21-Feb-2014 10:35 PM

SilkAir adds first 737-800. Can a new fleet & brand campaign help it overcome difficult conditions?

Analysis

Singapore Airlines (SIA) regional subsidiary SilkAir began a new chapter on 20-Feb-2014 as its first Boeing 737-800 entered service, taking over from slightly smaller A320s on four short-haul sectors. The carrier has just completed a momentous week as 21-Feb-2014 marked its 25th anniversary while on 17-Feb-2014 it rolled out a new brand campaign emphasising its full-service offering.

SilkAir has been extremely successful over the past decade, with steady profits and growth despite low-cost carriers invading its home market. LCCs now account for one-third of total capacity in Singapore and about half of the short-haul market, compared to virtually zero 10 years ago.

SilkAir, however, faces some of its biggest ever challenges as it begins its 26th year. Singapore's short-haul market is suffering from overcapacity, impacting yields and load factors across LCCs and full-service carriers. SilkAir is fighting back with product, network and brand improvements but the market will not likely be able to fully absorb the capacity it is adding in 2014 as it places into service eight 737-800s.

Summary

SilkAir, a regional subsidiary of Singapore Airlines, has begun operating its first Boeing 737-800, marking a new chapter for the airline.
SilkAir has been successful in the past decade despite competition from low-cost carriers (LCCs) in Singapore's short-haul market.
The airline faces challenges due to overcapacity in the market, but is fighting back with product, network, and brand improvements.
SilkAir plans to add eight 737-800s in 2014, increasing its fleet size by 17% and total seat capacity by 24%.
The airline aims to differentiate itself from LCCs through its network, which provides more connection opportunities, and its full-service product.
SilkAir is confident in the long-term viability of its new routes and plans to expand its network in China and India.

SilkAir takes first 737-800

SilkAir took delivery of its first of 23 162-seat 737-800s on 3-Feb-2014. The delivery was a major milestone for both SilkAir and Boeing as it marked the first time a Singapore carrier has operated a Boeing narrowbody since SilkAir transitioned its fleet from 737-300s to A320s around the turn of the century.

There are currently 68 A320s operating in Singapore, including 24 at SilkAir, 25 at Tigerair Singapore and 19 at Jetstar Asia/Valuair, according to the CAPA Fleet Database. The A320 is the most common type in Singapore, accounting for about 37% of the total Singapore-based commercial aircraft fleet.

Singapore market share by aircraft types (%) in service: as of 21-Feb-2014

SilkAir's first 737-800 arrived in Singapore for the first time on 12-Feb-2014, completing a three-day three-stop ferry flight with four pilots (including three from SilkAir and one from Boeing) and five engineers (from SIA Engineering).

A 25th anniversary decal was quickly pasted on the aircraft, which also happens to be number 25 in SilkAir's current fleet, prior to it being displayed at the Singapore Airshow on 14-Feb-2014.

SilkAir began 737 revenue flights on 20-Feb-2014

After being used for a few days to complete pilot training for an initial group of pilots, SilkAir's first 737-800 was placed into service on 20-Feb-2014 operating on four of the carrier's shortest routes: Singapore to Kuala Lumpur and Penang in Malaysia, Medan in Indonesia and Phuket in Thailand.

Kuala Lumpur (KUL), Phuket (HKT), Penang (PEN) and Medan (KNO) are SilkAir's four largest routes. Kuala Lumpur is currently served with 47 weekly return flights (and is supplemented with 17 weekly return flights from Singapore Airlines). Phuket is served with 30 weekly return flights, Penang with 28 weekly frequencies (increasing to 35 at the beginning of Mar-2014) and Medan's Kuala Namu International Airport is served with 16 weekly flights, according to OAG data.

SilkAir top 10 routes based on weekly return frequencies: 17-Feb-2014 to 23-Feb-2014

The flexibility to swap 150-seat A320s for 162-seat 737-800s gives SilkAir the opportunity to expand seat capacity by up to 12% in its largest markets without having to add more frequencies. While SilkAir's average load factor has been only about 70% over the last year, certain markets are performing well and can use larger capacity aircraft, particularly during peak period.

The opportunity to up-gauge is particularly important for Phuket because SilkAir is currently unable to add any flights to Phuket due to slot restrictions at the Thai airport. SilkAir now serves Phuket with 35 weekly flights during the northern hemisphere summer season but has to reduce its Phuket operation to 30 weekly flights during the winter season.

SilkAir would like to increase Phuket to 35 weekly flights year-round, and potentially add a sixth daily flight during certain peak periods, but cannot as there are no additional slots available except during overnight hours, which are not suitable given Singapore-Phuket is an under two-hour flight. Currently SilkAir is only using its 737-800 on one daily Phuket frequency, resulting in a less than a 2% increase in its total seat capacity in the Singapore-Phuket market. But the carrier will likely look to up-gauge other Phuket flights, particularly during peak periods.

SilkAir to add second 737-800 in Mar-2014

SilkAir plans to take delivery of its second 737-800 in Mar-2014. The aircraft will enable SilkAir to transition from 17-Mar-2014 some A320 flights to six more destinations: Cebu and Davao in the Philippines, Hyderabad and Kochi in India, Danang in Vietnam and Siem Reap in Cambodia. (Danang is combined with Siem Reap and Cebu is combined with Davao on triangular routings.)

SilkAir chief executive Leslie Thng says some of the carrier's China flights will also transition to the 737-800 as SilkAir takes its third and fourth aircraft. SilkAir currently serves seven destinations in China. Only India (eight) and Indonesia (12) have more SilkAir destinations.

SilkAir plans to take eight 737-800s in 2014, marking the most number of aircraft deliveries for the carrier in one year since it launched operations in 1989. SilkAir also plans to phase out four of its oldest A320s in 2014, resulting in fleet growth of 17% from 24 to 28 aircraft.

The growth in total seats across the fleet will be even higher, 24%, from 3,468 at the start of 2014 to 4,308 at the end of the year, as SilkAir's 737-800s have 12 or 8% more seats than its A320s. SilkAir currently operates 18 150-seat A320s and six 128-seat A319s.

SilkAir fleet summary: as of 21-Feb-2014

Aircraft	In Service	On Order
Total:	25	53
Airbus A319-100	6	0
Airbus A320-200	18	0
Boeing 737-8	0	31
Boeing 737-800	1	22

The A319s are also slated to be replaced with 737-800s, although none of the A319s are due to exit the fleet this year. This will result in 27% seat growth on flights now operated with A319s.

Acquisition of 737s to give SilkAir growth of over 20% per annum

SilkAir has not provided an aircraft delivery breakdown beyond 2014, in line with SIA Group policy to only provide fleet and capacity growth data for the current year. But the carrier expects to receive the last of 23 737-800s in 2016 and take the first of 31 737 MAX 8s in late 2017. It plans to take the last 737 MAX 8 by the end of 2020 while also phasing out its last A320 towards the end of the decade.

A fleet of 54 aircraft at the end of 2020 will mark 125% growth compared to the 24 aircraft at the beginning of 2014, or an average of 4.3 additional aircraft per annum. Assuming SilkAir sticks to a 162-seat configuration for the 737 MAX 8, the carrier's fleet at the end of 2020 will have a combined 8,748 seats compared to only 3,468 at the beginning of 2013. This represents an increase of 152% or an average of 22% per annum over the next seven years.

The ambitious expansion reflects SIA's confidence in the regional market within Asia, which has seen consistently rapid growth. While LCCs have driven most of the short-haul growth in Asia, including in Singapore, SilkAir has performed well in recent years despite intensifying LCC competition.

SilkAir has been profitable in its last 12 fiscal years and is on track to extend this streak to 13 years as it turned an operating profit of SGD43 million (USD34 million) through the first three quarters of FY2014, which ends on 31-Mar-2014. SilkAir has recorded a bigger profit than Singapore's largest LCC, Tigerair Singapore, every year since Tigerair launched in 2004. SilkAir also has more than tripled its annual revenue stream since the 2004 launch of Tigerair and Jetstar Asia.

See related reports:

SilkAir impacted by overcapacity in Singapore market

But market conditions have become significantly more challenging in recent quarters, providing an indication that SilkAir's expansion rate is perhaps overly ambitious. SilkAir's operating profit for the most recent quarter, 3QFY2014, was only SGD6 million (USD5 million), representing a decline of 82% compared to the SGD34 million (USD27 million) profit from 3QFY2013.

SilkAir is still in the black - unlike Tigerair Singapore, which was back in the red in 3QFY2014. But SilkAir's operating profit for the full fiscal year will fall well below the SGD95 million (USD75 million) profit from FY2013 and likely be less than half its record profit of SGD121 (USD95 million) from FY2011.

Overcapacity was for the first time clearly evident in SilkAir's 3QFY2014 figures as its yield dropped a discouraging 10% while its load factor slipped by 5.3ppts to only 70%. ASKs were up 13% but RPKs increased by only 5%. Passenger traffic for the quarter was up only 4% to 900,000.

While SilkAir's load factor has been consistently tracking below prior year levels for all of 2013, the October to December period marked the first quarter there was also a yield decline. Over the first three quarters of FY2014, the carrier's load factor was down 5.1pts to 69.6% while yield was down only 2%. During 1HFY2014 SilkAir still managed to increase its yield by 3% although a 5.1ppt drop in load factor to 69.3% impacted its profitability.

SilkAir operating highlights: 3QFY2014 vs 3QFY2013 and 9MFY2014 vs 9MFY2013

While LCCs, particularly Tigerair, have been the main cause of the current overcapacity situation in the Singapore short-haul market, SilkAir also has contributed by expanding too rapidly. Tigerair Singapore ASKs were up 25% in the first three quarters of FY2014 (April through December) while SilkAir ASKs were up 14%.

In FY2013, SilkAir ASKs were up 20% for the full year while Tigerair Singapore ASKs were up 16%. While most of the capacity in FY2013 was absorbed the Singapore market is too small and mature to swallow consecutive years of double-digit increases. With SilkAir and Tigerair Singapore again planning double-digit ASK growth for FY2015 the pressure on yield and load factors is not expected to ease anytime soon.

ASK figures for the fiscal year starting 1-Apr-2014 have not been provided by either carrier but are likely to be above 15% for SilkAir and above 20% for Tigerair based on current fleet projections. Even if both carriers elect to slow down growth by reducing aircraft utilisation levels, ASKs will still easily be up by over 10%, which the market is unlikely able to absorb given it comes on top of two years of rapid growth.

SilkAir however has a much brighter outlook than Tigerair as it has successfully differentiated itself from LCCs and proven there is still space - and a growing space - for a full-service carrier in Singapore's short-haul market. The differentiation so far has come through two main areas - network and product.

SilkAir's growing network provides a key differentiator

About 50% of SilkAir's passengers connect with flights operated by Singapore Airlines. While Tigerair and Jetstar are also heavily promoting their connection products in Singapore, recognising the local market is too small to absorb the recent capacity increases, they will never be able to come close to matching the combined network of SIA and SilkAir.

SIA and SilkAir are very closely joined, ensuring much closer network and schedule coordination than an LCC or an LCC with a full-service carrier (such as Jetstar Asia with Qantas). SilkAir's full-service product and premium cabin also open up opportunities for high yielding passengers that LCCs generally are unable to attract.

As SilkAir rapidly expands its fleet it continues to add destinations, opening up new connection opportunities for SIA passengers. SilkAir currently operates scheduled services to 45 destinations in 12 countries (includes Singapore but excludes Dili in Timor-Leste, which is served under a wet-lease agreement with Air Timor). Combined, the SilkAir and SIA network serves over 90 destinations in 37 countries, including seven destinations that are served by both carriers. (Both SilkAir and SIA serve the following destinations: Kuala Lumpur; Bangalore, Chennai and Kolkata in India; Hanoi in Vietnam, Surabaya in Indonesia and Yangon in Myanmar.)

SilkAir expects to add three to four destinations per annum, including in 2014. It has already announced the launch of services to Kalibo in the Philippines (from 27-May-2014) and Mandalay in Myanmar (from 10-Jun-2014). These additions will give SilkAir three destinations in the Philippines, two in Myanmar and 30 in Southeast Asia.

Much of SilkAir's focus over the past year has been Indonesia, where the carrier added three destinations in 2H2013 for a total of 12. SilkAir continues to look at potential new destinations in Indonesia, such as Banda Aceh, but will focus more on other markets in 2014 as the Singapore-Indonesia market has been challenging.

Several carriers added significant capacity in the Singapore-Indonesia market in 2013 following a new bilateral agreement between the two countries. Mr Thng is confident in the long-term viability of SilkAir's new Indonesia routes and other markets the carrier has opened in recent years but acknowledges it will take time to build up load factors, saying the new routes represent long-term strategic investments. "With all new destinations it takes time to build up awareness," he says. "We believe SilkAir will be there for the long-term."

While SilkAir sees opportunities for further growth in Southeast Asia, including Indonesia, much of its network expansion over the next couple of years will be focused on China and India. China and India account for 15 of its 17 destinations outside Southeast Asia (Kathmandu in Nepal and Darwin in Australia are the only exceptions).

SilkAir capacity share (% of seats) by region: 17-Feb-2014 to 23-Feb-2014

Hangzhou could be SilkAir's next new destination

SilkAir is currently looking at launching services to Hangzhou, which would become its eighth destination in China. Hangzhou could be launched by the end of 2014.

Hangzhou provides an appealing mix of business and leisure passengers as well as a potentially relatively even mix of local and connecting passengers. Singapore-Hangzhou is currently only served by Jetstar Asia with four weekly flights. Hangzhou is one of three destinations that has survived a restructuring in Jetstar's once thriving Singapore-China network, an indication of its viability. Jetstar Asia has seen average load factors on Singapore-Hangzhou approaching 80%.

Pune is SilkAir's most likely next destination in India but is not expected to be launched until at least 2015, following the completion of an airport upgrade project. SilkAir is currently restricted to growing in secondary destinations in India as there is no room for capacity increases on primarily routes under the Singapore-India bilateral, which has no restrictions on services to secondary cities. SilkAir has had some success in Visakhapatam, which was launched in late 2012 and falls outside the bilateral.

Visakhapatam has virtually no local demand from Singapore but has had sufficient demand from Visakhapatam and from connecting destinations, particularly Australia and the US. SilkAir's flexibility to leverage its relationship with SIA and enter markets with very little ex-Singapore demand opens up destinations such as Visakhapatam which would likely not be viable for LCCs.

But SilkAir also has proven it can compete effectively against LCCs on overlapping routes. LCCs currently serve almost 30 of SilkAir's 45 routes but SilkAir on most of these routes is the market leader. Having the ability to carry a mix of transit and local passengers gives it the volume in most cases to offer more frequencies than the leading LCC.

SilkAir product improvement reinforces full-service positioning

In addition to network, the other differentiator that is a key component to SilkAir's strategy for competing in Singapore's highly competitive short-haul market is product. Most of the growth in regional travel within Asia has been at the budget end of the market, driven by the rapid rise in Asia's middle class. But a large portion of the population still prefers to stick with full-service airlines. A full-service product is also needed to provide passengers coming off SIA long-haul flights with a relatively seamless experience.

SilkAir is introducing several product improvements in conjunction with the entry into service of its first 737 that is designed to reinforce its full-service positioning and ties with one of the world's leading premium carriers, SIA. To highlight this positioning, SilkAir is investing heavily in a new brand campaign, titled 'A Joy to Fly'. The campaign, which was rolled out on 17-Feb-2014, emphasises the full-service benefits that come with flying SilkAir - from the check-in process to the on-board meals and in-flight entertainment (IFE).

SilkAir's new brand campaign: emphasising full-service product

SilkAir's new brand campaign: emphasising network

SilkAir is particularly focusing on improving its IFE product as it begins to transition to 737s. The carrier began trailing in Dec-2013 a wireless IFE solution from Panasonic, using one of its A320s. Encouraged by results from the trial, SilkAir now plans to begin implementing the solution in 2Q2014. All of its new 737s will be outfitted with the capability and most A320s will also be retrofitted (except aircraft that are slated to be removed from service in the short term).

Once fully implemented, up to 20 movies, 26 short features and 100 music albums will be available for download for all passengers on a complimentary basis. Under the current trial a restricted amount of content had been available. Economy passengers will need to bring along their own personal devices while business class passengers will be loaned devices on flights over two hours.

SilkAir's new 737-800 fleet has been configured with in-seat power sockets, with one socket for each business class seat and two sockets for every three economy seats. The carrier's A320 fleet does not offer power sockets in either class.

The 737s also feature in-seat audio and 12in drop down IFE screens. The A320s have 10.4in drop down screens with no audio capability, limiting SilkAir to rely entirely on silent programming.

The specs of the seats are similar - with 30in pitch in economy on both the A320s and 737s. But the 737s do offer one inch of additional legroom as a result of the more modern seat design. B/E Aerospace is the seat supplier for SilkAir's 737-800s.

SilkAir's new IFE product does not quite match some regional full-service competitors in Southeast Asia, which have configured their 737s or A320s with seatback monitors. But SilkAir believes most passengers prefer to use their own devices and concluded the extra cost and weight of seatback monitors was not justified. While the carrier has a clearly communicated full-service message it is conscious of keeping costs as low as possible, realising competition in the Asian short-haul sector is fierce and continues to intensify.

SilkAir gambles with larger rather than smaller aircraft

The third potential differentiator for a full-service regional carrier is aircraft size. But in deciding to acquire 737s in 2012, SilkAir ruled out splitting its purchase between regional jets and narrowbody aircraft.

SilkAir still has the option of converting some of its orders to the smaller 737-700 and 737 MAX 7, as well as upsizing to the 737-900 and 737 MAX 9. But at least for the medium term the carrier has ruled out regional jets.

Regional jets would theoretically allow SilkAir to increase frequencies in thin markets and open new destinations which would not otherwise be viable. Of SilkAir's 45 routes, over half are served less than daily.

SilkAir is confident it will be able to gradually increase services as demand for regional travel within Asia continues to grow, enabling it to add frequencies and up-gauge A319 flights to 737-800s. But smaller aircraft would enable the carrier to raise its relatively low average load factor and increase frequencies at a much faster clip.

SilkAir ideally needs double daily flights in as many destinations as possible in order to offer daily connections on a two-way basis. For example, most connections from Australia and Europe require morning SilkAir flights from Singapore and evening return flights to Singapore. To offer this SilkAir needs two different flight timings for most of its routes. Even on SilkAir's thinnest routes the carrier now splits up its flights with a couple of weekly return frequencies in the morning and a couple of weekly return frequencies in the afternoon or evening.

Slot constraints at Singapore and at some of its destinations factored into SilkAir's decision to opt for an all-737 fleet. The carrier also was concerned with the higher unit costs that come with regional aircraft and the fact that many airports in Asia, including Singapore Changi, disincentive the use of smaller aircraft. One example of this is landing and handling charges are not always discounted for smaller aircraft.

Ultimately SilkAir may relook at regional aircraft, particularly as slots open at its home airport near the end of the decade, when a third runway is expected to become operational at Changi. For now the carrier has committed to rapid capacity growth as it transitions in just seven years from a fleet of 24 A319/A320s to 54 larger 737-800s/737 MAX 8s.

SilkAir has a lot to be proud about as it celebrates its silver anniversary, including a stellar financial performance over the last decade despite new LCC competition, a network that is stronger than ever and a well positioned full-service product that is reinforced with the delivery of its first batch of 737s. But the next five years will be challenging as SilkAir grasps with an increasingly competitive marketplace that is showing signs of overcapacity just as the carrier enters a major growth phase.

Part Two

The 737 MAX will be the focus of a second part in this series of analysis reports on SilkAir and its new 737 fleet.