23-Aug-2016 1:18 PM

Thailand's NokScoot plans ambitious expansion with seven more 777s and complete focus on China

Analysis

Thailand's medium/long-haul LCC NokScoot is planning ambitious expansion, with the acquisition of seven additional 777-200s. A fleet of 10 aircraft, compared with the three currently, will result in improved scale and efficiencies, potentially enabling NokScoot to become profitable.

The joint venture start-up between Thailand's Nok Air and Singapore's Scoot is bullish on opportunities in the fast-growing Thailand-China market. NokScoot already serves five destinations in mainland China, despite only having three aircraft.

A sixth Chinese destination is being added in Sep-2016 when Taipei - NokScoot's only destination outside mainland China - is dropped. NokScoot needs to expand its fleet to pursue further growth in China and also still has long-term aspirations to serve Japan and South Korea.

Summary

NokScoot had a challenging start

Nok and Scoot established NokScoot in late 2013 and the new JV commenced operations in early 2015. NokScoot was initially set back by lengthy regulatory delays, resulting in large losses and underutilisation of its fleet.

In 2015 NokScoot incurred a loss of THB1.223 billion (USD36 million) and generated revenues of only THB2.176 billion (USD64 million), equating to a dismal negative 56% net margin. NokScoot had three aircraft in its fleet nearly the entire year but was only able to begin scheduled flights in May-2015, and for most of the remaining seven months only operated a limited schedule.

Initially NokScoot had to compromise on serving the Bangkok-Singapore route, which was not in its business plan but became necessary after Korea and Japan issued restrictions in early 2015 that prevented all Thai airlines from new routes. NokScoot decided to focus on China instead, but Chinese regulators would not authorise the airline until it had a certain number of flights under its belt.

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NokScoot gradually expands China operation

NokScoot dropped Singapore in Aug-2016 after incurring heavy losses during the three months of operating the route. Services to China were launched in Jun-2016 with Nanjing, and NokScoot has since then been able to build up its Chinese operation gradually.

The airline could not immediately deploy all its capacity to mainland China as Chinese regulators do not typically allow a new foreign airline to add several flights in a short period. Therefore, NokScoot was unable to utilise its 777 fleet fully until Jun-2016, when its fifth Chinese route was launched - Bangkok-Chongqing. The airline took delivery of its first two 777s in late 2014, during the certification phase, and had three aircraft by the time it launched scheduled operations in May-2016.

NokScoot is currently utilising its three aircraft for an average of just under 12 hours per day (based on schedules in OAG for week commencing 22-Aug-2016). Mainland China is served with 21 weekly flights: six to Nanjing, five to Qingdao, four to Tianjin, three to Chongqing and three to Shenyang.

NokScoot one-way seat capacity to China: Jun-2015 to Sep-2016

Dalian to replace Taipei

NokScoot also currently serves Taipei in Taiwan with four weekly flights. Bangkok-Taipei was launched in Oct-2015 as NokScoot was eager to find another market other than mainland China in order to boost its aircraft utilisation rates.

Taipei has struggled, however, whereas all the mainland China routes have been relatively successful. Nok Air CEO and NokScoot board member Patee Sarasin told CAPA that Bangkok-Taipei had suffered from visa restrictions imposed on Thai citizens by Taiwan, as well as having been allocated unattractive slots at Taipei.

Nok Air plans to take over the Bangkok-Taipei route from NokScoot in Sep-2016. The Nok group believes Nok's 189-seat 737-800s will enable a better match of capacity with demand on Bangkok-Taipei, compared with NokScoot's 415-seat 777-200s.

The suspension of Taipei enables NokScoot to expand further in mainland China with its current three aircraft fleet. NokScoot recently filed a new schedule featuring three weekly flights from Bangkok to Dalian starting late Sep-2016. Dalian is now listed as a destination in NokScoot's website, but ticket sales have not yet begun.

NokScoot to allocate 100% of capacity to China from Oct-2016

Based on the current plan NokScoot will allocate all its capacity to mainland China in Oct-2016, with a total of 24 weekly flights and 9,960 weekly seats. This will give NokScoot a 5% share of total seat capacity between Thailand and China compared with 4% currently.

Aircraft utilisation will be just under 12 hours per day in 4Q2016, matching the level it has been since Jun-2016. Three weekly Bangkok-Dalian flights have the same total block hours as four weekly Bangkok-Taipei flights - approximately 31 hours per week - as Taipei is a shorter route. As a result, the total block time for the fleet will be maintained at the current level of 249 hours per week.

NokScoot hopes to be profitable for the first time in 4Q2016. Higher utilisation is a key driver, as is the 100% focus on China where NokScoot has experienced high demand, particularly during peak months. The fourth quarter is typically a peak period for Thailand and the Thailand-China market.

NokScoot needs larger fleet to be profitable on an annual basis

However, the airline will still be in the red for the full year. In 1H2016 NokScoot reported a loss of THB230 million (USD6.5 million) on revenues of THB1835 billion (USD52 million). The negative 12.5% margin represents a significant improvement over 2015 but remains unsustainable.

NokScoot was still not fully utilising its 777 fleet for most of 1H2016 - due partially to restrictions limiting the pace of growth in China. If it had been able to operate more flights to China and fully utilise its fleet the airline might have been able to break even in 1H2016.

While NokScoot's outlook has significantly improved, the airline is still subscale and needs a larger fleet to be profitable over the long run. CEO Mr Patee told CAPA TV on the sidelines of the 4-Aug-2016 CAPA Asia Pacific Aviation Summit in Brisbane that NokScoot is now planning to add seven 777s, for a total of 10 aircraft.

Used 777s are a more cost-effective option than new 787s

NokScoot has decided to expand the 777 fleet rather than pursue a transition to 787s or other new generation aircraft, since used 777s are much less expensive to acquire. The airline also believes that 415-seat 777-200s have proven to be a cost-effective aircraft for Thailand-China routes, given the buoyant demand from China.

NokScoot's sister airline Scoot completed a transition from 777-200s to smaller 787s in 2015 - a transition that has enabled Scoot to become profitable. However the situation with NokScoot is different as Bangkok is a much denser market than Singapore, making it easier to fill 415 seats. The value of used 777s has also decreased significantly in recent years, making them a more attractive option.

Mr Patee said that NokScoot still plans to transition to 787s eventually. However, a transition to 787s is not likely in the short to medium term as it will take a few years for NokScoot to recoup the investment of retrofitting each 777.

NokScoot to stick with the 415-seat configuration

NokScoot plans to stick with the same type of 777 (the non-ER version of the 777-200) and configuration. Its three 777-200s are now configured with 391 seats in economy and 24 in ScootBiz (similar to premium economy on full service airlines).

NokScoot has not yet identified the seven additional 777s that are part of its revised business plan, and therefore does not have specific delivery dates. It is considering 777-200s that are coming out of the fleet of Singapore Airlines (SIA), as well as from other potential sources. All three of its existing 777-200s were previously operated by SIA, which owns a 100% stake in Scoot and therefore an indirect 49% stake in NokScoot.

NokScoot is only planning on taking 777-200s less than 14 years old, since Thai regulations do not allow the import of aircraft older than 14 years. This regulation initially prevented NokScoot from taking over any of the 777-200s that Scoot had reconfigured.

Scoot operated five 777-200s in 402-seat configuration (370 economy and 32 business), but these aircraft have mainly been scrapped.

Scoot also briefly operated one 777-200 which it kept in SIA's 323-seat configuration (293 economy and 30 business). As this aircraft was less than 14 years old it was acquired by NokScoot and retrofitted along with its two other 777s, which Scoot never operated.

Mr Patee told CAPA that the 777-200 has "very good economics", and demand in China is sufficient to justify expanding the fleet. "I'm quite amazed at the ability to full up those 415 seats", he said.

NokScoot does not expect to launch Japan or South Korea until at least 2018

Through at least 2017 the focus for NokScoot will entirely be on expanding in China. Mr Patee said that NokScoot also still aims to serve Japan and South Korea eventually, but the airline does not expect the current restrictions on Thai airlines from Japanese and Korean authorities to be lifted for approximately another 18 months.

"Things aren't going as fast as they should", Mr Patee said, adding that the exact timing is hard to predict because the ICAO recertification schedule is contingent on work being done by the Thai DCA.

For the restrictions to be lifted Thai authorities need to pass a new ICAO audit. ICAO initially flagged the Thai authorities for not meeting international safety standards in early 2015, leading to the restrictions from Japan and South Korea.

Thai airlines already serving Japan and South Korea at the time of the ruling were grandfathered and have been able to continue with their current services - although restricted from adding any flights. Unfortunately for NoKScoot the restrictions came just before it was about to start scheduled flights to Japan and South Korea. Its main rival, Thai AirAsia X, launched flights to both Japan and South Korea in 2015, having begun operations slightly earlier than NokScoot.

The ICAO red flag also has led to all airlines in Thailand being recertified by the Thai DCA. Nok Air and NokScoot have now been recertified and both airlines have also sought IOSA certification. Mr Patee said that NokScoot should be IOSA-certified by the end of Aug-2016, and an IOSA audit of Nok Air is expected by the end of 2016.

NokScoot to continue focusing on China

Some of the seven aircraft to be added by NokScoot could eventually be used to serve Korea and Japan, but for now NokScoot is entirely focusing on China. Mr Patee said that NokScoot also has no interest in serving Australia or any market outside North Asia.

Focusing on China is sensible, particularly during this early stage, given the rapidly growing inbound demand in the Thailand-China market. Thailand recorded 71% growth in Chinese visitors in 2015, to nearly 8 million. In 1H2016 Chinese visitor numbers increased another 22%, to 5.8 million.

Chinese visitor numbers to Thailand: 2009 to 1H2016

With a fleet of 10 aircraft NokScoot should be able to triple its seat capacity to China to 30,000 one-way seats. This would give NokScoot a more significant but not infeasible 14% share of the Thailand-China market - based on current seat capacity levels.

However, given the rapid overall rate of capacity growth NokScoot's share will likely be less than 10% by the time all seven additional 777s enter service. Total seat capacity between Thailand and China has more than doubled over the past two years. Several Thai airlines have been focusing expansion on China - hardly surprising given the restrictions preventing growth in Japan and South Korea.

Thailand-China total one-way total seat capacity: Aug-2013 to Sep-2016

NokScoot leverages Scoot's Chinese network

With China NokScoot is also able to leverage its sister airline Scoot, which now serves six destinations in China. Scoot is also launching Dalian in Nov-2016.

Scoot now serves all but one of NokScoot's destinations in China. Once Dalian is launched by both airlines, five of NokScoot's six Chinese destinations will also be served by Scoot. (The only exception is Chongqing).

Since launching services in 2012 Scoot has invested heavily in building up its brand in China. Scoot has helped NokScoot from a distribution standpoint in China, and also operationally at each station.

Nok Air Group has a dual brand strategy for China expansion

NokScoot and Nok have combined their network planning teams to coordinate expansion in China. Mr Patee said that the length of flight and market size are considered in deciding if each new market is more suitable for NokScoot 777s or Nok 737s.

As there is a huge number of potential destinations in China there is plenty of demand to support expansion by both airlines. Mr Patee said the two brands will not overlap on any route.

As recently highlighted by CAPA, Nok currently has several charter routes to China and is planning to start scheduled services to China in Nov-2016. Nok plans to expand its operation to China significantly over the next year and primarily with charters, although eventually several of these routes will be upgraded to scheduled services.

NokScoot works closely with Nok and Scoot

Nok Air also recently started selling NokScoot and Scoot flights, enabling the Nok Air Group to virtually expand its network.

NokScoot and Scoot have always shared a common reservations platform whereas the Nok system is different. However, a new link that has been activated as part of the Value Alliance technology now enables Nok to sell NokScoot-operated and Scoot-operated flights. Nok, NokScoot and Scoot are all founding members of the Value Alliance, which was established with five other Asian LCCs in May-2016.

The link with Scoot is important because Scoot is now operating flights from Bangkok to Osaka Kansai and Tokyo Narita, using fifth freedom rights. This gives the Nok Group an ability to offer services to Japan's two largest cities nonstop while Japan's restrictions on Thai airlines are still in place.

NokScoot is also now selling Nok-operated flights. This link is important as a large proportion of Chinese tourists in Thailand are heading to destinations other than Bangkok. Nok is now offering NokScoot's Chinese passengers domestic connections and aims later to start offering international connections to destinations such as Yangon in Myanmar.

NokScoot puts all its eggs in the China basket

Offering options beyond Bangkok is important in case demand for Bangkok starts to slow. NokScoot is now relying almost entirely on the inbound Bangkok-China market. (There is very limited outbound demand from Thailand to China, particularly for secondary Chinese cities. Japan and major Chinese cities, none of which are served by NokScoot, are more popular international destination for Thais.)

Putting all your eggs in one basket can be a dangerous strategy. However, it is the only sensible option for NokScoot given the restrictions in Japan and Korea and the limitations posed by other potential markets.

NokScoot needs to expand to gain scale and become profitable. At least for now, China is the only place to turn to fill the additional seats that the seven additional 777s will generate.