03-Jan-2013 1:50 PM

Air Macau takes encouraging steps to support the Macau market as "resort" tourism balloons

Analysis

Air Macau's history is not illustrious. It has long sat on an effective monopoly as flag carrier, without exploiting its advantage, yet other airlines have been precluded, greatly upsetting the local tourism and hospitality industries.

But signs are emerging the carrier is beginning to take steps to have a more positive role in Asian aviation. For years Air Macau focused as a transit operation for passengers between mainland China and Taiwan, where direct flights were prohibited until mid-last decade. In doing so, it ignored its hometown market, a tiny enclave that quickly grew this century to be Asia's gambling capital. Inertia cost it market opportunities, especially in Southeast Asia, where agile low-cost carriers moved quickly.

Aircraft were wet-leased to part-owner Air China but now Air Macau's fleet is due to expand in a long-overdue bid to support Macau's growth. Target markets are mainland China and North Asia, but the carrier also hopes to make inroads in Southeast Asia. Air Macau is advantaged with Macau's gradual diversification from just gambling, as well as its concession agreement that runs until the turn of the next decade. But there are challenges, operationally and also being a subsidiary of Air China, which has larger priorities across the region.

Summary

Air Macau has historically focused on transit operations between mainland China and Taiwan, neglecting its hometown market in Macau.
The carrier is now expanding its fleet to support Macau's growth and is targeting mainland China, North Asia, and Southeast Asia as its key markets.
Macau is diversifying its offerings beyond gambling, with a focus on entertainment, shows, restaurants, and shopping, which aligns with Beijing's preference for a wholesome image.
Air Macau faces challenges due to its lack of an outbound market and the need to overnight aircraft and crews to accommodate the preferred schedule of arriving early in Macau and departing late.
Air Macau's ownership by Air China has not resulted in strategic planning or support, with Air China prioritizing other projects and initiatives.
The carrier is expanding its route network, with a focus on mainland China, and has formed codeshare partnerships with Asiana and All Nippon Airways to strengthen its international presence.

Air Macau sits on potential, but also faces challenges

Macau may be known as Asia's gambling capital, but moves are well underway to make it more of Asia's entertainment capital, offering shows, restaurants and shopping - a less hedonistic focus than pure gambling. That goes down well with Beijing, which likes to portray a wholesome image. Macau, like Hong Kong, is a Special Administrative Region of mainland China. On paper that allows the region local control, but in practice Beijing's influence is heavy to definitive.

While new casinos continue to be built, there are increasingly more high-end hotels being opened with smaller casinos or without dedicated casinos. Instead they feature shops, from casual to high-end (mainland China has a high luxury tax rate) and even low-key water park amusements for families with children in tow. But many markets are not aware of these activities, still seeing Macau as a purely gambling location.

A diversified offering also means Macau can better inch its way into the meetings, incentives, conventions and exhibitions category. That translates to more traffic but also promises balance as the more corporate MICE market can fill seats during the week compared to the leisure-heavy weekend travel days. The MICE market can also fill premium seats, although premium seat sales do okay for Air Macau given that some passengers want a luxurious holiday from start to finish. But overall the yields associated with premium travel around greater China are not as high as in other parts of the world.

Macau has negligible originating traffic

There are challenges. Macau has virtually no outbound market, although there have been passing thoughts to operate a bus service from Zhuhai, just over the Macau border, to the Macau airport in such a way to bypass Macau's immigration formalities. The airport in Zhuhai is less convenient, and mainland Chinese wishing to enter Macau, even just to use the airport, need approval to do so.

The lack of an outbound market is a difficult scenario in the long-term for inevitable slowdowns, but one with the immediate challenge of scheduling priorities. As an inbound market holidaying passengers would prefer to arrive in Macau early in the day and end their trip with a late departure (a further constraint is that major target cities are in the same time zone, give or take, as Macau). Air Macau's challenge is that to accommodate that schedule it would need to overnight aircraft and crews, increasing costs. Otherwise its scheduling predisposition is to offer an early departure from Macau and then a later return to Macau, convenient if there was a local market but less so for foreign markets. This can be offset, however, if Air Macau is the only operator on the route.

Cost reduction has not been a strong focus at Air Macau - let alone at carriers in mainland China (Air China, via indirect holdings, is Air Macau's largest shareholder). This contrasts to modern deals where synergies are critical if not driving forces of equity arrangements; airberlin will pool its 787 fleet with part-owner Etihad. Higher costs are a problem in Southeast Asia where LCCs have largely cleaned up the Macau market. They are more nascent in North Asia (or, in the case of Korean LCCs, barely low-cost themselves) but this is changing.

The majority of Air Macau's capacity is in mainland China where full-service carriers dominate, with the exception of Spring Airlines, although even then Spring gives a free baggage allowance. Southeast and North Asian LCCs will pressure Air Macau to evaluate if a full-service offering can be sustained at an entirely leisure destination or more likely if it needs to explore new fare structures to profitably capture the high and low end of the markets. The impetus to consider that may not come until there is significant change in how mainland Chinese carriers compete with each other - and that is off the radar for now. There is the exciting possibility in theory for Air China to use much-smaller Air Macau as an experiment for new fare structures and service models, but Air China has numerous projects and limited bandwidth.

Air China ownership is a mixed-blessing - for all involved

Air Macau has received two significant cash injections in recent years, first from Air China, which in 2009 announced that it would inject CNY431.2 million (USD63 million) into Air Macau by issuing new ordinary shares to existing investors and non-voting redeemable preference shares to the government of Macau. The injection insured the survival of the ailing carrier, which had suffered chronic operating losses and a deterioration in the situation in 2008. In a statement filed at the time with the Shanghai stock exchange, Air China advised that the net asset value of Air Macau stood at negative CNY91.2 million (USD13.4 million) at the end of 2008. The statement went on to say that the only alternative option, absent the cash injection, was to dissolve the company in accordance with Macau laws.

Air China's indirect ownership at the time stood at 81%. While Air China saved Air Macau from collapsing (although a secondary shareholder could have pumped capital in - and indeed the Macau government later did so), Air China effectively gave money and turned away from strategic planning while maintaining oversight, locking Air Macau into purgatory: afloat but unable to take steps to be profitable and avoid another capital injection.

Air China is the country's flagship carrier and is government-preferred. As part of that, Air China focused on international route development and cooperation outside of mainland China; it has a cross-equity arrangement with Hong Kong's Cathay Pacific. But for smaller and lower-profile Air Macau and its namesake city, it is unclear if Air China sees strategic value in Air Macau or if the relationship is forced from above.

But the result has largely been Air China ignoring Air Macau's needs, often with good reason. At the turn of the decade Air China was preoccupied with its Cathay stake and plans for a Shanghai-based cargo joint venture carrier, an ownership battle for Shenzhen Airlines and watching the burgeoning international plans from competitor China Southern. Air Macau simply did not rank highly on the priority list.

The equity, and greater oversight, did produce results with Air Macau reporting a profit of MOP200 million (USD25 million) in 2011 and MOP231 million (USD29 million) in 2010 compared to losses of MOP250 million (USD31 million) in 2009 and MOP416 million (USD52 million) in 2008, staggering losses for a fleet of approximately 15 aircraft. In the five years to 2009, Air Macau incurred losses of MOP857 million (USD107 million). Last year, 2012, looks bright despite gloom elsewhere in the region: 1H2012 profit was up 10.3% to MOP125 million (USD15.9 million) and full year profitability was estimated in Sep-2012 to be up 20% on the back of 8-10% passenger growth in 2012 with load factor improvement of between three and five percentage points. 2011 saw yield improvements of 19%.

Much of the 2010 profit was a result of Air China wet-leasing a third of Air Macau's all-narrowbody fleet and deploying them into other markets with higher chances of profitability, like Hong Kong-Beijing. In 2010 only nine of Air Macau's 15 aircraft were operating in Macau. The move earned money but was controversial for stemming Air Macau's potential. Air Macau's 2012 capacity is 30% down from its 10-year peak in 2006, but up from a low in 2010.

Air Macau annual seat capacity: 2003-2012

A hint of progress came in late 2011 when the Macau SAR government injected MOP700 million (USD87.5 million) into Air Macau with the objective being to help Air Macau in "upgrading herself" to support the development of Macau to become the "world alluring centre of tourism and leisure".

Macau SAR's ownership increased from 5% to 21.5% while other shareholders, including Air China, saw their stakes reduced. The injection was accompanied by promises of increasing Air Macau's fleet to make it a serious operation. As the Macau government said of Air Macau, "It is obvious that the company shall shoulder the responsibility as the local flag carrier. In the long run, it is mandatory that Air Macau should upgrade itself in order to achieve the results aimed by the MSAR Government."

Air Macau plans expansion in mainland China

Air Macau's staple market had been the transit market between mainland China and Taiwan, where until last decade direct flights were prohibited for political reasons. In 2003, Taiwan was Air Macau's largest foreign destination with 28% of all seats going there (50% went to Macau, leaving just 22% of the carrier's capacity to serve other regions).

China in 2003 accounted for 19% of capacity, making it Air Macau's second-largest market, and in 2012 the situation was sharply reversed: mainland China accounts for 30% of seats and Taiwan 10%. Taiwan is Air Macau's second-largest destination by far, with other contenders seeing significantly less capacity: 3.7% for Thailand (third-largest market) followed by 2.7% for Japan and 2.4% for Korea. Air Macau was faster in pulling out of Taiwan than spooling up in China.

Mainland China and Taiwan annual seat capacity share for Air Macau: 2003-2012

The opening of Cross-Strait flights between mainland China and Taiwan is having an affect on traffic flows across the region.

Since 2010 Air Macau has increased frequencies on existing services and launched two new routes, but it is since the Macau SAR government's 2011 injection that Air Macau appears be on a stable track - perhaps for the first time in its history. Air Macau is due to take an A321 in each of Feb-2013 and Mar-2013 with possibly two more A321s in 2014. Additional deliveries beyond 2014 will see Air Macau return to a fleet size in operation in Macau comparable to last decade.

The obvious market for any Asian airline to target is mainland China with its high growth and under-served status, and that is where Air Macau will initially focus growth but for other reasons too: Macau offers a high-energy escape from the mainland, gambling is legal there but not in the mainland, and a positioning on China's southern border allows an ideal year-round climate, unlike the piercing summers and biting winters of some parts of the mainland. Mainland carriers barely serve Macau; yields are higher in the domestic market and to Taiwan.

With only a few cities being added to the carrier's route network, the growth may seem small but is bold for Air Macau, a carrier not typically associated with growth.

Air Macau top 10 routes ranked on seat capacity: 31-Dec-2012 to 06-Jan-2013

Shenyang is first to see new Air Macau service, with interest in Zhengzhou, Wenzhou and Jinjiang

The first expansion is to Shenyang, in northern mainland China, with four weekly A319 services from 09-Jan-2013. Air Macau will be the only operator on the route, which serves the capital and largest city of Liaoning Province. The region once significantly lagged behind neighbouring heavyweights Beijing and Tianjin but has in recent years seen strong growth, putting it in the same category as the high-growth region in China's west. The growth translates to higher disposable incomes and increased propensity to travel.

Air Macau has flagged interest in serving additional mainland Chinese cities, including Zhengzhou, Wenzhou and Jinjiang Quanzhou. Zhengzhou is the capital and largest city of Henan Province in north-central China and has seen its own rise as manufacturing moves inland from the traditional coastal region. Zhengzhou is particularly known for electronic manufacturing.

Cathay Pacific's subsidiary Dragonair, which is something of a bellwether for emerging cities in China, will launch passenger services to Zhengzhou on 08-Jan-2013 with a daily A320 flight. Wenzhou and Jinjiang are both prosperous cities along costal China, south of Shanghai. Wenzhou and Zhengzhou in Jan-2013 do not have services to Macau while Jinjiang Quanzhou does with five weekly services operates by Xiamen Airlines, one of China's most agile carriers.

The expansion follows recent changes to Air Macau's route network, including three weekly flights to China's Changsha from Sep-2012. Services to China's Chongqing and Taiyuan commenced in mid-2011 while other destinations across its network have seen frequency increases. Tokyo Narita was temporarily increased despite the route pushing the range of Air Macau's A321.

International routes are also to expand, helped by Asiana and ANA partnerships

Beyond China, Air Macau is finding friends, with South Korea's Asiana codesharing on Air Macau's Macau-Seoul services while All Nippon Airways codeshares on Air Macau's Osaka Kansai and Tokyo Narita services. Air Macau does not serve the Philippines while LCC heavyweight Cebu Pacific does. Air Macau does, however, codeshare on Philippine Airlines' service from Manila.

Air Macau will have a strong codeshare platform via Air China's equity stake. Air China has a minuscule presence in Macau with only five weekly flights to Wuhan. China Eastern has a small presence with a daily flight to Shanghai while China Southern has no presence. Xiamen Airlines is the sixth largest carrier at Macau based on seat capacity.

Macau Airport seat capacity by carrier: 31-Dec-2012 to 06-Jan-2013

Air Macau's concession agreement preotected it against local competition. This was awarded when the airport was built and the flag carrier was established as Portuguese rule was coming to an end in the 1990s. At the time Macau seemingly had no prospects as it was home to no casinos (but plenty of gang activity). Similar concession agreements cover other areas. Carriers have tried to form under a sub-concession agreement from Air Macau but failed. One temporary success was Viva Macau, although its history was brief as it constantly battled Air Macau for approval to secure routes. Air Macau rejected Viva's application for routes Air Macau did not serve - a perplexing attitude no one understood but which still hurts the local Macau market today.

More recently too, several LCCs attempted actively to establish cross-border jont ventures in the SAR, most notably the then low cost Virgin Blue's (now Virgin Australia) operation, but were rebuffed, despite sometimes encouraging albeit mixed noises from the locals.

Air Macau withdrew Singapore services at the end of 2012. The route, which it had flown once or twice a week, was largely reliant on tour agency group bookings, Air Macau having lost the market years ago when Singaporean-based LCCs entered (Jetstar Asia has since withdrawn, however). Viva Macau tried to enter but was prevented by Air Macau.

Asia is a growing market but some opportunities are gone in the foreseeable future for Air Macau or any prospective Macau entrant, unlikely to materialise this decade while Air Macau's concession arrangement still holds.

A stronger Air Macau will undoubtedly help the SAR's airport, whose traffic dropped after 2007 but, helped by aggressive marekting campaigns, has rebounded in recent years.

Macau Airport monthly passenger numbers: Jan-2010 to Oct-2012

Air arrivals are a minority; more flights to Hong Kong are a worry for Air Macau

A mere 6% of Macau's 21 million visitors from the first to third quarter of 2012 arrived by air.

Sea arrivals account for 41%; there are extensive ferry links to mainland China but predominantly Hong Kong where ferry companies offer services upwards of every 15 minutes. The majority - 53% - arrive by land, with mainland Chinese accounting for 83% of all land arrivals. 44% of all visitors to Macau through the third quarter of 2012 were mainland Chinese visitors crossing via land borders.

Air Macau's competition then is as much fellow airlines as land and ferry options. Low-cost carriers are far more willing to serve both Macau and Hong Kong than full-service carriers, which typically defer to Hong Kong, but also Guangzhou and Shenzhen. Of LCCs that serve both Macau and Hong Kong, Hong Kong typically sees more capacity than Macau.

Regional carriers (excluding China) serving both Hong Kong and Macau, and optionally Shenzhen: 23-Jul-2012 to 29-Jul-2012

Increasing air links to Hong Kong are a competitive worry for Air Macau. Of Hong Kong's 42 million visitors in 2011, 52% visited another destination on their Hong Kong itinerary. Macau was the most popular other destination, with 38% of all Hong Kong visitors making the one-hour ferry crossing to Macau. 43% of all of Macau's ferry crossings are by same-day guests. Even amongst visitors who do overnight in Macau, their duration in Macau is typically far less than at Hong Kong or a mainland Chinese city.

As air services grow to Macau, they will also grow to Hong Kong, and it could be difficult to argue for passengers to fly into and out of Macau and then take the ferry, with luggage, to Hong Kong rather than fly into and out of Hong Kong. Air fares to Macau can be lower than into Hong Kong, but typically not by much.

2013 will be a year of growth between Hong Kong and North Asia, primarily amongst low-cost carriers. Spring Airlines is adding new routes to mainland China from Hong Kong, new Japanese LCCs will likely enter Hong Kong (supplementing Peach, which may expand its Hong Kong service), Jetstar Hong Kong will launch and Hong Kong Express is due to possibly be transformed into a LCC. Of all of Hong Kong's major markets, it is visitors from North Asia who are most likely to visit Macau on a Hong Kong itinerary; 49% did so in 2011. 15% of mainland Chinese visitors to Hong Kong also went to Macau on the same itinerary. (But overall the vast majority - 81% - of mainland Chinese visitors only visit Hong Kong and no other destination during their trip.)

So while Southeast Asia becomes difficult for Air Macau because of existing LCCs, potential North Asian markets are a worry as carriers from those regions give preference to Hong Kong. Mainland China in some regards becomes the de facto growth market for Air Macau.

Mainland carriers tend to serve Shenzhen more than Macau, each in the Pearl River Delta (as is Hong Kong), but increased capacity at Shenzhen is less a worry as ferry connections are scattered compared to Hong Kong-Macau ferry services, making flying into Shenzhen and catching a ferry to Macau unlikely compared to flying into Macau, or into Hong Kong and then taking a ferry.

Mainland Chinese carriers serving both Hong Kong and Macau, and optionally Shenzhen and/or Zhuhai: 23-Jul-2012 to 29-Jul-2012

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A changing wind - but breeze or powerful gust?

For some years Air Macau had been, at best, written off and, at worst, deemed a nuisance (for example by Viva Macau and other would-be entrants). But change - the new theme for North Asia - now seems to be afoot.

It will take more than a few new routes and service increases for Air Macau to gain credibility, but it is at least on its way. Air Macau does need to make up for lost time, although some endeavours - a sustainable Singapore service - are gone.

Never mind, for new growth opportunities are not lacking in Asia. But Air Macau will need to be agile, find those cities before competitors, and call on its tourism partners - many of them wary of the carrier after its years of stagnation - to put deals together. In the medium-term, fare and service structure must be re-evaluated.

As if that were not enough, Air Macau must also balance Air China's ownership, ensuring synergies are made and Air China's legacy ways avoided. Air Macau's future is finally no longer a gamble, and the odds slowly turning in its favour. The demand is certainly there, but the competition is increasing daily. Some opportunities will not reappear, so Air Macau has only a limited window to stake its claim as a long term serious player.