28-Aug-2014 7:22 PM

Royal Brunei Airlines outlook brightens as fleet is renewed and regional network expands

Analysis

Royal Brunei Airlines (RBA) should start to see improvements over the next year in its long-haul operation after completing the transition to an all-787 widebody fleet. The long-haul network, which has been highly unprofitable and relies heavily on transit traffic, will also benefit from new regional feed from Bali and Ho Chi Minh.

RBA's short-haul operation, which is not nearly as unprofitable as it relies primarily on higher yielding point to point traffic, should also see improvements as the network is expanded. Larger gains will come in 2017 when the airline starts to take delivery of A320neos, which will reduce operating costs and open up new medium-haul routes that are too thin for widebodies.

RBA is looking at using the A320neo to resume expansion in Australia and launch services to South Asia. Beijing, Seoul and Tokyo may also be added as part of a new five-year plan. Modest expansion is a realistic scenario for RBA as the flag carrier is now tracking ahead of the targets set in its last five-year plan, which was prepared in 2011 and initially focused on a restructuring.

Summary

Royal Brunei Airlines (RBA) has completed the transition to an all-787 widebody fleet, which is expected to improve its long-haul operation.
The long-haul network, which has been unprofitable, will benefit from new regional feed from Bali and Ho Chi Minh.
RBA's short-haul operation, which relies on higher yielding point-to-point traffic, should also see improvements as the network is expanded.
RBA is considering using the A320neo to expand in Australia and launch services to South Asia, Beijing, Seoul, and Tokyo.
RBA has noticed fuel burn, maintenance, and weight savings as a result of the transition to a wireless in-flight entertainment (IFE) system.
RBA is considering expanding the business class cabin and introducing premium economy to mitigate the impact of not having enough business class seats.

Royal Brunei starts to see benefits of 787

RBA currently operates a fleet of four 787-8s and six A320 family aircraft to 13 destinations. RBA transitioned its entire long-haul operation from 777-200ERs to 787-8s between Oct-2013 and Apr-2014.

The carrier currently uses 787s on daily services to Melbourne and to London Heathrow via Dubai. It also uses the 787 for seasonal services to Jeddah in Saudi Arabia and some peak flights to Singapore (generally Mondays and Sundays, when Royal Brunei sees a spike in business demand).

Royal Brunei Network, Aug-2014

Royal Brunei Airlines chief commercial and planning officer Karam Chand told the 7-Aug-2014 CAPA Australia Pacific Aviation Summit that the airline has so far recorded a 25% reduction in fuel burn compared to the 777-200ER. On an average Bandar Seri Begawan-Dubai-London Heathrow flight there is a savings of approximately 100,000L in fuel.

RBA also has noticed fuel burn, maintenance and weight savings as a result of the transition to a wireless in-flight entertainment (IFE) system. The new IFE along with lie-flat business class seats and increased pitch in economy are among several product improvements which should eventually help RBA increase revenues and yields. "We've improved across the board in terms of operational improvements but also from a customer perspective," Mr Chand told CAPA TV in an interview after participating in the summit.

Royal Brunei CCO Karam Chand discusses how the 787-8 the future A320neo will transform RBA's operations

RBA has not yet noticed an improvement in profitability as a result of the 787 but believes there will eventually be a positive impact on the bottom line. Mr Chand told CAPA it is too early to make an assessment because while the fuel burn improvement is noticeable almost immediately it will take about another six months to gain a better understanding of other costs including maintenance.

Melbourne market becomes even more challenging for Royal Brunei

It may also take longer for Royal Brunei to notice profitability improvements in its long-haul network as demand has weakened this year, particularly in the Australia market. RBA is fortunate to have been able to transition Bandar Seri Begawan-Melbourne to the smaller and more efficient 787 at the beginning of Apr-2014 because if it was still operating the 777-200ER losses would have likely increased in 2Q2014 and 3Q2014 due to the unfavourable market conditions.

Competition in the Australian market has intensified significantly as several Southeast Asian airlines added capacity. Outbound demand meanwhile has weakened recent months due to reduced consumer confidence, pressuring yields and load factors.

Melbourne has seen about 13% increase in seat capacity to Southeast Asia over the last year, according to CAPA and OAG data. RBA is the third smallest of the 12 carriers serving the Melbourne-Southeast Asia market, accounting for about 4% of total capacity. But of all the carriers it has by far the smallest local market, making it more reliant on transit traffic.

In addition to competing against all 11 other carriers for traffic to Southeast Asia, eight of the carriers also compete against RBA in the Melbourne-London market.

Melbourne to Southeast Asia total capacity (one-way seats per week): 19-Sep-2011 to 22-Feb-2015

RBA's 787s have 30 fewer seats than its 777-200ERs, which in theory should have enabled the carrier to improve load factors and yields in the Melbourne market in 2Q2014. But the weakening market conditions have so far made that difficult to achieve. In 2013 RBA had an average load factor on the Melbourne route of 60% to 65%.

Melbourne transit traffic to get an extra boost as Ho Chi Minh is launched

RBA expects the Oct-2014 launch of Ho Chi Minh to help improve its Melbourne performance. Australia-Vietnam is a large and relatively unserved market. Vietnam Airlines, which serves Melbourne and Sydney with daily flights, is currently the only non-stop carrier between Australia and Vietnam. But several airlines compete in the one-stop market, including Kuala Lumpur based long-haul LCC AirAsia X, which counts Ho Chi Minh as one of its largest transit destinations in the Australian market.

RBA relies heavily on transit traffic to support its long-haul network. Approximately only 20% of RBA's Melbourne, Dubai and London passengers are point to point. London is the most common destination for Melbourne, particularly in the northern summer months, and accounts for 40% to 50% of RBA's Melbourne traffic. There are also large volumes of transit passengers to Dubai and Asia, particularly in the northern winter months. Asia connections generally offers higher yields although the Australia-Asia market has become almost as competitive as the Australia-UK kangaroo route.

RBA changed its Melbourne schedule in Mar-2012 to maximise connections although the change impacted utilisation rates as the aircraft now sits in Melbourne for over seven hours. At the same time Melbourne was increased from four weekly flights to daily.

RBA recognised it needed a daily frequency to be competitive in connecting markets. Before its 2011 restructuring RBA served multiple Australian destinations with non-daily frequencies. Focusing on a single destination with a consistent product, which has further improved with the transition to the 787, should eventually lead to a better result. As Melbourne was only launched in 2011, and quickly increased to daily, RBA considers the market to still be maturing and is confident it will perform better over time.

Melbourne is unlikely to become profitable in the foreseeable future but will be maintained as RBA needs more than just one long-haul route from a network and operational perspective. The Bandar Seri Begawan-Dubai-London route is considered a nationally critical route that cannot be cut. Serving London non-stop is also not an option as RBA does not believe it is feasible with the 787-8 without payload restrictions.

Dubai and London route also still has challenges

Only about 20% to 25% of RBA's Dubai and London passengers are heading to or from Brunei. In addition to Melbourne, RBA sees significant volumes of transit passengers from Indonesia and the Philippines. It also picks up local passengers between Dubai and London.

The Dubai and London route has been performing better than Melbourne with load factors closer to RBA's systemwide average of slightly over 70%. But as in the case with Melbourne RBA has been impacted by intensifying competition which has at least partially offset the positive impact generated by the transition to the 787.

For example Cebu Pacific's Oct-2013 launch of long-haul low-cost services from Manila to Dubai has impacted one of RBA's largest source markets for Dubai, Manila. The launch of Qantas services in the Dubai-London market in Mar-2013, when the Australian flag carrier changed the stopover of its two A380 London flights from Singapore to Dubai, also has impacted RBA's ability to pick up passengers between Dubai and London.

The Melbourne and Dubai/London routes currently use the equivalent of three 787-8s. RBA now uses its fourth 787 seasonally for Jeddah and sometimes to take over for the A320 on short-haul flights. The recent decision to use the 787 to operate two weekly flights to Singapore is the first example of RBA committing to using the 787 on a short-haul sector on a more permanent basis.

RBA ordered five 787-8s in 2010 and initially planned to take all five aircraft in quick succession. But the carrier later pushed back delivery of the final aircraft to 2018.

The current 2018 delivery slot gives RBA the luxury of reassessing its widebody requirement over the next few years. RBA expects to expand its network mainly using the A320neo, which will be delivered from 2017. But even without any expansion of the long-haul network the carrier believes it will probably still need a fifth 787-8 to support the existing operation when taking into account heavy maintenance requirements as the 787 fleet ages. There could also be opportunities to up-gauge more regional routes as demand increases and slot constraints preclude additional frequencies in market such as Hong Kong, Manila and Shanghai.

Royal Brunei considers expanding 787 business cabin and introducing premium economy

The 787 is an important component of its current five-year plan - which focuses on fleet simplification, cost reductions and increased focus on service - as it has reduced operating costs while enabling RBA to improve its product. The introduction of lie-flat business class seats was particularly important as RBA competes in the Brunei-London and Brunei-Dubai markets with Asian carriers, particularly Singapore Airlines (SIA), that had been offering a much better premium product.

RBA's previous fleet of 777-200ERs, which were leased from SIA in SIA configuration, had 30 angled business class seats and 255 economy seats. The 787-8s have 18 lie-flat business class seats and 237 economy class seats.

RBA is satisfied so far with the response to its new lie-flat product. But it has discovered the 12-seat reduction in business class seats is too steep and ideally the 787s would have 24 business seats rather than 18.

RBA is looking at potential options for expanding the business class cabin and eventually may retrofit its 787s to add in another business class row. But as post production retrofits are expensive and require aircraft downtime for now it will have to make do with the smaller business class cabin.

RBA is also contemplating the introduction of a potential premium economy product, which could mitigate the impact of not having enough business class seats. Mr Chand points out that the front five to six economy class rows on RBA's 787s already feature extra legroom, with 35in seat pitch compared to 32in to 33in pitch for the rest of the economy cabin.

RBA could potentially block the middle seats and provide a separate level of service without having to invest in a retrofit. But as this would add a layer of complexity RBA may instead look to at a more simple extra legroom product. (Currently RBA does not have a system in which it can charge more for the extra legroom seats at the front of the cabin.)

A320neo to lead to further operational and network improvements for Royal Brunei

The introduction of the A320neo in 2017 will provide RBA an opportunity to improve its short-haul product. RBA has not yet decided on a configuration for its seven A320neos, which it ordered in May-2014 along with three options. But the airline is planning to use the A320neo to improve the in-flight experience through cabin, seat and IFE upgrades. A wireless IFE system with seatback monitors matching the product on the 787 will likely be featured.

RBA is also contemplating a larger business class cabin than the 12 seats or three rows that is configured on its current generation A320s. While some leisure focused routes do not require a larger premium cabin some short-haul business routes could benefit from more seats, particularly Singapore. There may also be a demand for a larger business class on new narrowbody routes as RBA intends to use the improved range of the A320neo.

New markets such as Beijing, Tokyo and Seoul particularly could benefit from a larger and improved business class given the length of these routes. RBA also plans to evaluate potential routes to South Asia and the resumption of services to more Australian cities, including Brisbane and Perth. South Asia, North Asia and Perth are all within the range of the A320neo. RBA views Brisbane as iffy with the A320neo but could potentially become feasible depending on how the aircraft performs after it enters service. (RBA will also consider the 787 for Brisbane.)

RBA expects an 18% improvement in fuel burn with the A320neo, resulting in significantly improved operating costs and better range. "In an environment where the average yields are coming down you need that kind of change in cost structure," Mr Chand said in the CAPA TV interview.

Royal Brunei could end up with up to 10 A320neos

Currently RBA's narrowbody fleet consist of four A320s and two A319s. RBA is now working to extend the leases of its existing A320 family aircraft until 2017 to 2018 to match up with its A320neo deliveries.

The current narrowbody leases currently come up between Dec-2015 and Jul-2016. RBA initially aimed to secure early A320neo delivery slots which would have allowed the current A320ceos to be replaced as they came off lease. But RBA ultimately had to settle for 2017 and 2018 delivery slots - not a bad outcome given it only placed its order earlier this year.

In addition to the one growth aircraft capacity expansion will be achieved as the two A319ceos are replaced with larger A320neos and as the average narrowbody utilisation rate increases. Currently RBA sets aside one of its six A320 family aircraft, which have an average age of over 10 years, as a spare. Five of the six A320 family aircraft now in RBA's fleet are between 10 and 11 years old while one is seven years old, according to the CAPA Fleet Database.

Royal Brunei Airlines fleet summary: as of 28-Aug-2014

Aircraft	In Service	On Order*
Total:	10	8
Airbus A319-100	2	0
Airbus A320-200	4	0
Airbus A320-200neo	0	7
Boeing 787-8	4	1

Royal Brunei Airlines average fleet age by aircraft type

RBA's current A320 utilisation rate is about nine hours. It has improved slightly as Bali was added and will improve slightly as Ho Chi Minh is also launched. A more significant increase is expected with the A320neo particularly as longer narrowbody routes are launched.

Further growth of the short-haul network is possible as RBA has options for three additional A320neos. These could be exercised as RBA is keen to add more regional destinations and increase frequency on existing routes. RBA aims to eventually serve all its regional destinations with at least one daily service and to offer at least two daily flights on popular business routes.

Royal Brunei has relatively low frequencies across its short-haul network

Singapore, Kuala Lumpur and Kota Kinabalu are RBA's only routes that are currently served more than once per day. Singapore and Kuala Lumpur are served with two daily frequencies, with Singapore being larger from a seat capacity perspective as some flights are operated with 787s, while Kota Kinabalu (BKI) is served with 12 weekly flights.

Royal Brunei Airlines top 10 routes based on seat weekly capacity: 25-Aug-2014 to 31-Aug-2014

Manila and Hong Kong are each served once per day while RBA's other five regional destinations are served less than daily. Bangkok and Jakarta are currently served with six weekly flights; Surabaya with five weekly flights; Bali with four weekly flights; and Shanghai with three weekly flights.

Kota Kinabalu is RBA's shortest route and only destination within the island of Borneo, which includes east Malaysia, Brunei and part of Indonesia. RBA promotes Kota Kinabalu along with Brunei as twin destinations, giving inbound leisure passengers the option of a combination itinerary. This programme has been highly successful, particularly with passengers from Shanghai and Hong Kong.

RBA has also started marketing Bali as a destination that can be combined with Brunei. The airline recognises that while Brunei has tourist attractions its very small size makes it hard to market by itself.

Overall more than 70% of RBA's short-haul traffic consists of point to point passengers. Kota Kinabalu, Surabaya and now Bali are by far the largest markets for transit passengers while Singapore and Kuala Lumpur are nearly entirely local.

Service to Bali was resumed on 26-Jul-2014 and is being served with four weekly flights. Ho Chi Minh is being resumed on 17-Oct-2014, becoming RBA's eleventh regional route, and will also be initially served with four weekly flights.

Royal Brunei tracking ahead of target in its five-year turnaround plan

Ho Chi Minh was one of five routes that RBA cut as part of its 2011 restructuring. The other routes were Auckland, Brisbane, Kuching and Perth - some of which will likely be resumed with the A320neo as the new types offers improved route economics. Bali was cut earlier as were several other destinations including Sydney.

The restructuring also included job cuts and fleet rationalisation. Other elements of the five-year business plan which began in 2011 included a rebranding exercise and an increased focus on service.

The current business plan repositioned RBA as a boutique carrier and emphasised the need to provide a unique service and compelling product to differentiate RBA from low-cost competitors. RBA recognises that LCCs will dominate short and medium-haul routes from Southeast Asia but still sees opportunities for other business models and niches.

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Mr Chand told CAPA that RBA is now tracking slightly ahead of the targets that were outlined in the consolidation plan that was prepared in 2011. While there are still two years to go in the 2011 plan he said RBA has started working on a new five-year plan, made easier by the recent completion of a long-term fleet plan with the A320neo deal.

The new business plan should provide new financial targets aimed at meeting the Brunei government's long-term goal for a profitable (or at least break-even) airline. RBA will certainly remain by far the smallest of the seven Southeast Asian flag carriers with widebody operations. But there will be opportunities for modest growth.

Royal Brunei has brighter outlook but is still a long way from achieving profitability

RBA will stick to the boutique model and not stray from its current plan of operating 12 to 15 aircraft by the end of this decade. It has no intentions of joining a global alliance and will instead focus on maintaining bilateral relationships on select routes. It believes the cost of a global alliance outweigh the potential benefits.

While a global alliance is certainly not necessary RBA could benefit from stronger partnerships and a larger offline network. All five of RBA's codeshare partners are within Asia and RBA does not place its code on any partner flights outside the region.

Royal Brunei codshare partners

As Brunei is a tiny local market only a limited number of direct routes can be sustained. But RBA does have the advantage of a higher than 70% market share in Brunei. While RBA competes for transit passengers against a huge group of airlines only four other carriers including two LCCs serve its home market.

Brunei has a population of only about 400,000 but enjoys a very high travel propensity as it has the world's fifth highest GDP per capita, providing sufficient discretionary income for frequent leisure trips. There is also a growing inbound market (currently about 225,000 visitors per year) driven by an emerging tourism sector and business traffic geared mainly around the oil and natural gas sectors.

RBA still faces huge challenges and is a long way from profitability. But the flag carrier has improved significantly over the last three years while most of its competitors in Southeast Asia have seen profitability decline.

RBA also has gained some notoriety - while improving its product - by being one of the first airlines to transition to a completely new generation widebody fleet. With the A320neo it will once again be one of the first airlines to transition to a completely new generation narrowbody fleet. RBA now needs to focus on making sure its fleet investments start to pay dividends to its bottom line.