14-Jul-2016 9:55 PM

AirAsia up-gauges with a 100 A321neo order; outlook improves and China in its sights

Analysis

AirAsia has joined other leading LCC groups in Southeast Asia by deciding to add higher density narrowbody aircraft. The 100 A321neos ordered by AirAsia at the 2016 Farnborough Air Show will enable the group to maximise slots at infrastructure constrained airports and further reduce unit costs.

The new order also enables the AirAsia Group to meet a requirement for additional aircraft that has surfaced due to the establishment of a leasing subsidiary which is looking at potentially placing some of the group's future aircraft with third party customers. AirAsia joins rival Lion Group and VietJet Air in pursuing potential opportunities to lease out some of 1,150 aircraft the three Southeast Asian groups have on order - a staggering number of aircraft that likely cannot be absorbed entirely by their own airline subsidiaries or affiliates - but which they need to have available in case high forecasts materialise.

The new deal lifts AirAsia's narrowbody order book to 404 aircraft, including 304 A320neos to be delivered from 2H2016 through 2028 and 100 A321neos slated for delivery from 2019 to 2028. The group took its last A320ceo in 2Q2015 and currently operates 171 of the type from bases in five countries.

Summary

AirAsia has ordered 100 A321neos to add higher density narrowbody aircraft to its fleet, enabling the group to maximise slots at infrastructure constrained airports and reduce unit costs.
The new order will also meet the requirement for additional aircraft due to the establishment of a leasing subsidiary, which is looking at potentially placing some of the group's future aircraft with third party customers.
The new deal brings AirAsia's narrowbody order book to 404 aircraft, including 304 A320neos to be delivered from 2H2016 through 2028 and 100 A321neos slated for delivery from 2019 to 2028.
AirAsia plans to take an initial batch of five A320neos by the end of 2016, with an initial batch of six A320neos expected to be delivered in 2019.
AirAsia is considering allocating a portion of the new fleet to its leasing arm, Asia Aviation Capital, which has quickly grown with a portfolio of approximately 50 aircraft.
The A321neo will enable AirAsia to boost capacity on slot constrained routes by 33% compared to the current A320ceo, or 29% compared to the A320neo, on routes where it cannot add frequencies due to slot constraints.

AirAsia now has more than 400 A320 family aircraft on order

Airbus and the AirAsia Group announced at the 12-Jul-2016 Farnborough Airshow an order for 100 A321neos. AirAsia has placed several orders for A320s since its initial deal for 40 A320s in late 2004 but this marks the first time the group has opted for the larger A321.

The AirAsia Group currently operates an all A320 fleet consisting of 171 aircraft in 180-seat single class configuration. This excludes three inactive A320s, two of which are currently in Japan where the group is in the process of certifying a new affiliate.

The AirAsia Group does not have any more A320ceos on order but has commitments for 304 A320neos, including several aircraft which were initially acquired as A320ceos and converted over the last few years to A320neos.

AirAsia Group fleet summary: as of 14-Jul-2016

Aircraft	In Service	Inactive	On Order
Total:	171	0	404
Airbus A320-200	171	3	0
Airbus A320-200neo	0	0	304
Airbus A321-200neo	0	0	100

AirAsia to take delivery of A321neos from 2019

AirAsia plans to take an initial batch of five A320neos, which will be configured with 186 seats, by the end of 2016. The group's new fleet plan now includes delivery of an initial batch of six A320neos, which are expected to be configured with 240 seats, in 2019.

AirAsia Group aircraft delivery schedule: 2016 to 2028

Deliveries of both types are now spread out through 2028, with the rate of deliveries accelerating significantly in the early part of the next decade. Staggering deliveries over such a long period is not unusual for AirAsia or other LCC groups with large order books.

Planning to accelerate the rate of deliveries in the out years of a fleet plan is also not unusual for AirAsia. The group typically adjusts the rate of deliveries closer to the time of delivery.

AirAsia has huge flexibility with its order book

Over the past few years AirAsia has deferred deliveries multiple times. Initially AirAsia was planning to take 22 A320neos in 2017 followed by 32 aircraft in 2018.

The group is now slated to take a more modest 10 A320neos in 2017 followed by seven aircraft in 2018. However a re-acceleration of deliveries is always possible with AirAsia; in the past it has taken back slots that were earlier given up.

Changes to AirAsia Group A320neo delivery schedule for 2016 to 2020

Delivery year	Current Schedule	Schedule as of mid-2015	Schedule as of mid-2014
2016	5	4	4
2017	10	9	22
2018	7	11	32
2019	10	20	34
2020	14	22	34

AirAsia enjoys tremendous flexibility with its order book, a luxury of being Airbus' largest single customer. The group will continue to make adjustments to its fleet plan depending on market conditions.

Improvements to AirAsia outlook could lead to re-acceleration of deliveries

Market conditions now seem to be improving and as a result AirAsia will likely try to accelerate some A320neo deliveries and take more aircraft over the next three years. The group is upbeat about its outlook, having recovered from a very challenging 2015.

Conditions have improved in all four of AirAsia's Southeast Asian markets - Indonesia, Malaysia, the Philippines and Thailand. The position of its only affiliate outside Southeast Asia, AirAsia India, has been bolstered by regulatory changes. The group has said it may accelerate fleet expansion of AirAsia India to meet the new policy enabling the launch of international operations after a fleet of 20 aircraft is reached (previously India required 5 years of domestic operation before international operations were allowed. AirAsia entered the market in expectation of the rule change, but it took longer than expected, as things can in India).

AirAsia is also bullish about its prospects in North Asia, which still has short haul LCC penetration rates approximately 40 percentage points below Southeast Asia and India. AirAsia plans to launch its new Japanese affiliate by early 2017 and is pursuing rapid expansion in China. For now the group is using its existing Southeast Asian affiliates to expand in China but it remains eager to forge a Chinese joint venture as soon as the regulatory environment permits.

Up-gauging has become a compelling option in Southeast Asia

AirAsia has stayed with a single aircraft type since completing the transition from 737-400s, which the group operated in its early years, to A320s. Operating with one aircraft type is common among LCC purists. For example, Ryanair operates exclusively 737-800s (with the exception of one 737-700 used for crew training) and IndiGo exclusively A320s.

Typically LCCs that have opted for a second type have gone with a smaller variant. For example, easyJet operates A319s alongside A320s. Southwest operates 737-700s alongside 737-800s.

However, large narrowbody aircraft have become increasingly popular in Southeast Asia where slot constraints limit growth opportunities at several major airports. Indonesia's Lion Air was the first Southeast Asian LCC to acquire larger narrowbody aircraft and has operated for several years a mix of 189-seat 737-800s and 215-seat 737-900ERs. Its two overseas affiliates - Thai Lion Air and Malaysia's Malindo - also now operate both types.

Over half of the Lion Group current order book of nearly 500 aircraft includes larger gauge narrowbody aircraft. Lion currently has 210 737 MAX 9s and 65 A321neos on order; it plans to start taking both new types in 2017.

Vietnam-based LCC group VietJet took delivery of its first A321ceo in 2015 and was the first operator of a new 230-seat configuration for the A321ceo. VietJet currently operates five A321ceos (four of which are configured with 230 seats) and has another 19 A321ceos on order along with 21 A321neos. VietJet's Airbus order book is now roughly equally split between A320s and A321s.

Cebu Pacific has 32 A321neos on order for delivery from 2017. When it placed its A321neo order in 2011 Cebu Pacific opted against acquiring any A320neos although the A320ceo is the backbone of the group's current fleet, accounting for 36 of its 57 aircraft. (The Cebu Pacific Group also operates A319ceos, which will soon be phased out, A330-300s and ATR 72 turboprops.)

As CAPA has previously highlighted, Citilink is now looking at converting some of its A320neo orders to the A321neo. The Garuda Indonesia LCC subsidiary has 35 A320neos on order for delivery from 2017 to 2021.

AirAsia A321neo order was inevitable

The decision by most of its main LCC competitors in Southeast Asia to go with large gauge narrowbody aircraft clearly prompted AirAsia to rethink its initial strategy of staying with an all-A320 fleet.

In a Dec-2015 analysis report outlining how Southeast Asian LCCs are increasingly responding to growing infrastructure constraints at several airports by up-gauging aircraft, CAPA predicted AirAsia would likely follow with its own A321neo acquisition:

Even the AirAsia Group, which has always maintained a single aircraft type strategy, could be swayed to acquire the A321neo. A 230-seat or 240-seat narrowbody aircraft would open up opportunities to grow at slot controlled airports. But perhaps more importantly if several of its rivals begin to operate the A321neo or 737 MAX 9 AirAsia may need larger gauge aircraft to compete effectively. This is particularly important if AirAsia does not adjust its current policy blocking sister long haul low cost airline group AirAsia X from operating on short haul routes of under four hours.

With no slots currently available at several Southeast Asian airports there is an obvious need to up-gauge in order to grow. More airports will run out of slots in the next few years, including airports that already do not have any available peak hour slots. Even for LCCs not based at a hub as constrained as Jakarta or Manila, using some larger aircraft makes sense in order to maximise flights to more congested airports in the region as well as constrained airports outside the region such as Guangzhou and Hong Kong.

A321neo enables AirAsia to boost capacity on slot constrained routes by 33%

By waiting until 2019 for A321neos AirAsia will be able to take all of its A321neos in the new 240-seat configuration. The A321neo will initially only be available in a 230-seat configuration, which Airbus initially introduced in 2015 with the A321ceo.

The 240-seat version will give AirAsia an opportunity to boost capacity by 33% compared to the current 180-seat A320ceo - or 29% compared to the 186-seat A320neo - on routes where it cannot add frequencies because of slots constraints. Even on routes where it does not face slot constraints on either side but experiences high demand, up-gauging to the A321neo will be compelling as the aircraft has significantly better seat costs compared to the smaller A320.

AirAsia Group CEO Tony Fernandes stated in the 12-Jul-2016 joint announcement with Airbus that "the A321neo will be operated on our most popular routes and especially at airports with infrastructure constraints. It will allow us to bring higher passenger volumes with the same slots, therefore providing immediate benefits to the airports."

A321neo enables AirAsia to maximise slots in Jakarta, Manila and Hong Kong

AirAsia has cited Indonesia as a potential base for its initial fleet of A321neos. AirAsia has a much smaller fleet in Indonesia than Malaysia or Thailand but basing A321s in Jakarta is sensible given the more severe infrastructure constraints in Jakarta.

The Philippines, where AirAsia also has a relatively small fleet, has not yet been cited but Manila would be logical given the constraints at that airport. Both Cebu Pacific and Philippine Airlines plan to operate A321neos from Manila while Lion and potentially Citilink will be operating A321neos or 737 MAX 9s from Jakarta.

AirAsia's original and largest operation in Malaysia is not likely to operate a larger number A321neos as Kuala Lumpur International Airport has the space to accommodate further growth following the opening of KLIA2 and a third runway in 2014.

However, Malaysia AirAsia will likely operate at least a handful of A321neos in order to increase capacity in markets such as Hong Kong and Guangzhou where frequencies cannot be added - at least during daytime hours.

AirAsia currently has five daily flights from Kuala Lumpur to Hong Kong and three daily flights from Kuala Lumpur to Guangzhou. The group also links Hong Kong with Bangkok, Chiang Mai, Kota Kinabalu and Manila while Guangzhou is also served from Bangkok, Krabi, Kota Kinabalu, Johor Bahru and Langkawi. The Bangkok flights, operated by Thai AirAsia, in particular could support up-gauging to the A321neo.

AirAsia will use Asia Aviation Capital to lease out aircraft

However not all of the 100 A321neos ordered by AirAsia will likely end up in the group's operating fleet. AirAsia has stated it is looking to allocate at least a portion of the new fleet to its leasing arm Asia Aviation Capital.

In fact, AirAsia's decision to add another 100 aircraft to its order book is driven more by the needs of Asia Aviation Capital rather than an improvement in market conditions or requirements from any of its affiliates. The group established Asia Aviation Capital in 2014 and the Labuan-based leasing subsidiary has quickly grown with its portfolio currently consisting of approximately 50 aircraft. In 1Q2016 Asia Aviation Capital generated USD54 million in revenues and posted an operating profit of USD39 million.

Asia Aviation Capital is being used to take over over the leases and ownership of a large portion of the AirAsia Group fleet. It was also used in 2015 to help find new homes for two of the group's older A320s, which were subleased to Pakistan International Airways. Asia Aviation Capital is also keen to pursue third party aircraft placements for new aircraft but previously AirAsia did not have a sufficient order book to support such transactions.

In addition to allocating A321neos for leases outside the group, the bigger overall order book could open up A320neo slots for potential third party customers. A formal transfer of orders to Asia Aviation Capital could take place if the group decides to divest the subsidiary; a float or sale has been under consideration.

AirAsia to gradually phase out A320ceo fleet

All 404 of the A320/A321neos now on order by AirAsia are therefore unlikely to end up with airlines in the group's portfolio. Also factoring in replacements, the anticipated rate of growth is relatively modest.

AirAsia is keen to use a significant number of A320neo/A321neos on order as replacements for its current generation A320ceos. In a 2015 analyst presentation the group stated it was aiming to sell 41 A320ceos between 2018 and 2020.

AirAsia is hoping to phase out A320ceos as they turn 12 years old. AirAsia's first A320 that was purchased from Airbus was delivered in late 2005 and will therefore turn 12 years old in late 2017.

AirAsia will have over 50 aircraft that reach 12 years old in 2018 to 2012, including more than 20 in 2020. The group has never taken more than 25 aircraft in a year. Based on the current fleet plan 2021 will be the first year exceeding 25 deliveries - although as previously discussed this is subject to change as AirAsia is often changing its fleet plan.

AirAsia Group current A320ceo fleet based on delivery date

The seven aircraft in the above chart that are more than 13 years old (delivered 2003 and earlier) are based in the Philippines and were inherited as part of the Zest acquisition. AirAsia is aiming to return or sell these aircraft as soon as possible; one is already inactive. The above figures also include the two currently inactive aircraft at AirAsia Japan and the two aircraft currently subleased to Pakistan International Airlines. However it excludes the aircraft that was lost in the Dec-2014 crash in Indonesia (delivered in 2008).

AirAsia currently has 176 A320s on its books, including the three inactive aircraft and the two aircraft in Pakistan. Of the 176 aircraft, 81 are currently registered in Malaysia, 49 in Thailand, 22 in Indonesia, 14 in the Philippines, six in India, two in Japan and two in Pakistan.

AirAsia Group current A320ceo fleet based on current country of registration

Leasing out aircraft has become an attractive option

AirAsia has traditionally owned its fleet but in recent years has grown its leased fleet, partially through sale and leasebacks. Currently 36 of the group's A320s are owned by outside leasing companies. Asia Aviation Capital has supported several of these transactions.

AirAsia is not alone among Southeast Asian airline groups in recognising the value of having its own aircraft leasing company. Lion Group has similar flexibility with its order book as leasing arm Transportation Partners can be used to place lease out aircraft to third party customers as well as help with arranging financing for aircraft being delivered to airlines within the Lion Group.

So far Transportation Partners has only placed three aircraft outside Lion as the group has required virtually all of its aircraft for its own expansion. However Transportation Partners is expected to eventually become more active in leasing out new as well as second hand aircraft - including Lion's oldest 737NGs - as the group takes more of 490 aircraft it has on order.

VietJet is now looking at leasing out some - and potentially all - of the 100 737 MAX 8 aircraft it recently ordered, which boosted the Vietnam-based LCC group's order book to 182 aircraft including 82 A320 family aircraft. VietJet has the fourth largest order book among Asia-based LCC groups after Lion, AirAsia and IndiGo.

Leasing out aircraft to third party airlines is an appealing option because it gives LCC groups more flexibility to match capacity with fluctuating demand. But perhaps more significantly it is also a profitable proposition for airline groups that have negotiated huge discounts with the manufacturers. Large LCC groups typically secure a better rate on new aircraft from the manufacturers than leasing companies placing their own orders.

Asia Pacific LCC groups with more than 100 aircraft on order

Group	Number of group airlines	Number of aircraft on order	Number of current aircraft
Lion	5*	490	252
AirAsia/AirAsia X	8	480	201
IndiGo	1	425	110
VietJet	2	182	34
Go Air	1	142	21
Jetstar	4	112^	120

AirAsia to regain the distinction of having Asia's largest order book

The AirAsia figure in the above chart includes 76 widebody aircraft orders at AirAsia X along with the earlier mentioned 404 A320 family orders at AirAsia. With the new A321neo order, AirAsia/AirAsia X combined retakes IndiGo with the second largest order book in Asia Pacific and also closes the gap with Lion to only 10 aircraft.

AirAsia/AirAsia X will likely have a larger order book than Lion by the end of 2016 as Lion is expected to take delivery of at least 20 aircraft in 2H2016 while not placing any additional orders compared to only five scheduled deliveries for AirAsia/AirAsia X.

AirAsia X currently has 66 A330-900neos and 10 A350s on order. The three medium/long-haul airlines operating under the AirAsia X sub-brand currently have a fleet of 30 A330-300s in 377 seat two-class configuration. AirAsia X's last A330-300ceos were delivered in 2Q2016; the group plans to begin taking delivery of A330-900neos deliveries in 2018.

A321neo should prompt review of AirAsia/AirAsia X four hour rule

AirAsia X has a separate ownership structure and stock listing from AirAsia but uses the same website and distribution channels. The licensing agreement between AirAsia and AirAsia X gives AirAsia X the opportunity to operate any route originating in Southeast Asia of over four hours.

The current structure is limiting as AirAsia X has been unable to operate thick routes of four hours or less where slot constraints prevent additional frequencies - such as Kuala Lumpur-Hong Kong. Other LCC groups such as Cebu Pacific have successfully deployed widebody aircraft on some short haul routes. The introduction of the 240-seat A321neo will mitigate this weakness but ultimately AirAsia will still need to review its current structure.

The A321neo has significantly better range than the A320ceo. The A321neo also provides significantly improved seat economics on routes of four to five hours, which the A320ceo is able to operate in 180-seat configuration without payload limitations but LCCs have often avoided due to the unfavourable economics.

The introduction of the A321neo gives the AirAsia Group an ideal complement to the A320neo and A330neo. The decision to acquire the A321neo is a positive step as it enables AirAsia to grow in key slot constrained airports and further reduce its already leading unit costs. However the group will need to eliminate its current four-hour rule separating AirAsia and AirAsia X if it is to get the most out of the A321neo and best match capacity with demand.