18-Sep-2014 10:23 AM

Singapore outlook Part 2: SilkAir slows its expansion. Strategic adjustments may be necessary

Analysis

SilkAir is joining Singapore's main LCC groups in slowing down expansion in response to overcapacity in Singapore's short-haul market. SilkAir capacity growth has been in the low single digits in recent months and will likely stay at modest levels as it accelerates the retirement of A320s.

The full service regional subsidiary of Singapore Airlines, SilkAir has expanded rapidly over the past several years despite intensifying competition with LCCs. SilkAir has doubled in size since 2007 and has consistently outperformed Singapore's two short-haul LCCs, Tigerair and Jetstar Asia, in the process securing valuable slots at Changi Airport for the group.

SilkAir has been planning to maintain annual double digit capacity growth, driven by the introduction of new 737-800s. But a slowdown is sensible given the current overcapacity situation in the Singapore short-haul market, which has led to a steep drop in profits at SilkAir as well as at LCC competitors.

Summary

SilkAir, the full-service regional subsidiary of Singapore Airlines, is slowing down its expansion plans due to overcapacity in Singapore's short-haul market.
SilkAir has doubled in size since 2007 and has consistently outperformed Singapore's two short-haul LCCs, Tigerair and Jetstar Asia.
SilkAir's capacity growth has slowed down in recent months and it plans to accelerate the retirement of its A320s.
SilkAir's profits have fallen for four consecutive fiscal years due to overcapacity in the market.
SilkAir has been impacted by weaker demand from China and Indonesia, two of its largest markets.
SilkAir will need to adjust its fleet plan and focus more on yields and connectivity rather than growth.

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This is the second in a series of reports on the Singapore market. The first report analysed the slowdown in growth and lack of profitability in the LCC sector. This report focuses on the slowdown in growth and profits at SilkAir, a key part of the SIA group.

LCCs (primarily the AirAsia, Jetstar and Tigerair groups) have accounted for about three-quarters of Changi's growth over the past seven years. About another 10% of the growth at Changi during this period has been driven by SilkAir.

SilkAir has successfully served as SIA's growth vehicle for several years

SilkAir has been steadily profitable, reporting operating profits for 13 consecutive fiscal years dating back to the year ending 31-Mar-2002. Several industry observers predicted SilkAir's demise in 2004, when the Singapore short-haul market was suddenly inundated with three LCC start-ups - Jetstar Asia, Tigerair and Valuair. But SilkAir instead thrived and has been used by the SIA Group, which initially elected against taking an active role or owning a majority stake in Tigerair, as its growth vehicle.

SilkAir's revenue stream has tripled since the year LCCs entered the Singapore market (FY2005) while SIA mainline revenues have been relatively flat.

SilkAir currently accounts for over 6% of airline revenues at the SIA Group, which also includes SIA Cargo and new long-haul LCC Scoot. Back in FY2005 SilkAir accounted for less than 3% of airline revenues at the SIA Group.

SilkAir portion of SIA Group airline revenues: FY2000 to FY2014

SilkAir growth has particularly accelerated since 2008. While SIA mainline traffic suffered a substantial setback during the global financial crisis, SilkAir traffic continued to grow.

SIA traffic is only now again approaching pre-GFC levels while SilkAir passenger traffic has nearly doubled during the period.

Singapore Airlines and SilkAir annual passenger traffic: 2008 to 2013

Over the past four years SIA has been further increasing its focus on expanding at the SilkAir brand as it saw bigger opportunities for growth in the regional market while market conditions in long-haul markets to Europe and North America were increasingly challenging. SIA also saw a continuing role for a full-service product regionally despite the rapid expansion of LCCs, which now account for about half of capacity in Singapore's short-haul market.

As a result SilkAir has pursued double digit ASK growth over the past four years, ranging from 11% to 21%. In comparison SIA's annual ASK growth during this period has been between zero and 5%.

Singapore Airlines and SilkAir annual ASK growth: 2010 to 2013

At a time when mainline SIA was not growing, SilkAir also has been able to perform a valuable role in ensuring that new slots at Singapore's Changi Airport have been retained for the group. In Hong Kong Cathay has used a similar strategy in growing its full-service regional subsidiary, Dragonair.

SIA was confident continued double digit capacity growth at SilkAir was sustainable

The SIA Group was initially planning more double digit ASK growth at SilkAir for 2014, driven by the introduction of 737-800s. In releasing financial results for FY2014 in May-2014, the group said that SilkAir would grow ASKs by 12% in the fiscal year ending 31-Mar-2015 (FY2015), matching the 12% ASK growth from FY2014.

The group stated that SIA would grow mainline capacity by only 1% in FY2015, continuing the recent trend of very modest to no growth at the main brand.

Unlike most other airline groups, SIA only releases capacity projections for the current fiscal year. But SIA clearly was intending to maintain rapid growth at SilkAir over the next several years given the group's ambitious 2012 order for 23 737-800s and 31 737 MAX 8s.

SilkAir has previously stated that the Boeing order will result in a fleet of 54 aircraft at the end of 2020. This compared to a fleet of only 24 aircraft at the beginning of 2014. (The new-generation MAX 8s, which are slated to be delivered from 2H2017, are not intended to replace the 737-800s, which are being delivered from 2014 through 2016, but will operate side by side for a total of 54 aircraft.)

As CAPA has previously calculated, the 54 aircraft represent 125% growth compared to the 24 A320 family aircraft SilkAir operated as of the beginning of 2014. As the 162-seat 737-800s and 737 MAX 8s are larger than the 18 150-seat A320s and six 128-seat A319s they are replacing, the actual growth in total seat count is over 150%. This is the equivalent of 22% growth per annum from 2014 through 2020 - an extremely ambitious figure for a typically conservative SIA.

See related reports:

SilkAir's expansion rate starts to slow

But SilkAir capacity growth has unexpectedly slowed since it took its first 737-800 in Feb-2014. ASKs were up by only 3% in calendar 2Q2014, 5% in Jul-2014 and 4% in Aug-2014.

Monthly ASKs are currently at about the 700 million mark, which is only slightly higher than 2013 levels.

SilkAir monthly ASKs: Jan-2012 to Jul-2014

Passenger numbers have also started slowing and were up by only between 1% and 2% in Jul-2014 and Aug-2014.

SilkAir initially planned to end 2014 with a fleet 28 aircraft, including eight 737-800s and 20 A320s. But it has decided to phase out six A320s instead of an initial plan to phase out four A320s and will now end the year with 26 aircraft, including eight 737-800s and 18 A320s. SilkAir began 2014 with 24 aircraft (all A320s).

The initial projection of a 12% capacity increase for the current fiscal year will likely be revised downwards when the group releases fiscal half year earnings in Nov-2014. This is a sensible adjustment given the current market conditions and was likely necessary for the airline to avoid slipping into the red.

SilkAir is still profitable - but barely

Similar to the Tigerair Singapore example (discussed in the first instalment in this series of reports), the Singapore market has struggled to absorb the capacity SilkAir has added over the past year. Yields and load factor have been impacted as well as profitability.

SilkAir continues to be profitable and outperform its LCC competitors. But its profits have fallen for four consecutive fiscal years since a record SGD121 million (USD95 million) operating profit was recorded in FY2011.

SilkAir and Tigerair Singapore annual operating profits: FY2000 to FY2014

SilkAir profits were down 64% in the fiscal year ending 31-Mar-2014 to SGD35 million (USD28 million). In the fiscal first quarter ending 30-Jun-2015 profits narrowed by a further 86% to only SGD2 million (USD2.5 million).

See related reports:

As CAPA highlighted in the first report in this series, SilkAir operating profits dropped by 77% in the 12 months ending 30-Jun-2014. Tigerair and Jetstar both reported losses for this period. The year over year swing at the two LCCs was SGD170 million (USD137 million) while the year over year swing at SilkAir was SGD78 million (USD62 million).

Operating profits/losses (in SGD million) for Singapore-based carriers: year ending 30-Jun-2014 vs year ending 30-Jun-2013

Carrier	2014 operating result	2013 operating result
Singapore Airlines	212m profit	183m profit
SilkAir	23m profit	101m profit
Jetstar Asia*	35m loss	3m profit
Tigerair Singapore	73m loss	59m profit
SIA Cargo	78m loss	176m loss
TOTAL	49m profit	170m profit

SilkAir competes in a different segment of the market from Tigerair Singapore or Jetstar Asia as it has a two-class cabin and approximately half of its traffic connects from and to SIA, including from long-haul markets not served by LCCs.

But SilkAir has clearly been impacted by the overcapacity in Singapore's short-haul market, which was caused primarily by overambitious expansion in 2013 and early 2014 by Tigerair Singapore. Tigerair Singapore ASKs were up 23% in the 12 months ending 30-Jun-2014 while SilkAir ASKs were up 8% and Jetstar Asia (including Valuair) ASKs were up 6%.

RPKs and ASKs (in billions) for Singapore-based carriers: year ending 30-Jun-2014 vs year ending 30-Jun-2013

Carrier	2014 ASKs	2013 ASKs	YoY ASK growth	2014 RPKs	2013 RPKs	YoY RPK growth	2014 Load Factor	2013 Load Factor
Singapore Airlines	120.76	119.29	1%	95.17	94.12	1%	79%	79%
Tigerair Singapore	12.34	10.04	23%	9.68	8.43	15%	78%	84%
SilkAir	7.98	7.38	8%	5.55	5.32	4%	70%	72%
Jetstar Asia/Valuair	7.89	7.47	6%	6.12	5.90	4%	78%	79%
TOTAL	148.97	144.18	3%	116.52	113.77	2%	78%	79%

SilkAir has been impacted by weaker demand from China

SilkAir (and Singapore's LCCs) also have been impacted by a reduction in local demand from Indonesia and China, which are two of SilkAir's three largest markets. Indonesia currently accounts for about 17% of SilkAir's seat capacity while China accounts for about 13%.

(Malaysia is SilkAir's largest market based on capacity but has significantly fewer destinations. The Malaysian cities of Kuala Lumpur and Penang are SilkAir's two largest routes.)

SilkAir capacity (seats) by country: 15-Sep-2014 to 21-Sep-2014

The number of Chinese residents arriving in Singapore by air was down 21% through the first seven months of 2014, according to Singapore tourism board data. But surprisingly total seat capacity in the Singapore-China market has remained flat over the last year, driving a drop in load factors for all carriers.

SilkAir has continued to expand in China, with capacity up by 12% over the last year to about 6,200 weekly one-way seats. SilkAir recently added its eighth destination in China, Hangzhou, and has about a 10% share of total seat capacity in the Singapore-China market. SIA, which has increased capacity to China by about 1% over the last year, has a 37% share, giving the SIA-SilkAir duo about half of the market.

SilkAir focuses on secondary markets, while SIA serves Beijing, Guangzhou and Shanghai. Both airlines have clearly been impacted by the reduction in Chinese tourists heading to Southeast Asia following the MH370 incident, which has impacted Singapore as Chinese tourists visiting Singapore typically combine Singapore with Malaysia or Thailand. (Thailand visitor numbers from China have been down this year due to the political instability in Bangkok.)

Indonesia has been another challenging market due to overcapacity

Inbound demand from Indonesia has been impacted over the last year by the devaluation of the Indonesian rupiah, which has reduced the spending power of Indonesians. Singapore is a popular destination for middle class and wealthy Indonesians, particularly for shopping.

The number of Indonesian residents arriving in Singapore by air was still up by almost 5% through the first seven months of 2014. But this growth represents a slowdown compared to the growth recorded in 2013 and lags the capacity increase the Singapore-Indonesia market saw in 1H2014. Over the last three months capacity has been adjusted to better match demand.

Several carriers, in particular Tigerair, were overly ambitious in adding capacity in the Singapore-Indonesia market after the two countries forged a new bilateral agreement in early 2013. Over the last few months there has been a major correction in the market with total capacity down by about 15%.

The Tigerair Group has made the biggest correction, driven primarily by the Jul-2014 suspension of its Indonesian affiliate Mandala, which had operated about 10 daily flights to Singapore. The Tigerair Group now only has a 7% share of capacity in the Singapore-Indonesia market compared to 15% a year ago. AirAsia's share has also slippped, from 18% to 16% as it recently cut capacity in the Indonesia-Singapore market by about 26%.

SilkAir's current capacity to Indonesia is down by 4% compared to Sep-2013, according to CAPA and OAG data. SilkAir currently serves 12 destinations in Indonesia but is dropping one, Solo, at the end of Oct-2014.

SilkAir should benefit as LCCs pull out of several Singapore-Indonesia markets

Although Indonesia has been a challenging market over the past year, SilkAir's performance on Singapore-Indonesia routes should start to improve as there is now a more rational level of capacity.

SilkAir's share of capacity in the Singapore-Indonesia market has increased slightly, from about 7% to 8% despite SilkAir also making some (relatively small) adjustments. The SIA Group overall has increased its share from about 32% to 38%. This includes capacity from Singapore Airlines, which operates several daily flights to both Jakarta and Bali and supplements SilkAir on the Surabaya route.

Across its other 11 Indonesian routes, SilkAir is now the only operator on seven. In two of these markets LCCs have pulled out - AirAsia from Makassar and Tigerair from Lombok - leaving only SilkAir.

The number of LCC competitors also has reduced from three to one in Medan and from two to one in Yogyakarta. Both AirAsia and Tigerair have dropped Singapore-Medan (leaving only Jetstar) while Tigerair has dropped Yogyakarta (leaving only AirAsia).

SilkAir has proven it can co-exist alongside LCCs

SilkAir has continually proven its ability to compete with LCCs. Markets it has dropped have typically been thin routes that had no competition and proved to be too small to be sustainable (such as Solo). Over the years LCCs have come and gone in several SilkAir markets - the four in Indonesia are just the latest examples.

SilkAir currently does not have any LCC competition on 20 of its 47 scheduled routes from Singapore, according to OAG data. This includes five routes that are served by other FSCs and 15 routes which are not served by any other airlines.

Of the 27 routes with LCC competition, seven are markets that are also served by SIA. These are primarily larger markets that have significant LCC and full service competition.

SilkAir has the most overlap with Tigerair (almost 20 routes). It competes with Jetstar on about 10 routes and with AirAsia on about 10 routes.

LCC capacity reductions in Singapore-Southeast Asia market should benefit SilkAir

While SilkAir competes against LCCs on some of its India and China routes as well as to Darwin (its only route in Australia), most of the overlap comes within Southeast Asia. LCCs now account for nearly half of total seat capacity in the Singapore-Southeast Asia market. But SIA and SilkAir have proven there is still a role for full service airlines.

SilkAir and SIA capacity within Southeast Asia has remained flat while the three main short-haul competitors in the LCC market - AirAsia, Jetstar and Tigerair - have all cut capacity in recent months. There are currently about 296,000 weekly one-way seats from Singapore to Southeast Asia, which represents an 8% reduction compared to Sep-2013, according to CAPA and OAG data.

SilkAir currently has about a 12% share of total seat capacity in the Singapore-Southeast Asia market while SIA has about 20%. SIA has fewer than 10 destinations within Southeast Asia compared to nearly 30 for SilkAir. But SIA has an all-widebody fleet and at least four daily frequencies on four routes: Bangkok, Bali, Jakarta and Manila.

Southeast Asia currently accounts for about 74% of seat capacity at SilkAir and for about 25% at SIA. Southeast Asia is also Changi's largest market, accounting for about 44% of current seat capacity.

SilkAir capacity share (% of seats) by region: 15-Sep-2014 to 21-Sep-2014

SilkAir will probably need to adjust its fleet plan

SilkAir will undoubtedly remain a critical component in the SIA Group strategy. Its success at expanding in the regional marketplace despite intensifying competition from LCCs has been clearly demonstrated. SIA needs the feed and for SilkAir to provide a differentiator from competitors (both full-service and low-cost) by using its narrowbody fleet to access smaller but popular niche destinations throughout Asia.

But there is a limit to how much SilkAir will be able to grow and it increasingly seems SilkAir's order for 54 737s was overly ambitious.

SilkAir has been unable to grow as rapidly as it had hoped in the first year under its 737 fleet plan. While market conditions could improve over the next couple of years a strategy of consistent double-digit capacity expansion is not likely to be sustainable.

Reducing the rate of growth by accelerating A320 retirements is a sensible move. But accelerated A320 retirements will only solve the issue temporarily.

If the A320 fleet ends up being phased out over the next three or four years - a likely outcome - instead of remaining in the fleet until the end of the decade as originally planned, SilkAir will undergo extremely rapid capacity growth after the first of 31 737 MAX 8 deliveries begins in late 2017. A second solution, potentially an early sale of some of its 23 737-800s or 737 MAX deferrals, could be required.

SilkAir will need to focus more on yields and connectivity rather than growth

SilkAir would probably have been better advised to transition at least some of its fleet to aircraft that are of similar size or even slightly smaller than its A319s and A320s. This would have enabled the carrier to expand its network to include more secondary destinations and increase frequencies to existing destinations, over half of which are served less than daily.

SilkAir has only five routes which are served at least twice per day - which is generally the minimum frequency to enable daily two-way connections to the SIA long-haul destinations.

SilkAir routes based on frequencies per week: 15-Sep-2014 to 21-Sep-2014

In deciding in 2012 to acquire 737s instead of a mix of 737s and regional jets, SilkAir was confident demand would grow to accommodate additional frequencies as well as larger aircraft. But the reality is several of its markets will remain too small to support daily services with 162-seat aircraft.

There is still a role - and a growing role - for a full-service regional carrier in the intensely competitive Southeast Asian market. But the top end of the market is much smaller than the bottom end of the market. Maintaining sufficient yields to maintain a full service proposition is possible - as SilkAir has a good mix of connecting and premium passengers - but only if the right amount of capacity is provided.

Until now, the group has been adept at managing this balance between SilkAir's point to point and connecting passengers. But as SIA - belatedly - transitions its LCC thinking to move towards greater connectivity between all of its various airlines, it will also need to be mindful of the impact this will have in potentially diluting SilkAir's connecting role.

While there will still be opportunities for further growth, the Singapore market may not be able to support another doubling in SilkAir's size over the next six years.

Meanwhile, the SIA group has to adapt in a fast changing world

Then again, the SIA group overall may feel the need for some fleet flexibility. Asia's markets will continue to grow at above global average rates and there is the potential for the group to expand through cross border establishment in joint ventures like its recent Indian operation with Tata in new airline Vistara; on a different level, the Scoot JV with Nok Air in Thailand's NokScoot is along the same track.

The region's growth, sometimes high and other times very high, but always generating increasingly competitive market conditions, has provoked several airlines to secure future aircraft slots that will allow them this flexibllity to undertake possible new ventures.

Inevitably this crossover between adding fleet for an airline's planned growth, at the same time as plotting for "strategic" potential expansion, means there will be constant imbalances in capacity - sometimes shortages, sometimes excess.

SIA has always proven itself adept at running a high quality, world benchmark operation. Now, as new entrants proliferate on short and long haul and as intra-Asian growth takes off, the need increases to be able to undertake increasingly sophisticated strategic moves. Its new tendency towards partnerships is one example of changed directions; coordinating a handful of different brands and national airlines - and their fleet needs - is a challenge that accompanies that. Almost by definition it means that mistakes will be made; keeping the level of risk at controllable levels, while leveraging existing strengths have become the goals.

Where SilkAir's needs will be in five years time cannot be accurately projected. But injecting sufficient room to move as a group will allow for some readjustments along the way.