26-Apr-2016 6:28 PM

Nok Air and NokScoot 2016 outlook: focusing expansion on China as profitability improves

Analysis

Thailand's Nok Air and its long haul sister NokScoot are planning to focus expansion on China for the remainder of 2016. Nok plans to commence scheduled services to China in Jun-2016, while NokScoot plans to expand its network beyond its current four scheduled Chinese destinations in 2H2016.

China will be allocated a majority of Nok's additional capacity as the airline grows its 737-800 fleet from 21 to 23 aircraft in 2H2016. As it takes two additional Bombardier Dash 8 turboprops Nok also expects to free up 737-800s for international routes; these are aircraft that are currently used for domestic services. The airline also expects to generate additional capacity by improving aircraft utilisation as it resolves a pilot shortage issue.

Nok has traditionally focused almost entirely on the domestic market - which accounted for 91% of its total passenger traffic in 2015 - but is trying to diversify by expanding internationally, with an initial focus on China. The 2015 launch of NokScoot also enables the group to expand internationally. NokScoot currently operates three 777-200s and is now aiming to add two more aircraft in 2016.

Summary

Nok Air and NokScoot are planning to expand their operations in China for the remainder of 2016.
Nok Air will commence scheduled services to China in June 2016, while NokScoot plans to expand its network beyond its current four scheduled Chinese destinations in the second half of 2016.
Nok Air will allocate a majority of its additional capacity to China as it grows its 737-800 fleet from 21 to 23 aircraft in the second half of 2016.
Nok Air has traditionally focused on the domestic market, but is now trying to diversify by expanding internationally, with an initial focus on China.
NokScoot currently operates three 777-200s and plans to add two more aircraft in 2016 to expand its operations in China.
Thailand recorded a 71% increase in Chinese visitor numbers in 2015, making it the largest source market for Thailand's tourism sector.

Nok Air is one of Southeast Asia's most established LCCs but is not well-known outside Thailand since it has focused almost entirely on the domestic market since its 2004 launch. Nok Air currently operates a fleet of 29 aircraft to 24 domestic destinations and three scheduled international destinations - Hanoi, Ho Chi Minh and Yangon. China is currently only served by a charter operation which commenced in 2015.

Nok to operate scheduled services to four Chinese destinations from June

Nok Air CEO, Patee Sarasin, told CAPA on 19-Apr-2016 that scheduled operations to China are expected to begin in Jun-2016. Initially Nok plans to serve Kunming, Nanning and Quanzhou from Bangkok, and Chengdu from Phuket.

Nanning has been served with three weekly charter flights since Mar-2015, while Chengdu has been served with one daily charter flight since Jul-2015. Kunming and Quanzhou will be new destinations and served daily while the Chengdu and Nanning services will be upgraded to scheduled flights.

In the Bangkok-Kunming market Nok will compete against China Eastern (two daily flights), Thai AirAsia (one daily flight) and Thai Airways (five weekly frequencies). In the Bangkok-Quanzhou market Shenzhen Airlines and Xiamen Airlines each operate three weekly flights according to OAG data for the week commencing 18-Apr-2016. Chengdu-Phuket is served by China Eastern, Orient Thai and Sichuan Airlines while Bangkok-Nanning is served by China Southern and Orient Thai (in addition to the current Nok charters).

Nok aims to continue expanding its new Chinese scheduled operation in 2H2016. While several competitors are adding capacity in the Thailand-China market, Nok believes that there is ample demand to support a significant increase in its own capacity.

Thailand recorded a 71% increase in Chinese visitor numbers in 2015, to 7.9 million, making it by far the largest source market for Thailand's tourism sector. Chinese visitor numbers were up another 45% in Jan-2016 and 21% in Feb-2016, according to Thailand Ministry of Tourism data.

Thailand annual Chinese visitor numbers: 2008 to 2015

Growth is expected to slow over the remainder of 2016. However, growth will likely remain in the high double digits and Nok is not concerned about potential overcapacity on its existing and new Thailand-China routes.

Nok and NokScoot have a very small share of the Thailand-China market

Nok's initial four scheduled routes will give the LCC slightly more than a 2% share of seat capacity between China and Thailand. Even including NokScoot, the group has a relatively modest 6% share. The Nok group clearly has an opportunity to grow its share of the China-Thailand market, as well as to expand with the market.

NokScoot currently operates 18 weekly flights to China from its Bangkok hub, including six to Nanjing, five to Qingdao, four to Tianjin and three to Shenyang. NokScoot operates 777-200s in 415-seat two class configuration (391 economy and 24 business), while Nok uses 189-seat all economy 737-800s.

NokScoot has steadily expanded in China since making Nanjing its first China route in Jun-2015, with an initial three weekly flights. NokScoot launched Qingdao in Nov-2015, Tianjin in Jan-2016 and Shenyang in early Apr-2016, while gradually adding capacity to Nanjing.

NokScoot one-way seat capacity to China: Jun-2015 to Jun-2016

NokScoot's only other route is currently Bangkok-Taipei, which was launched in Oct-2015 and is now served with four weekly flights. It is no coincidence that all five of NokScoot's destinations are also served by Scoot from Singapore as the two sister airlines have sought to pursue network synergies. Scoot, a fully owned subsidiary of Singapore Airlines, owns a 49% stake in NokScoot. Nok also owns a 49% stake and NokScoot executives own the remaining 2%.

NokScoot shifts focus to China

NokScoot commenced scheduled operations with service to Singapore in May-2015, but dropped Bangkok-Singapore after only two months. Singapore was only pursued after NokScoot was unable to implement its original business plan, which focused on Korea and Japan.

NokScoot and other Thai airlines were blocked from launching new routes to Korea and Japan after ICAO raised concerns with Thai authorities in early 2015. South Korean and Japanese authorities will not approve any new service from any Thai airline until Thai authorities pass a new ICAO audit.

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NokScoot wisely shifted its focus to China as it became clear that the restrictions to Korea and Japan would not be eased in the near term. China does not follow Korea and Japan in prohibiting new services from airlines based in countries flagged by ICAO, but it has other general requirements for new foreign airlines that make it difficult in the early phases of launching scheduled services.

NokScoot essentially needed to complete two months of operating highly unprofitable fights to Singapore - accumulating enough hours under its belt to qualify for scheduled services to its first Chinese destination, Nanjing. Subsequently, it has had to expand slowly in China as it gained hours and met additional Chinese regulatory requirements.

NokScoot to expand further in China as two more 777s are added

NokScoot is evaluating more potential new destinations in China. The airline is now seeking board approval to add two 777-200s, which would at least initially be used to expand in China.

Nok stated in a 25-Feb-2016 financial filing that NokScoot would not expand its fleet until Thailand's DCA resolves the ICAO audit issue, which would enable the launch of flights to Korea and Japan. However Mr Patee told CAPA that NokScoot is now keen to expand its fleet by two aircraft.

If board approval can be secured quickly the additional 777s could be acquired, reconfigured and placed into service in 2H2016. SIA, which is leasing NokScoot its initial three 777-200s, could potentially provide additional aircraft since it is planning to phase out more 777-200ERs as new A350-900s are delivered.

NokScoot expects improvement in profitability after dismal 2015

The decision to resume expanding NokScoot's fleet is likely generated by an improvement in the airline's financials, and opportunities in the Thailand-China market. NokScoot incurred a loss of THB1.223 billion (USD36 million) in 2015, according to Nok Air's annual financial filing. NokScoot generated revenues of only THB2.176 billion (USD64 million) in 2015, which equates to a dreadful negative 56% net margin.

NokScoot was impacted by lengthy launch delays as it had initially planned to commence scheduled operations in early 2015 with flights to Tokyo Narita. The Singapore route was highly unprofitable and while China has performed much better, it has taken a year for NokScoot to build up its China operation and fully utilise its initial fleet of three aircraft.

Mr Patee said that NokScoot is now utilising its 777 fleet an average of 12 hours per day and was profitable in Feb-2016. He expects that NokScoot could post a profit for the full year in 2016, which would represent a dramatic turnaround from 2015.

A larger 777 fleet and bigger network in China would enable NokScoot to achieve a greater economy of scale and hence, further boost profitability. Eventually NokScoot should also finally be cleared to serve Korea and Japan, a move that it would be able to make faster if it had a larger fleet.

The acquisition of two additional 777s would require a significant investment, including retrofit costs. However, NokScoot now has the business case and a strategic need to expand as there are opportunities in the fast-growing Thailand-China market. NokScoot is also content with sticking with 777s for at least the next few years, making an investment in 777 retrofits worthwhile, and is not yet planning to transition to 787s.

Nok Air also expects profitability improvement in 2016

Nok Air is also confident that it can achieve a significant improvement in profitability. The short haul LCC incurred a loss of THB422 million (USD12 million) in 2015 on THB13.387 billion (USD391 million) of revenues.

Nok's losses were flat compared with 2014, when the airline incurred a loss of THB399 million (USD12 million), but revenues increased year-over-year by 10%, and RPKs by 20%. While relatively small, the Nok Air losses in 2014 and 2015 are disappointing as the airline had been profitable for five consecutive years from 2009 through 2013.

As CAPA has previously highlighted, Nok was impacted in 2014 and 2015 by intensifying competition in the domestic market. Thai Lion has pursed aggressive and rapid domestic expansion since commencing operations at the end of 2013, impacting yields.

Nok's unit revenues (RASK) declined by 14% in 2014 and a further 7% in 2015. Nok has been more impacted by intensifying domestic competition than Thailand's other longstanding LCC, Thai AirAsia, as Nok is predominantly a domestic airline, while Thai AirAsia has an even domestic/international capacity split, broadly speaking.

Mr Patee said domestic market conditions improved in 1Q2016, but Nok was again unprofitable due to a pilot shortage, which led to significant flight cancellations. The pilot shortage has impacted Nok's cost base as it has been underutilising its fleet. Nok is currently using its fleet an average of 9 hours per day, slightly better than the 8.5 hours average during the peak of the crisis in Feb-2016, but well short of its pre-crisis average of approximately 11 hours per day.

Mr Patee expects Nok's average utilisation rate to reach 10 hours per day by May-2016 and 11.5 hours by Sep-2016 as more newly hired pilots come online. The 11.5 hour figure is even higher than its historical average, due to the expansion on China routes. The new China flights are the longest in Nok's network and some are operated during overnight hours, which improves overall utilisation rates.

Mr Patee said Nok aims to break even for the full year in 2016 and to be profitable again in 2017. The expanded China operation, which is expected to be profitable and result in overall lower costs for the rest of the network (due to the higher aircraft utilisation rates), is a key driver of the anticipated turnaround.

Nok needs a larger international operation

While Nok is hopeful of improved domestic market conditions its expected improvement in profitability relies significantly on the international market. Strategically Nok needs to expand its international network as Thailand's domestic market is becoming relatively saturated after several years of rapid growth, and is likely to remain extremely competitive.

In 2015 Nok flew 7.95 million domestic passengers and only 810,000 international passengers. Its domestic operation generated THB10.998 billion (USD321 million) in revenues while its international operation (including charters) generated a much smaller THB1.732 billion (USD51 million).

Passenger traffic has quadrupled since 2010, but virtually all the growth has come in the domestic market. Nok flew 26% of total domestic passengers in Thailand in 2015 but only 1% of total international passengers.

Nok Air annual passenger traffic: 2010 to 2015

Nok expands in Myanmar and Vietnam

Nok's international revenues increased fivefold in 2015, but on a very low base. In 2015 Nok launched several charter routes to China, launched scheduled services to Ho Chi Minh and Hanoi in Vietnam, and added a third daily flight to Yangon in Myanmar.

Yangon was initially launched in late 2013, marking a resumption of international services. Nok has previously operated scheduled services to Bangalore and Hanoi but suspended both routes in 2007.

Nok launched Ho Chi Minh in Oct-2015 and resumed services to Hanoi on 1-Dec-2015. Mr Patee said that Ho Chi Minh had performed well, with initial load factors above 80%, while Hanoi was slowly improving.

Ho Chi Minh is currently served with two daily flights and Hanoi with eight weekly flights. Nok is considering potentially adding capacity on the Bangkok to Hanoi and Yangon routes by the end of 2016.

Nok to reconsider more Vietnam and Myanmar expansion in 2017

In the last analysis of Nok, in Aug-2015, CAPA highlighted Nok's plans to also launch services to Da Nang in central Vietnam. At the time Nok was also planning to launch services to Singapore and evaluating potential new routes to Myanmar.

See related reports:

However, most of Nok's expansion plans for 4Q2015, including new China routes and Da Nang, were put on hold due to the pilot shortage issue. Mr Patee said that China expansion is the immediate priority following the resolution of the pilot shortage issue. Da Nang and potential new routes to Myanmar are still in the business plan but will likely not be added until 2017.

Singapore has been dropped from the business plan as the Bangkok-Singapore market is oversaturated. Nok has instead decided to focus on expanding its presence in its three current international markets of China, Myanmar and Vietnam before considering expansion in a fourth market.

This is a sensible strategy as launching other new markets would be riskier. However, eventually Nok will need to offer a broader international network if it is to become a significant player in Thailand's international market.

Nok to continue expanding its fleet

Da Nang and the new routes to Myanmar (such as Mae Sot-Yangon and Bangkok-Mandalay) will be served with the Dash 8-Q400 turboprop fleet. Mr Patee said that Nok plans to lease two more new Q400s by the end of 2016, giving it eight of the type, and is also evaluating the acquisition of up to four more Q400s over the next couple of years.

Nok also operates two ATR 72-500s, which the airline intends to eventually phase out, but will keep in the fleet until the leases expire in 2019.

Nok Air fleet summary: as of 21-Apr-2016

Aircraft	In Service	On Order
Total:	29	12
ATR 72-500	2	0
Boeing 737-8	0	8
Boeing 737-800	21	4
Bombardier DHC-8Q-402(NG)	6	0

While Nok intends to start operating international routes with Q400s in 2017 the two additional aircraft for 2016 will be used in the domestic market, mainly to take over from 737-800s on routes such as Bangkok-Khon Kaen. This in turn will free up 737-800s to support Nok's expansion in China.

Nok also plans to take delivery of two more 737-800s in 2H2016, which will also be used to support expansion in China. Nok has already taken delivery of one 737-800 in 1Q2016, giving it 21 of the type.

In 2017 Nok plans to take its last 737-800 and begin 737 MAX 8 deliveries. Mr Patee said that Nok intends to use the new generation 737 MAX 8s for a combination of growth and replacement as some of Nok's oldest 737-800s start to come off lease in 2017.

Generally Nok expects to grow its 737 fleet by two aircraft per year but there is flexibility to make adjustments, depending on demand. In 2015 Nok added two 737-800s and two Q400s, growing its fleet from 24 to 28 aircraft.

Nok and NokScoot outlook brightens

2015 was a dismal year given the unfavourable domestic market conditions and the initial setbacks at NokScoot. A pilot shortage which began in 2H2015 became a crisis in Feb-2016, leading to operational problems and significantly reduced aircraft utilisation rates.

Nok now seems to have turned the corner. It still faces risks and challenges - including an intensely competitive domestic market - as it starts to focus more on international expansion. However the group's outlook has brightened, and both its airlines are well-positioned to benefit from the continued growth in the Thailand-China market.