30-Jan-2014 9:00 AM

Philippine Airlines defers Cambodian joint venture. Does Cambodia (or PAL) need a new carrier?

Analysis

Philippine Airlines (PAL) has shelved its planned affiliate in Cambodia nine months after signing a joint venture agreement with a local partner to launch Cambodia Airlines.

Cambodia Airlines was intending to compete in Cambodia's tiny domestic market, which is now only served by Cambodia Angkor Air, and the country's fast-growing international market starting with a new link to PAL's hub in Manila. But its launch, originally planned for mid-2013, was repeatedly delayed as the PAL Group and parent San Miguel re-examined the viability of the project.

The deferral and likely abandonment of the project makes sense as establishing a new carrier in Cambodia would be a risky proposition. The Cambodian market is growing rapidly but is unlikely to support a second full-service carrier. For PAL the group has a lot on its plate and does not need the distraction of an overseas venture.

This is the second in a two-part series of analysis reports on the Cambodian market. The first report analysed the rapid growth in the Cambodian market, driven by expansion at Cambodia Angkor Air and foreign carriers, as well as the outlook for 2014. This report looks at proposed start-up Cambodia Airlines and whether the market needs a second full-service carrier.

Cambodia Airlines' planned 2013 launch never materialised

Cambodia Airlines was first unveiled in Apr-2013 as a joint venture between PAL, which has been controlled by Philippine conglomerate San Miguel since 2012, and leading Cambodian investment company Royal Group of Cambodia. After signing the joint venture agreement at the beginning of Apr-2013, the two shareholders stated they intended to launch Cambodia Airlines in the domestic market as early as Jun-2013 with a fleet of two Bombardier Dash 8s sourced from the PAL Group. International services were expected to start in Oct-2013 with an initial fleet of two A321s, which were also to be sourced from PAL's existing fleet and order book.

While the project was subsequently delayed, the PAL Group continued to maintain it was committed to launching the airline. In Aug-2013 a revised closing date for the transaction of Oct-2013 was provided, which suggested the airline could still potentially launch by the end of 2013. But the Oct-2013 deadline was missed, making it impossible for Cambodia Airlines to launch for Cambodia's peak season, which is in the northern hemisphere winter months.

PAL and San Miguel president Ramon Ang continued to express optimism in 4Q2013 that the Cambodian carrier would still be launched. But in a U turn, Mr Ang acknowledged to Philippine media in late Jan-2014 that the Cambodian project was deferred while the group studies the viability of the project.

Potential political instability was a factor in deferring Cambodia Airlines project

PAL expressed concerned about the threat of political instability. Cambodia has been stable for several years, providing a foundation for rapid economic growth, but saw a spate of at times violent protests in Jan-2014. The opposition could be plotting a bigger response as it continues to protest low garment worker wages and the Jul-2013 elections, which were won by the ruling party.

However the long-term outlook for the Cambodian aviation market remains bright. Cambodia has emerged as one of Asia's most popular and fastest growing tourist destinations.

Political instability could create a blip but - as the tourism industry in neighbouring Thailand has proven again and again - the market will likely recover. So far tourists have shown no signs of cancelling trips to Cambodia despite the recent protests. Visitor arrival figures at Cambodia's airports were reportedly up 26% year-over-year in the first three weeks of Jan-2014.

Fast-growing Siem Reap has bright outlook

Almost 60% of visitors arriving in Cambodia by air land at the tourist town of Siem Reap rather than the capital Phnom Penh. Siem Reap has seen faster growth than Phnom Penh and would not likely be impacted by any political instability. As CAPA reported in the first instalment of this series, Siem Reap has been one of Asia's fastest growing airports with passenger traffic having more than doubled since 2009 to 2.7 million passengers in 2013.

Siem Reap annual passenger traffic: 2008 to 2013

The Cambodian market, particularly Siem Reap, is poised for more growth in 2014. Five foreign carriers began serving Siem Reap in 4Q2013 while Cambodia Angkor Air is in the process of expanding its Siem Reap network from three to eight destinations in a period of just five months (Sep-2013 to Feb-2014).

North Asia is accounting for most of the growth at Siem Reap, particularly China. Four of the five new carriers serving Siem Reap are from North Asia - including two from Korea, one from China and one from Hong Kong. All of Cambodia Angkor Air's five new Siem Reap routes are to mainland China.

Rapid growth can continue without launch of a new Cambodian airline

While there are opportunities for more new services, there is not necessarily a need for a new Cambodian carrier. The growth in demand can easily be met by Cambodia's existing and foreign carriers.

As Cambodians account for less than 20% of total airport passenger traffic in Cambodia, foreign carriers are particularly well placed to respond to the surging inbound demand. Foreign carriers are generally able to achieve larger economies of scales and leverage their strong brands at point of sale. As Cambodia is a seasonal market, foreign carriers are also able to more easily adjust capacity than Cambodian carriers to meet fluctuations in demand as they can redeploy capacity to other markets during the off-peak months.

The Cambodia Airlines project envisioned economic growth leading to more air travel by Cambodians, particularly in the domestic market. But income levels remain very low in Cambodia and a middle class has not yet developed as it has in other Southeast Asian countries.

Cambodian domestic market will remain small

There are opportunities in the domestic market but they are limited. There were only about 180,000 scheduled domestic passengers in Cambodia in 2013 - all of which were flown by Cambodia Angkor Air using the carrier's ATR 72 turboprop fleet. Cambodia's domestic market has only grown modestly over the past two years. Before that the market shrunk slightly. In 2007, when there was competition in the domestic market, there were also about 180,000 domestic passengers in Cambodia. As CAPA reported in Jan-2013:

Cambodia Angkor Air's monopoly on the domestic market has led to high fares and no growth since the carrier launched services in 2009. ... Cambodia's domestic market could use competition, particularly as tourism in the country continues to grow and Cambodia is promoted as a destination in itself rather than packaged with Thailand or Vietnam as traditionally has been the case. For tourists to combine Cambodia's famous temples at Angkor Wat with the unspoiled beaches Sihanoukville - instead of with the beaches of Thailand - domestic connectivity needs to improve. The huge potential of Sihanoukville, where projects are underway to improve the area's limited tourism infrastructure including roads and hotels, cannot be untapped without more air services.

The Cambodia Airlines business model envisioned stimulating demand in the domestic market by bringing competition to Cambodia Angkor Air's two domestic routes - Siem Reap to Phnom Penh and Sihanoukville - and opening up new domestic markets such as Battambang and Ratanakiri.

Long and arduous bus journeys are common in Cambodia. Flying may be more appealing but is not affordable to the overwhelming majority of the country's 15 million people. New flights could open up more remote areas for tourists but for now the infrastructure - including roads, hotels and steady electrical supply - are lacking outside Siem Reap and Phnom Penh. Even in the beach town of Sihanoukville, where a new airport opened seven years ago, the market has been very slow to develop due primarily to a lack of infrastructure.

There are over 15 airports in Cambodia but only three currently have scheduled service. The country's other airports, including Battambang and Ratanakiri, are served only by small charter or air taxi operators such as Aero Cambodia.

Cambodia's airports

Cambodia domestic market needs small turboprops rather than PAL's Dash 8s

While there is potential for more scheduled domestic services, routes other than Siem Reap to Phnom Penh and Sihanoukville are not large enough to support larger turboprop aircraft such as Dash 8s or ATR 72s. PAL had been looking to move over to Cambodia two Dash 8s currently operated by PAL Express. According to the CAPA Fleet Database PAL Express currently operates five 76-seat Dash 8-Q400s and four 50-seat Dash 8-Q300s.

Smaller 19-seat or 30-seat turboprops are a more logical option for seeding the Cambodian domestic market. New domestic destinations are unlikely to support 50 or 70-seat aircraft for at least a few more years. Sihanoukville, which has great potential as a beach destination, also could support more frequent service with smaller aircraft. Cambodia Angkor Air currently only operates one daily flight to Sihanoukville but has six daily flights between Siem Reap and Phnom Penh.

Cambodia Airlines would have also been able to use its proposed fleet of Dash 8s to serve short-haul international markets including Thailand, Vietnam and Laos. But these markets are competitive and smaller domestic markets would be challenging.

Cambodia's international market also does not need a new Cambodian airline

There would be opportunities to use A320s to pursue growth in the Cambodia-China market, but this also has become very competitive with Cambodia Angkor Air now serving four Chinese cities with a fifth, Fuzhou, to be added in Feb-2014. Five Chinese carriers also serve this market and have a competitive advantage as it is predominately an outbound China market dominated by agents selling packages.

Another larger market from Cambodia, Korea, is already served by five Korean carriers and small Cambodian carrier SkyWings Asia Airlines. Three Thai carriers and three Singaporean carriers also already serve Cambodia. In total there are currently 27 foreign carriers serving Cambodia, accounting for about 84% of international seat capacity.

Cambodia international capacity share (% of seats) by carrier: 27-Jan-2014 to 2-Feb-2014

The 13% share from Cambodia Angkor Air and 3% share from SkyWings are modest and will likely grow. But foreign carriers have a competitive advantage in serving the Cambodian market given their larger scale and the fact the market has seasonal fluctuations and consists predominately of inbound tourists.

A new Cambodian carrier would face challenges expanding to a sustainable size and likely make it more difficult for the existing local carriers rather than succeed at taking significant market share away from foreign carriers. There are opportunities for Cambodia Angkor Air and SkyWings to expand their networks but the prospect of competing against Cambodia Airlines would have significantly diminished the outlook for all Cambodian carriers. There was already one airline casualty in Cambodia in 2013, as small charter carrier Tonelsap Airlines ceased operations.

Cambodia Angkor Air top seven international routes ranked by seat capacity: 27-Jan-2014 to 2-Feb-2014

PAL could use feed but transit traffic from Cambodia would be limited

PAL was particularly keen to open a new link between Phnom Penh and Manila. Phnom Penh-Mania would have likely been Cambodia Airlines' first international route. PAL was also looking at operating the route ahead of its proposed Cambodian sister carrier starting its own A320 operation.

Currently the only flight linking the Philippines and Cambodia is a service from Manila to Siem Reap which was launched by Philippine LCC Cebu Pacific Air in Apr-2012. Cebu Pacific launched the route with three weekly flights and added a fourth frequency in Dec-2013.

Cambodia-Philippines is a small market, with Filipinos accounting for only 109,000 visitors in the first 11 months of 2013, according to Cambodia Ministry of Tourism data. Cebu Pacific has successfully stimulated demand as there were only 63,000 Filipino visitors to Cambodia in the first 11 months of 2011, when there were no direct flights between the countries. But the opportunities for additional stimulation would likely be relatively limited.

PAL would rely heavily on transit passengers for the Manila-Phnom Penh route and viewed Cambodia Airlines as a potential feeder as PAL pursues rapid expansion of its international network. But the opportunities to use Cambodia Airlines to feed PAL's long-haul network would have been rather limited as the Philippines is not well geographically positioned to serve Cambodia's traditional source market of Europe.

PAL launched London in Nov-2013 and plans to add more European destinations in 2014. It also launched services in late 2013 to four Middle Eastern destinations. PAL can use feed for all of its new long-haul routes but Cambodia would not be an option as it is west of the Philippines.

There could be some opportunities to serve Japan and North America, both of which are relatively large source markets for Cambodia. But these markets are highly competitive with other carriers, particularly Korean Air, offering more convenient connections and having a more widely recognized brand overseas.

The reality is Cambodia does not need a large national carrier, even under a politically stable environment. One smallish flag carrier and a couple of other small niche carriers, following regional or leisure/charter models, should suffice. Cambodia Angkor Air, which is a joint venture with Vietnam Airlines, already has rather ambitious expansion plans. Overlap with Cambodia Airlines would be inevitable, leading to overcapacity in some markets.

Cambodia could instead use more LCC capacity

Cambodia could use competition in the domestic market and there are opportunities for smaller regional carriers to emerge and fill this role. In the international market, there is sufficient competition in most international markets. The only major exception is Vietnam-Cambodia, which is dominated by the Cambodia Angkor Air and Vietnam Airlines combination. But fast-expanding Vietnamese LCC Vietjet Air could enter and provide some needed balance.

There are opportunities generally for LCCs to expand in Cambodia. The nine LCCs serving Cambodia currently only account for 18% of total international capacity. There are no LCCs currently operating in Cambodia's largest market, Vietnam. There is only one LCC, Spring Airlines, accounting for only about 6% of Cambodia's fastest growing market, China.

Cambodia LCC capacity by carrier: 27-Jan-2014 to 2-Feb-2014

Rank	Airline		Total Seats
1	FD	Thai AirAsia	7,560
2	AK	AirAsia	7,560
3	3K	Jetstar Asia	3,600
4	TR	Tigerair	2,880
5	ZE	Eastar Jet	2,604
6	BX	Air Busan	1,560
7	LJ	Jin Air	1,504
8	9C	Spring Airlines	1,440
9	5J	Cebu Pacific Air	1,432

Asian LCC groups have looked at Cambodia but have concluded the market is too small to support a local LCC. The domestic market is tiny and at this point can only be viably served with turboprops. The international market is bigger - about 5 million passengers in 2013 - but is not big enough to support the minimum fleet size carriers generally need to successfully follow the LCC model.

Asian LCC groups can meet most of the potential demand in Cambodia by using existing subsidiaries or affiliates. AirAsia Group, which is already the largest LCC brand in Cambodia with a 50% share of LCC capacity and about a 9% share of total international capacity, already serves Phnom Penh and Siem Reap using its Malaysian and Thai affiliates. But AirAsia's Indonesian and Philippine affiliates do not yet serve Cambodia.

Jetstar only serves Phnom Penh and Siem Reap from Singapore but could potentially add services from Vietnam, Japan and potentially Hong Kong. Tigerair only serves Phnom Penh from Singapore but also has affiliates in Indonesia and soon Taiwan. Lion, Asia's second largest LCC group after AirAsia, does not yet serve Cambodia but could potentially serve the market from Malaysia, Thailand and Indonesia.

Foreign airlines well placed to meet most of the expansion opportunities in Cambodia

More foreign carriers, particularly LCCs, will be attracted to the Cambodian market as the country's tourism sector continues to grow rapidly. More Chinese carriers - and more capacity from the five Chinese carriers serving Cambodia - are likely as China is the fastest growing source of visitors, including 40% growth in the first 11 months of 2013.

The launch of service from a Japanese carrier is also a possibility as Japan is the largest market without a direct flight. Japan is the sixth largest source of tourists for Cambodia, with 185,000 visitors in the first 11 months of 2013, representing a 16% increase over the same period of 2012.

There are also opportunities for growth in the international market for Cambodian carriers but these can be met by the existing carriers, Cambodia Angkor Air and SkyWings Asia. Cambodia Angkor Air's fleet plan envisions doubling its A320 family fleet to six aircraft over the next two years, which will enable significant expansion with a focus on North Asia.

Philippine Airlines has other bigger priorities to contend with

While PAL has enough aircraft commitments to support a new overseas venture, the group is better off focusing on reducing expenditure and improving profitability of its Philippine operation. In recent months the group has added three destinations in Australia, five in the Middle East, one in Europe and several within Asia. One of the Australian destinations has already been cut while a planned sixth Middle Eastern destination was pulled prior to launch. Further long-haul expansion is expected in 2014, including up to three destinations in continental Europe. Trying to also juggle the launch of an overseas affiliate would pose a distraction, draining resources and the attention of management when significant work is required at home.

PAL needs to focus on maturing all of its new markets and building up its Manila hub. It also has a need to forge new partnerships to help market its new long-haul flights and virtually expand its network. Japan's All Nippon Airways (ANA), which looked at buying a stake in PAL in 2013 before talks fizzled, is a logical first new partner for PAL. ANA could help support PAL's expansion in Japan, which includes the launch of services to Tokyo Haneda at the end of Mar-2014 and capacity increases to its four existing Japanese destinations, and provide connections beyond Tokyo.

PAL is not in a global alliance and has a limited number of codeshare partners. Expanding its partnership portfolio is much more pressing than building its own empire with overseas affiliates. Cambodia may be a growing market with opportunities but is small and can barely support additional capacity to the Philippines yet alone a new full-service airline.

PAL's decision to shelve and question the viability of its Cambodian joint venture project is the right move. The group should focus on the Philippine market, where it has opportunities but challenges including stiff competition from LCCs. It should avoid the temptation of revisiting the Cambodian project or pursuing any other potential overseas joint venture.