05-Mar-2013 4:45 AM

AirAsia’s 2013 outlook marred by intensifying competition and continued losses at new affiliates

Analysis

AirAsia faces a potentially challenging 2013 as it accelerates expansion in its three core markets as part of an attempt to fight off intensifying competition within Southeast Asia. Meanwhile, the group will continue to incur losses at the two affiliates it launched during 2012, in the Philippines and Japan, and will incur start-up costs for its new joint venture in India.

The AirAsia Group plans to focus growth in 2013 at the three affiliates which are profitable - AirAsia Malaysia, Thai AirAsia and Indonesia AirAsia. This established trio of LCCs, all of which are now at least seven years old, will take a record 25 aircraft in 2013 for a total of 138 A320s, representing 22% fleet growth.

AirAsia Philippines, AirAsia Japan and AirAsia India are only expected to take about seven A320s in 2013, a surprisingly small figure for the Philippine and Japanese affiliates given they have not yet reached initial economies of scale. The group is waiting for AirAsia Philippines and AirAsia Japan to move into the black, which could take a few years, before pursuing more ambitious expansion.

Summary

AirAsia plans to focus growth in 2013 on its profitable affiliates in Malaysia, Thailand, and Indonesia.
AirAsia Malaysia will increase its fleet from 64 to 74 A320s to add domestic capacity ahead of the launch of Malindo.
Indonesia AirAsia plans to grow its fleet from 22 to 30 A320s to establish a bigger presence in the Indonesian domestic market.
AirAsia Philippines and AirAsia Japan are expected to take only seven A320s in 2013 as they have not yet reached initial economies of scale.
AirAsia Malaysia and Thai AirAsia were the most profitable affiliates in 2012, while Indonesia AirAsia reported a lower operating profit margin.
AirAsia faces new competition in Malaysia from Lion Air, prompting the acceleration of growth in the country.

AirAsia pours additional capacity into Malaysia, Indonesia and Thailand

AirAsia Malaysia is slated to grow its fleet in 2013 from 64 to 74 A320s as the carrier adds domestic capacity ahead of the planned late Mar-2013 launch of Malindo, which will become the second LCC in the Malaysian market and is partially owned by the Lion Air Group. Indonesia AirAsia plans to grow its fleet from 22 to 30 A320s as it tries to establish a bigger presence in the crowded but promising Indonesian domestic market, which is dominated by rival Lion. Thai AirAsia will take seven A320s in 2013 for a total of 34, with the additional aircraft being used primarily to increase domestic capacity as competition intensifies with Thai Airways and its LCC affiliate Nok Air.

The result will be a significant increase in capacity for AirAsia within Southeast Asia, a market which already has a LCC penetration rate exceeding 50%. AirAsia is trying to tighten its grip on this market and fend off rapidly expanding competitors, particularly Lion. AirAsia and Lion both control about 30% of LCC capacity within ASEAN. But there is a risk of over-capacity and irrational competition on several routes.

In Japan, which has a LCC penetration rate below 15%, AirAsia will grow its fleet in 2013 from three A320s to a still modest seven aircraft. Assuming the group takes a total of 32 A320s from Airbus during 2013, the last three aircraft will be left for AirAsia India. The new carrier, a joint venture between the AirAsia Group and the Tata Group, has said it aims to launch in 4Q2013 with an initial fleet of three or four aircraft.

AirAsia Group fleet by affiliate

Carrier	Launch year	A320s as of 31-Dec-2011	A320s as of 31-Dec-2012	A320s as of 26-Feb-2013	A320s as of 31-Dec-2013*
AirAsia Malaysia	2001	57	64	65	74
Thai AirAsia	2004	21	27	28	34
Indonesia AirAsia	2005	17	22	22	30
AirAsia Japan	2012	0	3	3	7
AirAsia Philippines	2012	0	2	2	2
AirAsia India	2013*	0	0	0	3
TOTAL		95	118	120	150

AirAsia Group projected delivery dates for aircraft on order*

Any of the AirAsia affiliates could end up with more A320s than currently planned by going to the leasing market. The group traditionally has relied on its own A320 orders but over the last two years has also taken five A320s that were ordered by lessors.

Currently the AirAsia Group operates 120 A320s, including 115 from its orders and five from leasing companies, and has another 360 A320s on outstanding order. The 360 figure includes 30 A320s for delivery over the last 10 months of 2013. AirAsia has already taken two aircraft this year (one each for AirAsia Malaysia and Thai AirAsia) and is slated take two more aircraft before the end of 1Q2013 (one for Japan and one more for Malaysia).

AirAsia Malaysia leads the way in profits

Once again AirAsia's original business in Malaysia was the stellar performer in 2012, with the carrier's 23% operating profit margin among the highest airline profit margins in the world. Thai AirAsia, which has been profitable for several years and completed an IPO in May-2012, also had a respectable operating profit margin of 11%. Indonesia AirAsia, which became profitable in 2010 after an initial several years of losses, reported an operating profit margin of only 3%.

Indonesia AirAsia, which on a cumulative basis is still in the red, is planning its own IPO with a listing on the Indonesia Stock Exchange slated to debut in 2H2013. The Malaysia-listed AirAsia Group currently has a 49% stake in Indonesia AirAsia and owns a 45% stake in Thai AirAsia.

AirAsia's Malaysian operation, which is a fully-owned subsidiary of the AirAsia Group, saw its net profit increase by 238% in 2012 to MYR1.88 billion (USD610 million), driven by one-time items (see background information). The carrier's operating profit was unchanged at RM1.16 billion (USD370 million) while revenues were up 11% to MRY5.00 billion (USD1.6 billion). As a result its operating profit (EBIT) margin slipped slightly from the 26% recorded in 2011 to 23%.

Thai AirAsia recorded a 10% decrease in net profit to THB1.81 billion (USD61 million) and a 2% decrease in operating profits to THB2.15 billion (USD72 million) as revenues were up 20% to THB19.35 billion (USD650 million). Indonesia AirAsia recorded a 129% increase in net profits on a low base to IDR142 billion (USD15 million) while operating profits were up 136% to IDR353 billion (USD36 million) and revenues were up 18% to IDR4.36 trillion (USD449 million).

The AirAsia Group was able to recognise its share of the Thai AirAsia profit as Thai AirAsia is cumulatively in the black. But the group will not be able to recognise any profits from Indonesia AirAsia until MRY163 million (USD52 million) of cumulative unrecognised losses have been reversed. The same policy applies to its new affiliates, which means it could be several years before the AirAsia Group is finally able to start booking profits from more than two its six airline affiliates or subsidiaries.

AirAsia Philippines and AirAsia Japan are still in the red and are unlikely to become profitable in the near term. AirAsia Philippines recorded a net loss of MYR93 million (USD30 million) for 2012, including MYR23 million (USD7 million) for 4Q2012. AirAsia Japan recorded a net loss of MYR97 (USD31 million) million for 2012, including MYR40 million (USD13 million) for 4Q2012. The AirAsia Group owns 40% of AirAsia Philippines and 49% of AirAsia Japan.

AirAsia Philippines off to rough start

The continued losses in the Philippines are particularly concerning as the carrier has now been operating almost one year. The carrier still only operates two A320s and has not yet been allocated a single additional aircraft from AirAsia Group's 2013 deliveries. AirAsia Philippines could still add aircraft in 2013 by taking aircraft directly from leasing companies but the AirAsia Group is clearly taking a very conservative approach to expansion in the competitive Philippine market.

The Philippine domestic market is particularly challenging with five LCCs competing, leading to over-capacity and irrational competition. The LCC penetration rate in the Philippines domestic market is currently 85% with AirAsia Philippines accounting for only 1% of domestic capacity within the country, according to Innovata data.

AirAsia Philippines is now focusing more on the international market, with flights from its base at Manila alternative airport Clark, to Hong Kong, Kuala Lumpur, Singapore and Taipei. Its domestic network has been reduced to just 11 weekly flights and two destinations - Davao and Kalibo.

The AirAsia Group has said the Philippines affiliate will focus more on China markets and regional connectivity as it tries to improve profitability. The Clark-Taipei route, launched in Dec-2012, has been successful and has already been boosted from four to seven weekly flights.

But the carrier has already struggled in other markets in greater China, pulling off the Clark-Macau route. AirAsia Philippines is keen to open new routes to mainland China but this is unlikely to occur until tensions between China and the Philippines ease.

AirAsia Philippines' lack of slots at Manila, where its four LCC competitors all operate, puts the carrier at a competitive disadvantage. The AirAsia Group noted within its results announcement for 2012 that Clark's airport authority will commence shuttle bus services from Manila, improving connectivity from the city centre. But it is unclear if passengers will be swayed to take a bus through Manila's notoriously bad traffic when there are generally low fare flights available from Manila International.

AirAsia Philippines has quickly discovered it is difficult to serve the domestic market from Clark. International services can potentially work with the right low fare stimulation. But there are not many potential international markets to serve given the tensions with mainland China and the fact the two other key North Asia markets - Philippines-South Korea and Philippines-Japan - are currently not open to additional Philippine carriers.

Southeast Asia is open but AirAsia already has affiliates in three other Southeast Asian countries, making the new Philippine operation unnecessary except in the Philippines-Singapore market. But the Philippines-Singapore market is already served by several LCCs, making it tough for AirAsia to carve out a profitable niche.

In hindsight, establishing a Philippine affiliate was probably not the smartest move. But the decision was made before an opportunity to join with All Nippon Airways in Japan surfaced and long before India's airline sector opened up to foreign investment.

The AirAsia Group did not necessarily need a fourth affiliate in Southeast Asia, particularly in such a highly competitive and challenging market as the Philippines. AirAsia will try to ride out the storm, hoping consolidation will occur, leading to an improvement in market conditions. In the meantime, the group will retain a very small presence in the market in a bid to minimise losses while it invests more heavily in bigger and more promising markets.

AirAsia Japan also off to a rough start but has more promising future

AirAsia also has had its share of challenges at AirAsia Japan since the carrier launched in Aug-2012. As reported by CAPA in Jan-2013, AirAsia Japan's load factors dropped below 60% in Oct-2012 and Nov-2012 and to around 10ppt below rival Jetstar Japan despite the two carriers having similar networks. AirAsia Japan also has reportedly suffered from poor on-time performance rates. In Dec-2012, the carrier's initial CEO, Kazuyuki Iwakata, resigned.

But the problems in Japan can be more easily resolved than the Philippines. The larger Japanese market is now only being penetrated by LCCs for the first time while in the Philippines Cebu Pacific has been operating as a LCC for over a decade, giving it a massive first mover advantage.

The AirAsia Group is optimistic the new management team in Japan can right the ship. The group is particularly bullish on the second AirAsia Japan hub at Nagoya, which will open in late Mar-2013 with two domestic routes. The Nagoya hub is made possible as the carrier takes its fourth aircraft in Mar-2013. The group has stated that the opening of the Nagoya hub will boost average aircraft utilisation rates and reduce costs as the Nagoya airport, unlike AirAsia Japan's Tokyo Narita base, is open 24 hours per day.

The group has also pointed out that the launch of agency sales in Japan should boost load factors in 1Q2013. It claims AirAsia Japan is already performing well in the international market, where it "dominates" Japan-Korea routes, and says more international routes will be launched in 2013 as the fleet is expanded.

However, the group is proceeding relatively cautiously in Japan. Growth of four aircraft in a LCC's second year of operation is modest, particularly given the size of the Japanese market.

AirAsia Group CEO Tony Fernandes stated in the group's 26-Feb earnings announcement: "The main focus for the next few years will still be the core markets - Malaysia, Thailand and Indonesia. Then grow Japan and Philippines in a way it will be profitable."

AirAsia faces new competitor in Malaysia, prompting acceleration of growth

In Malaysia, the group notes that with RM2.3 billion (USD740 million) in cash in the bank it has the "strength to compete with all competitors".

Growth in Malaysia has taken a back seat in recent years as the focus has shifted more to Indonesia and Thailand to prepare the group's second and third affiliates for IPOs. Passenger traffic at AirAsia Malaysia only grew by 9% in 2012 to 19.7 million while Thai AirAsia saw 21% growth to 8.3 million and Indonesia AirAsia saw 17% growth to 5.8 million (see background information).

With the upcoming launch of Malindo, now is the time to again pursue growth in Malaysia. The 10 A320s being added to AirAsia Malaysia's fleet in 2013 will be used to "dominate" domestic trunk routes as frequencies are increased. The carrier says capacity will in particular be added on domestic routes to East Malaysia and Johor Bahru.

Some new international routes will also be added in a bid to further improve international connectivity. But the focus will be on maintaining AirAsia's leading position in Malaysia's domestic market, where it currently accounts for 52% of seat capacity.

Malaysia domestic capacity share (% of seats) by carrier: 03-Mar-2013 to 10-Mar-2013

Given the relative small size of the Malaysian market, the extra capacity will likely come at the expense of yields. AirAsia Malaysia is confident it can grow its load factor to 85%, compared to 80% in 2012.

Higher loads and a renewed focus on ancillaries, which dropped by 11% in 2012 on a per passenger basis, could potentially help offset a reduction in yields brought on by a fare war. But with Lion breaking the cosy AirAsia-Malaysia Airlines duopoly in Malaysia's domestic market it will be challenging for AirAsia Malaysia to maintain its extremely high profit margins.

Indonesia AirAsia tries to establish a meaningful domestic presence

In Indonesia, AirAsia is conversely looking to build from a point of weakness. While Indonesia AirAsia is the largest carrier in Indonesia's international market, it currently has less than a 5% share of domestic capacity. Most of the eight A320s being added by Indonesia AirAsia in 2013 will be allocated to the domestic market.

The 2013 push for Indonesia AirAsia (IAA) began on 01-Mar-2013 with the opening of a new hub at Makassar, where the carrier has launched five new domestic routes. Makassar is the furthest point east in Indonesia served by Indonesia AirAsia, which previously only served the western half of the massive country. The carrier will continue to extend its network eastward in 2013 as it looks to develop a more meaningful network, which currently only consists of 12 domestic destinations.

In an attempt to reach a larger demographic, Indonesia AirAsia (IAA) recently strengthened its distribution channels. The carrier now has a network of 3,500 agents, enabling it to access more of Indonesia's massive population. A large agent network is Lion's key strength and is necessary to compete in Indonesia's LCC sector as most of the population does not yet buy tickets on the internet or have credit cards.

Prior attempts by AirAsia to compete against Lion in Indonesia's domestic market failed as AirAsia did not recognise the importance of offline distribution. AirAsia still faces an uphill battle domestically in Indonesia but is willing to invest heavily in trying to secure a large slice of Indonesia's domestic market. The recent bankruptcy of Batavia, a full-service carrier AirAsia looked at acquiring in 2012, is a boost as it means there is one less competitor to worry about.

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"IAA, already a leader in the international market, has a good turnaround story with high increase in revenue and profit and with the recent change in strategy to focus more on domestic growth, we will see a lot more contribution coming from them as it begins to rise and compete with the larger airlines," Mr Fernandes stated in the AirAsia Group 2012 earnings announcement. "IAA will be going for listing in the second half of 2013. Capacity is being put into IAA to support this rapid expansion plan."

Thai AirAsia grows from position of strength

The AirAsia Group says the additional capacity being added in Thailand in 2013 is part of a strategy to "dominate" the domestic market as well as the Thailand-Southeast Asia and Thailand-China markets. Thai AirAsia also expects to expand its operation in India, where it will be used as a feeder for AirAsia's new domestic Indian joint venture.

The AirAsia Group is particularly confident in Thai AirAsia's position in the market following the carrier's move in Oct-2012 from congested Suvarnabhumi Airport to Bangkok's old airport, Don Muang. The move to Don Muang has lowered Thai AirAsia's cost base and given the carrier a unique product along with Nok, which is also based at Don Muang.

Thai AirAsia currently has a leading 31% share of seat capacity in Thailand's domestic market and a 7% share of capacity in the international market, which is second to Thai Airways. But Nok has also been expanding rapidly over the last year in the domestic market and plans to launch international services in mid-2013.

Thailand domestic capacity share (% of seats) by carrier: 03-Mar-2013 to 10-Mar-2013

Thai AirAsia also faces a new competitor in hybrid carrier Thai Smile, which the Thai Airways Group launched in mid-2012 and is being used along with Nok to try to fend off Thai AirAsia. Thai Smile selected Thai AirAsia's second international largest route, Bangkok-Macau, as its launch route and is now competing against Thai AirAsia on nearly all of its routes. Nok's forthcoming initial international route, Bangkok-Yangon, is Thai AirAsia's third largest international route.

Lion poses the biggest challenge to AirAsia

While the competition is intensifying in Thailand, the conditions for 2013 are not as challenging in Thailand as they are in Indonesia or Malaysia. In Thailand, AirAsia is already well established in both the domestic and international markets and its main competitor, the Thai Airways Group, has traditionally struggled to compete against LCCs. In Indonesia and Malaysia, AirAsia faces in Lion a LCC with an extremely low cost structure and an ambitious expansion plan that is supported by an order book that is almost as massive as AirAsia's.

Indonesia is a big enough market for AirAsia and Lion as well as other LCCs such as Tiger affiliate Mandala and Garuda subsidiary Citilink. But these four carriers could be in for a prolonged battle for the fast-growing lower end of Indonesia's domestic market, resulting in over-capacity in some markets and losses for at least some of the players. Malaysia is not a big enough market for two large LCCs and there could be a blood bath if new Lion affiliate Malindo expands ambitiously.

AirAsia will certainly survive any looming battle and is well positioned to remain the leading LCC in its extended home market of ASEAN as well as in the broader Asian market. But it faces a challenging chapter as competition intensifies in Asia's dynamic LCC sector.

While there is a risk of hyper competition in Southeast Asia, the group also faces two strong competitors in the new Japanese LCC market and will have to compete against several established LCCs when it launches in India in 4Q2013. AirAsia India will attempt to carve out a new niche by focusing on secondary routes from a base at Chennai but it will almost certainly face a response from India's five existing LCCs given the LCC penetration rate in the Indian domestic market already exceeds 60%.

2012 was a milestone year for AirAsia as it added two new carriers to its portfolio, ending a hiatus of seven years without launching a new affiliate. But adding two new affiliates at almost the same time created challenges and is a drain on resources, both financial and intellectual. The launch of yet another new affiliate in 2013 will add to the short-term headache. Exacerbating the situation, AirAsia faces new competitive challenges in its original three markets.

AirAsia says it is now finished with expanding its portfolio. Eventually at least some or, as Mr Fernandes hopes, all three new affiliates will be profitable. If all the ventures are ultimately successful, AirAsia will be one of the top three LCC groups in the world and the fleet of 475 aircraft that the group has committed to will easily be absorbed. But for now the pain of expansion, and in the case of Malaysia the pain of being so wildly successful to spur new competitors, is being felt. AirAsia clearly has the cash to withstand the storm of challenges that 2013 brings and the group's strong position in its core Southeast Asian markets should allow it to stay in the black by a healthy margin.

Background Information:

AirAsia Malaysia operational highlights: 2012 vs 2011