26-Mar-2015 12:00 PM

Thai Airways embarks on major network and fleet restructuring but long-term challenges remain

Analysis

Thai Airways is moving forward with a major restructuring aimed at improving the carrier's long-term outlook after incurring more than USD700 million in operating losses over the last two years. Thai has accelerated the phase out of A340-600s and Boeing 747-400 aircraft and is dropping freighter operations entirely as it cuts long-haul capacity.

The flag carrier has so far decided to axe three of its 15 long-haul passenger destinations. More network reductions are expected as the airline shrinks its widebody fleet by 17 aircraft over the next several months.

Most of the upcoming capacity cuts will focus on Europe, where Thai has been impacted by intensifying competition from Gulf carriers. The group strategically needs to maintain its presence in Asia-Pacific, particularly in the fast-growing Chinese and Japanese markets, but should down-gauge several underperforming regional routes by transferring them to regional subsidiary Thai Smile.

This is the third instalment in a series of reports on the Thai market. The first report analysed the outlook for Thai Airways full-service regional subsidiary Thai Smile including its potential role in the restructuring at its parent. The second report looked at the outlook for Thailand's other full-service carrier, Bangkok Airways, as expansion at its airport on the popular tourist island of Samui is pursued.

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Thai Airways market share drops as LCCs expand

In 2014 Thai Airways and Thai Smile combined accounted for about a 28% share of passengers in the Bangkok market, which includes both Suvarnabhumi and Don Mueang airports. This compared to around a 31% share of the Bangkok market in 2013.

Thai Airways has been steadily losing market share to LCCs over the last decade but the trend accelerated in 2014 as market conditions became challenging due to the prolonged period of civil unrest. LCCs accounted for 35% of total passengers in the Bangkok market in 2014 compared to 28% in 2013, based on Airports of Thailand data.

The overall Bangkok market grew by only 0.2% in 2014 to 68 million passengers. But LCCs recorded 25% growth to about 24 million passengers, driven primarily by domestic expansion at Nok Air, Thai Lion Air and Thai AirAsia.

FSC traffic in the Bangkok market dropped 9% in 2014 to about 44 million passengers, driven primarily by a sharp reduction at Thai Airways. Foreign carriers also saw their traffic to Bangkok slip as the civil unrest impacted inbound demand while Thai Smile and independent full-service carrier Bangkok Airways recorded increases.

As CAPA previously highlighted, Thai Airways reported in Jan-2015 an alarming 17% drop in passenger traffic for 2014 to 17.76 million passengers (excluding passengers flown under the Thai Smile operators' certificate). RPKs were down 11% as Thai cut mainline capacity by 5%, resulting in a 6.8ppt drop in load factor to only 69%.

Annual passenger numbers fell to the lowest level since 2004 while 2014 marked the first time in at least 10 years that Thai's load factor was below 70%. Thai's passenger numbers are now below pre global financial crisis levels and are unlikely to again exceed the 20 million mark given the current restructuring initiative.

Thai Airways annual passenger numbers: 2008 to 2014

Thai Airways annual load factor: 2008 to 2014

Thai Airways does not breakdown its traffic by airport but about 99% of its seat capacity is currently allocated to its hub at Bangkok Suvarnabhumi. The carrier currently only operates two point to point routes which bypass Suvarnabhumi - a daily service from Phuket to Hong Kong and a three times weekly service from Phuket to Seoul. Thai is cutting Phuket-Seoul from 29-Mar-2015 as part of its network restructuring initiative.

Thai Airways was highly unprofitable in 2014

The Thai Airways Group incurred a net loss of THB15.612 billion (USD482 million) for 2014, compared to a net loss of THB12.047 billion (USD392 million) in 2013. Its loss before one-time charges for 2014 was THB23.019 billion (USD710 million) as Thai benefited from currency gains. USD accounts for 61% of Thai's expenses but only 30% of its revenues.

Thai's operating loss on an EBIT basis widened from THB2.896 billion in 2013 (USD94 million) to THB16.944 billion (USD523 million) in 2014. Revenues dropped 10% to THB191.266 billion (USD5.90 billion) as inbound demand was impacted by the prolonged period of instability. Passenger revenues were down by 10% to THB154.881 billion (USD4.78 billion).

Thai has been highly unprofitable since early 2013 and has now incurred operating losses in seven consecutive quarters. Over these quarters the group has accumulated operating losses exceeding THB23 billion (USD723 million).

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More losses are expected in 2015, although should be significantly reduced as the airline benefits from lower fuel prices and higher load factors. Thai Airways is now aiming to return to the black in 2016 and emerge from its current restructuring as a leaner and more productive company that would be capable of being profitable on a sustainable basis even as competition continues to intensify.

Over the years the group's financial results have been partially impacted by events out of its control such as civil unrest and flooding. But profits overall have come down as competition has intensified with LCCs in the domestic and regional markets and with Gulf carriers in the Thailand-Europe market

Thai Airways annual net loss (in THB, billions): 2008 to 2014

Thai Airways annual operating loss (in THB, billions): 2008 to 2014

European cuts are inevitable as Thai focuses more on China and Japan

Europe remains Thai's biggest market, accounting for only 14% of passengers but 36% of RPKs in 2014. Europe is primarily an inbound market with the Euro accounting for 26% of the group's revenues in 2014.

Europe continues to be a major source market for Thailand's tourism sector, accounting for 28% of all visitor arrivals at Bangkok's two airports in 2014. European visitor arrivals at Bangkok dropped by 5% in 2014 to 4.33 million passengers, according to Thailand Ministry of Tourism data. The European market held up relatively well as total visitor arrivals at Bangkok's two airports declined by 11% in 2014 to 15.52 million, driven by a 15% drop in arrivals from other East Asian countries.

But Asia is where the largest long-term growth opportunities are, particularly China and Japan. While Bangkok's two airports saw a 12% drop in visitor numbers from China in 2014, visitor numbers from China have spiked in recent months. Japan meanwhile has also seen a partial recovery in inbound numbers after an 18% drop in 2014 along with rapidly growing demand for outbound travel from Thailand.

Thai faces growing competition in the Thailand-China and Thailand-Japan markets, including from LCCs. But these are important growth markets that Thai sees as strategically critical to maintain. Thai currently serves eight destinations in China and six in Japan (a small number of services to secondary Chinese cities are operated using Thai Smile A320 aircraft).

But Europe is not a growth market and Thai has been waging a losing battle in trying to maintain its slice of the pie. The group is better off cutting back in Europe and focusing on routes which are still sustainable in the current environment.

Competition in the Europe-Thailand and broader Europe-Southeast Asia market has intensified as Gulf carriers have pursued ambitious expansion in Thailand and the rest of Southeast Asia. Emirates, Etihad and Qatar Airways currently provide about 44,000 one-way weekly seats in the Thailand market. A majority of their Thailand-bound passengers originate in Europe.

Thai Airways currently provides 34,000 weekly one-way seats to Europe, according to CAPA and OAG data. But its capacity to Europe will be reduced as it cuts two of its destinations and reduces frequencies or down-gauges to smaller widebody aircraft on some of its remaining 11 destinations.

European cuts start with Moscow and Madrid

Thai Airways is dropping service to Moscow on 29-Mar-2015 and has decided to suspend services to Madrid from 06-Sep-2015.

Moscow is a logical cut given the economic and political situation in Russia. Thai also faces intense competition in the Russia-Thailand market from Russian carriers, which have an advantage as the market consists almost entirely of Russian tourists. Three Russian carriers (Aeroflot, S7 and Transaero) currently provide 18,000 weekly one-way seats to Thailand, according to CAPA and OAG data.

Madrid is also a logical cut given the relative weakness of the Spanish economy and outbound market. Thai's withdrawal leaves Air China and Korean Air as the only Asian carriers in the Madrid market. Air China and Korean rely primarily on outbound demand as Spain has emerged as a popular tourist destination for Koreans and particularly mainland Chinese.

More cuts to the European network are expected. The suspension of Madrid and Moscow still leaves Thai with 11 destinations in Europe - Brussels, Copenhagen, Frankfurt, London Heathrow, Milan, Munich, Oslo, Paris, Rome, Stockholm and Zurich. Thai still has the second largest European network among Asian flag carriers after Singapore Airlines, which currently serves 13 destinations in Europe. In late 2014 Thai wisely dropped plans to launch services to Dusseldorf, which would have been its third destination in Germany and 14^th in Europe.

Competition in the Scandinavian market has particularly intensified by the 2013 launch of services to Bangkok by Norwegian's new long-haul low-cost operation. Norwegian currently competes against Thai on all three of Thai's Scandinavian routes - Bangkok to Copenhagen, Oslo and Stockholm. The Gulf carriers and Scandinavian Airlines also compete in the Thailand-Scandinavia market.

Brussels could also be a difficult market to sustain given its small size. Thai Airways and Hainan Airlines are currently the only airlines from East Asia serving Brussels but Brussels is served by all three of the main Gulf carriers.

Thai's only remaining long-haul destination outside Europe, Los Angeles, could also potentially be cut as the airline continues to implement its network restructuring initiative. Thai currently operates four weekly weekly to Los Angeles via Seoul.

Thai has already cut Johannesburg, which along with Los Angeles had been its only destination outside Asia-Pacific or Europe. Thai's last flight to South Africa operated on 15-Jan-2015.

CAPA previously highlighted Johannesburg as a likely route to be suspended as it has been consistently unprofitable. Thai reported an average load factor of only 57.3% in 2014 for its only African route.

Regional routes more likely to be handed to Thai Smile than cut entirely

Some adjustments on short and medium-haul routes within Asia-Pacific are also expected as Thai continues to restructure its network. So far Thai has so far identified only one regional route for the axe, Phuket-Seoul, which will be suspended from 29-Mar-2015.

Thai is particularly keen to maintain its presence in China and Japan. Routes in other Asian markets could be cut but it is more likely such routes will be handed to Thai Smile rather than eliminated entirely.

Thai Airways has stated it is looking to cut about 20 unprofitable routes in 2015. This would suggest another 16 of its nearly 70 international routes could be cut beyond the four which have already been identified. But this figure almost certainly includes routes that will instead by operated by Thai Smile.

Thai is already planning to transfer back to Thai Smile several international routes which Thai Airways has been temporarily operating over the last year with five A320s that were initially intended for Thai Smile. Thai Smile secured its own air operators' certificate (AOC) in 2Q2014, enabling it to transition from a unit flying under the TG code to a subsidiary flying under the WE code. But some of its international routes had to be temporarily transferred to Thai Airways as it was unable to secure the required traffic rights and permits from foreign authorities. As CAPA reported in the last instalment in this series, Thai Smile plans to take back these flights along with the five A320s that are now under the Thai Airways AOC by the start of the northern winter schedule in late Oct-2015.

There are also a handful of regional routes that are now operated by Thai Airways with widebodies but are more sustainable with smaller aircraft. In some cases Thai Airways could retain frequencies during peak hours while handing off peak frequencies to Thai Smile.

Since it was initially launched in mid-2012 Thai Smile has already taken over several domestic routes from Thai Airways. In its 4Q2014 results presentation Thai Airways stated its domestic capacity is down to just under 100,000 weekly seats in the current northern winter schedule compared to about 162,000 weekly seats in its winter schedule from one year ago.

But Thai has only reduced its international seat capacity by about 4% from about 422,000 weekly seats in its northern winter 2013/2014 schedule to about 406,000 seats in its northern winter 2014/2015 schedule. Thai is expected to pursue a much steeper reduction in its international seat capacity for the northern winter 2015/2016 schedule.

But the upcoming capacity cuts will be partially offset by an increase in international seat capacity at Thai Smile. Thai Smile currently primarily operates domestic services as most of its international routes are temporarily flown using the five A320s under the Thai Airways AOC (although some of these services are branded Thai Smile and use Thai Smile crews).

Thai Smile accounted less than 2% of the group's ASKs in 2014

Thai Smile carried 1.34 million passengers in 2014, based on group traffic figures in the Thai Airways results presentation for 4Q2014. This only includes passengers flown under its own AOC; about another 1 million passengers were carried under the Thai Smile brand using the Thai Airways AOC.

Almost all of Thai Smile's passengers board or disembark in Bangkok as the airline only operates one route bypassing Bangkok, a daily service connecting Chiang Mai and Phuket. But it does now have two hubs in Bangkok including a small but growing operation at Bangkok Don Mueang.

Thai Smile passenger numbers for 2013 were not reported as Thai Smile at the time was still a unit flying under the Thai Airways AOC. Combined Thai Smile and Thai Airways flew 19.10 million passengers in 2014. This marked a 9% drop compared to the 21.51 million passengers from 2013, when all of Thai Smile passengers were counted under Thai Airways.

Total RPKs for Thai Airways and Thai Smile were down 9.9% in 2014 while ASKs were down 3.1%. The combined load factor for the two airlines was 68.9%, representing a 5.2ppt drop compared to 2014.

Thai Airways Group operating highlights: CY2014 vs CY2013 and 4Q2014 vs CY2013

Thai Smile flew 817 million RPKs in 2014 and 1.317 billion ASKs, giving it an average of load factor of 62%. The low load factor is likely a reflection of the intense competition in the domestic market, which suffered from overcapacity in 2014 as LCCs pursued rapid expansion. As previously stated, most of Thai Smile's capacity is currently allocated to the domestic market as a majority of its international routes are now being flown by the five A320s under the Thai Airways AOC.

Thai Smile should see an improvement in load factor as it takes over more international routes, including flights that will be down-gauged from Thai Airways widebody aircraft. The portion of ASKs at Thai Smile will also increase significantly as Thai Smile takes over more international routes and expands its fleet from 13 aircraft currently to 20 at the end of 2015 (includes two new deliveries and five aircraft being transferred from the Thai Airways AOC). In 2014 Thai Smile only accounted for 1.6% of the group's ASKs. (Note: Thai Airways Group figures do not include Nok as Thai only has a 39% stake in Nok.)

Thai Airways has indicated it will cut ASKs over the next several months by up to 20%, driven primarily by reductions across its long-haul network. But the cuts will be partially offset by further expansion at Thai Smile as was the case in 2014, when Thai Airways ASKs were down by 4.7% but group ASKs were down by 3.1%.

Thai Airways accelerates 747-400 and A340-600 phase outs

The capacity cuts at the mainline brand will be implemented as Thai Airways reduces its widebody fleet. The group ended 2014 with a fleet of 102 aircraft, including 19 narrowbodies and 83 widebodies. Thai has said it expects to end 2015 with fewer than 90 aircraft, including 22 narrowbodies. As a result Thai's widebody fleet should be cut in 2015 by more than 15 aircraft.

So far Thai has identified 22 aircraft to be phased out in 2015, including six A330-300s, six A340-600s and 10 747-400s (eight 747-400 passenger aircraft and two 747-400 freighters). The A330-300 retirements were already part of Thai's previous fleet plan while the phase-out of the A340-600s and 747-400s fleets have been accelerated as part of the new transformation plan.

The previous fleet plan did not earmark the 747-400 fleet for retirement until the end of the decade, with an initial two aircraft slated to be phased out in 2017. But as CAPA highlighted in Apr-2014, Thai had been looking previously at moving up four to six 747-400 retirements to 2015. The airline's new management team has accelerated this further and is now aiming to phase out 10 747-400s in 2015, including eight passenger aircraft and its only two freighters. This would leave Thai with only four remaining 747-400s.

Retaining only four 747-400s, which Thai now plans to phase out in 2017 and 2018, makes little sense, particular as fleet simplification is a major component of the Thai transformation plan. Thai will inevitably relook at accelerating the phase out of its last 747-400s to 2016. This could be a painful exercise because while the overall 747-400 passenger fleet is over 20 years old on average these four aircraft are between 11 and 14 years old. But the benefits of phasing out 747s entirely are clear.

Meanwhile, the phase out of the A340-600 fleet has been accelerated significantly as the previous version of Thai's fleet plan did not envision phasing out the type until next decade. While Thai phased out its fleet of A340-500s, which had been used for non-stop services to the US, in 2011 it was initially intending to retain its A340-600s for several years as the aircraft are still relatively young.

Thai's A340-600 fleet is only nine years old on average with some aircraft being only six years old, according to the CAPA Fleet Database. But the four-engine aircraft, which Thai configures with only 266 seats, is highly inefficient even with the reduction in fuel prices. With the A340-500s already phased out at a relatively young age it makes sense for Thai to entirely remove the A340 family.

Thai uses its A340-600s and 747-400s on long-haul services to Europe as well as some regional flights within Asia-Pacific including Australia. Thai will need to cut capacity to Europe as it removes from service six A340-600 and eight 747-400 passenger aircraft. But such cuts are feasible as Thai has a pressing need to adjust its European operation in response to current market conditions.

Thai also plans to suspend freighter operations at the end of Mar-2015 as its two 747-400 freighters are removed from service. This is also a sensible move given the challenging conditions in the cargo market. Thai a few years ago removed 777 freighters, which had been wet-leased from a US-based operator.

Thai's widebody fleet to shrink by nearly 20 aircraft in 2015

If all the phases-outs are completed as currently planned Thai's widebody fleet will be reduced by 17 aircraft in 2015 when also factoring in Thai's commitment to taking delivery of two additional 787-8s and three additional 777-300ERs. This would give Thai a fleet of 88 aircraft at the end of 2015, including 66 widebody aircraft (34 777s, 16 A330-300s, six 787-8s, six A380s and four 747-400s) and 22 narrowbodies (20 A320s and two 737-400s).

Thai Airways Group fleet: as of 31-Dec-2014

Thai Airways aircraft phase out plan: 2014 to 2018

Thai Airways new aircraft delivery plan: 2014 to 2018

Thai Airways has not pursued any delivery deferrals as part of its current restructuring. But there was little need to pursue deferrals or adjust its new aircraft commitments given its relatively small order book.

Besides the A320s, 787-8s and 777-300ERs that were committed for 2015 (which were to near-term to defer), the group only has 14 outstanding orders including two 787-9s and 12 A350-900s. The A350 deliveries are slated to begin in Jun-2016 and be completed in May-2018 while both 787-9s are slated to be delivered in 2017.

Thai could potentially place orders for additional 787s, A350s or 777s as replacements for some of its older 777s and, eventually, for growth. But such decisions are not expected until after the airline fully recovers.

Thai's 787s are used regionally as the aircraft have its regional rather than long-haul lie-flat business class product. But as Thai accelerates retirement of its A340s and 747s the 787s could emerge as a potential solution for maintaining its thinner European routes.

Transferring the 787s to long-haul low-cost start-up NokScoot would also be a possibility. Maintaining both 787s and A350s is not logical given the small size of each fleet (eight 787s and 12 A350s) and Thai's focus on fleet simplification. NokScoot plans to launch services in May-2015 with an initial fleet of three 777-200s that have been sourced from Singapore Airlines but the start-up is eager to transition to 787s as soon as possible.

Thai desperately needs fleet simplification as it restructures

Thai's transformation plan envisions the group reducing the number of aircraft families from nine to six, which the airline has said should lead to about a 6% reduction in costs. Cost reductions and efficiency improvements are also expected to be generated by improving aircraft utilisation rates. Thai's average utilisation rate was only 10.6hrs in 2014 compared to 11.2hrs in 2013. With a newer and simpler fleet Thai should be able to increase utilisation beyond what the group achieved in 2013.

But Thai could potentially further accelerate its fleet simplification initiative by moving up the retirement of its last four 747-400s and last two 737-400s as well as by potentially transferring its 787s to NokScoot. For now Thai does not plan to phase out its final two 737-400s until 2017.

Thai removed three 737-400s from its fleet in 2014 along with its last five A340-600s. The final two 737-400s are being retained for flights to Samui, which cannot accommodate A320s, and for royal family VIP flights.

The use of the 737 for VIP flights makes an earlier phase out politically challenging to pursue. But a phase out of the 737 in 2015, which would give Thai Airways mainline an all-widebody fleet as Thai Smile takes over all of the A320s, would be sensible. Samui could be served through a codeshare with Bangkok Airways or by acquiring A319s for Thai Smile.

The reduction in the fleet is also expected to raise capital as Thai looks to sell or part out its excess aircraft. Thai has said it is seeking to sell about 40 aircraft but this figure includes 22 aircraft that were decommissioned long before Thai started to pursue its current restructuring.

Thai restructuring is a step in the right direction but challenges remain

Thai is also looking to raise capital by selling non-core assets such as hotels. Meanwhile it is confident its losses can be narrowed significantly in 2015 as several cost reduction and revenue enhancement initiatives are implemented. Thai will also clearly benefit from lower fuel prices.

Costs are being cut through voluntary retirement schemes, improved labour productivity, fleet simplification and capacity reductions. Thai has vowed to quickly eliminate routes which have consistently been loss-making and have no potential for profit while working to improve the performance on routes which have been loss-making but have potential for a turnaround.

Meanwhile Thai is targeting revenue growth through improved revenue management and higher load factors. Thai is confident it can achieve an 80% average load factor in 2015, which would be a remarkable 12ppt improvement compared to 2014. An 80% load factor seems overly ambitious given Thai's load factor has traditionally been in the mid 70s during years of relatively robust demand.

Thai clearly still has its share of short-term as well as long-term challenges as it tries to right the ship. Competition continues to intensify with LCCs, including new long-haul LCCs, and Gulf carriers. Thai is hoping to woo back passengers by focusing on service and improving its product. But this is not an easy task. Prior attempts to improve its product failed to generate yield or load factor improvements. Prior attempts to restructure also failed to address most of Thai's longstanding problems including efficiency levels.

The industry dynamic has forever changed in Thailand and in Asia overall. Thai is finally starting to respond to these changes and trying to plot a sustainable path. The next several months will be critical as Thai restructures and faces several key strategic decisions that will shape its future outlook.