06-Mar-2013 7:00 AM

Malaysia Airlines 2013 outlook clouded by increasing competition and launch of Malindo

Analysis

Malaysia Airlines (MAS) faces a challenging 2013 as low-cost carrier competition intensifies in the Southeast Asian market. The new oneworld member is back in the black, having posted profits for 3Q2012 and 4Q2012. But MAS remained in the red for the full year and will struggle to meet its goal of returning to full year profitability in 2013.

MAS operates in a highly competitive home market, competing against AirAsia on a majority of its routes. Competition will intensify after new Lion Air Group affiliate Malindo launches services in late Mar-2013, becoming the second LCC in the Malaysian market. Meanwhile challenges remain on long-haul routes, where MAS one year ago reduced capacity significantly as part of a new business plan, due to rising fuel prices and unfavourable global economic conditions.

Summary

Malaysia Airlines (MAS) faces intense competition from low-cost carriers, particularly AirAsia, in the Southeast Asian market.
MAS reported a small profit for 4Q2012, marking its second consecutive profitable quarter after six consecutive quarters of losses.
MAS still incurred a net loss after tax of MYR431 million (USD139 million) and an operating loss of MYR361 million (USD116 million) for the full year 2012.
MAS has reduced its long-haul network and focused more on short and medium-haul flights within the Asia-Pacific region.
MAS is a member of the oneworld alliance, which allows the carrier to offer a comprehensive global network.
MAS is facing increasing competition from other carriers, both full-service and low-cost, in the Southeast Asian market.

MAS was back in the black in 2H2012

MAS reported on 28-Feb-2013 a small profit for 4Q2012, marking its second consecutive profitable quarter following a string of six consecutive quarters of losses. The group turned a net profit after tax of MYR51 million (USD16 million), compared to a net loss of MYR1.277 billion (USD412 million) in 4Q2011.

MAS quarterly operating and net profits/losses: 1Q2011 to 4Q2012

The group's operating profit for 4Q2012 was MYR44 million (USD1.18 million), compared to a MYR1.321 billion (USD426 million) operating loss in 4Q2011, as revenues increased by 5% to MYR3.66 billion (USD4.3 billion). Improvements in RASK and load factor were recorded, providing an encouraging sign to MAS' ongoing turnaround efforts. The RASK and load factor figures were the highest in eight quarters, but passenger yield was still down slightly compared to 4Q2011 levels.

MAS quarterly load factor, passenger yield and RASK: 1Q2011 to 4Q2012

For the full year MAS still incurred a net loss after tax of MYR431 million (USD139 million) and an operating loss of MYR361 million (USD116 million), compared to a net loss of MYR2.521 billion (USD813 million) and operating loss MYR2.296 billion (USD741 million) in 2011 (see background information). MAS embarked on a major restructuring programme in late 2011, cutting unprofitable routes and costs in a bid to avoid bankruptcy.

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MAS still has long road ahead as it continues restructuring initiative

While the restructuring effort is starting to bear fruits, MAS still has a long road ahead to achieve sustainable profitability. The carrier has a dismal track record of several failed restructurings in recent years which typically show a relatively brief period of profitability followed by a return to losses.

MAS is hopeful the changes implemented this time - including a smaller long-haul network, an improved premium product, an increased focus on regional flying and membership in oneworld - improve the carrier's long-term outlook. But it is still early days and MAS should not view joining oneworld as a panacea. As CAPA reported in Jan-2013:

With the benefits from oneworld not likely to come in the short-term, MAS needs to focus on further reducing costs and fully implementing the latest version of its business plan. The carrier's restructuring is still a work in progress and by no means is MAS out of the woods.

There have been several major adjustments to the MAS business plan over the last several months, including a reversal of capacity cuts and dropping plans to establish a new short-haul premium carrier. But the core component, a focus on premium services, remains the same. MAS is still investing significantly in fleet renewal as well as a product enhancements to reinforce its premium position.

MAS focuses more on Asia

MAS is banking on Asia, where there is rapid growth and generally more profitability. MAS in early 2012 slashed nearly half of its long-haul network, dropping service to Buenos Aires, Cape Town, Dammam, Dubai, Johannesburg and Rome.

The carrier now only serves seven long-haul destinations - Amsterdam, Frankfurt, Istanbul, Jeddah, London, Paris and Los Angeles. While MAS has increased capacity to London and Paris by introducing A380 services, MAS has reduced its overall exposure to long-haul markets and cut costs by eliminating several stations.

The changes to the long-haul network has helped MAS improve profitability as it has reduced its exposure to the European market, which has been impacted by the economic downturn and intensifying competition from Gulf carriers. Middle East carriers currently offer approximately 25,000 weekly one-way seats from Malaysia while MAS' entire long-haul network consists of only about 17,000 weekly one-way seats. MAS has significantly smaller long-haul networks than its two main Southeast Asian rivals, Singapore Airlines and Thai Airways, putting it at a competitive disadvantage as it tries to focus more on corporate accounts and premium passengers as part of its new business plan.

But the increased focus on short and medium-haul flights within the Asia-Pacific region is logical given the growth in the intra-Asia market and MAS' position in oneworld. MAS is the first member from Southeast Asia and significantly boosts the alliance's position in several regional markets. For MAS, oneworld membership allows the carrier to virtually offer a comprehensive global network, a key component in winning back corporate customers, without having a large long-haul operation. (MAS, however, has not yet been able to fully exploit the benefits that oneworld can bring to its long-haul offering as it has not yet forged a codeshare deal with any of oneworld's members from Europe or the Americas with the exception of niche carrier Finnair.)

MAS exposed to intensifying competition within Southeast Asia

The strategy of focusing more on the Asia-Pacific market also has its challenges as other carriers from the region - both low-cost and full-service - are similarly increasing their focus on Asia. From the full-service sector, SIA regional subsidiary SilkAir is growing at an annual clip approaching 20% while new Thai Airways unit Thai Smile is rapidly expanding its international network. But it is from the LCC sector that MAS is facing the toughest challenge.

MAS and its biggest rival, AirAsia, have significant network overlap as AirAsia is now similarly focused on the Asia-Pacific region, having dropped European services in 2012. AirAsia already has a leading 52% share of capacity in Malaysia's domestic market, compared to 47% for the MAS group (includes turboprop subsidiary Firefly).

Malaysia domestic capacity share (% of seats): 04-Mar-2013 to 10 Mar-2013

AirAsia Malaysia also now offers as many international seats as MAS. The AirAsia brand overall (includes all AirAsia Group affiliates and sister company AirAsia X) currently accounts for 39% of seat capacity in Malaysia's international market compared to only 27% for MAS.

Malaysia international capacity share (% of seats): 04-Mar-2013 to 10 Mar-2013

In the Malaysia-Southeast Asia market (includes both domestic and international flights), the AirAsia Group currently has a 50% share of seat capacity compared to about 39% for the MAS group. While there is rapid growth in this market, driven by the region's rapidly growing economies and middle class, competition is intensifying.

AirAsia Malaysia in 2013 is pursuing the fastest growth in recent history, adding 10 A320s for a total of 74. Sister long-haul carrier AirAsia X is planning to add seven A330s, giving it a fleet of 16 A330s. Meanwhile Malindo plans to launch services in late Mar-2013 with an initial fleet of two 737-900ERs and operate a fleet of at least 12 aircraft by the end of the year.

As a result, the total size of Malaysia's LCC fleet will grown an estimated 40% in 2013 from 73 to 102 aircraft. MAS, which currently operates a fleet of over 100 passenger aircraft (excludes regional aircraft operated by Firefly and MASWings), is not expected to expand the total size of its fleet in 2013. But there will be some modest capacity growth for MAS as 737-800s continue to replace smaller 737-400s and as two additional A380s lead to the phase out of its remaining 747s.

MAS continues to grow domestic and regional capacity, but modestly

MAS says it plans to take delivery of 12 additional 737-800s in 2013 and will take another nine in 2014, allowing it to complete the renewal of its narrowbody fleet which now consists of a mix of 737-800s and ageing 737-400s. The carrier says it will also take four A330s in 2013 and one additional A330 in early 2014 as part of its widebody fleet renewal programme. The other part of that programme involves the A380; MAS took its fifth A380 in Feb-2013 and will take its sixth and final A380 in Mar-2013.

Malaysia Airlines fleet: as of 4-Mar-2013

MAS projected delivery dates for aircraft on order being purchased directly from manufacturers: as of 04-Mar-2013

Capacity expansion will primarily be allocated to the domestic and regional international network with the exception of the Kuala Lumpur-Paris route, which saw a 75% increase in capacity on 01-Mar-2013 as A380 service was introduced. MAS reduced system-wide capacity (ASKs) by 6% in 2012. But the cuts to the long-haul network that were implemented in 1Q2012 accounted for almost the entire decrease. During the course of the year MAS added capacity, primarily within Asia and to London, and as a result the carrier's ASKs were flat in 4Q2012 compared to 4Q2011.

While international ASKs were down by 7%, domestic ASKs were up in 2012 by 5%. Domestic RPKs increased at a faster 14% clip, resulting in a 5.9ppt increase in domestic load factor to 72.9%. International RPKs dropped by 9%, resulting in a 0.9ppt drop in international load factor to 75% (see background information).

The improvement in domestic load factor came as AirAsia Malaysia saw its load factor drop 0.6ppt to 80.1% (AirAsia does not break down domestic and international traffic figures). While MAS' ability to close the load factor gap with AirAsia is meaningful, pressure will come in 2013 as significant domestic capacity is added in the market, led by AirAsia and Malindo.

According to CAPA and Innovata data, MAS Group seat capacity within Southeast Asia (domestic and international) is up by 9% in Mar-2013 compared to Mar-2012 levels. During the same period, the AirAsia Group added capacity by only a slightly faster clip of 12%.

Malaysia-Southeast Asia capacity by carrier (one-way seats per week): 19-Sep-2011 to 25-Aug-2013

But 2013 will see much faster growth from AirAsia as well as rapid growth from Malindo while MAS capacity will be up only slightly. As a result, MAS will see a significant drop in its share of the domestic and regional markets.

MAS to be impacted by expected over-capacity on domestic trunk routes

AirAsia Malaysia is planning to use its additional 10 A320s for 2013 to increase frequency on domestic trunk routes, including to East Malaysia and Johor. Malindo plans to launch several domestic and regional international routes within its first year.

Malindo reportedly plans to launch with serves from Kuala Lumpur to Kuching and Kota Kinabalu. These are the two largest domestic routes in Malaysia, with AirAsia currently operating 14 daily flights on Kuala Lumpur-Kota Kinabalu and 13 daily flights on Kuala Lumpur-Kuching. MAS currently operates between nine and 10 daily flights on Kuala Lumpur-Kota Kinabalu and seven daily flights between Kuala Lumpur and Kuching.

Over-capacity on several major routes including Kuala Lumpur to Kota Kinabalu and Kuching is likely, leading to fare wars and irrational competition. Competing against AirAsia while challenging for MAS has been manageable but adding a second LCC will completely change the dynamics as the AirAsia-MAS duopoly on domestic trunk routes is eliminated. AirAsia Malaysia has benefitted from being the only LCC in the market, resulting in relatively high average fares for a LCC and fares that are sometimes higher than MAS, particularly when comparing all-inclusive prices that take into account AirAsia's charges for checked bags, seat assignments and credit card payments.

With the Lion Group entering the market, fares will almost certainly drop across the board. With Malindo a LCC, AirAsia will in theory be its biggest competitor. But Malindo is not following a pure LCC model, allowing it to compete more directly with MAS while also competing with AirAsia. For example Malindo plans to configure its 737-900ERs with two classes and offer seatback in-flight entertainment, matching products provided by MAS and not AirAsia.

MAS is cognisant of the threat of Malindo and the prospects of increased competition in the domestic and regional markets. In releasing its 2012 results, MAS warned that: "Whilst Malaysia Airlines is located at the centre of aviation's future growth hub, the airline remains cautiously optimistic of a challenging operating environment in the future. Although increased demand will be driven by emerging markets, a host of low cost carriers now offer value-for-money travel and increased competition, thereby putting pressure on yields of all airline players. In addition, rising fuel costs, demand shocks and seat over-capacity continue to bring challenges."

MAS' lack of a LCC subsidiary is being exploited

Lion and its Malaysian joint venture partner NADI are exploiting MAS' failure to follow other Southeast Asian carriers in establishing a LCC affiliate or subsidiary. MAS briefly experimented in 2011 with a LCC operation on domestic trunk routes using the Firefly brand but discontinued the operation after forging a partnership and stock swap with AirAsia. The partnership and stock swap with AirAsia was subsequently undone but MAS has since been adamant about not needing a LCC subsidiary.

MAS is confident it can compete against LCCs despite its higher cost structure by focusing on the premium end of the market. Its membership in oneworld is designed to help cement this premium position. MAS also recently increased its check-in baggage allowance by 10kg across all classes and reduced fees for excess baggage in a bid to further differentiate itself from LCCs.

But inevitably MAS will have to compete against Lion and Malindo on short-haul routes as the portion of premium or high fare economy passengers on domestic and regional international routes is relatively small. Malindo's business class product will also likely match MAS' premium offering at a much cheaper price. As CAPA reported in Dec-2012:

MAS management believes it can selectively compete with LCCs in some lower segments of the market as long as it continues to reduce its costs. Matching AirAsia's costs are impossible but as long as MAS is successful at attracting a premium from business passengers and high yielding economy passengers, through corporate accounts and travel agents, it will be able to continue matching and even under-cutting some AirAsia fares for select buckets. MAS recognises it will miss out on some lower ends of the market but believes it can offer the right product and services that appeal to all segments it sees as valuable.

MAS management believes Firefly's short-lived LCC operation created confusion among customers and its revised strategy of having Firefly and MASWings focus entirely on the full-service regional model, operating very short routes of under two hours with ATR 72s, has proven to be successful. MAS management also believes Firefly's 737 operation cannibalised MAS own short-haul operation more than AirAsia's much larger short-haul operation. As a result MAS is currently not considering establishing a new budget brand.

But with the right strategy and product position the MAS group should be able to succeed with a multi-brand strategy that includes a LCC brand and minimise cannibalisation. The experiences of the Qantas, Garuda, Thai, PAL and SIA groups have proven the strategy of having a LCC subsidiary has a home in the Asia-Pacific region despite its earlier failures in Europe and North America. Inevitably, MAS will eventually revisit its short-haul strategy.

MAS has reduced its costs but not by enough to compete effectively over the long term

While MAS for now is not willing to entertain the concept of a LCC subsidiary to fend off competition from AirAsia and Malindo, it is working to further reduce its cost. MAS will never be able to match the industry leading low costs of the AirAsia and Lion groups but it is imperative for MAS to reduce the gap with its rivals if it is to effectively compete.

In its 2012 results announcement, MAS stated that it "expects 2013 to continue to remain challenging" and "that within this environment, Malaysia Airlines continues to accelerate implementation of its Business Plan to increase revenue and yields and reduce costs. Aggressive marketing and promotions, better capacity management, improved cost management and driving productivity for better efficiencies system-wide remains the focus area."

MAS has been working hard over the last year to reduce the costs of its short-haul operation through such initiatives as higher aircraft utilisation and quicker turn times. The renewal of its narrowbody fleet, which will be completed in 2014, has made such initiatives possible while reducing fuel and maintenance costs. The new narrowbody and widebody fleets are critical components of MAS' turnaround plan from a cost as well as a product standpoint as the new aircraft come with an improved in-flight product, reinforcing the carrier's premium position.

MAS recorded an improvement in costs in 2012 of 13% (or 7% excluding one-off provisions), amounting to MYR2.1 billion (USD680 million). Fuel costs were down 10% due to lower consumption and aircraft handling costs were also reduced, partly driven by the closure of several overseas stations.

MAS cost expenditure: 2012 vs 2011

MAS will need to continue reducing costs if it is to overcome the current competitive challenges. MAS says it is now working on several initiatives aimed at further reducing costs and improving unit revenues in 2013, including even higher aircraft utilisation, improved fuel efficiency and renegotiation of supplier contracts.

But the carrier has a long way to go to achieving a cost base that is needed for sustainable profitability. It will not be an easy task given the company's history of failing to implement cuts due to union opposition and political interference.

MAS CEO Ahmad Jauhari Yahya remains confident, saying the "massive swing" in the carrier's financial performance from 2H2011 to 2H2012 "shows our business plan is working" and that "we continue to gain traction in multiple initiatives that focus on increasing revenue and managing costs".

Indeed MAS had several noteworthy accomplishments in 2H2012 and early 2013, including improved profitability, introducing A380s and joining oneworld. The carrier claims its investment in its new flagship aircraft has paid off, with its A380s spurring new demand. MAS reported an 88% load factor in the first four months the A380 operated on Kuala Lumpur-London (July to October) and said projected initial loads on Kuala Lumpur-Paris also exceed 85%. The accomplishments of the last several months represent a major change compared to a tumultuous 1H2012 characterised by capacity cuts, major business plan revisions and the unbundling of the AirAsia stock swap.

But MAS cannot celebrate just yet. The carrier will potentially face more challenges in 2013 than 2012. As MAS has learned with previous failed restructuring attempts, two or three quarters of profitability does not ensure a successful turnaround. With increasing competition in its home market, MAS could be in for a long and difficult 2013.

Background information

MAS financial highlights: 4Q2012 vs 4Q2011 and FY2012 vs FY2011

MAS operating highlights: 4Q2012 and 4Q2011 and FY2012 vs FY2011

MAS key revenue, traffic and yield: FY2011 vs FY2012