Outlook 2006: A Make-Or-Break Year for Many Airlines

Press Release

(SYDNEY, 22 December 2005) 2006 will be the make-or-break year for major expansion plans by airlines in the Asia Pacific region, according to the Centre for Asia Pacific Aviation. Moreover, this situation will be exacerbated if the current rosy economic conditions deteriorate.

The Centre, announcing its expectations for key aviation markets in the year ahead, sees some uncertainty under an otherwise positive outlook and warns that slow progress towards airline restructuring and a greater liberalisation of air routes and critical pilot shortages threaten the realisation of growth strategies.

“As we enter 2006, there is a higher than usual level of unpredictability, as the still-unknown impact of higher fuel costs continues to flow through to consumer spending. As the airline industry is in the frontline of economic indicators, any change will be quickly felt.

“At the same time, we’re seeing unprecedented orders for new aircraft by Asian operators for delivery from 2007, in response to opportunities for expansion both on short and long haul sectors within and beyond the region,” Mr Peter Harbison, the Centre’s Executive Chairman, says.

“2006, in many ways, will be the quiet before the storm – a period when airlines need to consolidate and put in place the necessary foundations for a massive upgrading of fleets and route systems. If, for whatever reason, their efforts are thwarted, it places in jeopardy strategic development plans which are essential to their medium term futures and, in some cases, to survival. There will be a delicate balance between traffic growth and meeting capital needs.

“This will increasingly bring into focus the pressures for outsourcing and cost reduction – and inevitably added tension in industrial relations.”

Mr Harbison cites China’s continuing evolution as the lynchpin market for Asia, India’s aviation reform programme and moves on the bilateral and multilateral fronts in North and Southeast Asia to more liberalised regimes as influential factors for 2006.

Among the key “micro” developments anticipated for the regional market are:

AustraliaQantas will maintain its position as one of the most effective and well-managed operators, with the launch of its low-cost subsidiary Jetstar onto medium to long haul international routes either in late 2006 or early 2007. The airline will announce its targeted initial routes in the first quarter of next year, expected to include destinations in China, Korea, Taiwan and possibly Japan.

The Australian Government’s deferred decision regarding a potential “open skies” pact with Singapore, as well as other initiatives, including a relaxation of Qantas’ foreign ownership limits, will be announced in March or April. The likely outcome will involve a phased introduction of “open skies”, allowing Singapore Airlines access to the South Pacific route but on a restricted basis. Given SIA’s stated requirement for a daily Sydney-Los Angeles service, this may be a sufficient disincentive to stymie the airline’s plans, at least temporarily. It may also offer an opportunity for Virgin Blue to proceed with its ambitions to establish long-haul services to the US.

“The Pacific issue represents a solid test of the government’s resolve in relation to liberalisation,” the Centre says. “Australia has led the way in this regard in the past, but there are broader questions relating to the economic return of allowing greater competition on what is a highly profitable sector for Qantas.

“There is the risk that a refusal to enter into open skies with Singapore will be perceived as unduly protectionist, and rebound on future attempts to gain improved access to certain markets for Australian carriers.”

New ZealandAir New Zealand’s progress towards establishing itself as a viable, long-term competitor in its own right will depend on the airline’s ability to further reduce operating costs to strengthen returns, in particular, on the Tasman. To that end, Air NZ will decide in early 2006 on outsourcing plans that could see 500 engineering jobs lost on top of the 110 redundancies recently announced. As with Qantas, the airline is driving to enhance productivity through progressive labour reforms and more flexible working. It is improbable that these changes will be introduced without upheaval.

Malaysia – Continuing high fuel prices and employee costs, and intensive regional competition, have applied significant pressures to Malaysia Airlines, increasing the urgency for the airline to undertake a RM3 billion restructure in 2006. MAS recently announced a second quarter loss of RM367.7 million and the fact that less than half of the airline’s routes to Europe and Latin America are profitable. The airline will face a watershed year in 2006, as the government’s patience runs low and AirAsia continues its growth pattern.

Singapore – Aside from its expansionary ambitions on the Pacific, SIA is contemplating an order for up to 60 new long-haul aircraft, either B777/787s or A350s. The airline is expected to announce its decision in the first few months of next year. Meanwhile, Singapore has been pushing the boundaries of liberalisation with demands for the proposed ASEAN “open skies” to be brought forward to 2006, and wide-ranging bilateral agreements with China and India. The Singapore hub has experienced a lively year, with low cost airline activity; many expect 2006 to see a slowing of activity in this area, but the Centre anticipates continuing volatility and expansion in this sector.

Hong KongCathay Pacific, like most other airlines in the Asian region, has set its sights on a high growth strategy from 2007, with its recent US$4.6 billion order for 16 B777-300ERs and 3 A330-300s. The airline has seen buoyant economic conditions in its key markets, including mainland China, drive substantial expansion in business and leisure traffic. Hong Kong Regional operator CR Airways has also signalled its intention to grow services into China by ordering 10 B787s and a number of B737-700s. The Hong Kong aviation market faces its most significant changes in over a decade in 2006, with new entrants challenging the status quo. As low cost pressures increase in neighbouring Macau, Hong Kong operators will be compelled to review their attitude to the LCC sector.

ChinaChina continues to be fertile ground for the aircraft manufacturers, as seen by the recent Airbus order for 150 A319s, A320s and A321s and other orders for 70 B737s from Boeing – despite a CAAC statement in early 2005 that the year would see no new orders! These deliveries will sustain the massive demand for air travel within China over the next 5 years as the domestic market matures. The influx of new aircraft will exacerbate shortages in skilled pilots and other airline personnel already being experienced by Chinese operators. Almost two thirds of China’s orders are for single aisle narrow body airport, suitable for short haul, possibly low cost operations. Financing the massive capacity increase will also be a challenge, with weak equity market conditions and inconsistent profitability likely to push carriers toward ever-increasing debt. This offers difficult choices for the administration, anxious on one hand to ensure economic viability of its three major airlines, while constantly being pressured to admit new independent entrants.

JapanJapan Airlines, facing heavy losses for the year to March 2006, will seek to forge ahead with its internal restructure next year, with the aim of returning to profitability. This will entail 10% cuts to salary levels across the airline, the retirement of older, less economic aircraft and JAL’s recruitment to the oneworld partnership. It remains to be seen if these measures will be sufficient to maintain competitiveness. Meanwhile, All Nippon Airways has made significant steps in the right direction. 2006 will see a new low cost domestic entrant, Starflyer, when the new Kitakyushu Airport opens in March. Despite the Japanese government’s conservative policy, 2006 is likely to see new inroads in low cost operations, as foreign LCCs enter and as more regional airports seek access to international operations.

South Korea – Each of Korea’s major airlines has suffered strikes in 2005 and, as the continuing need for restructuring flows through to more applying greater economies, the industrial situation could see further turbulence. Both Korean and Asiana are in the higher cost bracket of the region’s international operators; more change is inevitable. Korean has the advantage of a substantial cash flow from air freight, which has proven a good buffer in recent downturns.

India – The partial float of up to 20% of India’s two government-owned carriers, Air-India and Indian Airlines, is due to take place in the first quarter of 2006. This will realise much-needed capital for the airlines, which plan to order 111 new aircraft between them. However, the Indian Government has again scotched speculation that there would be a merger of Air-India and Indian Air. The frenetic growth of low cost airline operation domestically seems likely to continue unabated in 2006. Meanwhile, however, the critical issue of airport infrastructure remains unresolved and the privatisation of Mumbai and Delhi Airports is sadly delayed further.

Middle EastEmirates has underlined its aggressive expansion strategy with the addition of an order for 42 B777s to its already hefty order book, bringing total aircraft orders to 132. 2006 will see the airline continue the development of its Dubai hub, with the introduction of a second non-stop service to Japan and additional flights to India. CAPA’s Airline of the Year will be keen to entrench its role as the aggressive push occurs from neighbouring Etihad and Qatar Airways.

According to Mr Harbison, the region’s shortages in skilled labour, especially pilots, and a potential moderation in market conditions could make the realisation of growth plans by the airlines more difficult.

“The reality of this situation will become clearly apparent in 2006 as the airlines face up to meeting the needs of voracious fleet expansion and funding its introduction. Attracting capital will be a major issue for 2006,” he adds.

The Centre’s full Outlook 2006 Report will be released in early February 2006.