AirAsia X SWOT: challenging times but first mover advantage and fleet flexibility are huge strengths

In this SWOT we look at the leader in the emerging medium/long-haul low-cost segment. The AirAsia X Group currently operates a fleet of 23 A330s across 22 routes from two (soon to be three) hubs. It already has more widebody aircraft than any other LCC and has about another 100 aircraft on order, ensuring it will remain the market leader.

In the process of its evolution AirAsia X has also had a transformational impact on the concept of hub connectivity by LCCs.

CAPA's Asia Aviation Summit and LCC Congress will he held at the Capella, Sentosa in Singapore 13/14 October, followed by a Corporate Travel Day on 15 October. To hear from AirAsia X CEO Azran Osman-Rani and learn about China's new LCC movements as well as the latest on all of Asia's key aviation markets and players, and meet 20 airline CEOs, click here: CAPA Asia Aviation Summit

AirAsia X STRENGTHS

1. Low costs: AirAsia X is the king of low costs

AirAsia X has the lowest unit costs in the industry. It is the only airline in the world with CASK below USD4 cents.

This is aided by AirAsia X operating longer average stage lengths (about 5,000km) than other LCCs. AirAsia X's shortest route is three and a half hours.

Other players in the medium/long-haul segment are not publicly traded or do not provide separate figures for narrowbody and widebody operations. But AirAsia X primarily competes against Asian full service carriers which have unit costs that are two to four times higher. AirAsia X is the only LCC on all 22 of its routes - although it does compete against other LCC groups on several connecting city pairs.

AirAsia X's costs inched up in 2Q2014 due primarily to higher fuel prices. But cost controls and productivity improvements have resulted in lower staff, sales and marketing costs. The group expects lower CASK in 2H2014.

AirAsia X CASK: 2Q2014 vs 2Q2013

Source: AirAsia X 2Q2014 results presentation

2. Fleet flexibility: AirAsia X has remarkable flexibility with its fleet

With its recent launch order for 50 A330-900neo aircraft AirAsia X has gained unusual flexibility with its earlier A330-300ceo and A350-900 orders. This reflects the strong relationship AirAsia X and sister short-haul group AirAsia have with Airbus. AirAsia and AirAsia X are all-Airbus operators and combined they are Airbus' largest customer based on current orders.

AirAsia X's current fleet plan envisions growing by an average of seven aircraft per year and reaching 98 aircraft by the end of 2024, when the last of the A330-900neos is slated to be delivered. But based on the flexibility AirAsia X has gained as part of the A330neo deal to cancel its last batch of A330-300ceo shortly before they would be delivered, the group could end 2024 with as few as 83 aircraft. It could also end up with as many as 107 aircraft.

AirAsia X fleet plan: end 2013 to end 2024

Source: AirAsia X 2Q2014 results presentation

AirAsia X also has additional flexibility not depicted here as most of its current fleet is leased, enabling it to return some of its older A330ceos as the operating leases expire. Also not depicted here is AirAsia X's much earlier order for 10 A350-900s, which are now slated for delivery from 2018. AirAsia X has the ability to cancel this order without penalty. Essentially the order while still on Airbus' books has turned into options.

AirAsia X plans to use this flexibility to assess in a few years how the A350 is performing and if it sees an opportunity in Western Europe. AirAsia X served London and Paris until early 2012 with inefficient A340s, which are now wet leased out and will finally be returned as their leases expire in 2015. The A350 could provide an opportunity to reconsider flights of over 10 hours, which for now are not part of the AirAsia X model.

3. Transit traffic: AirAsia X has been able to grow transit traffic to record levels

Over 50% of AirAsia X's traffic now connects onto other AirAsia X or AirAsia flights. It has pioneered the network LCC model and is almost certainly the only LCC with such a high portion of transit traffic.

The group's success at more than doubling its portion of transit traffic in only three years has enabled rapid expansion. The local Malaysian market would have never been able to absorb the growth over the last year. Total passenger traffic at AirAsia X was up 23% in 2013 to 3.2 million, driven by 39% growth in 2H2013. Passenger traffic was up another 40% in 1H2014 to 2.1 million.

AirAsia X transit traffic (% of total traffic connecting onto other AirAsia X or AirAsia flights): 2011 to 1H2014

Source: AirAsia X 2Q2014 results presentation

So far the additional transit passengers have come at the expense of yields as AirAsia X has transitioned from a sum of sectors to origin and destination pricing model. But this should be a short-term issue as market conditions have been challenging, driving down yields for all carriers.

Capacity growth will also slow significantly in 2H2014, enabling AirAsia X to end some of the deep discounting it had to engage in as it aggressively added capacity in 2H2013 and 1H2014. As fares creep back up AirAsia X's industry leading cost base will put it in a strong position to profitably carry passengers in one-stop markets such as Australia-North Asia.

4. Multiple hubs: AirAsia X gains scale and connects the dots by using cross-border JVs

AirAsia X is starting to follow the successful AirAsia model of pursuing growth through cross-border joint ventures. Not surprisingly AirAsia X has followed AirAsia in selecting Thailand and Indonesia for its first two overseas affiliates, using the same local partners.

Thai AirAsia X launched scheduled services in Jun-2014 and currently serves three routes connecting Bangkok with Seoul, Tokyo and Osaka. Indonesia AirAsia X is planning to launch services by the end of 2014 and is expected to initially connect Bali with Melbourne and Sydney. All five initial destinations and all future planned destinations are already served from Kuala Lumpur by the Malaysian subsidiary, enabling the group to further build up its already strong position in its four main markets of Australia, China, South Korea and Japan.

Having multiple hubs also enables the group to build up scale it would not otherwise be able to achieve operating only out of Malaysia.

More joint ventures are possible at a later phase but for now AirAsia X will focus on Bali and Bangkok, two strong local inbound markets with a wide range of connection opportunities with Indonesia AirAsia and Thai AirAsia. Combined, the three carriers should be able to support the approximately 100 aircraft envisioned by 2025.

5. First mover advantage: AirAsia X has emerged as the leader in the long-haul low-cost segment

AirAsia X launched after Jetstar began its long-haul operation but has surpassed Jetstar as a larger widebody operator. Its large order book ensures it will remain the leader in this segment.

Widebody LCCs: current fleet and outstanding commitments for additional new aircraft: as of 25-Sep-2014

Airline group	Launch year	Current fleet	Outstanding orders/commitments
AirAsia X	2007	25 (22 A330-300s, 2 A340-300s*, 1 A330-200*)	97 (50 A330-900neos, 37 A330-300Es, 10 A350-900s)
Jetstar	2006	14 (7 A330-200s*, 7 787-8s)	7 (787-8s)
Scoot	2012	6 (6 777-200s*)	20 (10 787-9s, 10 787-8s)
Norwegian	2013	7 (7 787-8s)	7 (6 787-9s, 1 787-8)
Cebu Pacific	2013	5 (A330-300s)	1 (A330-300s)
flynas	2014	3 (2 A330-300s, 1 A330-200 wet leased)	0 (only committed to additional wet leases)
Azul	2014	2 (A330-200 delivered but not yet operating)	5 (A350-900s)
TOTALS		62	137

Notes: *aircraft which will be phased out by end of 2015
Azul planning to launch long-haul services in late 2014
Scoot figures include NokScoot (launching late 2014)
AirAsia X figures include Thai AirAsia X (already launched) and Indonesia AirAsia X (launching late 2014)
MOUs that have not yet been converted into orders are included under the commitments
Source: CAPA Fleet Database

AirAsia X WEAKNESSES

1. Lack of profitability: AirAsia X losses have been disappointing

AirAsia X has been unprofitable three out of the last four years (2011, 2013 and 2014). Most recently it has been unprofitable in three consecutive quarters including a MYR129 million (USD 40 million) net loss in 2Q2014, which was over three times the loss from 2Q2013.

The group's financials improved significantly following the early 2012 network restructuring, which saw AirAsia X pull out of several unprofitable markets including Christchurch, Paris, London, Delhi and Mumbai. Without the restructuring it is unlikely AirAsia X would have been able to complete an initial public offering in Jul-2013. But since the IPO the group has struggled financially.

The losses can generally be blamed on oil prices and challenging market conditions, particularly in Australia, fuelled by the need to pursue strategic growth. Australian routes account for about 35% of the group's seats - and for most of the losses in 2Q2014. But the losses have weakened AirAsia X's balance sheet and somewhat clouded its outlook.

2. Investor scepticism: AirAsia X's stock has performed poorly since IPO

There are not nearly as many sceptics in the long-haul low-cost model as there were back in 2007, when AirAsia X launched. But some investors and equity analysts are still concerned the model may not be capable of producing sustainable profits.

The AirAsia X IPO failed to meet initial expectations and had a lacklustre debut on the Kuala Lumpur Stock Exchange. The stock is currently trading almost 40% below its initial price.

AirAsia X share price (in MYR) over the last 12 months

Source: CAPA - Centre for Aviation and Bloomberg

3. AirAsia-AirAsia X relationship has limitations

AirAsia X is a separate company from AirAsia Group with a different ownership structure. There is some overlapping ownership and there are synergies which clearly benefit both companies. But ultimately AirAsia X only exists because of a licensing agreement with AirAsia that comes up for renewal in 2017.

AirAsia X also only has the first right of refusal on new long-haul AirAsia-branded franchises in Southeast Asia. If the AirAsia Group's new partners in India and Japan later look to add a long-haul operation - a scenario already being mooted - there is no guarantee that it will be done under the AirAsia X relationship.

From Southeast Asia, AirAsia X is only entitled to operate routes of more than four hours. Any shorter route can only be pursued with permission from AirAsia. So far this has only occurred for Kuala Lumpur-Colombo, which AirAsia X was able to launch in 2013 after AirAsia could not make the route work and exited.

Ideally AirAsia X would also operate high volume short-haul routes, particularly to airports with slot constraints such as Hong Kong. AirAsia X could be used to up-gauge existing AirAsia flights of under four hours where slots preclude additional frequencies (Hong Kong is slightly under four hours from Kuala Lumpur).

Cebu Pacific has successfully been using its new A330 fleet to up-gauge certain regional flights from A320s. Singapore Airlines' long-haul low-cost subsidiary Scoot also now operates two short-haul routes. The current four-hour rule puts AirAsia X at a strategic disadvantage while the licensing agreement poses a long-term risk.

AirAsia X OPPORTUNITIES

1. Malaysia Airlines restructuring could benefit AirAsia X

Flag carrier and main hub competitor Malaysia Airlines (MAS) is planning to cut jobs and capacity as part of a recovery plan which will be implemented over the next nine months. AirAsia X could potentially pick up routes as well as some employees that MAS drops as the ailing flag carrier attempts a challenging turnaround.

MAS currently serves 14 of the 19 routes AirAsia X operates from Kuala Lumpur. The two also compete across most of AirAsia X's main connecting markets.

MAS will also likely drop routes which AirAsia X currently does not serve, including routes to Europe. As a considerable proportion of its Australian traffic (where MAS expanded by 30% in late 2013 and early 2014) connects to Europe, MAS is likely to have to cut back in this key AirAsia X market. AirAsia X will closely assess all route MAS reduces or axes and could even reconsider Europe under the right conditions.

See related reports:

• Malaysia Airlines restructure will need partners - perhaps Etihad, BA, Finnair or Qatar Airways
• Malaysia Airlines restructuring: cost cuts must be deep to improve short-haul competitiveness

Another component of the MAS recovery is focus on improving yields, which should bring an end to the irrational competition and aggressive pricing. MAS over the past year has been undercutting AirAsia X in many cases. This pricing strategy, which was reinforced following the MH370 and MH17 incidents as MAS tried to woo back passengers, is not sustainable given MAS' significantly higher cost structure.

2. China presents AirAsia X with huge opportunities for expansion

China has been a challenging market in recent months as outbound visitor numbers to Southeast Asia plummeted due to a combination of the MH370 incident and political instability in Thailand. But AirAsia X continues to be successful in China and is looking to further expand its Chinese network.

X'ian was launched in Jul-2014 and has so far performed ahead of expectations. Chongqing will become AirAsia X's sixth destination in China in Feb-2015. A potential seventh and eighth Chinese destination from Kuala Lumpur will be added in 2015 as the Malaysian subsidiary focuses expansion primarily on China. Thai AirAsia X also will likely start serving northern China by the end of 2015, leveraging the strong brand AirAsia has built up in the mainland Chinese market.

While the Chinese visitor numbers in Thailand and Malaysia have dropped in 2014, AirAsia X has seen rapid growth in China-Australia traffic, where upside is large and direct services are limited. New relationships with Chinese online travel agencies have particularly helped AirAsia X push into one-stop markets ex-China.

Chinese secondary cities are expanding fast but non-stop routes to Australia and other parts of Southeast Asia are generally not viable. Kuala Lumpur and Bangkok are ideal hubs for this traffic and AirAsia has the low fares needed to stimulate the price sensitive Chinese leisure traveller, many of whom are venturing overseas for the first time.

China is currently the Malaysia-based carrier's second largest market but should eventually overtake Australia, where AirAsia X is now responding to the challenging market conditions by cutting capacity, albeit modestly.

AirAsia X capacity share (% of seats) by country: 22-Sep-2014 to 28-Sep-2014

Note: does not include Thai AirAsia X
Source: CAPA - Centre for Aviation & OAG

3. AirAsia X is well positioned to expand premium revenues and cabin

AirAsia X has built up a strong niche in the premium end of the market, capitalising on its position as the only LCC with a lie-flat product. So far AirAsia X has focused on the upmarket leisure and small business segments but has the potential to start targeting corporate accounts as it continues to expand its network.

The upcoming network restructuring at MAS and the recent opening of KLIA2, Kuala Lumpur's hybrid terminal, particularly open up opportunities for AirAsia X at the top end of the market. KLIA2 provides a much improved passenger experience over the former LCCT and has enabled AirAsia X to start providing lounge access as part of its package for premium passengers.

Business class currently accounts for only 8% to 9% of AirAsia X's revenues. AirAsia X for now is sticking with small 12-seat business class cabins. But ultimately it could expand its business class cabin and introduce new products that appeal to economy class business travellers. Such initiatives would help AirAsia X efforts to push up yields and reduce the number of seats sold at promotional prices.

4. Lower fuel prices progressively open up new route expansion and profitability possibilities

At present, fuel costs account for 50% of AirAsia X's operation. Consequently, AirAsia X gains a disproportionate cost improvement as fuel prices fall, both giving the airline an advantage when competing head to head with full service airlines and in terms of the range that can be flown commercially. As a rough benchmark, five years ago when oil was priced around USD70 per barrel, AirAsia X not only operated European services with the fuel-hungry A340, but was also planning service to the US west coast.

Oil prices have tended downwards recently, to around 12 month lows, although they remain above USD90 per barrel; jet fuel has fallen in sync. A combination of more benign fuel prices and new fuel-efficient A330neos would greatly increase AirAsia X's range of network options. It would also increase the margin between the LCC and its full service competitors.

In a similar context, an independent AirAsia X also becomes an increasingly attractive proposition for partnership with a European full service airliine, something that would potentially deliver it a feeder network at both ends of any Asia-Europe route. Lufthansa for example is explicitly exploring the possibility of partnering with another airline to deliver a long-haul low-cost operation.

AirAsia X THREATS:

1. AirAsia X will continue to face intense competition

Southeast Asia has become an intently competitive market, forcing AirAsia X to cut fares as it rapidly added capacity. While market conditions should improve at least slightly some competitors are likely to continue to respond aggressively.

AirAsia X's network low-cost model, with a heavy focus on transit traffic, has the potential to shake up several medium-haul markets which until now have only been served by full-service carriers. As a result AirAsia X has the potential to stir up the pot across Asia-Pacific. Often-bigger competitors will naturally try to fight off AirAsia X as its model poses a threat to their own survival.

AirAsia X's is well positioned to win any fare war given its low cost structure. But some of its competitors have deeper pockets and larger networks, allowing them to stomach losses on a certain route or across a handful of one-stop city pairs.

2. Fuel prices will always be a concern for long-haul LCCs

Fuel accounts for 49% of AirAsia X's costs (based on 2Q2014 figures). Fuel prices have increased since AirAsia X was established, making longer routes challenging and reducing the portion of costs that can be controlled. If fuel prices increase further the portion of controllable costs will slip and the gap with full-service airlines will narrow.

AirAsia X has discovered that at the current price of fuel the medium/long-haul model generally works at flights of up to eight or nine hours. Higher fuel prices could change the economics of routes that are now profitable. They would also make it nearly impossible to resume services to Europe as efficiency improvements that come with new generation aircraft would be offset.

3. A reversal of national flexibility on market access could reduce opportunities for growth

LCCs of all kinds have been able to expand in Asian international markets in ways that were ruled out as impossible only a decade ago. The region is today unique in supporting genuinely international LCC services on such a scale; the US is primarily domestic and intra-EU operations do not require bilateral air services agreements. The remarkable access achieved by Asian LCCs has been largely aided by governments adopting a relaxed approach to ownership and control provisions in the many cross border joint ventures established.

In the (unlikely) case that governments seek to restore protection for their flag carriers, this flexibility might be reduced. The price would be to reverse a range of social change and popular expectations of low price travel and to restrict valuable tourism flows - so logically the likelihood is small, but there are many illogical government policies where airlines are concerned.

AirAsia X outlook: High potential but challenges also loom

AirAsia X has demonstrated the long-haul low-cost model can work with the right focus.

It has done so by reshaping the low-cost airline model, achieving many of the full service airline connectivity features, but at a much lower cost. However it still has to prove it can build a profitable business case beyond its initial expansion, while still securing its strategic foothold in expanding Asia-Pacific markets.

Its leading position in Asia's fast growing medium/long-haul low-cost sector comes with potentially huge rewards. But full service carriers, as well as other long-haul low-cost competition now emerging, will be keen to exploit weaknesses and make life difficult for AirAsia X.

Background information

See related analysis reports on AirAsia X published by CAPA over the last two years (in reverse chronological order):

• The evolving long-haul low-cost network airline model: AirAsia X and the new LCC connectivity
• AirAsia X records 2Q2014 loss as Australia underperforms. But long-term prospects are still bright
• AirAsia X reinforces position as long-haul LCC leader with 50 commitments for A330neos
• AirAsia further slows fleet expansion as 1Q profit falls - with the potential to accelerate later
• AirAsia X drives 43% transit traffic at Kuala Lumpur's KLIA. Can Singapore follow the same recipe?
• AirAsia cements leading position in Indonesia international market with new AirAsia X Bali base
• AirAsia X multi-hub strategy to shake up Thailand market from early 2014. Is Indonesia next?
• AirAsia X emerges as Australia's fourth largest foreign airline, overtaking rival Malaysia Airlines
• AirAsia X strives to widen the gap with long-haul LCC competitors as IPO enables accelerated growth
• AirAsia X IPO prospectus shows strength. AirAsia synergies help, also require definition

CAPA's Asia Aviation Summit and LCC Congress will he held at the Capella, Sentosa in Singapore 13/14 October, followed by a Corporate Travel Day on 15 October. To hear from AirAsia X CEO Azran Osman-Rani and learn about China's new LCC movements as well as the latest on all of Asia's key aviation markets and players, and meet 20 airline CEOs, click here: CAPA Asia Aviation Summit