10-May-2014 4:30 PM

Singapore Airlines incurs 4QFY2014 operating loss, adds premium economy as latest strategic response

Analysis

Singapore Airlines (SIA) continues to evolve its long-term strategy in response to challenging market conditions, which drove an operating loss for the group and parent airline for the quarter ending 31-Mar-2014. The decision to introduce a premium economy product on long-haul aircraft from 2H2015 is the latest in a growing string of initiatives aimed at improving the carrier's position.

SIA has studied premium economy for several years but repeatedly decided against a fourth class of service on long-haul flights. The group now recognises premium economy has become more mainstream and that it is necessary to be competitive, particularly in the corporate sector.

Premium economy will be introduced as SIA starts to retrofit some of its fleet with the new first, business and economy cabin products that were introduced on new 777-300ERs in late 2013. Both initiatives are part of a broader move to continue improving its service standards as competition intensifies. Increased emphasis on partnerships and a more active role in the dynamic Southeast Asian budget sector also have become important components of the still evolving SIA Group strategy.

SIA reports group and parent airline operating loss for 4QFY2014

SIA was able to again report a profit for the fiscal year ending 31-Mar-2014 (FY2014), keeping intact its remarkable record of never incurring an annual loss. But for the third consecutive year the group was in the red on an operating level for its fiscal fourth quarter. The SIA Group incurred an operating loss of SGD60million (USD47 million) for 4QFY2014 compared to an operating loss of SGD44 million (USD36 million) in 4QFY2013 and an operating loss of SGD5 million (USD4 million) in 4QFY2012.

The group was able to improve its operating profit for the year from SGD229 million (USD184 million) in FY2013 to SGD259 million (USD206 million) in FY2014. But the fact the group's operating loss widened in the final quarter of the year after recording profit gains in the first three quarters is a discouraging sign and an indication of the challenging outlook for FY2015.

SIA Group quarter by quarter operating profit: FY2014 vs FY2013

On a net level, the group's profit dropped by 5% to SGD359 million (USD285 million) for FY2014. The net figure was impacted by a SGD96 million (USD76 million) loss from investments in associate companies, with the SGD223 million (USD177 million) loss at the Tigerair Group the primary contributor. SIA has a 40% stake in Tigerair, which has embarked on a turnaround effort that will be headed by new CEO Lee Lik Hsin, a 20-year veteran of the SIA Group.

SIA Group annual net profit: FY2010 to FY2014

SIA mainline and SilkAir impacted as competition in Asia-Pacific intensifies

SIA mainline was in the red in the fiscal fourth quarter for the second consecutive year, reporting an operating loss of SGD60 million (USD47 million) in 4QFY2014 compared to an operating loss of SGD69 million (USD56 million) in 4QFY2013. SIA Cargo was also in the red while regional full-service subsidiary SilkAir eked out a small profit.

For the full year, SIA mainline saw its operating profit improve by 37% to SGD256 million (USD203 million) but this gain was wiped out by sister carrier SilkAir's 64% decline in operating profit to SGD35 million (USD28 million). SIA Cargo narrowed its losses but still ended FY2014 with an operating loss of SGD100 million (USD79 million). SIA does not provide any financial or operating figures for its other 100%-owned airline subsidiary, Scoot, but the long-haul low-cost carrier is not yet profitable.

SIA Group operating profit by subsidiary: FY2014 vs FY2013

SilkAir has been impacted by intensifying competition and over-capacity in the regional market within Southeast Asia. SilkAir's load factor slipped 4ppts in FY2014 to 69.6% and its passenger yield dropped by about 10% (see background information).

SIA has also been impacted by the regional market within Southeast Asia but is more exposed to the over-capacity and intense competition in the Southeast Asia-Australia market. There have been some improvements in the Southeast Asia-Europe market but not enough to offset the decline within Asia-Pacific. Some of the carrier's European routes remain unprofitable.

Weak Southeast Asia-Australia market impacts SIA

Point of sale group revenues in Europe increased 5% in FY2014 to SGD1.43 billion (USD1.13 billion) despite relatively flat capacity on European routes. Point of sale revenues in Australia and New Zealand (Southwest Pacific) decreased by 12% to SGD1.46 billion (USD1.16 billion) despite an increase in capacity in the Australian market.

SIA, which is the second largest foreign carrier in Australia after Emirates, has been impacted by a combination of the depreciation in the Australian dollar as well as intensifying competition. Several Southeast Asian carriers pursued ambitious expansion in Australia in 2013 including Malaysia Airlines and AirAsia X.

East Asia revenues, which includes SIA's home market of Singapore and other markets in Southeast Asia and North Asia, were up marginally in FY2014.

SIA Group revenues by area of original sale: FY2014 vs FY2013

Total group revenues were up 1% for the year to SGD15.24 billion (USD12.11 billion), including a 1% increase in SIA mainline revenues to SGD12.48 billion (USD9.92 billion). Mainline RPKs were up 1% in FY2014 while ASKs were up 2%, resulting in a 0.4ppts drop in load factor to 78.9%.

Passenger yields were down 3% in FY2014, including 1% in 4QFY2014. Monthly yields were down on a year over year basis for 11 of the 12 months in FY2014, a strong indication of the tough market conditions.

SIA monthly passenger yields (including fuel surcharge): Apr-2012 to Mar-2014

SIA mainline capacity to grow by only 1% in FY2015 but SilkAir remains ambitious

SIA expects yields to remain under pressure in FY2015 as it continues to offer promotional pricing across SIA mainline and SilkAir in a bid to maintain load factors amid aggressive competition. SIA plans to grow mainline capacity by only 1% in FY2015 as the fleet increases by two units from 103 aircraft to 105 aircraft. (Eight new aircraft are being delivered and two are being returned to SIA from sub-lessees while eight aircraft are being decommissioned for a net gain of two aircraft.)

SilkAir is planning capacity growth of 13% in FY2015 as its fleet expands from 24 to 27 aircraft, with seven 737-800s being delivered and four A320s exiting. This roughly matches the 12% ASK growth recorded by SilkAir in FY2013. About half the capacity growth at SilkAir in FY2015 will be generated by the upcoming launch of three new destinations - Hangzhou in China, Kalibo in the Philippines and Mandalay in Myanmar - while the other half will be driven by capacity increases in existing markets.

More double digit expansion for SilkAir could prove to be overly ambitious given current market conditions and the fact the capacity added by the carrier in FY2014 was not fully absorbed, as RPKs were up by only 6% in FY2014 despite the 12% increase in ASKs. SilkAir has already made some adjustments to its FY2015 capacity plan (it was previously planning to end calendar 2014 with a fleet of 28 aircraft and now plans to have only 27 aircraft at the end of Mar-2015). The group is now looking at potentially further slowing down growth at SilkAir by accelerating the retirement of A320s. This would be a sensible move.

The group for now is hoping opportunities for expansion in some markets will open up as other Southeast Asian carriers cut capacity or exit entirely. While SIA is clearly struggling, some of its competitors are in much weaker condition and have indicated they may have to cut back.

SilkAir and SIA are closely monitoring capacity adjustments by competitors and are ready to pounce. While SIA's overall mainline capacity will be up only 1% in FY2014 there will be opportunities to increase capacity in select markets as it is reducing capacity in Australia, with A380s coming off some Melbourne and Sydney flights. (SIA is introducing A380 service to Delhi and Mumbai but on these routes the jumbo jet is taking over for two 777 frequencies as there is no room for overall capacity increases in the Singapore-India air services agreement.)

Strategic changes to be implemented in a bid to improve the long-term outlook

While there is hope market conditions will improve at least slightly, SIA recognises a lot of the challenges it faces today will remain in place for the long term. The group has slowly but surely been rolling out new strategic initiatives since Goh Choon Phong took over as group CEO at the beginning of 2011.

Perhaps the biggest initiative to date has been increasing focus on the budget end of the market, where there are much bigger growth opportunities, through the establishment of Scoot and increased involvement in Tigerair. The planned 2H2014 launch of Thai long-haul LCC NokScoot, which will be 49% owned by Scoot (and therefore by SIA) is yet another step to increase SIA's role in Southeast Asia's fast-growing but increasingly competitive budget sector.

Mr Goh envisions Scoot using and leveraging Bangkok as a second hub. He pointed out at SIA's 9-May-2014 results briefing that Bangkok is a more popular destination for budget travellers than Singapore and the new Bangkok hub will be able to cater to a slightly different customer base.

SIA is also diversifying outside Singapore by establishing a new joint venture full-service carrier in India. More joint ventures or investments - either full-service or low-cost - could potentially be added in other strategic markets such as Indonesia and China.

But partnerships offer a much easier alternative for expansion in most markets. Under Mr Goh SIA has forged several new partnerships, including with Virgin Australia and more recently with Air New Zealand. Other partnerships have expanded significantly including most recently with South Korea's Asiana and Turkish Airlines. The still evolving SIA partnership strategy will be examined in a separate analysis report to be published by CAPA within the new few days.

Premium economy is another game changer for SIA

The latest strategic move from Mr Goh - and one of his biggest moves to date - is to introduce premium economy. At the 9-May-2014 briefing to discuss FY2014 results Mr Goh announced that SIA is planning to introduce a premium economy product in 2H2015. The decision to go with premium economy was made last year but SIA is still working on product details, which will be announced later.

SIA plans to eventually retrofit the economy cabins across its 777-300ER and A380 fleets to incorporate a new premium economy section (and take delivery of its next batch of five A380s with premium economy already fitted). It also plans to include premium economy on future A350s.

Economy cabin seat counts will be reduced as a result, a sensible strategy given the impact intense competition has had on SIA's economy yields and load factors. The advent of Scoot, which is planning to grow rapidly about the time premium economy will be introduced, also gives the group the ability to try to push some of its low end economy passengers to its new low-cost long-haul subsidiary.

But the key driver is the corporate sector and the increasing popularity of premium economy in some of SIA's most important markets. SIA has studied premium economy several times over the years but repeatedly decided against introducing the product, driven primarily by a fear of cannibalising business class sales. But over the years the premium economy market has gradually matured, making it less of a niche play and a product regularly requested by corporate travel buyers. SIA executives say they have identified specific market segments for premium economy, primarily the corporate and upmarket leisure sectors, and plan to offer it on long-haul and some medium-haul segments.

Premium economy positions SIA more competitively in key Australia and UK markets

SIA has seen more and more of its competitors introduce premium economy, generally with success. It could not afford to not join the party.

Australia and the UK are particularly big markets for SIA and for premium economy. With local carriers Qantas and British Airways offering premium economy, SIA has been at a disadvantage in selling to Australian and British corporates, particularly those that have put in place travel policies authorising premium economy on long-haul flights but no longer authorising business class. With Australia accounting for 18% of SIA's ASKs and the UK accounting for 9%, these markets are simply too important to miss out on any segment.

SIA competitors on routes to continental Europe also have been introducing premium economy including Air France and Lufthansa. But the biggest sway for SIA was likely archrival Cathay Pacific, which introduced premium economy in 2012.

Offering premium economy will also help SIA offer a more aligned product with some of its partners, particularly Air New Zealand and Virgin Atlantic. Air NZ plans to resume services to Singapore in late 2014 as part of a new joint venture with SIA, while SIA continues to codeshare with Virgin Atlantic on services from London to North America. (Virgin Atlantic does not serve Singapore.) Several other SIA partners also offer premium economy although generally on a more limited selection of routes, including All Nippon Airways, EVA Air, SAS, Turkish Airlines, and Virgin Australia.

SIA continues to invest in full-service proposition

Premium economy joins other initiatives aimed at making sure SIA retains its position as a leading premium player. While SIA is keen to continue increasing its involvement in the faster growing budget sector, it is not taking its eye off the top end of the market.

In Sep-2013 SIA introduced a new generation of economy, business and first class cabin products, which the carrier initially committed to installing on a batch of eight additional new 777-300ERs (three of which were delivered in FY2014 with three more slated to be delivered in FY2015). On 9-May-2014, SIA announced plans to retrofit all 19 its earlier 777-300ERs with the new products. The retrofits will begin in early 2015 and be completed by Sep-2016, a schedule which should allow some of the aircraft to be simultaneously retrofitted with premium economy.

SIA has not yet committed to retrofitting its A380s or installing the same products on its A350s, which will be delivered from 2015. But SIA is investing in designing new medium-haul cabin products for the A350s, which will mainly be used to replace A330s on regional routes, and is now studying product options for its new batch of five A380s that are slated to be delivered from 2017. SIA is likely to refrain from installing its latest generation of cabin products on its 19 existing A380s and instead wait to retrofit these aircraft with whatever product is ultimately selected for the five additional A380s.

But in the interim, SIA will retrofit its 19 existing A380s to accommodate the new premium economy cabin. Waiting to retrofit the entire aircraft is not a serious issue as the product introduced in 2013 only marked a slight improvement compared with the previous generation, which was introduced in late 2006.

Also under its goal of maintaining product leadership and service excellence, SIA is investing in lounge upgrades, enhancing its frequent flyer programme and training frontline staff to deliver a more proactive and personalised customer experience. In addition SIA is in the process of redesigning its website.

Strategic shifts should improve SIA's position over the long-haul

SIA still has huge challenges to overcome as it operates in an extremely competitive environment that will likely only become tougher over time. It is not easy to chart ways through the current turbulent environment, with large levels of low priced capacity and new entry in local markets, along with increasing premium competition on long-haul. Singapore Airlines has relied for decades on providing a high quality, high yielding product and has shown great reluctance to move far from that position. Caution has been the byword.

But today maintaining the status quo is certainly not a viable option. Diversifying outside the relatively mature Singapore market with new overseas joint ventures; diversifying outside the relatively mature full-service sector with budget subsidiaries; and diversifying the product mix with premium economy are all steps in formulating new directions.

Much of this movement is inevitably experimental, as the sands of competition are constantly shifting. Pragmatism is a trait that is coming gradually to Singapore Airlines; it is a characteristic that will be greatly needed in future.

Background information

SIA Group financial highlights: FY2014 vs FY2013 and 4QFY2014 vs 4QFY2013

SIA mainline and SilkAir operating highlights: FY2014 vs FY2013 and 4QFY2014 vs 4QFY2013