft in 2H2017 with the remaining aircraft to be delivered by the end of the decade. The 15-aircraft commitment with Boeing, which was announced at the 2014 Singapore Airshow, has not yet been formally booked by the manufacturer.

While the order with Boeing is significant as Nok has previously always relied on leasing companies, it is relatively small given the larger orders placed by most of Nok's LCC competitors in the region.

This is a reflection of Nok's rather modest approach. Mr Patee does not see the 46% ASK growth from 2013 being repeated and expects the carrier to grow at clip of about 15% per annum between 2014 and 2018. Faster growth would likely require more orders or lease commitments.

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Nok Air adjusts its regional aircraft fleet

Nok also signed in Nov-2013 a purchase agreement for two Bombardier Dash 8 Q400s for delivery in 2H2014. In Mar-2014 Nok committed to another two Q400s.

Nok plans to use the Q400, which it will configure with 86 seats, to replace its current fleet of two ATR 72-500s. Nok initially planned to phase out the ATR 72 by the end of 2014. But following the recent termination of its partnership with Siam General Aviation (SGA), which was operating six Saab 340 turboprops on Nok's behalf under the sub-brand Nok Mini, it may now continue to operate its two ATR 72-500s until it receives all four Q400s.

Nok came close to buying SGA and inheriting the six Saab 340s but the deal fizzled in Mar-2014, leaving Nok without a small turboprop operation as the SGA partnership expired on 30-Mar-2014. Nok has been able to maintain most of the regional routes that were served with the Saab 340 by using its two ATR 72-500s while reducing frequencies to compensate for the fact that the ATR 72 is about twice the size of the Saab 340.

Nok also has the option of temporarily operating two ATR 72-200s, which it returned to Thai Airways after leasing its two ATR 72-500s about a year ago. Thai Airways owns the ATR 72-200s, which are about 20 years old and are listed for sale with availability from 4Q2014.

Nok also is now using 737-800s on some former ATR 72 routes and even a small number of former Saab 340 routes including Chiang Mai-Udon Thani. But some regional routes that had been operated by SGA have been suspended, including Chiang Mai-Mae Hong Son, Chiang Mai-Mae Sot, Mae Sot-Yangon and Mae Sot-Mawlamyine. The latter two were short international routes connecting northern Thailand with Myanmar.

While the small regional routes had value in that they helped Nok differentiate from other LCCs, the portion of Nok's passengers that came under Nok Mini was not significant and Nok will still be able to maintain a leading domestic network using its 737-800s and ATR 72s (and later Q400s).

Nok also has purchase rights for a further four Q400s, which it plans to look at exercising once it starts operating the new type. Given the success it has had regionally it would not be surprising to see Nok end up with a larger turboprop fleet.

Nok has a successful hybrid model and a bright outlook

Another key differentiator is Nok's product, which is positioned more like a hybrid rather than LCC carrier, in line with its self-proclaimed "premium low-cost airline" label. Nok offers several complimentary frills including checked bags, drinks, snacks and seat assignments. While online channels accounted for 61% of its bookings in 2013, Nok also has a flexible distribution strategy which embraces agents and alternative channels such as convenience stores.

Nok reservation channels (% of sales): 2011 to 2013

Nok and its part-parent Thai Airways believe the hybrid model works and it should avoid any temptation to adopt a purer LCC model as budget competition intensifies. Nok has succeeded over the years in charging a premium compared to other LCCs which more than offsets the cost of the frills. The carrier still has a respectable ancillary business, which accounted for THB638 million (USD21 million) of revenues in 2013 or 6% of its total revenues.

While Nok's hybrid model means Thai Airways lacks a pure LCC in its portfolio, it is hard to argue with the carrier's success, particularly its track record at appealing to Thailand's younger generation. As domestic competition intensifies Nok is right to focus on leveraging its strong position in the local market.

Nok and the Thai Airways Group could risk missing the boat when it comes to the regional international low-cost segment, but it can be dangerous to try to do too much at once. Southeast Asia's market already has more than its fair share of overambitious LCCs.

But the Group overall still risks being a bystander as the fast growing international market takes off. Despite Nok's financial success, the airline remains small and there is unfinished business in the potentially much bigger international market.