10-Mar-2014 12:02 PM

Japan's StarFlyer, struggling to expand its niche, will reduce its fleet and receive new management

Analysis

One of Japan's smaller carriers, StarFlyer is finding that being boutique does not imply versatility. The carrier in just a year has swung from slight profits to a negative 10% operating margin, spearheading the resignation of its president and cutting the all-A320 fleet from 11 to nine. Weighing the carrier down, besides foreign exchange, was a drastically unsuccessful foray into the international market with a Kitakyushu-Busan service that linked two secondary cities with limited demand and too high a cost base to stimulate demand.

StarFlyer has strengths. It retains the fourth-largest slot pool at Tokyo Haneda and sees healthy codeshare bookings from All Nippon Airways, which also owns part of the carrier, a measure likely to support ANA's position relative to rival Japan Airlines. It is possible to address past performance, and a restructuring plan intends to do so. But the future will pose further challenges. Shorter routes are being impacted by LCCs, and StarFlyer has ended Fukuoka-Osaka Kansai services. Skymark's forthcoming all-premium A330 service will deliver better comfort at lower prices, which it can sustain with a cost base half that of StarFlyer and ANA. That low cost base is the critical ingredient giving Skymark expansion opportunities. The restricted nature of Haneda grants security and, likely, a future for StarFlyer. But expansion opportunities also look restricted, possibly confining StarFlyer to its niche and ultimately see the carrier lose relevance.

StarFlyer has grown aggressively - and now there is a downside

StarFlyer in recent years has seen double digit increases in domestic passenger numbers, as high as 50% in some months and years. It appears though the carrier is reaching a limit on how many routes it can offer service with its model. Even then, profits are falling.

StarFlyer annual domestic passengers: 2008-2013

StarFlyer monthly domestic passengers: 2012-2014

StarFlyer goes from a small profit to -10% operating margin

StarFlyer has reduced its nine months to 31-Dec-2013 profit from JPY537.5 million (USD5.4 million) in FY2013 to an operating loss of JPY2477 million (USD24.9 million), representing a negative operating margin of 10%. Its full year (12 months to 31-Mar-2014) shows a -10% margin too. This follows FY2012's performance that saw a 97% decrease in operating profit.

StarFlyer revenue up 30% - financial highlights for nine months ended 31-Dec-2013:

Revenue: JPY24,514 million (USD246.7 million), +29.5% year-on-year;
Costs: JPY25,053 million (USD252.1 million), +48.5%;
Operating profit (loss): (JPY2477 million) (USD24.9 million), compared to a profit of JPY413.9 million (USD4.2 million) in p-c-p;
Net profit (loss): (JPY2558 million) (USD25.7 million), compared to a profit of JPY537.5 million (USD5.4 million) in p-c-p;
Total assets: JPY19,753 million (USD198.8 million);
Cash on hand and in banks: JPY2094 million (USD21.1 million);
Total liabilities: JPY17,090 million (USD172.0 million);
FY2013 forecast:
- Revenue: JPY32,700 million (USD329.1 million), compared to previous forecast of JPY33,700 million (USD339.2 million);
- Operating profit (loss): (JPY3300 million) (USD33.2 million), compared to previous forecast of a loss of JPY2040 million (USD20.5 million);
- Net profit (loss): (JPY3300 million) (USD33.2 million), compared to previous forecast of a loss of JPY1740 million (USD17.5 million).

This is a marked change from StarFlyer's initial FY2013 forecast given in May-2013:

Revenue: JPY34,400 million (USD414.5 million);
Operating profit: JPY190 million (USD2.3 million);
Net profit: JPY510 million (USD6.1 million).

StarFlyer in 2013 started a restructure with the announcement of suspending its Kitakyushu-Busan service. In Feb-2014 StarFlyer denied reports president Shinichi Yonehara had resigned, only to confirm days later he would resign effective 31-Mar-2014. Associate senior corporate executive officer Makoto Takahashi has been appointed acting president. StarFlyer's leadership had become embattled in some quarters, with some believing management was not tuned in to StarFlyer's strengths and weaknesses.

The restructure also sees StarFlyer's all-A320 fleet reduced from 11 aircraft to nine, a cut of executive salaries by 15-30% and a 10% workforce reduction through voluntary retirement. This entails an employee decrease from 740 to 660. As of Jan-2014, 26 staff had resigned, with StarFlyer believing the overall reduction was on track. StarFlyer estimates staff cuts will reduce costs by JPY580 million (USD5.9 million), taking about 15% out of FY2012's total staff costs. In FY2012, staff costs accounted for 16% of operating costs, accounts show. This will reduce StarFlyer's overall FY2012 operating costs by 2.5%.

StarFlyer in Nov-2013 attributed its 1H2013 loss due to:

Foreign exchange: JPY500 million in exchange loss compared to the previous corresponding period;
Fuel costs (including currency): JPY350 million;
Aircraft maintenance costs: JPY850 million;
Other: JPY200 million.

However, StarFlyer skirted the issue of weak revenue performance. StarFlyer projects it will miss its target unit yield of JPY12 (FY2013 new target: JPY11.7 (USD 11.8 cents)) and cost unit of JPY11 (FY2013 new target: JPY12.4 (USD 12.5 cents)). StarFlyer for the full year FY2013 is expecting an impairment loss of JPY233 million (USD2.3 million) from the suspension of international services and a loss of JPY201 million (USD2.0 million) from retirement subsidies such as its early retirement programme due to planned suspension of international services.

StarFlyer cancels its first scheduled international route, Kitakyushu-Busan

StarFlyer was one of a number of so-called "new entrants" in Japan's domestic market and upon its launch last decade positioned itself as a distinctly different carrier. Its all-black branding was visually different from the conservative ANA and JAL. Its aircraft were similar to JetBlue, with around 150 seats in an A320, allowing extra legroom. Power outlets and personal TV screens were at every seat, whereas they are seldom found on ANA and JAL's domestic routes.

StarFlyer in Jul-2012 launched its first (and still only) scheduled international route, a double daily service from Kitakyushu to Busan that lacked support even from the beginning. As CAPA wrote at the time of the route's launch:

StarFlyer also plans to run charter services to Guam later in 2013, and previously had charter services to Hong Kong and Seoul Incheon before introducing its first scheduled international service, to Busan, Korea's second-largest city. Busan and Kitakyushu are directly opposite each other across the Korea Strait, a flight distance of 243km. That makes the service a low-risk introduction, but StarFlyer is not seeing immediate success.

Sale fares between Kitakyushu and Busan were offered for JPY17,000 (USD191) return, although day trip promotional fares were even lower at JPY6,000 (USD68). The carrier says that, at an undisclosed high load factor, fares of JPY17,000 will make the service profitable. But StarFlyer's average domestic load factor is around 70% and it is aiming for 65% to Busan, making profitability elusive. History does not provide confidence: South Korean LCC Jeju Air suspended services to Kitakyushu from Seoul, which has a larger population although it is farther than Busan and was served only three times a week. StarFlyer is targeting business travellers and day-trippers (shopping in Korea is a popular holiday) with double daily return services.

Short of a favourable corporate contract out of Kitakyushu, Tokyo Haneda is all but the preferred airport for international services. As in the domestic market, routes will be designed for target point-to-point traffic rather than connections. Other points in StarFlyer's network like Fukuoka and Osaka Kansai are unlikely to see international service, as are unserved points like Sapporo or Naha in Okinawa (which, with more southerly geography could access more parts of Asia).

Only in four months during 2013 did StarFlyer achieve a load factor above 65% to Busan, and this was likely with low yields.

An overnight trip from Kitakyushu to Busan in Mar-2014 with less than a week's advance purchase is offered for JPY14,700 (USD143.17) round-trip including taxes.

StarFlyer monthly passenger load factor (international): 2012-2014

StarFlyer in Nov-2013, after just over a year on the route, announced that for unspecified reasons the Kitakyushu-Busan service would end on 29-Mar-2014. Shortly after the announcement, Kitakyushu's mayor said he intended to ask StarFlyer to return the subsidy the city paid to support the Busan service. The subsidy was dependent on the service lasting for three years. A decision was due in Jan-2014 but there have been no known public reports regarding the outcome.

StarFlyer has announced charter services to Korea's Muan (likely low-risk) but no further scheduled international services have been announced. The carrier's intent to stay with the A320 limits destinations, and on major routes slots are not available. Even if they were, the carrier could face stiff competition and does not have the low-cost base to stimulate new traffic. The domestic market, which StarFlyer intended to be its main focus, remains far more promising.

As CAPA previously wrote:

StarFlyer is also considering international services, but this is not a key driver for the carrier. Japan's domestic market is a very profitable one, and more so than international services - at least for now, as LCCs are still relatively at bay. The vast majority of StarFlyer's capacity will remain in the domestic market, the carrier intends.

StarFlyer does not intend to acquire aircraft besides A320s, limiting it operationally to North Asia and the northern parts of Southeast Asia. China, Hong Kong, South Korea and Taiwan are the carrier's main focus, offering large markets but also corporate-heavy routes. Beijing and Shanghai would be ideal for StarFlyer's proposition, but the limited slots makes the possibility impossible in the medium-term unless StarFlyer were to use midnight-hour slots at Beijing and Shanghai, which its corporate travellers would not favour.

Secondary Chinese cities are a possibility but demand is weaker and the carrier does not have price as a stimulant the way AirAsia Japan and Spring plan to do.

Taipei's convenient downtown airport is equally restricted, but the city is not ruled out entirely. Hong Kong is a quiet favourite and the carrier has experience running charters in the past.

Select Asian airline CASK measured against average stage lengths: 2012*

StarFlyer cancels Osaka-Fukuoka, likely due to LCCs, but will launch Nagoya-Fukuoka

StarFlyer's domestic routes had been to/from Tokyo Haneda until Oct-2013 when StarFlyer began Osaka Kansai-Fukuoka services, launched as part of its initiative to differentiate from Haneda, which offered no further growth opportunities as slots were all utilised. StarFlyer's four daily services competed with LCC Peach's four services, and one daily service from each Jetstar Japan and ANA. There is far larger capacity out of domestic Osaka airport, Itami, where premium demand is higher than the more leisure-oriented Kansai, making StarFlyer's location a mis-match, but Itami slots are restricted.

The 452km route would normally fall under the category of being cannibalised by high-speed rail, which generally holds an advantage over air services on routes under 800km. However, Japan's high-speed rail, shinkansen, is expensive, making air travel logical, quixotically so. LCCs hold advantages on short routes where their cost differential is most apparent and passengers notice less the low-cost atmosphere. Conversely that also means that a premium proposition, such as StarFlyer's, carries less value.

StarFlyer in late 2013 acknowledged pressure on the route from LCCs, which offer lower fares, and in the case of Peach the same level of frequency. In Dec-2013, barely two months on the route, StarFlyer announced it was cancelling services from Feb-2014.

StarFlyer also said it is feeling pressure from high-speed rail slowly becoming more savvy and offering promotions. Prior to the arrival of LCCs, high-speed rail in Japan had been stagnant with zero revenue management and little marketing promotion.

StarFlyer in late Mar-2014 will launch three daily Nagoya-Fukuoka services. Nagoya-Fukuoka is a smaller market (24th largest in 2013 based on seat capacity) compared to Osaka-Fukuoka (16th in 2013) but is less competitive. AirAsia Japan had offered double daily services on that route, but Nagoya services were not resumed when AirAsia Japan re-launched as Vanilla Air. Jetstar Japan offers double-daily services in Mar-2014 but this decreases to 11 weekly in Apr-2014 for most of northern summer 2014.

StarFlyer's fares are about twice the price of Jetstar Japan but slightly less than ANA, although some of ANA's low fares are actually StarFlyer codeshares. StarFlyer will be advantaged as it will carry ANA's codeshare, whereas Osaka Kansai-Fukuoka did not have ANA's codeshare. LCC competition is less with at most two daily flights whereas Osaka Kansai-Fukuoka saw up to five LCC flights a day.

Nagoya marks a different airport environment from Osaka or Tokyo as there is only one airport, meaning LCCs and full-service carriers operate from the same facility whereas in Osaka and Tokyo they operate from farther-flung airports. In Nagoya that erodes any disadvantage for LCCs but also means full-service carriers lose a point of differentiation.

One-way economy fare Nagoya-Fukuoka: 21-May-2014 as of 06-Mar-2014

Carrier	Lowest Fare	Typical Fare
ANA	JPY7610 (USD74.12)	JPY11100 (USD108.21)
Jetstar Japan	JPY4990 (USD48.60)	JPY4990 (USD48.60)
StarFlyer	JPY9710 (USD94.58)	JPY9710 (USD94.58)

Elsewhere, StarFlyer is bulking up its network by adding frequencies on Haneda-Fukuoka and Haneda-Kitakyushu while decreasing Haneda-Kansai. It is unclear if there is more demand that StarFlyer can pick up or rather will spread existing revenue over more flights.

StarFlyer scheduled services: northern summer 2014

Route	Frequency	Change From Summer 2013 (Typical)
Tokyo Haneda-Fukuoka	10 daily	Increase from 9 daily
Tokyo Haneda-Kitakyushu	12 daily	Increase from 11 daily
Tokyo Haneda-Osaka Kansai	5 daily	Decrease from 6 daily
Nagoya-Fukuoka	3 daily	New service
Kitakyushu-Busan	-	Cancelled

Skymark's all-premium A330s can shake up Japan's domestic market, challenging StarFlyer

Kitakyushu and the Fukuoka routes are matters that can be evaluated and moved on from, either with a suspension or replacement service. But a structural problem will likely emerge with Skymark's introduction of A330 services, now due in May-2014.

Japanese carriers had largely been under the assumption that there could be no shake-up at Tokyo Haneda, the country's most important airport for premium travel, owing to slot restrictions. Skymark dealt that assumption a sudden and forceful blow with its plan to introduce A330s on domestic routes, replacing 737s. (Skymark briefly had very limited 767 operations in past years.)

Not only would Skymark be able to deliver increased capacity with the same number of slots, it would challenge ANA and JAL on other areas: lower tickets, greater fare flexibility and most importantly product. Skymark's A330s are in all-premium economy configuration, although this is perhaps a misnomer as Skymark's A330 product is superior to ANA or JAL's domestic business product, and the seat is certainly better than European short-haul business travel, for example. Skymark plans little change in its fare structure, reckoning that its lower cost base (half that of ANA) can let it sustainably offer a less dense product for a lower fare.

One-way economy fare Tokyo-Fukuoka: 18-Jun-2014 as of 06-Mar-2014

Carrier	Lowest Economy Fare	Typical Economy Fare	Lowest Business/Premium Fare	Typical Business/Premium Fare
ANA	JPY9,490 (USD92.58)	JPY9,490 (USD92.58)	JPY30,590* (USD298.44)	JPY31,590* (USD308.19)
JAL	JPY10,090 (USD98.44)	JPY10,090 (USD98.44)	JPY11,090 (USD108.19)	JPY11,090 (USD108.19)
Jetstar Japan	JPY6,490 (USD63.32)	JPY7,990 (USD77.95)	n/a	n/a
Skymark	JPY7,800 (USD76.09)	JPY7,800 (USD76.09)	n/a	n/a
StarFlyer	JPY10,090 (USD98.44)	JPY10,090 (USD98.44)	n/a	n/a

The implication for StarFlyer is that it risks being squeezed. StarFlyer's product and service was once clearly different, and many would argue superior, to ANA and JAL, and was often around the same cost but with lower frequency. Skymark's lower cost base than StarFlyer gives it a superior product (minus personal TVs), lower fares and better frequency than StarFlyer but not quite the same as ANA or JAL.

Skymark's initial A330 route will be Haneda-Fukuoka, StarFlyer's second-largest route after Haneda-Kitakyushu, which Skymark is unlikely to enter. Haneda-Fukuoka accounts for over a quarter of StarFlyer's network, placing significant pressure on any inroads made from Skymark. Pressure is further heightened given the strength of Haneda-Fukuoka relative to the rest of StarFlyer's network. StarFlyer's other route, Tokyo Haneda-Osaka Kansai, sees marginal performance. Skymark's other A330 deployment plans are to Sapporo and Okinawa Naha, which StarFlyer does not serve.

In short, StarFlyer's network will comprise the Haneda-Kitakyushu route (also served by JAL but with less capacity, and StarFlyer benefits from Kitakyushu's support), Haneda-Fukuoka (to come under pressure from Skymark), Haneda-Kansai (weak performance), and Nagoya-Fukuoka (to be tested). This is not a strong outlook. Nor is it clear where else StarFlyer, with its premium product and position, might go. It lacks the scale of ANA and JAL but also lacks the low cost of Skymark or the new LCCs' ability to stimulate demand. ANA codeshares with Air Do on the Sapporo route, giving an uncertain future to StarFlyer's competitive ability as well as possibility for an ANA codeshare. ANA codeshares are critical for StarFlyer's success. In any event, StarFlyer would meet Skymark's A330 competition on the Sapporo and Naha routes.

StarFlyer, one of the original innovators in Japan, may lose relevance after not securing a low cost base

Elsewhere in the world boutique operations have been able to go full-scale, as carriers such as JetBlue and then-Virgin Blue demonstrate. But their expansion is enabled by a low cost base. StarFlyer made a quiet revolution in Japan, relatively speaking, with its service, product and position. It was a breath of fresh air to the conservative and legacy ANA and JAL, and still is. But StarFlyer's revolution was on the passenger side and not supported by drastic change in the cost side.

Skymark started life more simply but has secured a cost base empowering it to now make position and product improvements - and even go long-haul with forthcoming A380s, although that is another matter.

There are a number of scenarios for StarFlyer. It could deeply restructure to take costs out and expand its potential route base, although history is not kind to carriers looking to do so. JAL did so only under bankruptcy, as did peers in America. StarFlyer's current restructure may reduce headcount and labour costs, but aircraft are decreasing too, so labour reductions would be expected. In 2012 ANA increased its share in StarFlyer to under 20%, making it the largest shareholder.

StarFlyer could not have achived its level of success (if any at all) were it not for ANA's codeshare. The question now is if ANA more strategically develops StarFlyer, or ensures StarFlyer has just enough room to be self-sustaining in the difficult space of not expanding.

Air Do, also partially owned by ANA, appears to be heading for that fate. These carriers are losing relevance as Skymark grows and new LCCs enter. Consolidation might be logical, but there is pride in the brands, not to mention possibly thorny calls to surrender precious Haneda slots if there is full-scale consolidation.

Japan is a unique market, especially domestically, and has produced outcomes not seen elsewhere. As for StarFlyer's future, Japan may very well conjure a solution. But as far as Japan's aviation future is concerned, the focus likely remains on ANA and JAL, complemented by an emboldened Skymark and agile new LCCs. Scale and cost appear to be the victors. Boutique may be increasingly fragile.

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