20-Aug-2016 2:49 PM

Thailand’s Nok Air to restore domestic capacity but focus expansion on China and India

Analysis

Thailand's Nok Air is planning to focus on international expansion over the next two years with a focus on China and India. The primarily domestic LCC needs a bigger international operation to diversify its business, improve profitability and unlock a new phase of growth.

Nok has struggled over the last two and a half years to contend with intensifying domestic competition, leading to losses in 2014 and 2015. A pilot shortage led to even steeper losses in 1H2016 as Nok was forced to temporarily reduce domestic capacity and aircraft utilisation levels.

The airline is confident it can return to profitability in 4Q2016 as domestic capacity is restored and is bullish on its medium term outlook as it grows its international operation. China expansion will be the priority in 2017 followed by India in 2018, which will be served with Nok's new fleet of 737 MAX 8 aircraft and supported by a potential new Indian partner.

Summary

Nok Air plans to focus on international expansion, particularly in China and India, to diversify its business and improve profitability.
The airline has struggled with intense domestic competition and a pilot shortage, resulting in losses in recent years.
Nok Air currently relies heavily on the domestic market, with only three scheduled international routes.
The airline experienced a decline in domestic passenger numbers in 1H2016, but international traffic increased on a low base.
Nok Air expects to return to profitability in 4Q2016 as domestic capacity is restored and aircraft utilization levels improve.
The airline plans to expand its fleet and add more international routes, with a focus on China in 2017 and India in 2018.

Nok Air now relies overwhelmingly on the domestic market

Nok is predominately a domestic airline and currently only operates three scheduled international routes - from Bangkok to Hanoi, Ho Chi Minh and Yangon. Nok CEO Patee Sarasin told CAPA recently that two more scheduled international routes are planned for 2016 - Bangkok-Taipei from Sep-2016 and Bangkok-Kunming from Nov-2016.

However neither are entirely new routes. Nok already operates charter flights on Bangkok-Kunming while Bangkok-Taipei is being handed over from sister LCC NokScoot. Taipei, which was launched by NokScoot in Oct-2015, is now served four times weekly with 777-200s and will be down-gauged to Nok-operated 737-800s.

In 1H2016, the domestic market accounted for 84% of Nok's passengers and 86% of its passenger revenues. Nok flew 3.47 million domestic passengers and 570,000 international passengers (includes charters) in 1H2016.

Nok's domestic passenger numbers dropped 16% in 1H2016

Nok's domestic traffic was down 16% compared to 1H2016 while international traffic was up 84% on a very low base. Its total passenger traffic was down 7%, from 4.44 million in 1H2015 to 4.14 million in 1H2016, despite a 2.9ppt improvement in load factor to 86.6%.

The decline in traffic ends a period of rapid traffic growth. Nok's passenger traffic quadrupled from 2010 to 2015, with annual growth of at least 15% every year.

Nok Air passenger numbers and year over year growth: 2010 to 1H2016

Almost all of the growth over the last five years was domestic as Nok only resumed international services in late 2013. The airline previously suspended international operations in 2008.

Pilot shortage forces Nok to reduce domestic capacity

The sudden decline in traffic in 1H2016 was a result of unplanned domestic capacity cuts the airline had to implement due to a pilot shortage. The cuts led to a significant reduction in average aircraft utilisation rates, from approximately 11 hours per day to as little as eight hours during the peak of the pilot shortage crisis.

Nok operated five more aircraft in 1H2016 compared to 1H2015 but reduced total ASKs by 3%, leading to the significant reduction in utilisation. As is the case with passenger numbers, Nok quadrupled annual ASKs from 2010 to 2015 with growth exceeding 15% every year.

Nok Air ASKs and year over year growth: 2010 to 1H2016

Nok includes charters in ASK figures. Its international charter operation grew rapidly in 1H2016 with several new charter routes to China, offsetting most of the domestic ASK decline.

Without the pilot shortage Nok would have continued to grow domestic capacity. The international charters can primarily be operated during overnight hours using aircraft that operate domestically during the day. Nok was initially aiming to increase aircraft utilisation by expanding its charter operation but in this case the opposite occurred as unexpected pilot turnover left it unable to operate the number of flights initially intended.

Nok reported a dismal negative 17% margin in 1H2016

Nok recorded a 15% decline in domestic revenues in 1H2016 to THB4.927 billion (USD139 million). International revenues (including charters) were up 157%, but on a low base, to THB806 million (USD23 million).

Total passenger revenues were down 6% while costs increased by 12%, leading to the biggest half year loss in at least seven years. Nok reported a net loss of THB1085 million (USD31 million) in 1H2016, which equates to a negative 17% margin.

Nok was break-even in 1H2015 but ended 2015 with a loss of THB424 million (USD12 million), partially driven by the cancellation of flights in late 2015 as the pilot shortage crisis began. Nok posted a similar loss of THB421 million (USD13 million) in 2014, ending a streak of five consecutive years of profitability (from 2009 through 2013).

Thailand's domestic market has been challenging

Domestic competition started to intensify in 2014 driven by the end 2013 launch of Thai Lion Air and rapid expansion from Thai AirAsia. Nok responded by also pursuing rapid domestic expansion, pressuring yields as all three of Thailand's LCCs had to reduce fares to stimulate demand and fill the huge surge in capacity.

In 2015 domestic market conditions remained challenging as Thai Lion continued to expand aggressively. Nok's share of Thailand's domestic market decreased from 29% in 2014 to 26% in 2015 as its domestic passenger growth failed to keep up with the 23% growth in the overall market. In 1H2016 Nok's domestic market share slipped further, to only 20.5%, as the total market grew by 13% compared to the 16% decline at Nok.

Nok plans to add back domestic capacity in 2H2016, which should enable it to win back some domestic market share. In Oct-2016, Nok's domestic seat capacity will again reach 213,000 weekly seats, according to CAPA and OAG data. This matches capacity figures from Nov-2016 - before the pilot shortage crisis begins. Nok's current domestic seat capacity is down 17% year over year.

Nok Air domestic weekly seat capacity: Aug-2013 to Jan-2017

Nok is unlikely to again capture more than a 25% share of Thailand's domestic market. The overall market continues to grow, although not at the same clip as the last two years.

"Growth is still there but is much, much slower compared to before," Mr Sarasin told CAPA TV on the sidelines of the 4-Aug-2016 CAPA Asia Pacific Aviation Summit in Brisbane.

Nok Air Patee Sarasin discusses domestic market conditions and opportunities for international growth, particularly in China and India

Nok Air expects to return to profitability in 4Q2016

Nok is more focused on returning to profitability and expanding internationally than domestically. Mr Sarasin expects the airline will again be profitable from Oct-2016, ending a period of two and half years of losses. Mr Sarasin said Nok now has enough pilots to boost aircraft utilisation, which is expected to be back at an average of 11 hours per day in 4Q2016.

Aircraft utilisation is a key driver for Nok - as it is for any LCC. As Nok has a relatively new fleet of leased aircraft it simply cannot afford to have aircraft sit idle for several hours every day.

Nok did not take delivery of any aircraft in 1H2016 but so far in 3Q2016 it has added two Dash 8 Q400s and one 737-800. The 737-800 was delivered on 17-Aug-2016, giving Nok a fleet of 22 737-800s. Nok's turboprop fleet now includes eight Q400s, all of which have been delivered over the last two years (including two in Jul-2016), and two ATR 72-500s.

Nok Air fleet summary: as of 18-Aug-2016

Aircraft	In Service	On Order*
Total:	32	10
ATR 72-500	2	0
Boeing 737-8	0	8
Boeing 737-800	22	2
Bombardier DHC-8Q-402(NG)	8	0

Domestic expansion will be modest

The three aircraft added in 3Q2016 and the anticipated improved utilisation of the 29 existing aircraft will enable Nok to resume capacity growth. However Nok only plans to pursue modest domestic capacity growth - in addition to restoring capacity to pre-pilot shortage levels.

Most domestic expansion in 4Q2016 and 2017 will be generated by the additional Q400s, which allows Nok to add frequencies in smaller markets. Nok is able to better match capacity with demand in smaller domestic markets compared to its two LCC competitors, which operate all jet fleets.

Nok is now looking at leasing more Q400s in 2017 although it currently does not have any commitments for more turboprops. Its two ATR 72s are currently slated to be returned in 2019.

Domestic trunk routes will continue to be served with 737s but are already served with multiple daily frequencies and cannot easily support additional capacity. On some domestic trunk routes slot constraints also limit growth opportunities.

Nok plans to allocate most of its additional 737 capacity to the international market. "We are trying to utilise our aircraft more in the international market than the domestic market but at same time we need to protect the [domestic] shares that we have," Mr Patee told CAPA TV.

Nok postpones first MAX 8 delivery to 2018

Nok has two more 737-800s on order, which are now slated for delivery in 2017. Nok also ordered eight 737 MAX 8 in 2014.

Deliveries of the MAX 8 were initially slated to begin in 2017 but have been pushed back to 2018. The slight deferral is a sensible move as Nok is keen to grow at a "humble" pace.

Nok has 737-800s coming up for lease from 2018 and the revised delivery schedule for the MAX 8 aircraft gives the airline the flexibility to use the MAX 8 as replacements rather than for growth.

Nok also has the opportunity to grow capacity by further improving utilisation. As more international flights are launched, utilisation rates will continue to improve. The 11 hour utilisation ration expected for 4Q2016 is based on a predominately domestic schedule with a limited number of overnight flights.

Nok Air to expand in China with focus initially on charters

New flights to China - and later India - will enable Nok to operate a much larger portion of its fleet on overnight flights.

The China expansion initially will focus primarily on more charters. Mr Patee said Nok plans to commence scheduled flights to China in Nov-2016 with the launch of Kunming.

However this represents an upgrade of an existing charter service to a scheduled service. It also represents a delay and a less ambitious plan than previously. Nok had been aiming to start scheduled services to China in Jun-2016 and have by now upgraded four charter routes to scheduled.

Mr Patee said Nok is now planning to add several new charter routes to China over the next six months, starting with Linyi and Wenzhou in the near future. However there are no near term plans for more scheduled flights (besides Kunming).

Nok Air expansion in China will be gradual

The growth on the charter side will also be gradual and based on the pace of regulatory approval. Chinese regulatory authorities do not typically allow a foreign airline that is new to the Chinese market to rapidly or suddenly launch several flights - even charters.

Mr Patee told CAPA TV that the charters enable Nok to gain an understanding of the Chinese market with guaranteed profitability. "It's been tremendously informative. At the moment it's more of a learning stage," he said.

More scheduled routes will eventually be added, most likely in 2017. By then Nok will have forged relationships with more Chinese agents and have had an opportunity to build up its brand. This is particularly important as Thailand-China is primarily an inbound market.

Nok aims to launch services to India in 2018 with Indian airline partner

Thailand-India is also primarily an inbound market that Nok aims to begin serving in 2018. Charters is not a common platform for India and therefore will require scheduled flights from the beginning. To build its brand in India Nok is now talking to a potential Indian airline partner.

Mr Patee said the Indian partner would support Nok in the Thailand-India market and will likely join the Value Alliance. Nok is one of the eight founding members of the Value Alliance and is already selling flights operated by three other members - Cebu Pacific, Scoot and NokScoot.

Nok briefly served Bangalore in India in 2006 and 2007 with 737-400s. Mr Patee said the use of newer generation and higher capacity aircraft should enable Nok to serve India profitably this time.

Nok to use ETOPS 737 MAX 8s for Indian market

He said India routes will be launched with the 737 MAX 8, which offers improved range and higher seating capacity compared to the 737-800.

Nok plans to certify its 737 MAX 8 for ETOPS, enabling more efficient routings between Thailand and India. "We are looking at going back to India in a proper way and ETOPS is required to cross the Indian Ocean to make it more cost efficient," Mr Patee said.

Nok will also likely use the 737 MAX 8 to operate longer routes into China. As the fuel consumption benefits of the MAX are more pronounced on longer routes it makes sense for Nok to use the generation aircraft primarily on medium haul routes while sticking with the 737-800NG for domestic and short haul international flights.

Nok plans to start serving Mandalay in 2017

Yangon, Nok's first international destination, is only slightly over one hour from Bangkok. Nok has steadily added capacity on Bangkok-Yangon since it entered the market in late 2013 and now operates three daily flights on the route.

Nok is keen to leverage its success in the Myanmar market by adding service to Mandalay. Mr Patee said Mandalay will likely be launched in 2017 with either 737-800 service from Bangkok or Q400 service from Chiang Mai.

Nok also has been looking at potentially using the Q400 to serve Da Nang in Vietnam. In 2015 Nok launched services to Ho Chi Minh and resumed Hanoi, which had been suspended back in 2008. Nok currently serves Bangkok-Ho Chi Minh with two daily flights and Bangkok-Hanoi with eight weekly flights (based on OAG data for the week commencing 15-Aug-2016).

Short haul international markets have become more challenging

Nok has been able to leverage its strong domestic brand in Thailand in the Myanmar and Vietnam markets as these are large outbound markets from Thailand. China and India are much different as they are predominately inbound, requiring Nok to invest in establishing its brand overseas.

Bangkok-Yangon was highly successful the first two years but has become more challenging since the launch of flights to Yangon by Thai Lion in Jul-2016. Thai Lion now operates two daily flights on Bangkok-Yangon. Mr Patee said Thai Lion is now using the same "price war tactics" on Bangkok-Yangon as it does in the domestic market.

He said yields in the Thailand-Vietnam market are also under pressure due to aggressive competition from VietJet and Vietnam Airlines. The latter is offering very low fares despite its full service model.

International expansion is strategically necessary but difficult

Nok strategically needs to continue to expand its international network. The domestic market is now relatively saturated and the current high level of LCC competition is not about to wane anytime soon.

However the international market also has challenges. Several short haul international routes from Bangkok are now as intensely competitive as domestic trunk routes with multiple LCCs fighting viciously for market share.

Nok is one Asia's oldest LCC, having commenced operations in 2004. But it has been very slow to pursue expansion outside Thailand. Catching up on international growth is not easy and requires significant investment.

Nok's modest rate of expansion is prudent

Committing to a significant investment and taking on risk is not easy given Nok's recent string of losses. However Nok does not have a choice as it strategically needs a more significant international presence. Nok is being sensible by pursing international expansion at a gradual pace - and in the case of China with an initial heavy reliance on charters.

The airline also has a modest - and sensible - fleet plan. The MAX 8 opens up opportunities for new medium haul routes while enabling Nok to reduce its 737-800 fleet - and therefore reduce its reliance on the domestic market.

Nok is at an important juncture as it attempts to return to profitability and chart out a sustainable plan for building a larger international network.