Nok Air's outlook improves after a challenging 2Q2014 as Thailand stabilises and NokScoot launches

Nok Air incurs 2Q2014 loss as yields and load factor dropped

Nok incurred a net loss of THB160 million (USD5 million) in 2Q2014 compared to a profit of THB260 million (USD8 million) in 2Q2013. Revenues increased by 8% to THB2.83 billion (USD87 million), including a 6% increase in passenger revenues, but costs increased by 28% to THB2.999 billion (USD92 million).

Nok Air financial highlights: 2Q2014 vs 2Q2013

Source: Nok Air 2Q2014 results announcement

Nok's capacity on an ASK basis increased by 30% in 2Q2014, outstripping a 17% increase in RPKs. As a result Nok's load factor dropped by 8.7ppt from 86.5% in 2Q2013 to 77.7% in 2Q2014.

Passenger figures were up 23% to 1.72 million, an impressive increase given the market conditions in Thailand. But Nok had to engage in aggressive discounting in response to intense competition and overcapacity. As a result passenger yields dropped by 9% and Nok's average fare declined by 14%. Unit revenues were down by 17% while Nok was only able to reduce unit costs by 1%.

Nok battles extremely challenging conditions as all Thai airlines incur losses in 2Q2014

Nok was not alone in Thailand in feeling the dual impact of reduced demand, due to the political instability, and intensifying competition. Demand for domestic travel in Thailand has remained relatively strong so far this year despite a prolonged period of political instability but the growth in demand has slowed compared to 2013 and general consumer sentiment has declined.

All three of Thailand's LCCs - Nok Air, Thai AirAsia (TAA) and start-up Thai Lion Air - have expanded ambitiously in the domestic market despite the slower demand, leading to overcapacity and putting pressure on yields. Nok's biggest competitor, TAA, incurred a loss of THB318 million (USD10 million) in 2Q2014 as its load factor dropped by 4ppts to 78% and average fares dropped by 14%. TAA's ASKs were up 20% in 2Q2014.

TAA is a larger airline overall, with 2.8 million passengers carried in 2Q2014 compared to 1.7 million for Nok, but the two are approximately the same size in the Thai domestic market. Nok has a larger domestic network and more frequencies, as it operates turboprops alongside its 737-800 fleet, but in terms of domestic passenger numbers the two are nearly identical. About 40% of TAA's passengers are international while Nok is entirely a domestic operator with the exception of one international route, Bangkok-Yangon, which it launched in late 2013 and now serves with two daily flights.

Thailand's international market has been significantly more impacted by the political crisis than has the domestic market, with inbound demand from other Asian countries particularly hard hit. According to Airports of Thailand (AoT) data, international passenger traffic at Bangkok's two airports dropped by 15% in 2Q2104 while the domestic market grew 17%. TAA still managed to increase its international passenger traffic by 10% in 2Q2014 to 1.1 million but its domestic passenger traffic grew much faster, at 21% to 1.7 million.

As a result TAA and Nok grew domestically at identical paces, maintaining their similar market shares in the Thai market. But in both cases the growth came at the expense of yields and profitability.

Thai Airways' losses not surprisingly were much steeper given the flag carrier relies much more heavily on the international market. Thai Airways, which owns a 40% stake in Nok, recorded a net loss of THB7.654 billion (USD233 million) in 2Q2014. CAPA will analyse Thai's performance and outlook in a separate (CAPA Member-only) report to be published later this week; TAA will also be looked at in more detail as part of another report to be published later this week on AirAsia's overall results.

Competition intensifies in Thailand's domestic market

Although market conditions have been dismal in Thailand's international market - as evidenced in Thai's 2Q2014 results - the Thai domestic market, and particularly the LCC sector, has experienced a huge increase in capacity that made it virtually impossible for any carrier to be profitable.

In addition to Nok and TAA continuing to expand domestically in 2014, start-up Thai Lion has so far focused predominantly on the domestic market. As CAPA previously noted Thai Lion was planning a larger international operation during its initial phase but shifted focus to the domestic market due to the challenging conditions in the international market.

Thai Lion's Bangkok operation currently consists of 13 daily domestic flights and only one international flight. This will increase to 19 domestic flights compared to one international at the end of Aug-2014 as four new domestic routes are launched.

See related report: Thai Lion Air focuses on domestic expansion, quickly gains scale on Bangkok to Chiang Mai & Hat Yai

Nok currently accounts for 27% of seat capacity in the Thailand domestic market compared to 26% for TAA and 23% for Thai Airways (includes flights operated by its regional subsidiary Thai Smile), according to CAPA and OAG data. Independent full-service carrier Bangkok Airways has about 16% share while Thai Lion has slightly more than 6% - but Thai Lion's share will increase to about 10% by the beginning of Sep-2014 as it adds two more 737-900ERs.

Thailand domestic capacity share (% of seats) by carrier: 11-Aug-2014 to 17-Aug-2014

Source: CAPA - Centre for Aviation & OAG

Thai Lion, Nok and TAA are all based at Bangkok Don Mueang Airport. According to AoT data, Don Mueang recorded a 36% increase in domestic traffic in 2Q2014 to 3.5 million. At Suvarnabhumi, where Thai Airways and Bangkok Airways have been operating, domestic traffic was down 7% to 1.9 million. (Thai Airways on 8-Aug-2014 also started offering some domestic flights at Don Mueang using its Thai Smile subsidiary - even though this rules out connectivity with the parent.)

Total domestic passenger traffic to and from Bangkok (both airports) was up 17% in 2Q2014 to 5.4 million passengers. The total number of domestic movements at Bangkok's two airports combined increased by 18% in 2Q2014 to 45,530 according to AoT data. Load factor data are not available but it obviously slipped as the average number of seats per flight increased (particularly at Don Mueang) due to the entry of Thai Lion, which operates 215-seat 737-900ERs compared to the 180-seat A320s at TAA and 189-seat 737-800s at Nok.

Nok is optimistic market conditions will improve in 2H2014

Nok cited the double impact of intensifying competition and the political instability as driving the loss in 2Q2014. But Nok CEO Patee Sarasin sees signs of improving market conditions in 2H2014 - at least for Nok, which caters primarily to the local Thai population travelling domestically. "This year has been a bit sickening but we'll be back to profitability probably within the next quarter or so," Mr Patee told CAPA's Australia Pacific Aviation Summit on 7-Aug-2014.

Speaking to CAPA TV after participating in the Summit, Mr Patee explained the political situation is stabilising and consumer sentiment is improving. He acknowledged domestic demand had dropped somewhat in 1H2014 due to the political situation and called the timing of Thai Lion's launch "unfortunate" as it led to more capacity on domestic trunk routes at an inopportune time.

Nok CEO Patee Sarasin discusses market conditions in Thailand and the international expansion plans for Nok Air including NokScoot: 7-Aug-2014

Source: CAPA TV

Nok has been consistently profitable the last five years and if predictions of a profit in 2H2014 are realised it will be able to end 2014 in the black, allowing it to extend its profit streak by another year.

Nok was one of Asia's most profitable airlines (on a margin basis) in 2013, when market conditions in Thailand were more favourable. Nok turned a record THB1.066 billion (USD35 million) profit in 2013, giving it a net profit margin of 9.4% and an operating profit margin of 9.7%. Nok was also profitable in 2009, 2010, 2011 and 2012, accumulating roughly USD50 million in profits during this period.

Nok's average load factor in both 2012 and 2013 was 84%. Nok's load factor and yields started dropping in 1Q2014 but the airline was able to stay in the black, eking out a THB41 million (USD1 million) profit.

See related reports:

• Nok Air and Thai AirAsia profits fall in 1Q but continue rapid growth in response to new competition
• Nok Air will continue its domestic focus as competition within Thailand intensifies
• Thailand's Nok Air poised for further expansion with bright outlook following successful IPO

Nok plans to expand in international markets as market conditions improve

The anticipated improvement in market conditions could come at an ideal time for Nok as the LCC prepares to expand in the international market. Nok is tackling the international market both organically using its expanding fleet of 737-800s and through its new joint venture with Singapore Airlines' long-haul low-cost subsidiary Scoot.

Nok is preparing relatively modest expansion in the regional international market with new services to Ho Chi Minh and Hanoi. Mr Patee said Nok's initial foray into the regional international market with services to Myanmar have been highly successful as the Bangkok-Yangon route was already profitable three months after it was launched. The launch of Yangon in Dec-2013 marked Nok's first international services since 2007, when the airline briefly served Hanoi and Bangalore.

Nok several months ago identified Vietnam as its second international market after Myanmar but is proceeding with international expansion cautiously. Mr Patee says Nok initially wanted to focus on Myanmar and try to full understand and capture the Thailand-Myanmar market before proceeding with the next phase of its international expansion. The political instability has prompted Nok to be even more conservative in continuing with international expansion. "Once things are steady, really steady, Vietnam will be the next market," Mr Patee said.

Nok will compete against archrival TAA on both the Bangkok-Ho Chi Minh and Bangkok-Hanoi routes. Vietnamese LCC VietJet also operates one daily flight on Bangkok-Ho Chi Minh but recently suspended Bangkok-Hanoi. Thai Airways and Vietnam Airlines also serve both routes while Qatar Airways serves Bangkok-Hanoi and Turkish Airlines serves Bangkok-Ho Chi Minh with local uplift rights as part of routes that originate in Doha and Istanbul respectively.

Thailand to Vietnam capacity by carrier (one-way seats per week): 19-Sep-2011 to 8-Feb-2015

Source: CAPA - Centre for Aviation & OAG

NokScoot will launch in 4Q2014 with 777-200s

With NokScoot, Nok does not have the luxury of waiting for Thailand's international market to fully stabilise as the two shareholders are committed to launching the new airline by the end of 2014. But Mr Patee is hopeful market conditions will be favourable by the time the new long-haul low-cost carrier commences operations.

NokScoot is well into the regulatory process and recently completed proving flights using its first 777-200. Mr Patee says NokScoot aims to launch services sometime in 4Q2014 and will initially serve major destinations in North Asia. An exact launch date and an initial route will be announced in the coming weeks but NokScoot is looking to only serve major markets, with Seoul and Tokyo the most likely initial destinations.

NokScoot is not ready to begin operations in Sep-2014, as some reports have indicated, as its first 777-200 has net yet been retrofitted. The 777-200 which was used to conduct proving flights in Jul-2014 on the Bangkok-Chiang Mai route was still in Singapore Airlines (SIA) configuration. NokScoot is sourcing at least its first three 777-200s from SIA.

NokScoot is unable to take over any of the 777-200s now operated by Scoot as these aircraft are older than 14 years. Thailand regulations prohibit any aircraft from being imported which are older than 14 years.

Transitioning to 787s will be an important future step for NokScoot

Mr Patee envisions NokScoot eventually transitioning its fleet to 787s. But at least for now joint venture partner Scoot has not allocated any of its 20 787s to NokScoot.

Scoot currently operates six 777-200s and has 10 787-8s and 10 787-9s on order. Scoot plans to take its first 787-9 in Nov-2014 and replace all six of its 777ss (which were also sourced from SIA) with 787s by mid-2015. Scoot plans to resume growth from its Singapore base in 2H2014 and 2015 as several more 787s are delivered, ending an approximately 18 month hiatus from fleet and network growth. But depending on market conditions allocating some of these 787s to NokScoot could become a sensible option. In addition to one in 2014, 15 787s are due for delivery to Scoot in 2015 and 2016 according to CAPA's Fleet Database.

CAPA has previously estimated the 787s are essential for Scoot to become profitable. NokScoot will likely end up coming to a similar conclusion, but meanwhile the 777 will be used to establish its position in a fast moving international market.

See related reports:

• Scoot outlook improves as Singapore Airlines long-haul LCC subsidiary prepares for 375-seat 787-9
• Singapore Airlines interline boosts Scoot's prospects but growth & profits are still two years away

Scoot's own operation expects 25% to 27% improvement in per seat fuel efficiency as it transitions its fleet from 777s to 787s. Scoot also expects the smaller size of the 787 to enable the carrier to open new thin medium-haul routes as well as increase some of its existing routes to daily. Scoot's 787-9s will be configured with 375 seats while its 787-8s will be configured with 335 seats compared to the 402-seats configuration on its six 777-200s.

NokScoot will have a similar two-class product to Scoot, with 10 seats abreast in economy and eight seats abreast in the premium cabin. The NokScoot premium seats will be similar to the current ScootBiz product on the 777-200s which feature recliner style business class seats that are similar to a premium economy product at full-service carriers. But NokScoot's premium cabin will have only three rows (24 seats) compared to the four rows currently on Scoot's 777s (32 seats). This decision reflects the fact the Thai market has a larger leisure component compared to Singapore.

NokScoot will unlock new growth opportunities for Nok Air, as connectivity develops

NokScoot represents an important growth vehicle for Nok as it enables the airline to start penetrating the medium/long-haul market, where it will compete with recently launched Thai AirAsia X. The two carriers are expected to both be operating in the Thailand-Japan and Thailand-South Korea markets by late 2014 or early 2015.

See related reports:

• Thai AirAsia X and NokScoot both target Thailand-Japan market, starting with Bangkok-Tokyo Narita
• NokScoot plans 2H2014 launch with two 777s, targeting Thailand-Japan and other North Asian markets

Connections will also be an important component of the NokScoot model. The new airline should drive incremental traffic onto Nok Air's existing short-haul operation as well as on Scoot's flights between Bangkok and Singapore. Scoot is moving its daily Bangkok flight from Suvarnabhumi to Don Mueang on 1-Sep-2014, enabling connections onto new interline partner Nok Air and later onto NokScoot.

Scoot CEO Campbell Wilson envisions Bangkok emerging as an LCC hub for North Asia, stating at CAPA's 7-Aug-2014 Australia Pacific Aviation Summit that Japan, Korea and China are the three main target markets for NokScoot. He points out that Bangkok is two hours closer to Korea and Japan compared to Singapore, making it an efficient hub for North Asia. Strong demand in the Korea-Thailand and Japan-Thailand markets are also an attraction.

Scoot will also continue to operate several routes to North Asia from Singapore hub but Mr Campbell sees Singapore as being the only jumping off point for Australia. Thailand is further from Australia and given the current overcapacity in the Australia-Southeast Asia market NokScoot is not expected to look at serving Australia at least during its initial phase.

In an interview with CAPA TV, Mr Wilson said Scoot's contribution to NokScoot "principally comes from our experience flying widebody aircraft on medium-haul routes [while] Nok brings to the table their 10 years experience in the Thai market".

He added. "NokScoot is a vehicle for Nok particularly to fly further afield, bring more tourists to Thailand and give Thai residents a new opportunity to fly overseas in a low-cost format."

Scoot CEO Campbell Wilson discusses the NokScoot joint venture, Scoot's new interline with Nok Air and Scoot's plans for the 787: 7 Aug-2014

Source: CAPA TV

Nok will expand its 737 and turboprop fleet in 2H2014

Nok also plans to continue pursuing expansion of its short-haul fleet and network in 2H2014. The carrier's 737-800 fleet will grow by one aircraft by the end of 2014 for a total of 17. Over the next few months Nok also plans to take delivery of four of the six Bombardier Dash 8 Q400s turboprops it ordered earlier this year.

Nok Air fleet summary: as of 18-Aug-2014

Note: *orders include those placed directly by the operator and by lessors assigned to the operator
Source: CAPA Fleet Database

The Q400s will replace Nok's two existing ATR 72-500s and be used to operate new regional routes as well as resume routes which were previously operated with Saab 340s under the Nok Mini sub-brand. The Nok Mini operation was terminated in Mar-2014 as Nok ended its relationship with small regional carrier Siam General Aviation (SGA), which operated six Saab 340s on behalf of Nok.

Nok currently serves 23 domestic destinations and one international destination (Yangon), according to OAG data. Its latest domestic destination, Khon Kaen, was added on 1-Jul-2014 with two daily flights from Don Mueang. Nok also recently announced plans to launch another new domestic destination, Lampang, in late Oct-2014 with two daily turboprops from Dom Mueang. Lampang is currently only served by Bangkok Airways, which according to OAG data operates three daily ATR 72 flights from Bangkok Suvarnabhumi.

Lampang represents a continuation of Nok's strategy of using its turboprop fleet to differentiate itself from TAA and offer the largest network in Thailand. But while some additional growth of the domestic network is possible Nok will eventually need to turn its attention more to the international market.

Nok enters an important new phase as it spreads its wings overseas

Nok has the largest domestic network in Thailand but has a weak presence in the international market. The launch of NokScoot and the expansion of Nok in the regional international market will finally bolster Nok's relatively weak brand overseas. The partnership with Scoot is nicely complementary, as Scoot has expertise in the long-haul LCC model and overseas experience while Nok has a strong local brand as well as a very successful and innovative distribution network in Thailand.

NokScoot should be able to capture some inbound traffic from North Asia, a large and fast growing source market, as Thailand's tourism sector starts to recover. But the new long-haul LCC should also be able to stimulate outbound demand by leveraging its strong presence and distribution network in the local Thai market. Nok has a particularly strong following among young Thais, who are starting to travel overseas more as income levels continue to rise.

Nok has quietly emerged as the leading LCC in Thailand's domestic market. Market conditions have been extremely challenging this year, leading to a loss in 2Q2014. But Nok has been consistently profitable over the years and should be back in the black in 2H2014 as it enters the most exciting (and challenging) phase in its 10-year history.