02-Jan-2014 4:48 PM

Korean aviation in flux. Asiana's new CEO comes from LCC Air Busan; AirAsia Korea files application

Analysis

The Korean market has had few major developments since the launch of a number of low-cost carriers mid last decade. That may change in 2014. Asiana Airlines has named Kim Soo Cheon as its new CEO effective 01-Jan-2014. Mr Kim leads the Kumho Group's flagship business, having served as CEO of part-owned subsidiary Air Busan, an LCC that fought to be recognised and at times appeared to be neglected by Asiana. Mr Kim brought Air Busan to profitability, and at Asiana will have a number of tasks, including bringing the carrier to profitability after it outpaced Korean Air in growth in 2013. Mr Kim will also preside over Asiana's introduction of the A380.

Air Busan may now take on a greater role with Mr Kim now at the top of the airline. This is not a moment too late, as the AirAsia group reportedly filied an application to launch a Korean subsidiary, AirAsia Korea. This would consummate AirAsia's long flirtation with the Korean market, and once again give the LCC group a North Asia subsidiary after it pulled out of AirAsia Japan.

Rival Jetstar already has Jetstar Japan while Tigerair plans to launch a subsidiary in Taiwan. Even VietJet is discussing a Korean venture. AirAsia's entry into Korea will give the market a long-needed adrenalin shot to become more competitive. The short-term would see pressure on Korean LCCs but little on Asiana and Korean Air, although the two would benefit from closer integration and expansion of their LCCs.

Asiana Airlines names new CEO effective 01-Jan-2014; also some management changes at Korean Air

Asiana Airlines on 24-Dec-2013 named Kim Soo-cheon as the carrier's new president, effective barely a week later on 01-Jan-2014. Mr Kim replaces Yoon Young-doo, who is 62 and served as CEO since 2009.

Mr Yoon was the face of Asiana following its Jul-2013 crash at San Francisco. While the investigation is ongoing, Asiana has been criticised for its lacklustre response. A spokeswoman told Bloomberg Mr Yoon's departure was unrelated to the accident: "Yoon has served as CEO for five years and has fulfilled his duties….This personnel change has nothing to do with the accident." Air Busan's new CEO is Asiana MD Han Tae-keun.

Rival and much larger carrier Korean Air announced its own management changes on 24-Dec-2013. Korean's changes are less significant and consistent with expectations that the Cho family will continue to run Korean Air and its parent, Hanjin. EVP Cho Won-tae (Walter) became CEO of Hanjin KAL Holdings, which amongst other activities reportedly looks after sales at Korean Air. Mr Cho, the only son amongst the third-generation Cho family, is further in line to succeed his father at the helm.

Mr Cho has two sisters, the youngest - and higher profile - of whom, Cho Hyun-min (Emily), was elevated from VP to SVP, and looks after PR, communications and is involved with Jin Air. Her older sister Cho Hyun-ah (Heather) is EVP and looks after catering, in-flight services and KAL's hotel business. Additional promotions outside the Cho family were also made at Korean Air.

Asiana is unprofitable while Mr Kim has made Air Busan profitable

Asiana in the nine months to 30-Sep-2013 incurred a net non-consolidated operational loss of KRW25.1 billion (USD23.8 million) representing a -0.6% operating margin. Asiana like Korean Air was unprofitable in the first two quarters of 2013 but helped with a profitable third quarter, covering the busy summer travelling season. But Asiana is likely to be unprofitable for the year. Korean Air is also operationally unprofitable, incurring a net non-consolidated operational loss of KRW35.4 billion (USD33.6 million) - larger than Asiana's but with a slightly improved operating margin of -0.4%, reflecting Korean Air's larger size than Asiana.

Asiana's yields in its key markets of China and Japan have been deteriorating owing to Japan-Korea territorial disputes, the weakening yen and concerns earlier in the year about bird flu in China. Asiana says demand from China is now positive. Korean Air does not disclose yield information while Asiana did not disclose market-by-market yield information for 3Q2013.

Asiana has contributed to the situation by growing 6.4% year-over-year through 30-Sep-2013, compared to Korean's comparative growth of only 0.8%. Asiana's load factor has declined 0.5ppt while yields have fallen 5.6%. The outlook from a short-term perspective is not encouraging as Korean Air will continue to practice capacity discipline, shrinking ASKs by 1.7% in 1Q2014 according to OAG. Asiana will grow ASKs by 6.6% in 1Q2014.

Asiana and Korean both had notable growth in 2012 with Asiana growing 6.6% and Korean 5.3%. Asiana's comparatively higher growth rate is further evident when considering growth in 2013 compared to 2011. In the first nine months of 2013, Asiana grew 13.2% compared to the same period in 2011 while Korean Air grew 8.2%.

While the growth may not be favourable in the short-term, Asiana is taking a long-term view that it needs a larger position, especially in long-haul markets where Korean Air is strong.

Asiana monthly available seat kilometres (International): 2011-2013

Korean Air monthly available seat kilometres (International): 2011-2013

Mr Kim, Asiana's incoming CEO, will likely continue with this long-term view, but may also be able to help the short-term. Mr Kim joined Air Busan in early 2008, after its founding but before its operational launch in Oct-2008. Mr Kim brought Air Busan to profitability, including its first maiden - albeit small - profit in 2010, about two years after Air Busan launched operations.

Profitability within about two years is unusually good in the aviation industry, but Air Busan has not performed better since its first profit in 2010, although that was an exceptionally strong year for airlines in Asia. Even if Air Busan's first profit was in a strong year, continued improvement should have offset any detriment from weaker years (Air Busan's most recent financial statements only cover the first eight months of 2012). This reflects Air Busan not achieving its full potential.

Air Busan revenue and profit/loss (KRW million) and operating margin: 2008 to Aug-2012

Air Busan could adopt a larger profile under Mr Kim

Those at Air Busan have recognised its under-achievement and the opportunities it has passed up as a result of its relationship with its paren. Air Busan does not even rank amongst the top nine carriers serving Korea. Three foreign carriers - China Eastern, China Southern and Thai Airways - have more capacity than Air Busan in Dec-2013. Even privately-owned t'way, once on the brink of market exit, has a larger presence than Air Busan.

South Korea system seat capacity by carrier: 23-Dec-2013 to 29-Dec-2013

So long as Air Busan was performing unprofitably (some of which was to be expected) there may have been cause to remain low key, but the carrier lately has been profitable, although complete financial records are not available.

The exact reasons for Air Busan's more recent stagnation are unknown. Ownership is complex, with the city of Busan holding a large stake, but Mr Kim will surely enter Asiana aware of the potential Air Busan is sitting on. From the group level he should be in a better position to see Air Busan achieve more - if he thinks that decision is right. It will not be an easy task. Already Korea's two largest LCCs, Jeju Air and Eastar Jet, are privately-owned. Jin Air, owned by Korean Air, is third-largest. Korean Air and Asiana have the scale to make their LCC subsidiaries vibrant and part of an effective dual-brand strategy, but the pride is very much with the full-service business.

Air Busan could consider expansion or start with fleet re-generation considering its mixture of old-generation 737s (other Korean LCCs have 737NGs) and A320/A321s to gain better scale and efficiency.

Air Busan Fleet Summary: as at 28-Dec-2013

Aircraft	In Service	In Storage	On Order*
Total:	11	0	0
Airbus A320-200	1	0	0
Airbus A321-200	4	0	0
Boeing 737-400	4	0	0
Boeing 737-500	2	0	0

Coming soon? AirAsia Korea files to establish

The AirAsia Group in Dec-2013 was reported to have filed an application with South Korea Ministry of Land, Infrastructure and Transport to establish AirAsia Korea, with the AirAsia Group taking a 25% stake and the balance held by unspecified Korean investors. Majority ownership of a Korean carrier must reside with Koreans.

AirAsia Korea will reportedly launch in Korea's tiny domestic market on the Cheongju-Jeju route, the country's fourth-largest domestic route, before applying for permission to launch international flights, which would be the real prize of a Korean affiliate. The AirAsia Group reportedly attempted to acquire t'way Airlines in 2012. AirAsia has not ruled out a Korean affiliate, with Group CEO Tony Fernandes saying in Jul-2013, "I'd love to [have AirAsia Korea] if the ministry allows me and if KAL and Asiana Airlines don't mind us."

A Korean affiliate will return the AirAsia Group to North Asia. While it already has a large North Asian footprint, this is via its Southeast Asian subsidiaries. AirAsia pulled out of AirAsia Japan in 2013, leaving it without a North Asian affiliate. The Jetstar Group has Jetstar Japan and a proposed affiliate in Hong Kong, Jetstar Hong Kong. Tigerair in Dec-2013 announced a joint-venture with Taiwan's China Airlines to establish Tigerair Taiwan. Even fledging VietJet is mulling an affiliate in Korea, as well as Taiwan and Myanmar.

AirAsia, along with Lion Air, had been the only major LCC group without a presence or planned presence in North Asia, although this was inevitably to change, given its regional spread. AirAsia even considered re-entering Japan with a new partner, a possibility that remains.

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Korea and Japan are neighbours but an AirAsia affiliate means very different things in those countries. Japan has the world's third-largest domestic market, which is characterised by large opportunities and limited competition. Korea's domestic market is the 18th largest, but only a fifth the size of Japan's. Routes are limited, competition is heavy and profits are few. Japan has moved further with liberalisation of air service agreements. Japan is heavily regulated but Korea can suffer from a lack of transparency towards smaller carriers. Even Asiana seems to fall victim at times to the longer established flag carrier, Korean Air. One strong advantage Korea has over Japan however is the potential for a significantly lower cost base.

While Korea is smaller than Japan, it has larger tourism opportunities from China. From Jan-2013 to Nov-2013 Japan recorded 1.2 million tourists from China. While this was down 11% owing to an ongoing territorial dispute between the two of them, even an adjusted figure is well short of the four million Chinese who visited Korea through mid-Dec-2013. The Korea-China bilateral is constrained - the Japan-China one is not - but carriers are able to partially work around this by offering charter services. A simmering of tensions between China and Japan, as well as Japan's weakening yen, could make Japan more attractive to Chinese, but it is difficult to see Japan overtake Korea.

Korea's LCCs would be given a jolt if AirAsia Korea enters - but consumers would benefit

Korea was at the forefront of LCC activity in North Asia when it permitted a number of carriers to launch, in the process catapulting Seoul-Jeju to the world's most trafficked route by some measure. But since then the sector has languished with its LCCs in airline purgatory: high costs and low yields. They embarked on the LCC path but never consummated the marriage by taking costs out of the business and pushing ancillary revenue. There was inertia but also a fear of Korean consumer backlash, even though foreign LCCs found ways to transport Korean passengers cheaply and with minimal complaints.

The launch in 2012 of three strong and aggressive LCCs - Peach Aviation, Jetstar Japan and AirAsia Japan (now Vanilla Air) - was the first impetus for change as the Japanese LCCs would be felt on the Japan-Korea market, which has been true in limitation. But the prospect of a local AirAsia brings the battle home. It was only in 2013 some Korean LCCs made more efforts by charging for meals and snacks.

LCC Capacity Share (%) of Total Domestic South Korea Seats: 2001 - 2013*

LCC Capacity Share (%) of Total International South Korea Seats: 2001 - 2013*

If AirAsia Korea eventuates, it will force change among Korea's LCCs. The long-term potential in Korea is for a more vibrant LCC sector, with consequential impacts on full-service incumbents. It will take at least a year for a possible AirAsia Korea to gain sizeable scale, but it can be expected to negatively impact incumbents wherever it goes. Domestic Korea is already a weak and saturated market with LCCs accounting for about a third of seats (higher on trunk routes), so AirAsia Korea will be felt more internationally, the long-term focus of a possible AirAsia Korea.

There are many international opportunities, but the problem is few have been realised by Korea's LCCs; LCCs account for only 11% of Korea's international seats. That sets up an inevitable clash wherever AirAsia Korea may go. Jin Air, with longer flights to Southeast Asia as well as the Pacific Islands, may be better insulated amongst the incumbents. Korean LCC consolidation - through mergers or market exit - is inevitable. For some, the prospect of AirAsia Korea may provide them with the courage to make changes they had been eyeing. It can be easier to be the second to make a change.

Seoul Incheon is a strong proponent of a LCCs, and recently Seoul Gimpo airport has mulled a LCC facility after Incheon raised the possibility of a LCC terminal. But this is something of a well-trodden path, with Tigerair being an unsuccessful early pioneer in North Asia with its proposed 2008 affiliate, Incheon Tiger Airways that was defeated by incumbents. What the mood is in Korea is difficult to tell, but the outcome in Korea would be no different than almost any other market that has welcomed LCCs: more passengers travel for less. The benefit on the larger economy far outweighs any distress on incumbents.

The potential impact is initially light on Asiana and Korean Air, but not non-existent. Asiana may be hurt more with its short-haul focus; Korean Air's main market is North America. The logical move is to be more savvy with their LCCs and integrate them better into a dual-brand strategy, but that will require a large change in their highly territorial thinking. This is easier said than done. Asiana and Korean Air have seemed to want to limit conflict rather than cannibalise their main operation so a competitor could not do it. There has largely not yet been such a threatening competitor, but AirAsia Korea may play that role.

Even deeper strategic thinking and LCC integration at Asiana and Korean is a possibility, such as expanding their LCCs to use them on what are today numerous unprofitable short-haul routes. All of this of course could be done without AirAsia Korea's entry, and would bring benefit, but without a fear there is little impetus to change.

Asiana international ASKs by region: 23-Dec-2013 to 29-Dec-2013

Korean Air international ASKs by region: 23-Dec-2013 to 29-Dec-2013

2014 could be a year of change in Korea - or not

Korea is an insular market and a difficult one to read. But there are pieces moving into place that could make for one of the most dynamic years, although this will be by the relatively sedate standards in Korea. Moving a CEO from low-cost subsidiary to the parent airline is not unprecedented (Qantas and Iberia have done so) but nor is it common. Asiana's appointment may only be a reflection of loyalty to the company and good work; this is common in North Asian airlines of having executives move between relatively un-related roles.

Alternatively it could be part of a drive for sharper strategic thinking. Asiana is heavily exposed to short-haul traffic - more so than Korean Air - and it is already experimenting with all-economy aircraft for some Japanese routes in a bid to improve profitability or limit losses. 2014 will see some long-haul growth as Asiana takes A380s, but the short-haul market cannot be neglected. Mr Kim has shown some success, albeit from a LCC with limited achievements. Asiana's growth continues in 2014 while Korean Air continues with capacity discipline, so some sharper short-haul performance is needed to accompany the capacity increases and limit the yield and load factor declines.

The larger possible force of change would be the launch of AirAsia Korea. This should not be taken for granted: in Japan AirAsia may have been challenged by what it perceived to be a difficult partner in All Nippon Airways, but in Korea AirAsia will enter a murky and opaque environment with many vested interests that do not want to see an AirAsia Korea launch.

A rare unification of competitors means they fear change. Inertia is comfortable.

And this perhaps is the greatest fear, that another year passes in Korea with little change and the market is yet to realise its potential.