25-Nov-2010 3:46 PM

AirAsia to face competition from Firefly

Analysis

Malaysia Airlines (MAS) has announced plans to step up the battle with AirAsia in the Malaysian market through its wholly owned subsidiary Firefly which is altering its network and fleet and lowering its unit costs to become a more serious contender in the LCC market.

Firefly will take delivery of 30 B737-800 aircraft over the next five years to expand domestically and within the region, with the carrier also targeting other ASEAN markets from Kuala Lumpur with a number of crossovers with AirAsia. Firefly plans to have the lowest unit cost in the country - and hence the world - with its new jet aircraft given that AirAsia is the world's lowest cost operator based on financial data for the three months ended Jun-2010.

Selected airlines RASK and CASK: Three months ended 30-Jun-2010

Airline	RASK	CASK
AirAsia	USD 4.87	USD 3.52
Air Arabia**	USD 4.88	USD 4.43
Tiger Airways	USD 4.61	USD 4.58
JetBlue	USD 6.72	USD 6.04
COPA	USD 7.37	USD 6.58
Norwegian Air Shuttle	USD 7.34	USD 6.82
Southwest	USD 7.73	USD 6.84
Vueling	USD 7.68	USD 6.91
China Southern Airlines**	USD 7.32	USD 6.98
Thai Airways	USD 6.76	USD 7.15
WestJet	USD 7.95	USD 7.43
Continental Airlines	USD 8.25	USD 7.52
Virgin Blue**	USD 7.43	USD 7.52
GOL	USD 7.99	USD 7.71
Air New Zealand**	USD 9.22	USD 7.71
Delta	USD 8.65	USD 7.74
US Airways	USD 8.93	USD 7.88
United Airlines	USD 8.82	USD 8.08
Air Berlin	USD 7.76	USD 8.12
Jet Airways	USD 8.09	USD 8.20
American Airlines	USD 8.51	USD 8.22
Cathay Pacific	USD 9.55	USD 8.41
TAM	USD 8.54	USD 8.44
China Airlines**	USD 10.60	USD 8.49
Air China**	USD 9.75	USD 8.60
China Eastern Airlines**	USD 9.25	USD 8.63
Malaysia Airlines	USD 7.90	USD 8.75
Singapore Airlines	USD 9.61	USD 8.92
LAN	USD 10.31	USD 9.18
British Airways	USD 8.88	USD 9.21
EVA Air**	USD 10.47	USD 9.38
Qantas**	USD 9.84	USD 9.68
Iberia	USD 9.78	USD 9.75
Korean Airlines	USD 12.65	USD 9.82
Finnair	USD 10.20	USD 10.68
Asiana	USD 12.48	USD 10.69
Air France	USD 12.05	USD 12.51
SAS	USD 15.03	USD 14.18
Lufthansa**	USD 16.41	USD 16.49
easyJet	USD 6.99	n/a

30 B737-800s on order; six for delivery in 2011

Firefly will take delivery of six of the aircraft in 2011, seven each in 2012 and 2013 and five each in 2014 and 2015. The carrier plans to partly lease and partly own its 30 new B737-800 aircraft with the carrier adding that the aircraft are separate to the 35 B737-800s parent Malaysia Airlines has on order. It has so far secured leases for four of the aircraft to be delivered in 2012.

Firefly Managing Director Eddy Leong stated Firefly, which is currently profitable, would finance the initial aircraft delivery via internal funds and will not look to raise funds. Mr Leong commented: "We will lease from the open market and will place (purchase) orders for the aircraft by third or fourth quarter of next year. Hopefully, by then, we will have enough cash for the pre-delivery payments".

Firefly aims to be Malaysia's lowest cost operator

Firefly will configure its B737-800 aircraft with 189 seats, nine more seats than AirAsia's typical A320 configuration. Mr Leong added that the aircraft choice was modelled after Southwest and Ryanair adding: "The B737-800 has a lower operating cost compared with another aircraft (A320). Firefly's fares will be extremely competitive and our unit cost (cost per available seat kilometre - CASK) will be the lowest in Malaysia".

AirAsia CEO Tony Fernandes stated the LCC is not concerned about Firefly's expansion plans and stressed that the carrier is the world leader when it comes to low costs. "We are beyond worrying about what legacy airlines do. AirAsia has grown and will continue to grow positively due to a disciplined focus on cost and short-haul single-class model. We are the lowest-cost airline operator in the world, which translates into the best low fares for our guests," he said.

However AmResearch Sdn Bhd, quoted by The Star, stated: "Our back-of-the-envelope calculation suggests that Firefly's unit cost will likely be 5% lower than that of AirAsia's at 11.2 sen. This is purely coming from a higher seat count per aircraft, all else being equal. Investors are better off with AirAsia for exposure to LCC play given its far superior route network and fleet size, which enables it to better tap the growing regional demand and provides it the critical mass to enable it to capitalise on ancillary initiatives."

HwangDBS Vickers Research and ECM Libra Investment Research in separate reports also stated lower than peer unit costs would be achievable with the carrier likely to ride on MAS' existing infrastructure and resources.

OSK Investment Bank meanwhile expressed concerns that Firefly's ambitious could cannibalise MAS' domestic and international routes and put downward pressure on yields, stating: "This is in view of Firefly's cheaper airfare and newer fleet. With MAS not cutting capacity on the same routes served by Firefly and the fierce competition with other low-cost carriers (LCCs), we see a cap on yield upside."

Commenting on the potential for competition with its parent, Mr Leong said: "Malaysia Airlines focuses on full service, we focus on value - the price sensitive market. I don't foresee a cannibalisation issue." He added that the market was large enough for the expansion, which he labelled as "conservative and calculated".

"Every year, the market grows and we are not trying to outgrow the market. We are expanding with six aircraft next year. You are basically catering to the growth that the market is naturally expanding anyway. Six aircraft out of the capacity that already exists is really quite marginal," he said.

OSK added that there is potential for large feeder traffic flows, stating: "MAS' feeder traffic that flows to Firefly is relatively small but as an indication, 20% of AirAsia X's traffic feed into AirAsia's regional flights. MAS' international traffic is six times the size of AirAsia X's and MAS entails much better long-haul connectivity than AirAsia X."

Firefly eyeing ASEAN expansion

Firefly Managing Director Eddy Leong stated the carrier plans to introduce the new fleet of B737-800 aircraft into operation from the main terminal of Kuala Lumpur International Airport. The aircraft will be operated in conjunction with its existing fleet of ATR 72-500 turboprops.

Firefly will launch B737-800 services to Kuching and Kota Kinabalu from 15-Jan-2011 with plans to increase frequency from twice daily per sector to three times daily to Kota Kinabalu and four times daily to Kuching on 24-Jan-2010. The carrier also operates seven turboprop ATR 75-200s for domestic routes, Singapore, Thailand and Indonesia at present with plans to add three more turboprops to its fleet by Jan-2011.

The carrier also plans to expand within the region with Mr Leong stating: "We are going through the traffic right approvals and also the slots. I think all the major Asean countries are potential candidates."

Mr Leong stated the carrier has chosen to operate from the main terminal at Kuala Lumpur International Airport instead of the airport's LCCT as it is congested and it would allow easier connections for its codeshare with MAS. The MD however did not rule out transferring to KLIA's new LCCT once it is completed. "We are in discussions with MAB (Malaysia Airports Holdings Bhd). We are waiting for a lot of details to be shared before we make a decision."

Malaysian carriers witnessing fleet expansion, possible pilot shortage

Malaysia Airlines (MAS) Operations Director, Captain Azharuddin Osman, separately stated there could be a possible shortage of pilots in Malaysia and Asia in general, as airlines take delivery of new aircraft. MAS, Firefly and Air Asia are expected to take delivery of up to 24 aircraft between now and 2011.

Malaysia's domestic sector recorded passenger volume of 13.5 million in 2009 and has been growing at a ten-year compounded annual growth rate (CAGR) of 4.7%. The international sector handled 12 million passengers in 2009and has grown at a 10-year CAGR of 7.3% according to Maybank Investment Bank Research. The Research House continued: "Assuming these growth rates continue, it implies four to five additional aircraft will be required per annum to meet both domestic and international demand growth."

In total, MAS will receive up to 86 new passenger aircraft by 2016 with the carrier's fleet orders being larger than its present fleet of 60 aircraft although only 58 of the new orders are firm. MAS are undertaking a fleet renewal exercise and will see it retiring its older aircraft. Firefly plans to have 44 new aircraft, jets and turboprops by 2015 compared with its current fleet of seven turboprops although the carrier only has three firm orders for the turboprops according to OAG. AirAsia has deferred its order from 23 to eight aircraft in 2011 but has 89 firm orders through 2015.

Fleet orders for Malaysian carriers: Remainder of 2010 to 2015

Operator	Aircraft type	Delivery year	Total
AirAsia	A320	2011	8
		2012	24
		2013	24
		2014	24
		2015	9
AirAsia Total			89
AirAsia X	A330	2010	1
		2011	6
		2012	6
		2013	5
	A350	2016	4
		2017	5
		2018	1
AirAsia X Total			28
Berjaya Air	ATR 72	2011	2
Berjaya Air Total			2
FireFly Airlines	ATR 72	2010	1
		2011	2
FireFly Airlines Total			3
Malaysia Airlines	A330	2011	7
		2012	5
		2013	3
		2014	3
		2015	1
	A380	2012	6
	B737 (NG)	2010	1
		2011	3
		2012	7
		2013	8
		2014	9
		2015	5
Malaysia Airlines Total			58
Total			180

Outlook: Rapid expansion planned for Malaysian market

This raises the question as to whether the traffic demand in the market will be able to support Firefly's fleet deployment plan, given that AirAsia and MAS also has their own significant fleet growth plans. It could be MAS that reduces capacity in the market to focus instead on international operations.

The overall idea of the Firefly expansion is for MAS is to beat competition with a low-cost model rather than a full service one with Firefly's expansion plans representing part of MAS' strategy in growing its network and building capacity in line with its business transformation plan. While Firefly's new jet aircraft routes would likely take one to two years to break even, its foray into the LCC market would likely help prevent existing revenue leakage for MAS to competitors such as AirAsia.

The move also recognises the fact that nearly 80% of the 24 million visitor arrivals in Malaysia in 2009 were from the short-haul segment and MAS will use Firefly to capture this market even as it expands into Asia with its own new fleet.