AirAsia 2Q profits drop as its Malaysian unit grapples with excess aircraft. But outlook improving

The AirAsia Group reported on 20-Aug-2014 a drop in operating profitability across all of its airline subsidiaries and affiliates for 2Q2014. The group's largest and only fully owned carrier, Malaysia AirAsia (MAA), was still in the black. Its four affiliates - Thai AirAsia (TAA), Indonesia AirAsia (IAA), Philippines AirAsia (PAA) and newly launched AirAsia India (AAI) - were all in the red with collective losses offsetting the profit at MAA.

This report focuses on MAA's results and outlook. A second report to be published within the next few days will analyse the results and outlook of TAA, IAA and PAA.

Malaysia AirAsia reports drop in operating profit

MAA recorded a 17% drop in operating profits for 2Q2014 to MYR174 million (USD54 million). But foreign currency gains drove a much higher net profit, which came in at MYR367 million (USD113 million) compared to MYR58 million (USD19 million) in 2Q2013.

Revenues at MAA were up 5% to MYR1.311 billion (USD405 million) as passenger numbers were up only 1% to 5.6 million. ASKs were up 3%, slightly outstripping a 2% increase in RPKs.

RASK improved by 2% and average fares were down by only 1%, an encouraging sign compared to the 3% drop in RASK and 9% drop in average fares from 1Q2014.

Malaysia AirAsia highlights: 2Q2014 vs 2Q2013

Source: AirAsia Group 2Q2014 results announcement

Malaysia AirAsia grapples with excess aircraft

MAA has been burdened with excess aircraft, leading to a decrease in aircraft utilisation rates. MAA ended 2Q2014 with a fleet of 80 A320s, an increase of 21% compared to the 66 aircraft at the end of 2Q2013 although ASKs were up only 3%. As a result the carrier's ASK per aircraft utilisation rate was down 11% year over year.

MAA had been expected to end 2Q2014 with a fleet of 74 A320s, based on the fleet plan provided when the group reported 1Q2014 earnings in May-2014. This would have represented only a two aircraft increase compared to the fleet size at the end of 2013 (as well as a two aircraft increase compared to the fleet size at end of 1Q2014).

MAA ended up being saddled with six more aircraft than anticipated due to the group's inability to sell aircraft as quickly as initially hoped. The AirAsia Group announced in Feb-2014 pans to sell six of its oldest A320s by the end of 2014 and in May-2014 announced plans to sell another six aircraft, citing a high level of interest in buying its aircraft.

All 12 of the AirAsia Group aircraft earmarked for sale were to come out of the fleet from MAA, including six aircraft which were to be removed from MAA's fleet in 2Q2014. But the group was unable to complete any aircraft sales in 2Q2014.

Meanwhile MAA still took delivery of eight new aircraft in 2Q2014. The plan was to have six of these eight deliveries offset by the sale of six aircraft, resulting in a more manageable net gain of two aircraft. But as none of the sales occurred the net gain was eight aircraft, forcing MAA to ground aircraft and reduce utilisation rates.

AirAsia's challenges in selling aircraft

In hindsight AirAsia was perhaps overly confident it could quickly sell aircraft. Selling aircraft was an option it turned to as part of an effort to slow down growth in response to overcapacity and unfavourable conditions in the Southeast Asian market. But selling aircraft can be very difficult, particularly given the current availability in the global aircraft market of second hand A320s. AirAsia has limited experience selling aircraft and has to compete against a wide array of experienced sellers, including leasing companies, in offloading its eight to nine year old A320s.

The failure to sell the six aircraft despite the group's initial confidence further highlights the challenges faced as airlines in Southeast Asia try to slow down growth and in some cases cut capacity. Rival LCC group Tigerair also has struggled to find new homes (through subleases in Tigerair's case) for excess aircraft, forcing it to ground 12 aircraft.

AirAsia has followed Tigerair in grounding several aircraft as a result of failing to find new homes for excess numbers. But unlike the well documented Tigerair case the grounding at MAA has been done discreetly and has never been announced.

See related report: Tigerair incurs another loss in 1Q. Turnaround hinges on increased transit traffic and partnerships

AirAsia stated in its 2Q2014 results presentation on 20-Aug-2014 that its first aircraft sale was finally completed on 8-Aug-2014. The group is now optimistic it will be able soon to sell another three aircraft which have been reserved by potential buyers for pre-inspection.

The group is still targeting eventually to sell 12 aircraft but its revised fleet plan for 2014 no longer assumes all these sales will be completed. AirAsia stated in its 2Q2014 results presentation that it is now talking to Airbus about selling four of its new A320 2H2014 delivery slots.

If successful the sale of four new aircraft slots would help the group meet its original plan for reducing the size of its fleet without having to sell as many existing aircraft. Although its preference was to sell its oldest aircraft, which are unencumbered but have increasing maintenance requirements, AirAsia may discover there is higher demand for new aircraft.

The group's newly revised fleet plan envisions MAA ending the year with a fleet of 78 aircraft. This would be only six aircraft above its end 2013 total and only two aircraft more than the 76 aircraft MAA was planning to have at the end of 2014 under its earlier fleet plan.

Malaysia AirAsia current fleet plan vs prior fleet plan

	End 2013	End 1H2014	End 2o14	End 2015
Prior Plan (as of May-2014)	72 A320s	74 A320s	76 A320s	N/A
Current Plan (as of Aug-2014)	72 A320s	80 A320s	78 A320s	80 A320s

Note: Prior plan did not provide projection for 2015
Source: CAPA - Centre for Aviation

Malaysia AirAsia's fleet plan is again subject to change

The revised fleet plan however still hinges on several new or used aircraft being sold. So there is still a risk that MAA could end 2H2014 with more aircraft than currently projected, as was the case in 1H2014.

The bulk of the group's new A320 deliveries continue to go to MAA, including four of the eight A320s slated to be delivered in 3Q2014. As a result several aircraft sales are still imperative for MAA to get down to the planned 78 aircraft level, which would allow it to improve utilisation rates and avoid continuing to have grounded aircraft in its fleet.

(Another option would be for some of MAA's older aircraft to be moved to AirAsia India. The early 2014 version of the group's fleet plan had older MAA aircraft being moved to India but the more recent versions have had AirAsia India expanding by taking new aircraft.)

The current fleet plan has only two aircraft exiting the MAA fleet in 3Q2014 (including the one aircraft which was already sold), resulting in a fleet of 82 aircraft at the end of Sep-2014. As a result another four more aircraft will need to exit the MAA fleet in order for MAA to achieve its year-end 78-aircraft target. (This assumes MAA will not take any more new aircraft in 4Q2014, which most likely hinges on the group's ability to sell the four new aircraft delivery slots it is now trying to remarket.)

As its fleet is increasing further in 3Q2014 from the already bloated 2Q2014 levels without a significant increase in capacity, MAA's 3Q2014 results will likely again be impacted from much lower than normal aircraft utilisation levels. There should be an improvement in 4Q2014 assuming the MAA fleet is reduced in the final quarter by four aircraft as currently projected.

AirAsia could end up using its excess aircraft if MAS cuts capacity

But the excess aircraft burden could end up having a silver lining as rival MAS starts to restructure. Malaysian government investment firm Khazanah, which is in the process of increasing its stake in MAS from about 70% to 100%, is expected to unveil a restructuring plan for the ailing flag carrier within the next couple of weeks. Capacity cuts are likely, which should significantly improve market conditions in Malaysia.

The Malaysian market has suffered from overcapacity over the past year as a result of aggressive expansion by MAS, which grew ASKs by 17% in 2013 and by another 14% in 1H2014, as well as the launch of Malindo. While traffic in the overall Malaysian market has been up significantly, including by 20% in 2013 and 12% in 1H2014, the gains came at the expense of yields.

Among Malaysia's four main carriers (AirAsia, AirAsia X, MAS and Malindo), AirAsia recorded by far the slowest growth in both 2013 and 1H2014. But AirAsia is the market leader and it is virtually impossible to maintain market share when smaller competitors are expanding very rapidly.

MAS captured about a 29% share of the Malaysian market in 2013 compared to 43% for AirAsia/AirAsia X. Malindo captured about a 2% share of the total Malaysian market in 2013 and is on pace to capture about a 4% share in 2014.

Malindo also stands to benefit from the MAS restructuring, perhaps more significantly as it is much smaller than AirAsia but has access to Lion's huge order book, where there is flexibility to change allocations depending on conditions in various markets.

Malindo currently operates only 15 aircraft, nine ATR 72-600s and six 737-900ERs, but plans to add four ATR 72-600s and two 737-900ERs by the end of 2014. Malindo for now plans to add another 10 aircraft in 2015, mostly 737s, but this could be accelerated significantly if MAS cuts back in the domestic or regional international markets (including South Asia, where Malindo is particularly strong).

See related reports:

• Malindo Air to resume international expansion in 4Q2014 with more capacity to India and Thailand
• Malaysia's Malindo Air rapidly grows turboprop operation with new Penang base and Subang expansion

Malaysia AirAsia should see margins return to its normal high levels

As CAPA suggested earlier this week in analysing earnings at separately listed long-haul LCC AirAsia X, it is not clear where Malaysia Airlines will cut capacity. Cuts in Australia, Korea, Japan and northern China would benefit AirAsia X while regional international or domestic cuts would benefit AirAsia. But MAS could focus cuts on Europe, which would not benefit either of the AirAsias (although perhaps reopening thoughts of European operations for AirAsia X).

See related report: AirAsia X records 2Q2014 loss as Australia underperforms. But long-term prospects are still bright

AirAsia is optimistic it will somehow benefit from the current crisis facing MAS and is anticipating a reduction in capacity. Even if MAA succeeds at reducing its fleet to 78 aircraft it would be able to increase flights by increasing utilisation rates. If its fleet is maintained at the current high levels, which is about 82 aircraft, it would have the ability to significantly and immediately increase capacity.

Capacity cuts at MAS should also allow MAA to push up yields and load factors, resulting in improved profitability. MAA has typically had among the highest operating profit margins in the Asian and global airline industry. But the carrier's EBIT margin was a relatively modest 13% in 2Q2014, down 4ppts compared to 2Q2013. Historically MAA's EBIT margin has been above 20%.

Malaysia AirAsia may need to accelerate fleet expansion in 2015

The AirAsia Group for now has only allocated MAA two of the 13 aircraft the group is expecting to receive in 2015. AirAsia disclosed in its 2Q2014 results presentation an initial breakdown for 2015 deliveries, which includes three aircraft for both Japan and India as well as five for Thailand and two for Malaysia.

AirAsia was originally slated to take 29 A320s in 2015 but announced 12 deferrals in Feb-2014, reducing the total to 17 aircraft. It now plans to defer another four aircraft, reducing the total to 13 aircraft. (In May-2014 the group said it was talking to Airbus about three additional deferrals, which would give it only 10 deliveries in 2015, but at least for now the group has 13 deliveries in its 2015 fleet plan.)

AirAsia Group delivery schedule: 2015 to 2018

Note: as of 20-Aug-2014
Source: AirAsia Group 2Q2014 results presentation

The deferrals are sensible as it allows the group to hold off on rapid expansion until the more efficient A320neo are delivered from 2H2016. Deferrals are also a much less riskier proposition than trying to sell aircraft. AirAsia is Airbus' largest customer, giving the group huge leverage to slow down the rate of deliveries or reaccelerate when market conditions become more favourable.

Depending on the extent of the capacity cuts at MAS, AirAsia could seek to take back some of its 2015 delivery slots. The 13 planned deliveries for 2015 are relatively modest given the group has now launched AirAsia India and forged a new joint venture in Japan which aims to launch services next year.

If restructurings at MAS - and Thai Airways - open up opportunities for AirAsia in either or both of these markets, AirAsia will likely need more aircraft in 2015.

New AirAsia leasing unit could ease the burden on MAA

The group also expects management of aircraft to become easier once it establishes its new leasing house, which plans to commence operations in Sep-2014.

The new AirAsia leasing arm has no intention of leasing aircraft outside the group, as Lion Air Group leasing subsidiary Transportation Partners has begun to do. But the leasing arm will facilitate subleases to affiliates and should reduce the burden on MAA.

Fleet issues have become troublesome for the AirAsia Group, with MAA bearing the brunt as it is the only full subsidiary and has always been the entity behind aircraft orders. But eventually the current fleet issues will be resolved, brightening MAA's outlook.

The MAA outlook is also poised to further improve due to the expected improvement in market conditions in Malaysia as MAS embarks on a major restructuring initiative.

What unfolds in the Malaysian market over the next few months is as unpredictable as the constantly changing AirAsia fleet plan. But MAA should be in a prime position to leverage its leading position in the Malaysian domestic and short-haul international markets.

AirAsia's potential opportunities in Thailand will be analysed in the second part of this series of reports on the AirAsia Group 2Q2014 results and outlook.