COVID-19 forces major change across Asia-Pacific airline industry

Summary:

• Although domestic markets have bounced back, second waves are a major threat.
• Progress on international travel corridors has been slower than anticipated.
• SIA and Cathay Pacific have strong support, but border openings are vital.
• Japanese airlines' big plans for 2020 have been thwarted by the pandemic.
• Struggling Southeast Asian flag carriers must re-evaluate their turnaround plans.
• Independent LCCs face financing challenges, and order books are a headache.
• In Australasia, some airlines are seizing new opportunities out of the crisis.

This report is contained in the latest issue of Airline Leader #53

Domestic markets have recovered relatively quickly

One of the more positive developments in the Asia-Pacific region has been the quick rebound of many important domestic markets. The expectation was that domestic markets would recover first, followed by short haul intraregional services, and with long haul international markets taking longest to return.

This has certainly been borne out in practice. As internal travel restrictions were removed in certain markets, airlines were able to reintroduce domestic routes fairly quickly. This was the case in the China, Japan, New Zealand, and Vietnam markets in particular.

In many cases, of course, capacity does not tell the full story. Although routes have been restored, filling the planes has been a challenge for airlines. Demand has lagged the capacity increases, but some airlines are restoring their networks in a proactive effort to stimulate travel.

Pandemic second waves could derail airlines' hard-won progress

There are some risks to domestic demand, however. Economic slowdowns will not help, and airlines will have minimal international feed into their domestic networks for some time. But the largest threat is the prospect of renewed surges of COVID-19 infections.

Second waves of coronavirus have recently hit several Asia-Pacific markets. This development has blunted domestic travel growth in Australia, and stalled the impressive bookings recovery in Japan. Rising infection numbers also raise the risk that authorities will reintroduce travel restrictions for certain cities, as occurred in Vietnam (Da Nang) in late Jul-2020 and the Philippines (Manila) in Aug-2020. A sustained return of broader travel bans could be a mortal blow to some Asian airlines.

The second-wave effect is shown in the chart below for Vietnam's VietJet. Domestic capacity bottomed out in Apr-2020, before rising rapidly. But then it slipped back somewhat in Aug-2020, due to a ban on flights to the popular leisure destination Da Nang because of an outbreak there.

VietJet: weekly domestic seats, 2017-2020. Exceeding 2019 levels since Jun-2020

Source: CAPA and OAG.

Bilateral corridors are a starting point, but few have eventuated

International capacity remains at very low levels and is only increasing fractionally. With most countries enforcing border closures or 14-day quarantine requirements, the majority of international traffic has consisted of repatriation flights or services operated mainly for cargo.

Some countries have established travel corridors between them, allowing those deemed as essential travellers to apply to enter a country with reduced quarantine if they follow testing requirements. China introduced such arrangements with South Korea in May-2020 and with Singapore in Jun-2020. Malaysia and Singapore also plan to launch a corridor in Aug-2020 for essential travel and for some "periodic commuting" workers.

The expectation was that bilateral arrangements like these would expand to multilateral corridors, and that more would emerge across the region. But while some are under discussion, progress has been slow.

In more limited cases there have been talks regarding broader "travel bubbles" between countries, allowing for quarantine-free entry for all types of travellers. Australia and New Zealand were expected to be the first with such an arrangement, but soaring infection rates in Australia have set this effort back significantly.

Reliance on international transit traffic is hurting SIA and Cathay

For Singapore Airlines (SIA) and Cathay Pacific, the resumption of international traffic is much more crucial as they have no domestic networks to fall back on. SIA has said that progress on removing international travel restrictions has been slower than expected, which means its recovery trajectory will also not meet its initial projections.

Singapore Airlines: weekly departing frequencies, 2017-2020

Source: CAPA and OAG.

The Singapore and Hong Kong governments have allowed transit traffic to resume at their major airports, which is an important step for Cathay and SIA. However, they will need key overseas markets to reopen to build the scale required for their connecting networks to be viable.

Fortunately, the two governments have been among the most supportive of their airlines. State-owned Temasek Holdings backed a SGD15 billion fundraising plan for SIA, and the Hong Kong government took the lead role in a HKD39 billion support package for Cathay.

Cathay and SIA are also undertaking major reviews of their operations to adjust to the new market realities. Cathay intends to complete its review by the fourth quarter, but is already making progress in renegotiating aircraft delivery timetables. Deliveries of Airbus A350s and A321neos will be stretched by two years, and Cathay is also in talks regarding deferral of its Boeing 777-9s.

SIA plans to finish its review around the end of its fiscal first half, in Sep-2020, and this will give an indication of what long term changes will be made to its network and fleet.

Chinese domestic capacity rebounds, but international access heavily restricted

China's domestic travel market was the first to be hit hard in the initial phase of COVID-19, but it also recovered sooner than others. The rebound has ebbed and flowed as infection spikes have occurred in different regions, but the overall trend has been upward, and has now essentially fully recovered.

China's weekly domestic seats through 17-Aug-2020. Now at 2019 levels

Source: CAPA and OAG.

Demand has generally lagged capacity, as airlines and the government have been eager to re-establish networks. The three state airlines in China are unable to reduce work forces as much as those in other countries, so adding back capacity is less difficult.

In order to help fill their extra capacity, some of the major Chinese airlines have introduced "all you can fly" deals recently. Rules for these vary somewhat by airline, but they allow unlimited flights for a set period. Such efforts should help fill seats, but obviously yields will take much longer to return.

However, China has kept a tight lid on international services. In addition to the quarantine requirements common to most countries, the Chinese government restricts Chinese and foreign airlines to a base level of one flight per week. The government can grant an increase - although it can also reduce the allocation if there are too many COVID-19 cases aboard a single flight.

There is clearly greater demand for China flights than the limited services allow, however.

U.S. airlines pushed for more access, after being blocked because they had temporarily suspended all flights to China. South Korean airlines had planned a faster resumption of China flights but had to curtail their plans. China is now such an important international market for so many Asian airlines that gaining greater access will be a top priority.

COVID-19 overshadows what should have been a pivotal year in Japan

Japan is another of the countries where domestic networks have come back strongly. The Japanese market did not shut down completely during the pandemic's first wave as others did, although services were cut back dramatically. Japan Airlines was operating just 28% of its usual domestic flights in late May-2020 and early Jun-2020.

Flights have been added back rapidly since internal travel restrictions were eased on 19-Jun-2020: JAL expects to be operating up to 72% of its domestic capacity in the second half of Aug-2020 and 66% in early Sep-2020, and ANA intends to operate 71% in late Aug-2020. However, these estimates have been trimmed back significantly from previous recovery assumptions thanks to the emergence of a second wave of coronavirus cases.

The arrival of COVID-19 was particularly bad timing for Japanese airlines, as they had been looking for 2020 to be a peak demand year due to Tokyo hosting the Olympic Games. Now the Olympics have been postponed to 2021 - and it cannot be guaranteed that the games will proceed then either.

The Japanese airlines and the government had targeted 2020 as the beginning of another growth phase in international visitor arrivals. New slots were created at highly sought-after Tokyo Haneda Airport this year, and these had been allocated to Japanese and foreign airlines for international services. But this growth pulse will obviously be put on hold for the immediate future.

Fortunately, both of the Japanese majors were in excellent financial condition leading into the latest crisis. They will have to reassess their strategies and long term assumptions like other airlines, and they are both negotiating to defer near term aircraft deliveries. Their survival is not in question, however.

Big airline deals have been thrown off course in South Korea

COVID-19 is disrupting some major airline merger and acquisition moves in the South Korean airline industry. One of these was Jeju Air's proposed takeover of fellow LCC Eastar Jet, which has now been called off.

The takeover was expected to provide some much-needed consolidation in the crowded South Korean LCC market. Jeju is the country's largest LCC, and it would have increased its dominance by adding Eastar, which was the fifth largest LCC before the pandemic.

The acquisition had been agreed to in principle, but had not closed before the coronavirus crisis emerged. This changed the equation significantly for Jeju - now expansion appears less palatable, and the already financially troubled Eastar is in worse condition and a potential major liability. Jeju Air officially pulled out of the deal on 23-Jul-2020, leaving the future of Eastar in serious doubt.

Another major deal is Hyundai Development Corp.'s proposed purchase of a controlling stake in Asiana. Once again, the potential benefits of the takeover are now a lot less than they were in Dec-2020, when the tentative agreement was reached. HDC has said that it wants to renegotiate the terms, and has called for another due diligence phase. The deal has appeared increasingly shaky, and the parties are involved in talks to determine if it can be salvaged.

The collapse of the takeover would leave few options for Asiana and its state bank creditors. It would also present a dilemma for the government, since it wants two major airlines in the South Korea market for competitive reasons.

The chart below shows that in January, before the pandemic struck, Asiana had the second largest number of international seats in the South Korean market, with a 14.8% share.

Interestingly, if Jeju and Eastar had been combined they would have been close behind, with almost 13%.

International seats in South Korean market for the week of 13-Jan-2020

Source: CAPA and OAG.

Need for major overhaul even more apparent for flag carriers

Three of Southeast Asia's major flag carriers were already in fragile financial condition before the COVID-19 epidemic struck, and their predicament has only worsened due to flight suspensions. Malaysia Airlines, Garuda Indonesia and Thai Airways were either in the middle of a turnaround effort or had just completed one.

The trio are predominantly state-owned. The assumption has always been that their governments would continue to bail them out to ensure their survival, but with many other economic priorities due to the pandemic, government patience with the airlines is wearing thin.

For example, rather than provide another bailout package to Thai Airways, the Thai government elected to send the airline to bankruptcy court for restructuring. Public opposition to the bailout alternative had grown, illustrating that states are far more comfortable pouring cash into airlines that have proven financial track records, such as SIA.

Governments will also play a key role in the fate of Garuda and Malaysia Airlines (MAB)

Garuda Indonesia has been in turnaround mode for some time, and as part of that process has been looking to defer or cancel aircraft orders to improve its financial health. The COVID-19 crisis has made these efforts more urgent, and the airline has confirmed that it does not intend to take delivery of any of its 49 Boeing 737 MAX orders.

Garuda took an important step in Jun-2020 with an agreement to delay major Islamic bond payments for three years, and the Indonesian government is considering an IDR8.5 trillion bailout package. Garuda's progress has also not been helped by a rapid CEO turnover in recent years, with the latest change occurring in Jan-2020.

The Malaysian government is also still considering its options for Malaysia Airlines Berhad (MAB). The airline is now 100% owned by the state, and it is in the midst of a multi-year turnaround project.

The government wanted to find a buyer to take a major stake in MAB, but no serious suitor has emerged. It also (again) floated the idea of merging MAB with AirAsia, but this appears even less likely. MAB has launched a new partnership with JAL - delayed by the coronavirus pandemic - but this will not involve investment.

Further state investment or loan guarantees are the probable outcome for these three airlines to navigate through the COVID-19 crisis. However, they will also be required to take a hard look at their operations and make deeper changes than they have previously put in place. The pandemic is pushing them to make significant adjustments to fleets and aircraft ordering plans as they realign networks and strategies. These efforts could result in a more "rational" - and certainly more subdued - Southeast Asian airline industry when demand eventually returns.

Independent LCCs appear most vulnerable, and orders are problematic

Asia-Pacific LCCs have some advantages and a broad range of disadvantages as they confront the post-COVID-19 industry environment. One major problem is that the region's LCCs are generally not receiving the same levels of government support as some of the state-backed full service flag carriers.

Some of the LCC groups do benefit from being at least partially owned by major airline groups, meaning they can access funding from the parent company. Peach, Jin Air, Jetstar and Scoot fall in this category.

But independent airlines such as AirAsia, Lion Air, VietJet and Cebu Pacific do not have this advantage. Some of the region's smaller independent LCCs may not be able to raise enough funding to survive.

LCC fleets dominated by narrowbodies could be well suited to the new market environment in Asia as travel restrictions ease. Domestic and international short haul demand will recover faster than long haul, but traffic will still be down on these routes, making smaller aircraft preferable to operate in the immediate future.

However, a looming headache for Asia's LCCs is their gigantic order books.

Just four LCCs. - AirAsia, IndiGo, Lion Air and Vietjet - account for a combined 1,700 narrowbody orders. This looked like an unrealistic number before the pandemic, and now even more so. The chart below illustrates how Asia-Pacific LCCs have far more orders than their peers elsewhere.

Fleet orders for LCCs, as of 7-Aug-2020

Source: CAPA.

AirAsia, the region's largest LCC, is scrambling to raise enough new funding to stay afloat through the pandemic. Its core Malaysian unit is seeking government-backed loans and is also talking to other parties about a range of investment and financing options.

AirAsia's Malaysian and Thai airlines are its largest and most successful units, and they will likely come through the COVID-19 crisis relatively unscathed. Survival will be more of a challenge for the group's smaller franchises in Indonesia, the Philippines, India and Japan, however.

Long haul LCC operators face major challenges

Also vulnerable is AirAsia's sister airline AirAsia X, which operates widebody A330s on medium and long haul routes. With no domestic network to fall back on, it has had to suspend operations indefinitely.

Long haul LCC operations in Asia-Pacific have yet to prove they can be sustainably profitable, and the COVID-19 pandemic has hit them particularly hard. Their reliance on widebody aircraft and longer international routes is a liability in the current environment.

Most of the LCCs operating widebodies also have large narrowbody fleets serving short haul networks. AirAsia X does not, and neither did NokScoot, a long haul LCC that was liquidated in Jun-2020.

Australasian airlines hampered by COVID-19 spikes

In the Australasian region, Air New Zealand has been buoyed by a sizeable government loan package and a domestic market that rebounded more quickly than expected due to the country's long run of success in controlling COVID-19. However, a new cluster of infections caused the reintroduction of travel restrictions on 12-Aug-2020.

Australia had a larger resurgence of infections - primarily in Victoria - causing state border closures that dampened the domestic recovery. The state capital Melbourne was at one end of two of the world's top five city pair routes by passenger numbers before the pandemic struck.

The graph below shows how the country's increase in domestic capacity levelled off in July.

Australian weekly domestic capacity, measured by seats, 2017-2021*

Source: CAPA and OAG.

Airline prospects vary widely in Australian market

Qantas is another airline that came into the COVID-19 crisis in strong financial condition and with a healthy balance sheet. It has enough of a backstop to sustain it if international demand remains in a multi-year slump.

Virgin Australia was in a far weaker financial position, and had to enter voluntary administration in April to find a purchaser. Virgin will emerge from this process with a streamlined operation and a more secure financial footing that should ensure its survival.

An interesting dynamic in the Australian market has been a couple of airlines bucking the trend of contraction by looking to add new aircraft types and grow their fleets.

Regional Express Holdings (Rex) wants to introduce narrowbody jets to make a foray into east coast trunk routes, and Alliance Aviation has secured funding to buy a fleet of 14 used Embraer E190 regional jets.

These two airlines will be able to take advantage of a buyer's market for aircraft, and weakened competition in their markets. Even in the depths of the industry's worst-ever crisis, there are still opportunities to be seized.