25-May-2012 10:21 AM

MAS should reconsider LCC strategy as losses continue while AirAsia reports more leading profits

Analysis

Malaysian low-cost carrier AirAsia has reported another highly profitable quarter, including the highest operating margin among publicly traded Asian airlines (both LCCs and full service carriers) while restructuring flag carrier Malaysia Airlines (MAS) remains one of Asia's most unprofitable carriers. The outlook for AirAsia Malaysia is bright, particularly if MAS fails to adjust its strategy following the unbundling earlier this month of the equity swap with AirAsia. The MAS outlook remains bleak as the group continues to push on with its new business plan, which focuses entirely on the challenging premium market just as nearly every other major airline group in Asia is investing significantly in the budget sector.

AirAsia Malaysia is the only publicly traded LCC in Southeast Asia to record an improvement in profitability for 1Q2012. The carrier reported a pre-tax net profit of MYR212 million (USD67 million), an improvement of 5%, while its after tax net profit improved by less than 1% to MYR172 million (USD54 million). Revenues at AirAsia Malaysia increased by 11% to MYR1.17 billion (USD371 million) as passenger traffic and seat capacity both increased by 12% to 4.8 million and 6.1 million, respectively.

Summary

AirAsia Malaysia reported a profitable quarter with the highest operating margin among publicly traded Asian airlines, while Malaysia Airlines (MAS) remains unprofitable.
AirAsia Malaysia's net profit improved by 5% to MYR212 million (USD67 million) in 1Q2012, while MAS incurred a net loss of MYR171 million (USD54 million) in the same period.
AirAsia Malaysia is the only publicly traded low-cost carrier (LCC) in Southeast Asia to record an improvement in profitability for 1Q2012.
MAS's restructuring plan, which focuses on the premium market, is in contrast to other major airline groups in Asia investing in the budget sector.
AirAsia Malaysia has consistently reported the highest margins in Asia's LCC sector, with an operating profit margin of 21% in 1Q2012.
The collaboration between AirAsia and MAS is unlikely to result in meaningful cooperation, and MAS may consider restoring its Firefly-branded LCC operation to compete in the budget market.

While the improvement in profits was very small, due primarily to a 9% increase in average fuel price, all the other publicly traded LCCs in the region have recorded significant decreases in net profitability including Cebu Pacific, Nok Air, Tiger Airways Singapore, Thai AirAsia and Indonesia AirAsia. Cebu, Nok and Thai AirAsia remained profitable while Indonesia AirAsia and Tiger Airways Singapore were in the red for the quarter ending 31-Mar-2012.

Thai AirAsia saw its net profit after tax drop by 23% in 1Q2012 to THB622 million (USD20 million) as revenues increased by 18% to THB4.868 billion (USD154 million) and passenger traffic grew by 17% to 2.1 million. Indonesia AirAsia recorded a net loss of IDR36.6 billion (USD4 million), compared to a net profit of IDR31.9 billion (USD3 million) in 1Q2011, as revenues increased by 17% to IDR911.3 billion (USD98 million) and passenger traffic grew 16% to 1.3 million (see Background information). The Malaysia-listed AirAsia Group now reports results for its Malaysian unit (AirAsia Malaysia) separately from its affiliates in Thailand and Indonesia as the two affiliates are now in the process of having their own initial public offerings.

Thai AirAsia IPO set for end of May-2012

Thai AirAsia stock is now set to debut on the Stock Exchange of Thailand on 31-May-2012 under a listing that values the carrier at about THB18 billion (USD570 million). Indonesia AirAsia has not yet set a firm date for its IPO but is expected to begin trading on the Indonesia Stock Exchange later this year. The AirAsia Group owns 49% stakes in Thai AirAsia and Indonesia AirAsia and a 40% stake in AirAsia Philippines, which launched services in Mar-2012. The AirAsia Group also has a 33% stake in new affiliate AirAsia Japan, which the group says is now targeted to launch no earlier than Aug-2012.

AirAsia Malaysia has consistently reported the highest margins in Asia's LCC sector, a streak it extended in 1Q2012. The carrier's EBIT or operating profit margin was 21% in 1Q2012, several percentage points higher than other publicly traded Southeast Asian LCCs.

Operating profit margins for publicly traded LCCs in Southeast Asia: 1Q2012 vs 1Q2011

Carrier	1Q2012	1Q2011
AirAsia Malaysia	21%	23%
Thai AirAsia	13%	20%
Cebu Pacific	5%	9%
Indonesia AirAsia	2%	1%
Nok	1%	6%
Tiger Airways Singapore	-6%	14%

MAS loses as much as AirAsia Malaysia earns in 1Q2012

MAS, meanwhile, has recorded some of the lowest margins over the last several quarters among all Asian carriers. MAS incurred a net after tax loss of MYR171 million (USD54 million) in 1Q2012, which ironically is almost exactly how much AirAsia Malaysia earned in the same period. The loss represents a slight improvement over the MYR242 million (USD77 million) net loss MAS incurred in 1Q2011. For the full year 2011 MAS recorded a staggering net loss of MYR2.532 billion (USD804 million).

MAS reported an operating loss in 1Q2012 of MYR307 million (USD97 million), which also represents a slight improvement over the MYR341 million (USD109 million) operating loss from 1Q2011 (See Background information). Revenues were down 2% to MYR3.059 billion (USD971 million) as costs decreased by 3% to MYR3.422 billion (USD1.086 billion) despite higher fuel costs. MAS implemented in Jan-2012 and Feb-2012 a 12% cut in capacity as part of a restructuring of its long-haul operation that included the discontinuation of service to five international destinations.

MAS ended 1Q2012 with a negative 10% operating margin, a slight improvement compared to the negative 11% operating margin for 1Q2012, but among the lowest in Asia.

Operating profit margins for publicly traded full service airline groups in Southeast Asia: 1Q2012 vs 1Q2011

Carrier	1Q2012	1Q2011
Garuda Indonesia	-1%	-5%
MAS	-10%	-11%
SIA	0%	3%
Thai Airways	10%	9%

The slight improvement in the losses at MAS could be a positive indication that MAS is on the right path with its restructuring, which began late last year. But the loss was still higher than expected, indicating that the restructuring could be proceeding at a slower pace than originally anticipated. In addition to the already implemented capacity cut, the restructuring envisioned positive contributions from a new short-haul premium carrier, its collaboration with AirAsia and membership in oneworld. But the short-haul strategy was adjusted earlier this year as MAS dropped plans to establish a separate subsidiary and brand for its short-haul full service operation.

Meaningful collaboration between AirAsia and MAS seems unlikely

While MAS is still on course to join oneworld later this year and still plans to pursue collaboration with AirAsia, the level of cooperation between the two former rivals will likely be limited. Most significantly, the two carriers are no longer expected to pursue any network tie-ups. (From a network perspective, MAS has already benefited from AirAsia X's withdrawal earlier this year from Europe and India, although the routes were not profitable for AirAsia X and would likely have been cut even if there was no collaboration. AirAsia X since also has gained access to Sydney and Beijing, which the Malaysian Government had previously approved but not given a final sign off for, and that process may have been accelerated by the equity swap.)

Joint purchasing and partnerships in the areas of maintenance and training are still possible although certainly not guaranteed, particularly given AirAsia's track record of abandoning planned partnerships with rivals. (AirAsia unveiled in Jan-2010 a cooperation plan with Jetstar that envisioned joint purchasing, including aircraft, but in recent months AirAsia has acknowledged the two leading LCC groups no longer have any plans to cooperate; questions linger if there was ever genuine intent or if the move was a distraction during rival Tiger Airways' quiet period for its IPO. With AirAsia and Jetsar, there were bigger potential benefits for joint purchasing compared to possible AirAsia-MAS cooperation as AirAsia and Jetstar both operate A320s while MAS' narrowbody fleet consists of 737s. MAS could potentially maintain AirAsia's A320 fleet, but this would require its engineering division to invest in adding A320 overhaul capabilities and would ultimately be contingent on MAS offering a highly competitive price to AirAsia. As for training, AirAsia already has a joint venture with CAE.)

The prospect of feed from AirAsia represented the biggest potential benefit for MAS as AirAsia has a more extensive network within ASEAN. Without this feed, MAS should start to question whether the benefits of the collaboration with AirAsia are now worth more than the potential benefits of following nearly all its Asian peers in having its own LCC subsidiary or unit. The equity swap with AirAsia indirectly gave MAS a budget brand in AirAsia (MAS parent Khazanah Nasional held a 10% stake in AirAsia while AirAsia's largest shareholder Tune Air had a 20.5% stake in MAS from Aug-2011 to early May-2012, when the swap was reversed).

MAS had previously recognised the benefit of a second brand for the fast-growing budget end of the market by deciding to use its Firefly subsidiary on domestic trunk routes. After taking delivery of the first of what was intended to be at least 24 Boeing 737s, Firefly started to compete head to head with AirAsia in Jan-2011, giving AirAsia LCC competition in the Malaysian domestic market for the first time. But after the equity swap with AirAsia was forged in Aug-2011, MAS quickly began the process of shutting down the Firefly-branded 737 LCC operation. This decision has left MAS as the only major flag carrier in Southeast Asia without a budget brand. Garuda Indonesia, Singapore Airlines, Thai Airways, Philippine Airlines and Vietnam Airlines all now have at least one fully or partially owned budget carrier unit or subsidiary.

LCC subsidiaries of full service airline groups in Asia Pacific

Airline Group	Full subsidiary	Partial ownership	Designated as a unit
Air India	Air India Express
All Nippon Airways		AirAsia Japan (launching Aug-2012) Peach
Asiana		Air Busan
China Eastern		Jetstar Hong Kong (launching 2013)
Garuda			Citilink
Hainan Airlines		Lucky Air
Japan Airlines		Jetstar Japan
Jet Airways	JetKonnect
Korean Air	Jin Air
Philippine Airlines		AirPhil Express
Qantas	Jetstar (Australia/NZ)	Jetstar Asia/Valuair (Singapore) Jetstar Hong Kong (launching 2013) Jetstar Japan (launching July-2012) Jetstar Pacific (Vietnam)
SriLankan Airlines	Mihin Lanka
Singapore Airlines	Scoot (launching Jun-2012)	Tiger Airways Australia Tiger Airways Singapore Tiger Airways Indonesia (Mandala)
Thai Airways		Nok Air	Thai Smile (launching Jul-2012)
Vietnam Airlines		Jetstar Pacific

Pressure could build for MAS to restore Firefly-branded LCC operation

So far MAS management has said it has no intentions to restore the Firefly-branded 737 LCC operation. But some parties are pushing for MAS to revisit its current strategy of only focussing on the full service end of the market. Malaysia Airports is confident MAS will again pursue the now common Asian full service carrier strategy of using a second brand for the budget market. Malaysia Airports managing director and former MAS executive Tan Sri Bashir Ahmad Abdul Majid tells CAPA that if Firefly does not resume 737 services another Asian LCC group such as Lion Air may end up entering the Malaysian domestic market.

Lion, which operates about 60 737-900ERs in Indonesia and is committed to expanding its 737 fleet to at least 400 aircraft, looked last year at establishing a joint venture LCC in Malaysia with local regional carrier Berjaya Air. Lion and Berjaya ended up breaking off talks without finalising a deal but Malaysia's domestic market remains potentially appealing to new LCCs, as evident by AirAsia's high operating margin. Mr Abdul Majib points out that fares on domestic trunk routes that Firefly operated with 737s before the carrier's 737 fleet was transferred to MAS mainline have increased.

AirAsia Malaysia recorded a 7% year-over-year increase in average fare in 1Q2012 to MYR177 (USD56). It is doubtful, however, that the discontinuation of Firefly's 737 operation was completely responsible for the fare increase as Firefly only competed with AirAsia on a few routes in 1Q2011. But if Firefly had followed through on its expansion plans, it would have begun to compete with AirAsia on almost all major domestic routes in Malaysia, inevitably putting pressure on fares as well as AirAsia Malaysia's yields and industry-leading profitability.

Firefly in early 1Q2011 launched services on AirAsia Malaysia's largest two domestic routes, Kuala Lumpur to Kota Kinabalu and Kuching, and in early 3Q2011 started operations on two other AirAsia Malaysia top 10 domestic routes, Kuala Lumpur to Sandakan and Sibu. Firefly also had set a Dec-2011 launch date for Kuala Lumpur-Langkawi, AirAsia Malaysia's third largest domesic route, and was expected to start competing against AirAsia Malaysia on more domestic trunk routes in 2012 as well as add more capacity on the routes launched in 2011.

Firefly's 737 operation incurred losses in the first three quarters of 2011 but the operation was not expected to be profitable in its first year (MAS initially projected breakeven results from early 2012). Mr Abdul Majib believes the operation would have proven to be profitable once it reached a larger size and says the strategy was to pursue market share rather than profitability in the first phase.

MAS has resumed services on Kuala Lumpur routes originally handed to Firefly, such as Sandakan and Sibu, but has generally not increased capacity (or only increased capacity very slightly) on routes it was operating alongside Firefly, such as Kuala Lumpur to Kuching and Kota Kinabalu. As a result total capacity on Kuala Lumpur-Kuching, the second largest domestic route in Malaysia, has dropped by about 25% since Firefly's exit while total capacity on Kuala Lumpur-Kota Kinabalu, the largest route in Malaysia's domestic market, has dropped by about 10%. Average fares on the ex-Firefly routes have increased as MAS is a premium brand while the overall reduction in LCC capacity gives AirAsia a potential opportunity to raise its average fares.

Kuala Lumpur to Kota Kinabalu capacity by carrier (seats per week, one way): 19-Sep-2011 to 11-Nov-2012

Kuala Lumpur to Kuching capacity by carrier (seats per week, one way): 19-Sep-2011 to 11-Nov-2012

Source: CAPA - Centre for Aviation & Innovata

Kuala Lumpur to Sibu capacity by carrier (seats per week, one way): 19-Sep-2011 to 11-Nov-2012

Kuala Lumpur to Sandakan capacity by carrier (seats per week, one way): 19-Sep-2011 to 11-Nov-2012

MAS has not replaced Firefly on some other domestic routes Firefly operated, such as Johor-Kuching and Johor-Kota Kinabalu, leaving AirAsia the only operator and again giving AirAsia a potential opportunity to raise average fares. Firefly had also launched international services from Johor to Bandung and Surabaya. These two routes, which only Firefly operated, were quickly dropped following MAS' decision to phase out the Firefly 737 operation by year-end 2011.

Prior to that, Firefly was planning further expansion in 4Q2011 with additional domestic routes including Kuala Lumpur to Langkawi as well as more international routes such as Johor to Bangkok. Firefly already had begun ticket sales on these routes. More domestic and international expansion was planned for 2012 as seven additional 737-800s were to be delivered to Firefly. After the equity swap with AirAsia, MAS reallocated these deliveries to the MAS mainline operation, which is now slated to take 13 737-800s in 2012 as part of an accelerated plan to phase out of its 737-400 fleet.

Firefly continues to exist but now only operates a fleet of ATR 72 turboprops. Unlike its short-lived no-frills 737 operation, Firefly's turboprops are operated under a community airline model with a relatively high level of service that includes free checked bags, drinks and snacks. There is virtually no overlap with AirAsia as most of Firefly's ATR 72s are based at Kuala Lumpur's old airport in Subang. Firefly no longer operates at Kuala Lumpur International, the main hub for AirAsia Malaysia and MAS, although it does have a small base at Penang where it operates a daily service to Medan in Indonesia in competition with Indonesia AirAsia.

Malaysia stands out in Southeast Asia for lack of domestic LCC competition

Firefly's withdrawal from domestic trunk routes has had a significant impact on several Malaysian airports. AirAsia clearly has been the primary beneficiary as the Malaysian domestic market finds itself in a position with less LCC competition than other major domestic markets in Southeast Asia.

There are currently three LCCs in Thailand's highly competitive domestic market (Thai AirAsia, Nok and Orient Thai) and four in Indonesia (Lion Air, Citilink, Indonesia AirAsia and Mandala-Tiger). The Philippines domestic market also has four LCCs (Cebu Pacific, AirPhil Express, Zest Air and AirAsia Philippines) with a fifth LCC (SEAir-Tiger) planning to launch domestic services later this year.

Malaysia's regional international market has more LCC competition as LCCs from other Southeast Asian markets, including the Philippines, Indonesia and Singapore, serve Malaysia. But generally there is less LCC competition in Malaysia's international market than in other major ASEAN countries. For example, Kuala Lumpur-Bangkok is only served by one LCC group, AirAsia, while Singapore-Bangkok is served by three LCCs.

At the time, MAS' decision to pursue collaboration with AirAsia along with an equity swap seemed to be strategically viable. There was huge risk with the Firefly 737 LCC operation as AirAsia is a strong and powerful carrier. Plus the benefits of the cooperation, as initially envisioned, arguably outweighed the benefits of pursuing a strategy of investing in a second budget brand. But with the equity swap now reversed and the benefits of the collaboration likely to be limited, the potential opportunity of not following most of Asia's other full service airline groups in establishing budget airline subsidiaries or units could prove too good to pass up. Resuming the Firefly 737 operation, or establishing a similar LCC operation under a new brand, would be logical.

(Conversion rates: 1USD = MYR3.15, 1USD = THB31.57, 1USD = IDR9259)

Background information

AirAsia Malaysia financial highlights: 1Q2012 vs 1Q2011

AirAsia Malaysia operating highlights: 1Q2012 vs 1Q2011

Thai AirAsia (TAA) and Indoneisa AirAsia (IAA) financial and operating highlights: 1Q2012 vs 1Q2011

Malaysia Airlines financial highlights: 1Q2012 vs 1Q2011