09-Jan-2014 8:31 PM

North Asian aviation 2014 outlook: cracks in the wall of inertia - but it is yet to fall

Analysis

North Asia is home to many of the world's most visible airlines based on size (China Southern), market capitalisation (Air China), profitability (Japan Airlines) and prestige (Cathay Pacific). The region's airlines face an encouraging 2014, and can certainly fare much better than European peers. The singular uniting theme for long-haul North Asian carriers is the strong market to North America, where corporate and premium travel is up while competitors are fewer than to Europe, for example.

Elsewhere the characterisation is that of nuances. Currency exchange rates are sharply impacting Japan, where the yen is down about 17%, while helping Chinese carriers with the appreciating yuan. Regional tensions continue to plague bilateral markets like Japan-Korea and China-Japan. There is growing sensitivity about unprofitable short-haul routes: Asiana will use a new single-class configuration while China Airlines and TransAsia expect to have new LCCs, adding more dual-brand strategies to the region, which otherwise lacks the vibrant LCC market of Southeast Asia - or Europe. Except in Japan, liberalisation has occurred more slowly in North Asia.

2014 will be a reflective year for liberalisation in the region. Jetstar Hong Kong continues to press for a licence while AirAsia is exploring Korea for new subsidiary options. Foreigners fear Taiwan's newfound pro-LCC attitude is only for LCCs established with an existing Taiwanese airline. And China, potentially the world's largest market for possible airline investments, shows no signs of receptiveness to foreign capital, which could be a game-changer on the global stage, although new airlines are being ushered in as part of government-led reforms. The wall is starting to show some cracks.

Summary

North Asian airlines are expected to have a strong 2014, with a focus on the North American market.
Currency exchange rates are impacting airlines in Japan and China differently, with the depreciating yen negatively affecting Japanese carriers.
Regional tensions between countries like China and Japan, and Japan and Korea, are impacting the aviation market in those areas.
Liberalisation in the North Asian market has been slower compared to Southeast Asia, but there are signs of progress.
Dual-brand strategies, with both full-service and low-cost carriers, are becoming more prevalent in North Asia.
The outlook for North Asian carriers in 2014 is positive, but there are missed opportunities and challenges to overcome.

North America is a uniting positive factor

In Northeast Asia many factors are taken for granted. Economies are growing, even if there are occasional slowdowns. The middle class - and travelling potential - continues to increase exponentially. There is relative political stability, with some upsets causing declines in specific markets, and not widespread decreases that take years to recover from.

A distinct, and relatively new, uniting factor is the strength of the North American market. Demand, including from the corporate and premium sectors, is high. Competitors are fewer than to Europe, and some of the biggest carriers benefit from two broad joint ventures, those between ANA and United, as well as between JAL and American Airlines.

Southeast Asian carriers are out of reach of profitable non-stop services to North America. Limits from an extra stop as well as constrained bilaterals' fifth freedom rights keep Southeast Asian capacity to North America to a minimum.

Southeast Asian carriers are large in the weaker long-haul market of Europe, while North Asian carriers are fortunate to have the alignment of a large presence with a well-performing market.

Conversely, Europe is open for all - and for many, within A330 range, making the market more appealing. Nearly every major carrier in the Northeast Asia-North America market will grow capacity during 2014, many - American Airlines, ANA, EVA Air, United - at double digit rates.

Every Northeast Asian carrier with widebody aircraft will fly to North America, except domestic Japanese carrier Air Do as well as regionally-focused Hong Kong Airlines and TransAsia. Skymark is due to receive its first A330 in Jan-2014 and will use it domestically, but by the end of the year will have A380s for New York JFK service. Sichuan Airlines made North America its first long-haul destination. Xiamen Airlines may follow suit.

United States to North East Asia seats per week, one way by carrier: 19-Sep-2011 to 6-Jul-2014

Canada to North East Asia seats per week, one way by carrier: 19-Sep-2011 to 6-Jul-2014

A banner year for liberalisation? Or not...

On the short-haul front, Northeast Asia lags in the liberalisation that has seen Southeast Asia become a vibrant and dynamic market. This mainly impacts low-cost carriers, but also full-service carriers: the Lion Air Group in 2013 launched hybrid full-service carrier Malindo Airways in Malaysia. The LCC penetration for travel within Northeast Asia (11%) is a fifth of that for travel within Southeast Asia (58%).

LCC capacity share (%) of total seats within Northeast Asia: 2001 - 2014*

LCC capacity share (%) of total seats within Southeast Asia: 2001 - 2014*

The encroachment of LCCs in North Asia is limited, benefitting incumbents, unlike in Southeast Asia where LCCs have made many short-haul routes unprofitable for full-service airlines. The challenge for full-service carriers is to seize the opportunity and craft a strategy that complements their existing business rather than have other carriers cannibalise traffic.

Northeast Asia had one liberalisation push at the end of the last decade as Japan undertook significant reforms partially prompted by JAL's bankruptcy, making Tokyo realise change needed to occur and would benefit its lagging tourism sector too. A large result was the launch of three LCCs, all in partnership with an existing Japanese carrier: Jetstar Japan with JAL as well as AirAsia Japan and Peach Aviation with ANA. Jetstar Japan and Peach had only minority interests from the full-service airline. The granting of a local licence to Spring Airlines, in partnership with Japanese companies but not any existing airline, is further evidence of liberalisation, as are the numerous open skies agreements and expanded bilaterals Japan has signed that benefit the country but not always its local airlines. This contrasts to the rest of Northeast Asia, perhaps except Taiwan, being relatively tight on bilaterals.

2014 could see Jetstar Hong Kong finally secure approval after being announced in Mar-2012. Incumbents are understandably mounting a protectionist battle while approval would be consistent with Hong Kong's open approach and encouragement of business. More speculative is AirAsia Korea, which has filed an application that has slim chances of being approved in the near future.

Taiwan has encouraged the development of local LCCs - around a dozen foreign LCCs already serve Taiwan - and in Dec-2013 TransAsia and then China Airlines announced they would launch a LCC, China Airlines in partnership with Tigerair. The market remains potentially lucrative to foreign LCC groups, but they are sceptical Taiwan's appearance of an open door to LCCs is applicable to those not partnering with a local carrier.

Imbalances between attitude and actions are also a concern in China, which has said it must encourage private capital in aviation as well the fostering of new carriers and in particular LCCs. But with airlines being seen by Beijing as serving national interests, and the general can-do attitude of China, the country is unlikely to cede valuable territory to foreign companies. Government-led reforms in China's sector are, however, ushering in a number of worthwhile changes and new carriers, including private ones and LCCs, which have become a buzzword in Chinese aviation.

See related reports:

As is typically the case, there is much to be gained from liberalisation but incumbents and nationalist feelings hold sway. Few are holding breath for China. More relevant is if private entirely Chinese owned airlines can secure ground, from fleet growth to route approvals. Taiwan, now with two planned LCCs, may have too much capacity in the short term for other LCC groups.

The two proposed LCCs may cause others to lose interest in the story of Taiwan's LCC; it is a small market.

Jetstar Hong Kong will be one of the most watched developments of the region this year, but its implications are limited. Approval may give an air of liberalisation but future start-ups are unlikely to have enough time to apply and be approved before slots run out; the next chance might not be until the early 2020s. Rejection, seemingly unlikely, would make Hong Kong a no-go zone for other entrants. The best implications to the region - besides the obvious gains of new services and passenger growth - is Jetstar Hong Kong being a catalyst for further liberalisation in the region; if Jetstar can win over objections from the mighty Cathay Pacific, other regulators may be inclined to loosen their shackles - or forced to by prospective entrants pointing attention at Hong Kong's advancements.

See related reports:

Four more dual-brand LCC/full-service strategies in North Asia in 2014

Short-haul services are no longer sacrosanct. On the full-service spectrum, Asiana is trialling an all-economy A320 configuration for thin short-haul services to Japan. But if moving from a dual-brand to mono-class aircraft is good for a route, further concentration on cost-cutting is even better. The answer for four carriers is a dual-brand strategy.

China Eastern will have a LCC in the form of China United Airlines, Juneyao with Jiu Yuan, China Airlines with Tigerair Taiwan and finally (for now) TransAsia with a planned LCC.

This will represent nearly a doubling of dual-brand strategies in North Asia, previously confined to Asiana with Air Busan, Korean Air with Jin Air, ANA with Peach and Vanilla Air, JAL with Jetstar Japan and Hong Kong Airlines with Hong Kong Express.

The range of integration at these existing dual-brand strategies varies considerably. Peach is adamant ANA is an interested, not controlling, shareholder. JAL and Jetstar Japan take a strategic approach where each gives and takes. Hong Kong Express is largely maintaining independence. But looking at the small footprint of Air Busan and Jin Air, they are deployed where necessary while minimising full-service cannibalisation - even if they could make more profit than their full-service parents.

The new dual-brand strategies will likely be even more diverse: China Eastern and Juneyao are planning for their LCC to operate well outside of their home base. Route overlap will be minimal. The LCCs will effectively be a new type of carrier to put in a competitor's backyard. The question for the medium and long term is how much future overlap is permitted and if the carriers can or need to adopt a more comprehensive dual-brand strategy where the LCC flies alongside most of the full-service carrier's routes.

LCC units in Taiwan will have to be more integrated, if only because geography confines them to a realistic operating base of Taipei. China Airlines is mindful of the necessity of short-haul connections for its long-haul network, but is also well aware of many leisure point-to-point routes a LCC could takeover today. Segmentation will be challenging at TransAsia, which operates only regional services and carries mainly point-to-point traffic. Its small size - 11 jet aircraft - is a further challenge to have scale. There is no easy solution. Either overlap will be large or opportunities will be missed. Both could use their LCCs on leisure-oriented secondary city pairings between Taiwan and mainland China, where existing full-service carriers are challenged for profitability.

These will prove to be interesting case studies to the dual-brand strategy textbook yet to be written. Further contributions will be made from additional dual-brand strategies that are surely on their way, especially in China.

Exchange rate changes close doors and open windows - but not at same time

Exchange rates can be friend or foe. The appreciating Chinese yuan has greatly benefitted Chinese airlines' net profit, even making many overlook under-performing operating results. The declining Japanese yen is so far a negative story for most carriers. Japan is an outbound market: 2012 (most recent full year for which statistics are available) saw 8.4 million foreign visitors to Japan while 18.5 million Japanese travelled overseas.

One argument is that if a weakening yen means fewer Japanese are travelling, more foreign visitors can visit Japan. That reflects the old adage of a door closing but window opening. These do not happen simultaneously. The yen's depreciation is likely here for the medium to long term, but Japan has years - in some cases possibly a decade - ahead of it to drop its reputation as an expensive destination. Further, even three years after the great east Japan earthquake and resulting tsunami and nuclear power plant issues, some still perceive Japan to be unsafe.

The pressure is greatest on Japanese carriers. The Japanese market has been strongly loyal to them, often paying fares considerably - even ridiculously - higher than foreign peers because ANA and JAL are Japanese and offer Japanese service. Any growth in foreign visitors compensating for declining Japanese tourists will not share the same affinity for ANA and JAL. ANA and JAL are further pinched as the depreciating yen comes as they seek a larger international profile. Other carriers recognise the market was too good and they enjoyed the benefits of the high yen but now are being met with the inevitable reality.

Regional tensions have a market-by-market impact

Regional tensions are confined but continue to be a concern. The China-Japan market suffered significant decreases in Sep-2012 after Japan nationalised the disputed islands of Senkaku/Diaoyu. 1Q2014 seat capacity is still down 4.5% compared to pre-crisis levels in 2012.

China to Japan seats per week, one way by carrier: 19-Sep-2011 to 6-Jul-2014

But this does not reflect weaker load factors that airlines have expreienced, as indicated by JAL statistics below (JAL is unique in disclosing such detailed information). JNTO data shows Japanese passengers to China declined 21% in the first 10 months of 2013 (the latest data available). Oct-2013 saw 8.6% growth compared to Oct-2012, but this was after a 27% decrease in Oct-2012 compared to Oct-2011.

Oct-2013 visitors are down 21% compared to Oct-2011. Chinese visitors to Japan are down 15% in the first 10 months of 2013, but since Mar-2013 have been up a staggering 44% compared to 2011's figures - a sign of rebound on the Chinese side; a Japanese rebound awaits.

JAL monthly passengers on Japan-China routes: 2011-2013*

JAL monthly load factor on Japan-China routes: 2011-2013*

Japan and Korea meanwhile have their own territorial dispute over the Takeshima/Dokdo islands, with tensions further inflamed by other factors, including the recent visit by Japanese prime minister Shinzo Abe to the Yasukuni war shrine.

Seat capacity in 1Q2014 is down 4.3% compared to pre-crisis 1Q2013 levels.

South Korea to Japan seats per week, one way by carrier: 19-Sep-2011 to 6-Jul-2014

Japanese passengers to Korea are down 24% in the first 10 months of 2013 compared to 2012. Passenger numbers are even down in Oct-2013 whereas Japanese passengers to China in Oct-2013 recorded a slight year-on-year gain. Korean passengers are up 27% in the first 10 months of 2013, but the growth was not enough to offset declines in Japanese passengers.

The total Japan-Korea market saw 4.7 million visitors in the first 10 months of 2012 but only 4.4 million in the same period in 2013. Depending how ongoing relations evolve - the Yasukuni shrine visit has flamed feelings and is still recent - the Japan-Korea market could rebound in 2014, much faster than the Japan-China market.

Strong growth by Korean passengers has translated to some better performance by JAL than on China routes, but this is probably at the expense of yield. Asiana earlier in 2013 saw deteriorating yields to Japan. Other carriers in the market did not disclose yields but likely saw performance similar to Asiana's.

JAL monthly passengers on Japan-Korea routes: 2011-2013*

JAL monthly load factor on Japan-Korea routes: 2011-2013*

These two political conflicts are the main ones involving North Asian countries, but they are not alone. A smaller conflict between China and the Philippines emerged in 2012 as well, and there are numerous historical differences that could, very potentially, turn into another conflict. But most countries seem eager to limit the extent of such issues, seeing them as non-sequiturs that cause harm.

Positive outlook for 2014, but opportunities remain

Robustness is necessary for an industry characterised by volatility. Upsets in 2014 are, unfortunately, likely. The crises of 2013 - bird flu scare in eastern China, ongoing territorial issues - were handled well. There are still lingering impacts but a way forward can be seen. Unfortunately, it is now clouded (for some) by the declining yen and new competitors, some in the form of LCCs that carriers have not had much direct exposure to.

There is a positive outlook for North Asian carriers in 2014, but it is not as strong as it could be. 2014 may be another year of missed opportunities. Inertia is breaking, but often with changes encouraged - or requested - by governments.

Addressing LCC development, Taiwan Minister for Transportation and Communication Yeh Kuang-shih told United Daily News: "Taiwan's pace is too small". For airlines, the low-hanging growth remains the easiest.