Japan Airlines files reorganisation plan; JAL and ANA LCC subsidiaries under consideration

The year started with a bang, with JAL filing for bankruptcy protection in Jan-2009, followed by ongoing tussles over the carrier's future alliance partnership (the carrier decided to remain with oneworld) and the subsequent reorganisation plan filing this week.

This has provided opportunities for growth among the nation's smaller airlines, as JAL (and ANA to a lesser extent) reduce capacity and move to codeshare services with their regional partners and LCC partners. As a result, the nation's LCCs, most notably Skymark, has focused on its expansion plans, while a number of LCCs in the region have also increased their presence and/or interest in the Japanese market.

This has prompted ANA and JAL to react, with both carriers now (belatedly) considering the establishment of LCCs. However, starting an LCC in Japan could be a very risky business in the next two years, especially for JAL, as it concurrently embarks on an all-encompassing rehabilitation plan.

Meanwhile, Tokyo Haneda Airport is undergoing a once-in-a-generation expansion in 2010 with a new fourth runway opening for the winter 2010/11 schedule, providing a massive increase in slots, including for international long-haul services. Tokyo Narita, which has its own expansion plans, meanwhile, has also expressed its intention to cater for the LCC market, as has Osaka Kansai. Both these developments also provide a unique opportunity for increased LCC penetration if a full-service carrier dominated the market.

JAL reorganisation to cut fleet by 40%, workforce 30%, network 22%

Japan Airlines Corporation, Japan Airlines International Co Ltd and JAL Capital Co Ltd filed its proposed reorganisation plan with the Tokyo District Court on 31-Aug-2010, and on that same day, the Court rendered an order to put the reorganisation plan to a creditors' vote.

As part of the plan, the carrier will eliminate approximately a quarter of its debt, 40% of its fleet, 30% of its global workforce, and one in eight international routes and a quarter of its domestic routes (the route reduction is more than expected), creating further opportunities for ANA, which is now larger than JAL traffic-wise (and also Skymark to a lesser degree) in the Japanese market. Chairman and CEO, Kazuo Inamori, stated: "JAL's flop has caused a lot of trouble to shareholders and financial institutions. Today is a new start for us."

While the rehabilitation plan is much as expected, following months of speculations and reports, there is some concern in Japan that the plan may be going too far, especially in the area of the drastic route reductions. This is, however, good news for ANA, which has been quick to capitalise on the JAL situation (Investors have also been happy, with ANA shares gaining nearly 11% in the past three months, with Skymark shares soaring 52%, compared with a 10% decline in the Nikkei Stock Average).

Key details of JAL reorganisation plan

Area	Details
Fleet	The carrier will retire 103 aircraft, including all B747-400, A300-600, MD-81 and MD-90 equipment, out of a fleet of 258 aircraft. It will reduce its fleet through early retirement of inefficient models, a reduction in aircraft size through deployment of new small and medium-sized aircraft with a focus on B737-800, E170 and B787 equipment
Domestic network	The carrier will eliminate 39 domestic routes, for a network of 109 domestic destinations, and focus on more frequent service routes using smaller aircraft. The carrier will maintain its network centreing on Haneda Airport routes
International network	Will eliminate 10 international services for an international network of 65, focused on major cities in the US, Europe and Asia. The carrier will also direct initiatives towards the strengthening of its network, including the utilisation of bilateral alliances with other airlines as part of which the carrier has applied for antitrust immunity with American Airlines
Merger of three debtor companies/renaming of airline	Japan Airlines Corporation, Japan Airlines International Co Ltd and JAL Capital Co Ltd will be merged into one entity: Japan Airlines International Co Ltd, to be named Nihon Koukuu Kabushi Kaisha (English name: Japan Airlines Co Ltd). This company will also absorb and merge with JALways and JAL LIVRE, its subsidiary handling the accounting divisions of the group
Profitability	The carrier plans to be profitable from the first year of the plan, with operating profit of JPYD64.1 billion in the 12 months to 31-Mar-2011. It was separately reported that JAL's operating profit is expected to improve to JPY117.5 billion in the fiscal year through Mar-2013 from an operating loss of JPY133.7 billion in the last fiscal year ended Mar-2010. However, its revenue is projected to decline 15% to JPY1.273 trillion from JPY1.5 trillion over the same period
Debt waiver	Banks including Bank of Tokyo-Mitsubishi UFJ Financial and Mizuho Financial will waive JPY521 billion (USD6.16 billion) in debt
Capital injection	Enterprise Turnaround Initiative Corporation of Japan (ETIC) resolved to implement a capital injection at the JAL Companies, subject to approval of the business revitalisation plan. The injection involves a new share issue by Japan Airlines International Co Ltd, covering 175 million ordinary shares, with a pay-in amount of JPY350 billion, with a pay-in date scheduled for 01-Dec-2010 (the day after resolution to implement the business plan)
Re-listing	The carrier stated it may re-list by 2013
"Aggressive" utilisation of alliances	The carrier stated it would "aggressively" utilise the intangible assets of alliance partners to maximise the alliance effect, particularly in the areas of facilities, IT systems and managerial know-how, with the carrier to also strengthen its bilateral partners with other airlines
Cargo	Freighters will be taken out of service, and the service will focus on cargo service using passenger bellyhold
Cost reductions	Through reform of airport cost structures, reform of facilities, and review of wage and benefit systems. The carrier will also direct efforts towards making fixed costs variable
Airport and tax reductions	The carrier plans to downsize self-operated airport facilities, with office space to be reviewed, airport terminal space to be partially returned and the carrier to request fee reductions in airport-related services. The carrier is also seeking to reduce aviation fuel taxes, landing fees and other taxes and public charges
Management	CEO Kazuo Inamori stated he would resign in Feb-2012, a year earlier than previously agreed, stating: "Initially, I said I would stay at my post for around three years, but I would like to be relieved in two years." The carrier will also restructure its business plan, adding that the multi-layer management structure and "redundant" functions of the organisation will be eliminated. The carrier added that new departments will be created that will be responsible for cash flow on individual routes
Job reductions	The carrier plans to reduce its workforce by approximately one third from 48,712 at the end of FY2009 to approximately 32,600 by FY2010 by Mar-2011. The carrier will also overhaul its wage and benefit systems
IT upgrade	The carrier will update its IT infrastructure, which is expected to have a flow-on effect into the carrier's efficiency and productivity improvements
Subsidiaries	Plans to sell or liquidate subsidiaries, including selling its hotel business, and concentrate managerial resources on air transport business
Basic policy and reorganisation claims	The carrier also provided details on handling of overlapping claims and reorganisation claims (secured and unsecured), provision of collateral assets and preferred reorganisation claims (including taxes and labour claims) and provisions concerning JAL Corporate Pension Fund claims
Government reaction	Japan's Transport Minister, Seiji Maehara, stated he met with relevant Cabinet ministers and they were positive about the plan. He commented: "I believe that JAL can implement (the revival plan) in terms of changing its aircraft and pulling out from unprofitable routes ... What is very important is for JAL to firmly carry on personnel cuts as scheduled."
Issues moving forward	Elimination of excessive debt: The carrier stated it had JPY959 billion in liabilities at the end of Mar-2010; Addressing event risk: Plans to implement risk management and planning strategies; Securing a proper managerial structure: Seeking to implement a structure that will include clarification of responsibility for numerical results; Initiatives addressing changes in the competitive environment: To better react to competitive environment with new fleet and network structure.

Source: Centre for Asia Pacific Aviation and Japan Airlines

JAL considers creation of LCC; Japanese Government supports the idea

Meanwhile, JAL President Masaru Onishi stated the carrier would consider the creation of an LCC as part of its restructuring programme, commenting: "There is a lot of interest in low-cost carriers and we will research the issue and decide how to proceed". He however added that nothing concrete has yet been decided on the carrier's plan.

Mr Masaru added that the proposed LCC would be a "Japanese-style low-cost carrier", although it would need to avoid the high operating cost structure characterising Japan's carriers, which have long-standing problems such as high labour costs.

Meanwhile, Transport Minister Seiji Maehara said, in reference to the potential LCC: "If we don't create this new company inside the group, it will become more fragile". The Nikkei has subsequently reported that the establishment of an LCC was added to the carrier's restructuring plan "at the last minute at the Transport Ministry's request".

It has previously been reported that the carrier would operated under its own brand name, rather than under the JAL brand.

Qantas likely to be involved

Back in Nov-2009, when jostling was occurring between oneworld and SkyTeam related to Japan Airlines' membership, Qantas pledged to advise the carrier in successfully establishing a low-cost offshoot, as it has successfully down with Jetstar. Qantas is still expected to advise the carrier on the potential LCC establishment.

Qantas, with its "dual brand" structure, is perhaps the ideal partner to advise on establishing an LCC subsidiary, as the Jetstar model, working closely with the mainline Qantas, has been enormously successful.

While the Japanese market conditions and route structures are very different from the climate in which Jetstar grew up, as a global model it would seem that Jetstar's founders could offer some pretty sound advice to JAL.

Jetstar has been a lifesaver for Qantas, both in fighting off low-cost competitors and then in expanding the Qantas Group's market - Qantas now uses Jetstar to substitute for it on long-haul routes from Australia, where the mainline carrier's cost base makes operations unviable. The subsidiary for example recently took over the key Tokyo Narita route for Qantas, protecting the valuable slots from being lost to competitors.

Apart from the possibility of supporting JAL into a successful LCC subsidiary, courtesy of Jetstar's experience and support, there are clear potential advantages for both carriers if a successful venture were possible.

A stand-alone JAL LCC, working with Jetstar, would offer advantages for both sides: for example, Jetstar is highly connective, codesharing not only with its parent, but open to others as well. Working jointly to support each other would alone deliver strong market presence. And the possibility of a joint venture -which would offer a lower-risk option on both sides - would seem to be a good solution, with considerable upside. And the advantage for oneworld would be in a tighter long-term linkage into the Japanese flag carrier.

ANA also seeks overseas partners to launch LCC as early as 2011

JAL's local rival All Nippon Airways is also considering establishing a LCC, possibly in partnership with investment funds or another Asian carrier, to help it ward off challenges from regional competitors, particularly from Chinese and Southeast Asian LCCs that have entered the market since Japan signed an open skies aviation agreement to liberalise civil aviation markets.

ANA, in Aug-2010, stated it would select partners to establish the new LCC as early as this month. ANA may take a stake of between 30% and 50% in the new company, with overseas airlines and investment funds owning slightly less than 30%, according to reports. ANA would also seek investment from Japanese travel agencies and hotels to offer wider services according to reports. It has been reported that the carrier would not operate under the ANA brand, and its salary system would also be different from that in place for existing ANA employees.

The airline, which is expected to have initial capital of more than JPY50 billion (USD578 million) will be established as early as 2011. Avoiding cannibalising its own services will be an integral part of ANA's approach. ANA currently codeshares with AirDo, Ibex and SkyNet Asia, which all limit their operations to the domestic market.

The latest update supplements commented made by the carrier's President, Shinichiro Ito in Jun-2010, in which he confirmed the carrier was considering plans to establish a Kansai Airport-based LCC to operate domestic and international (China and other Asia) services. He said LCCs have been "gaining power in Europe and Asia, and expanding their market shares". Mr Ito added: "As there are a certain number of customers who prefer low-priced services, we're discussing how to operate a low-cost carrier in Japan."

The carrier also stated it would offer international fares at approximately half the rate of major airlines, while domestic fares will be priced at less than JPY10,000 (USD111). The LCC will reportedly be branded separately from ANA.

Previous planning to set up a Hong Kong based subsidiary was put on hold in Apr-2009, when economic conditions made it impossible. However, ANA's "Outline of the next term management strategy", which was released on 30-Oct-2009, touched briefly on the plan under the heading of consideration of a new international and domestic aviation business model - outside the Tokyo metropolitan area.

Skymark Airlines - profitable in Jun-2010 quarter

LCCs have been established in the Japanese domestic market since the mid/late-1990s (eg Skymark Airlines, Air Do), as well as new entrants last decade (StarFlyer, AirNext, Ibex, Fuji Dream, SkynetAsia).

Skymark is now the only airline other than ANA to be listed on the Tokyo Stock Exchange now that JAL is no longer listed.

The carrier has performed strongly financially, with a first quarter revenue increase of 19% to USD1,120.8 million and a net profit of USD8.2 million, compared with a loss of USD4.6 million in the previous corresponding period. The carrier is forecasting a FY2011 net profit of USD28.8 million with recurring and operating profits of USD51.9 million and USD53.0 million, respectively, on revenues of USD588 million.

Skymark financial highlights for three months ended 30-Jun-2010

Currency: USD		% Change
Revenue (mill)	1,120.8	+18.6%
Operating profit (mill)	12.9	^
Recurring profit (mill)	11.1	~
Net profit	8.2	/
Passenger numbers	n/a	+25%
Load factor (%)	81.4%	+13.7 ppts
Breakeven load factor (%)	72.8%	+2 ppts

Source: Centre for Asia Pacific Aviation & Skymark Airlines
Based on the conversion rate USD1 = JPY86.7309
^ Compared with a loss of USD4.6 million in p-c-p
~ Compared with a loss of USD4.9 million in p-c-p
/ Compared with a loss of USD5.2 million in p-c-p

The Jun-2010 quarter result partly reflects the achievement in efficiencies from its fleet restructuring. The carrier is scheduled to take delivery of seven more B737NG aircraft between now and 2012, two in the remainder of 2010, two in 2011 and three in 2012.

The carrier - in addition to Skynet Asia Airways, Hokkaido International Airlines and Star Flyer - will also benefit from Haneda's expansion, which gives it additional domestic frequencies (eight slots), with the carrier also gaining from JAL's withdrawal on some domestic routes. Skymark will increase its network with the addition of five new routes out of Kobe airport later this year. The carrier's crew shortage problems have also now been resolved, with Skymark now recruiting ex-JAL pilots.

Difficult market environment for LCCs

Overall, the market environment in Japan does not currently favour LCC operations, with LCCs often being described more as "low-fare carriers", due to the high cost environment in Japan, with these operators being constrained by a few key factors.

Operating costs are high, with ANA and JAL dominating the supply chain, and labour costs are high. However, in a positive development, some costs - notably landing fees and fuel taxes - are scheduled to be reduced in 2011, with the national also having plenty of underutilised airports which may be suitable for LCC operations.

Another key impediment to international expansion of the LCC, or private non-flag carrier model, has been conservative regulatory regimes, with protectionism still widely prevalent. The market has also under-performed over the past decade, rocked first by the Asian financial crisis, then by SARS and dampened by the sluggish performance of the Japanese economy.

Furthermore, domestic low-cost airline operations in Japan have found it hard to compete, given a combination of very fast (subsidised) trains and a high cost base where suppliers are in each case dominated by two major international airlines.

Massive growth potential to be realised in the next decade

However, as previously predicted by CAPA, the second decade of the 21st century will likely see LCCs arrive on a massive scale in Japan and North Asia in general, entering a market currently dominated by the two major flag carriers - JAL and ANA - and their various offshoots. LCC penetration in Japan is at one of the lowest levels on a worldwide basis, at less than 5% and significantly below the Asia Pacific average of 15.7% and the worldwide average of 22%.

The region has not seen significant low-cost airline entry to date - one of the few parts of the world to have missed the phenomenon. It is a major anomaly in this respect, because the geography, economy and demography of the North Asian countries offer near-ideal conditions for LCC growth.

Asia Pacific domestic LCC penetration by capacity (seats): 2009

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Source: Centre for Asia Pacific Aviation & OAG Facts

However, while Japan has long kept its air travel market tightly protected, recent deregulation combined with newly expanded airport capacity in Tokyo and other large cities has opened the door wider to foreign airlines.

Jetstar, for example, operates services between Australia and Japan, while Chinese LCC Spring Airlines, has made a noisy entrance into the market, offering cheap fares from Ibaraki. Meanwhile, AirAsia also has plans to enter the market. These carrier have an advantage in that they are based overseas where costs are lower than in Japan.

Osaka Kansai and Tokyo Narita attempt to become LCC bases

From an airport perspective, there has also been a new interest by some Japanese airports to cater for LCCs.

Tokyo Narita International Airport Corp has announced plans to add a passenger terminal in spring 2013 that will exclusively serve LCCs, becoming the first LCCT in the country and costing up to USD228 million. The airport - one of the highest cost airports to operate to in the world - will commence construction in spring 2011 on what will become Japan's first terminal dedicated for budget carriers.

The move should significantly increase Narita's attractiveness to foreign LCCs like Jetstar, AirAsia and Tiger Airways in establishing local JVs to tap the massive potential Japanese and North Asian budget airline market.

The move has partially been prompted by Haneda Airport's expansion and the (re)introduction of long-haul international services with the opening of that airport's fourth runway from late Oct-2010. Narita Airport, 100% owned by the government, is reportedly under pressure from the Transport Ministry to attract more carriers to the airport to raise its competitiveness.

Narita Airport projects that approximately 10% of its landing and departure slots will eventually be used by budget carriers, up from less than 1% currently (just one LCC, Jetstar, currently serves the airport).

According to reports (in The Nikkei), several sites for the proposed terminal have been identified, including one close to the existing two terminals. The Narita LCC Terminal is expected to cost JPY20 billion (USD228 million), although it is unclear how large the terminal will be and its capacity in terms of annual passengers. The facility is expected to be a simple single-storey structure with no aerobridges, to facilitate fast turn-arounds. Narita International will also consider preferential treatment for such carriers, such as lower landing and handling fees. Such moves are expected to raise opposition from full service carriers.

Meanwhile, Osaka Kansai Airport is also likely to become the base for low-cost carriers operating in the country as it has greater capacity than Tokyo area airports. Kansai Airport is waiving landing fees for any new low-cost carrier operating at the airport in their first year. The airport is also considering the construction of an LCCT.

2010 - a year of change for Japanese aviation

2010 has proven to be a decision year for Japanese aviation, with the changes and impact of the JAL bankruptcy expected to continue over the next few years.

JAL will eventually emerge from bankruptcy with a lower cost base and a more efficient operation, with the potential establishment of LCC subsidiaries by JAL and ANA also likely to shake-up the market.

In the short-term, however, ANA and the nation's existing LCCs, such as Skymark, will likely benefit not only from JAL's route withdrawals and capacity reductions, but from the Japanese Government's realisation that something needs to be done to support the nation's aviation industry, with the Government now proposing jet fuel tax and airport landing fee reductions (lower fuel taxes is expected to be worth USD200 million in profit p/a from ANA alone, according to estimates by JP Morgan).