Malaysia Airlines restructure will need partners - perhaps Etihad, BA, Finnair or Qatar Airways

This is the second in a series of CAPA analysis reports on Malaysia Airlines' outlook. The first report looked at the carrier's 2Q2014 earnings, released on 28-Aug-2014, and its bleak outlook for 2H2014. This report analyses some of the restructuring initiatives announced on 29-Aug-2014 by MAS parent Khazanah and the outlook for the group in the long-haul market.

The next part will look more specifically at MAS' position regionally and at the job cuts, which are aimed at improving productivity and closing the gap with Asian competitors.

See related reports:

• Malaysia Airlines 2Q loss widens. Restructuring is imminent but outlook remains bleak

• Malaysia Airlines restructuring: cost cuts must be deep to improve short-haul competitiveness

To take part in the discussion about Malaysia's aviation market and to meet all of Asia's key aviation players, sign up now to CAPA's three day Asia Aviation Summit and LCC Congress, plus a full day of corporate travel at Singapore's Capella Sentosa 13-15 October, 2014: https://centreforaviation.com/events/upcoming/

Malaysia Airlines aims eventually to re-privatise or relist

Khazanah has drafted a recovery plan which will be implemented over the next year and aims to bring MAS back to profitability by the end of 2017. The government investment firm is now in the process of increasing its stake in MAS from 69% to 100% as part of a delisting which is expected to be completed in late 2014. But it aims eventually to relist MAS within three to five years.

A relisting or a re-privatisation through a possible sale of a strategic stake will only become realistic if the recovery plan is executed flawlessly and market conditions, which have been brutal in Southeast Asia over the last year, become relatively more favourable.

Japan Airlines (JAL) relisted in 2012, capping a turnaround which began with the carrier's early 2010 bankruptcy filing. But JAL has a much bigger home market and - at least until recently - has not been confronted with LCC competition. The LCC penetration rate is currently 51% in Malaysia compared to about 17% in Japan, according to CAPA and OAG data.

The option of partially privatising through the sale of a strategic stake sale could emerge as a more feasible option. The attractiveness of a stake in MAS to airlines in the Middle East or Europe could particularly increase as MAS reduces long-haul capacity as part of an increased focus on its regional network and attempt to build its global network virtually through partnerships.

Etihad or Qatar could emerge as key partners, with equity stakes to potentially come later

MAS already had been discussing enhancing its partnership with Etihad. So far the Etihad-MAS talks have been only about a more comprehensive codeshare. Currently MAS puts its code on Etihad flights from Kuala Lumpur to Abu Dhabi and beyond Abu Dhabi to three points in the Middle East - Bahrain, Kuwait and Muscat. As CAPA previously suggested, an expanded codeshare partnership could potentially evolve into an equity partnership if Khazanah ends up seeking a strategic partner as part of a later phase in the recovery plan.

See related report: Malaysia Airlines considers tie-up with Etihad Airways as restructuring process slowly begins

Etihad could potentially benefit from having a Southeast Asian airline in its equity alliance while MAS would benefit from having strong a partner in the Gulf to provide offline access to the Middle East, Europe, Africa and the Americas. But until the restructuring, which includes about 6,000 job cuts, can be fully implemented the attraction of MAS to any investor within or outside the industry will be limited.

Qatar Airways, which joined oneworld just a few months after MAS, also has been talking to MAS about an expanded partnership. MAS and Qatar also currently have a limited codeshare with Qatar carrying the MH code on Kuala Lumpur-Doha.

Qatar has not been nearly as aggressive as Etihad at pursuing strategic stakes in other airlines. But it could also at a later phase consider a stake in MAS in the event it edges out Etihad in forging a close partnership with the restructured Malaysian carrier.

MAS will need more and stronger partners in Europe

MAS will also likely look to forge closer relationships with European oneworld members, which along with a Middle Eastern partner would help improve MAS' presence in Europe and the Americas.

MAS currently only has a codeshare with one European oneworld member, Finnair. But Finnair does not serve Kuala Lumpur while MAS does not serve Helsinki. As a result the two carriers only have a limited partnership covering Helsinki via four intermediary points in Europe. MAS' biggest and longest standing European partner is still SkyTeam member KLM, which provides offline access to 10 European destinations via Amsterdam.

As CAPA outlined in the first instalment in this series of reports, MAS currently operates only seven routes outside Asia-Pacific: Amsterdam, Dubai, Frankfurt, Istanbul, Jeddah, London Heathrow and Paris. Four long-haul destinations - Buenos Aires, Cape Town, Johannesburg and Rome - were already cut in early 2012 as part of the carrier's last restructuring initiative while Los Angeles was cut in Apr-2014.

The seven remaining long-haul routes currently account for only 12% of MAS' international seats but 31% of international ASKs. The five European routes account for about 10% of international seats and 29% of international ASKs.

Malaysia Airlines international capacity share (% of seats) by region: 1-Sep-2014 to 7-Sep-2014

Source: CAPA - Centre for Aviation & OAG

Malaysia Airlines international capacity share (% of ASKs) by region: 1-Sep-2014 to 7-Sep-2014

Source: CAPA - Centre for Aviation & OAG

As the new recovery plan envisions an even smaller long-haul operation MAS will likely further cut capacity to Europe and the Middle East through a combination of frequency reduction, aircraft downgauges and potentially axing two or three of its seven destinations. Currently London is served with two daily flights; Amsterdam, Dubai and Paris are served once daily; Frankfurt is served five times per week and Istanbul is served three times per week. Capacity to Jeddah varies significantly - from one to seven scheduled frequencies - depending on the time of year.

(Note: the seven long-haul routes are based on geography as they are the only seven routes MAS currently operates outside Asia-Pacific. Dubai and Jeddah could also be viewed as medium-haul routes as they are of similar length to MAS' longer Australian routes. Auckland is even longer than the Middle East routes and slightly longer than Istanbul, making it the fifth longest route in the MAS network.)

British Airways could be enticed to serve Kuala Lumpur with support from MAS

While a smaller European and Middle Eastern operation would make MAS more attractive to potential Gulf partners, it would also make MAS more attractive to potential European partners. British Airways for example has looked as serving Kuala Lumpur but was dissuaded as it believes the Malaysia-London market became oversupplied after MAS upgauged its two London flights to A380s.

As MAS looks to cut its own capacity to Europe, a scenario could emerge in which BA takes over one of MAS' two Kuala Lumpur-London Heathrow flights (and slots). BA and MAS could potentially seek a joint venture arrangement on Kuala Lumpur-London and cooperate on the London-Australia kangaroo route.

BA currently operates one daily 777 flight to Sydney via Singapore. Moving the Sydney stopover to Kuala Lumpur with MAS cutting back in both London and Sydney would be sensible. (MAS added a third daily flight to Sydney at the the beginning of 2014, which has proven to be too much capacity. If BA shifts its London-Singapore-Sydney 777 flight to Kuala Lumpur it would have one daily flight to Singapore, which is now served with an A380.)

Finnair could also end up launching Kuala Lumpur

Finnair could also consider serving Kuala Lumpur as MAS reduces capacity to Europe, potentially under a joint venture arrangement. Finnair already has a joint venture partnership with another Asian oneworld member, JAL.

Finnair would be able to provide quick Malaysian passengers connections beyond Helsinki to destinations throughout Europe as well as potentially New York. MAS would be able to provide Finnair with connections beyond Kuala Lumpur to destinations throughout Southeast Asia as well as Australia and New Zealand.

Finnair now relies on a mix of partners beyond Singapore and Bangkok, but neither of these is a oneworld hub. For example Finnair uses Qantas to access Australia via Singapore. But Qantas' service reductions and re-timings in Singapore have increased connection times in some markets and eliminated some connection markets altogether (such as Adelaide and Perth). BA connections to some offline Australian cities also have suffered as Qantas has adjusted its Singapore operation.

BA and Finnair also now often use Hong Kong and connections with Cathay Pacific to provide offline access to Southeast Asia and Australia. But MAS is likely to provide better onward rates and more direct routings.

Kuala Lumpur could provide both Finnair and BA better options for accessing offline markets in Southeast Asia, Australia and New Zealand. The feed would also help MAS retain its regional operation, particularly Auckland and secondary destinations in Australia such as Adelaide and Darwin which could potentially be cut as MAS reviews its network.

oneworld member airberlin could also potentially look at serving Kuala Lumpur, particularly if MAS gets closer to Etihad, which owns a stake in airberlin. But Etihad may prefer to instead focus on boosting Abu Dhabi-Kuala Lumpur capacity and using the Abu Dhabi hub to provide connections throughout Europe to Malaysian passengers including several points in Germany.

BA and Finnair flights would help oneworld grow Malaysia-Europe market share

Kuala Lumpur is currently served by four European carriers - Air France, KLM, Lufthansa and Turkish Airlines - none of which are oneworld members.

KLM and Turkish serve Kuala Lumpur daily while Lufthansa operates five weekly flights and Air France four weekly flights. The Lufthansa and KLM flights continue onto Jakarta ; the Air France and Turkish flights turn around in Kuala Lumpur but Air France offers connections from Kuala Lumpur to Jakarta via sister carrier KLM.

Malaysia to Western Europe capacity by carrier (one-way seats per week): 19-Sep-2011 to 1-Mar-2015

Source: CAPA - Centre for Aviation & OAG

MAS currently has about a 73% share of capacity in the non-stop Malaysia to Western Europe market. When also including Central/Eastern Europe, MAS has about a 68% share of non-stop capacity between Malaysia and Europe.

But its share of the overall Malaysia-Europe market, when including one-stop services, is much less as the three Gulf carriers have more seats to Malaysia than MAS has to all of Europe. Emirates, Etihad and Qatar combined have about 20,000 weekly one-way seats from their hubs to Kuala Lumpur while MAS has about 14,600 weekly seats to Europe.

(Note: Gulf carrier figures exclude their flights beyond Kuala Lumpur. Emirates, Eithad and Qatar currently operate a combined nine daily flights between their hubs and Kuala Lumpur. One of Emirates' four flights continues onto Melbourne while one of Qatar's three flights continues onto Phuket. Etihad accounts for the other two flights.)

Malaysia to Middle East total capacity (one-way seats per week): 19-Sep-2011 to 1-Mar-2015

Source: CAPA - Centre for Aviation & OAG

The Malaysia-Europe market has become increasingly tough for MAS not only because of continued expansion by the Gulf carriers but by the entry of more European carriers. Air France launched services to Kuala Lumpur in 2013 while both Lufthansa and Turkish commenced operations earlier this year.

To take part in the discussion about Malaysia's aviation market and to meet all of Asia's key aviation players, sign up now to CAPA's three day Asia Aviation Summit and LCC Congress, plus a full day of corporate travel at Singapore's Capella Sentosa 13-15 October, 2014: https://centreforaviation.com/events/upcoming/

MAS cuts will benefit existing players in Malaysia-Europe market and potentially AirAsia X

A MAS downsizing in Europe would benefit all the European and Gulf carriers serving Kuala Lumpur, leading to potential capacity increases by the existing players. It could also prompt AirAsia X to reconsider a resumption of long-haul routes to Europe, a potential that grows if fuel prices fall.

AirAsia X dropped London and Paris in early 2012. The long-haul LCC group has so far resisted returning to Europe and is now focusing on expanding within Asia-Pacific. But significant cuts in Europe could create a void that AirAsia X may be tempted to fill.

The entry of a long-haul LCC in the Malaysia-Europe market could ultimately hinge on how full-service competitors respond and what happens with pricing. MAS has been discounting steeply and Gulf carriers also generally have been aggressive, leaving few openings for long-haul LCCs to come in with significantly lower fares (particularly given that fuel accounts for a much higher portion of costs on long-haul flights compared to medium-haul flight). But if fares increase and as new aircraft technology becomes available the economics of European flights for AirAsia X could change.

(Another intriguing possibility surrounds the vague suggestions Lufthansa has made about entering the long-haul low cost Asian market. There have been some discussions between Lufthansa and AirAsia X in the past.)

See related report: AirAsia X records 2Q2014 loss as Australia underperforms. But long-term prospects are still bright

For MAS it is obviously better if the void it leaves as it reduces long-haul capacity can be filled by the launch of services to Kuala Lumpur by oneworld European members. A quick response will likely go a long way in dissuading AirAsia X.

Network cuts in Europe are inevitable for MAS

Reducing long-haul capacity in favour of new and enhanced partnerships will enable MAS to cut costs and streamline its widebody fleet. As CAPA previously outlined, the 777 fleet is by far the oldest among all its aircraft types and was already being considered for replacement even before the MH370 and MH17 incidents (both of which involved 777-200s). MAS' 777s are now an average of almost 15 years compared to an overall very young fleet with an average age of about four years, according to the CAPA Fleet Database

A phase-out rather than replacement could become an option under the new recovery plan. With a cut in long-haul capacity MAS could potentially use its six A380s to cover its entire European network. The A380 is currently used on all London and Paris flights while Amsterdam, Frankfurt and Istanbul are served with 777s.

The Istanbul route could be axed entirely or could be served with the carrier's A330-300, which is now only used regionally within Asia-Pacific including on most Australia flights. Turkish Airlines launched services to Kuala Lumpur in Apr-2014, making the Istanbul route more challenging for MAS. An extended codeshare with Etihad or Qatar could provide offline access to Istanbul. The route may not be viable for MAS over the long-run unless it partners with Turkish, which is unlikely as Turkish is in Star and recently expanded its partnership with MAS rival Singapore Airlines.

Amsterdam and Frankfurt will be tougher decisions for MAS. One of the routes could be potentially upgraded to the A380 if one of the two London flights is cut back (potentially as part of a partnership with BA). But feed would be required to support the A380.

Amsterdam would be the more logical destination to maintain as MAS has a strong relationship with KLM. But the MH17 incident could continue to impact in the short term on MAS' ability to sell in the Dutch market. The KLM partnership will likely be retained as oneworld is relaxed about allowing its members to continue working with members of other alliances. But the codeshare may not be expanded to include more points beyond Amsterdam as the priority could become working more closely with oneworld members.

Frankfurt has become a challenging route for MAS as it does not have any connections in Frankfurt. airberlin could emerge as a new MAS partner but has a very small presence in Frankfurt with only two routes operated at least once per day (Berlin and Palma de Mallorca). A Berlin-Kuala Lumpur service would provide more connection opportunities but would be better operated with smaller widebodies, such as airberlin's A330-200s.

Widebody fleet adjustments are also inevitable for MAS

MAS could also potentially acquire A330-200s, which offer more range than the A330-300s it currently operates. But MAS may be better off downsizing its widebody fleet and relying more on partners than acquiring additional aircraft.

The A380 is also far from ideal. MAS would be better off with the 787 or A350 for its remaining long-haul flights. But its A380s are only about two years old and remarketing the aircraft would be very difficult. MAS will likely have to make do with retaining six A380s and using the flagship for its remaining European routes.

In addition to Istanbul, Amsterdam and Frankfurt MAS also now uses its 13 remaining 777s for Auckland and Jeddah, one of its three daily Melbourne flights and on some regional flights within Asia. But the A330-300, which is on average less than three years old, could take over these flights. Capacity cuts to Australia, where MAS predominately uses A330s, could free up capacity in the existing 15-aircraft A330-300 fleet to take over the 777 routes that are now within range of the A330-300s.

Malaysia Airlines fleet summary: as of 1-Sep-2014

Source: CAPA Fleet Database

MAS could also free up A330 capacity by again cutting Dubai, which was relaunched in 2013 and is currently served daily with A330-300s. MAS has continued to struggle in the Dubai market and has been looking at trying to forge partnerships in Dubai to help make the service sustainable. But the opportunities are limited to small codeshares with other Middle Eastern carriers.

MAS would be wiser to terminate the Dubai route, as competing head to head with Emirates is always going to be a loss making proposition. Working with fellow oneworld member Qantas also has been essentially ruled out as a result of the Emirates-Qantas partnership. Emirates is the largest foreign full-service carrier in Kuala Lumpur.

Focusing on other hubs where its partners have a strong presence is a better strategy for taking on Emirates, which has steadily grown its presence in the Malaysian market. As Khazanah stated in the recovery plan, MAS should "focus the network where MAS can win".

Khazanah promised that "the new MAS will apply purely commercial criteria to its route decisions; only flying profitable routes while securing global connectivity through oneworld and other alliances" It added that "MAS will also re-configure its fleet to better fit MAS' network and markets, which could include moving to smaller aircraft, retiring specific aircraft types, and/or adding seats to aircraft to reduce unit costs."

MAS makes another attempt at an old strategy

The increased focus on partnerships is hardly a new strategy for MAS. The Malaysian flag carrier has been pursuing more partnerships since joining oneworld in Mar-2013, which it saw as an opportunity to improve its offline network and yields.

But so far it has added or expanded partnerships with only a small number of oneworld members and has not forged any comphrensive partnerships, seemingly keener to focus on its own expansion in a macho battle with its AirAsia neighbours.

See related reports:

• New oneworld member Malaysia Airlines seeks to finally turn the corner in 2013 but challenges remain
• Malaysia Airlines finally gives oneworld a presence in fast-growing Southeast Asia market

Meanwhile attempts to leverage oneworld and an investment in product improvements to increase yields took a back seat due to market conditions, which led to aggressive pricing. Over the last year MAS instead resorted to trading yields for load factor.

See related report: Malaysia Airlines pursues rapid expansion but yields and profits are under pressure

MAS is now aiming to again boost yields as part of its new recovery plan. This will be very difficult to achieve, particularly if overall market conditions do not improve significantly - an unlikely scenario. At least for the foreseeable future the market is likely to remain intensely competitive. MAS also hardly has much upside pricing power these days.

MAS is also aiming to lower costs as part of dual bid to decrease unit costs while increasing unit revenues. Khazanah recognises that MAS needs lower unit cost to compete with LCCs while the unit revenue gap it has with other full-service airlines in Asia must be narrowed. These initiatives, including the planned 6,000 job cuts, will be reviewed as part of the third part in this series of reports on MAS.

The focus on partnerships is the easier part of the strategy to implement. oneworld members should be eager to work with MAS and carry its long-haul passengers as the airline focuses more on its relatively extensive regional network.

In theory the partnerships should help provide higher yielding feed to the MAS regional network, which will become the primary focus as the flag carrier restructures. Competition regionally is fierce, both with LCCs and other Southeast Asian full-service airline groups. A partnership strategy could deliver a substantial advantage.

In short Malaysia Airlines has very limited options in its own right. Even after making significant cuts and with substantial partner support - and getting those right will not be simple - the flag carrier's future is far from secured.