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AirAsia further slows fleet expansion as 1Q profit falls - with the potential to accelerate later

Short-haul LCC group AirAsia has reported a sharp drop in profits for 1Q2014, including for its original subsidiary in Malaysia. Long-haul sister group AirAsia X meanwhile swung to a loss in 1Q2014 despite strong traffic growth and load factor improvement as yields in the Malaysian market deteriorated.

AirAsia has made another downward adjustment to its fleet plan, removing six aircraft from its 2014 fleet through aircraft sales. This brings the total reductions for 2014 to 19 aircraft when including the six sales and seven deferrals announced in Feb-2014. The group also expects to defer another seven aircraft in 2015, adding to the 12 deferrals announced earlier and leaving it with a mere 10 deliveries next year.

The new adjustments, which also include deferrals for 2016 to 2018, are understandable given the challenging market conditions. But they may prove to be a step too far, particularly if the pending restructuring at Malaysia Airlines (MAS) proves to be significant, providing AirAsia an opportunity to accelerate growth and improve yields in its home market.

AirAsia reports profit declines in Malaysia & Thailand; losses in Indonesia & Philippines

Malaysia-listed AirAsia Berhad on 20-May-2014 reported a reduction in profitability for 1Q2014 across all its affiliates and subsidiaries. The group’s original carrier, fully owned Malaysia AirAsia (MAA), recorded an 11% drop in operating profits to MYR224 million (USD68 million).

Affiliate Thai AirAsia (TAA) recorded a 65% drop in operating profits to THB330 million (USD10 million); Indonesia AirAsia (IAA) reported an operating loss of IDR390 billion (USD33 million) after turning a small operating profit of IDR42 billion (USD4 million) in 1Q2013; and Philippines AirAsia (PAA) saw its operating loss widen by 25% to MYR25 million (USD8 million).

The higher loss for PAA and reduction in profit for TAA was covered as part of reports published by CAPA earlier this week analysing the Philippine and Thai markets.

See related reports:

As CAPA described in Feb-2014, IAA has been impacted by challenging market conditions in Indonesia including the depreciation of the Indonesian rupiah. The AirAsia Group says IAA is now pursuing a network restructuring which will see it cut nine unprofitable routes and reduce frequencies on six others while redeploying this capacity to grow in select markets which have been performing better.

IAA’s fleet will stay at 30 aircraft for all of 2014 as it decided in early 2014 to defer all six of its deliveries originally slated for this year. (IAA also has entirely cancelled plans for an initial public offering, which was originally slated for 2013 and was initially postponed until 2014.)

See related report: Indonesia AirAsia slows expansion. Domestic share to suffer but international position to strengthen

This analysis will focus on the 1Q2014 financial performance of the Malaysian subsidiary under AirAsia Berhad, Malaysia AirAsia (MAA), as well as Malaysian medium/long-haul LCC AirAsia X (AAX).

The latter has a separate ownership structure and reports results under another Malaysian-listed company, AirAsia X Berhad. TAA also reports its results separately, under its Thailand-listed parent Asia Aviation, but AirAsia Berhad aims to start providing consolidated results combining MAA, IAA, TAA and PAA from 2015. Asia Aviation will continue to have its own separate listing but the short-haul group’s previous strategy of pursuing additional listings, starting with Indonesia, has been dropped.

Malaysia AirAsia average fares drop 9% drop while AirAsia X fares drop 25%

MAA revenues were flat at MYR1.3 billion (USD394 million) despite a 4% increase in passenger numbers to 5.4 million and a 7% increase in RPKs. The carrier’s seat load factor improved 2ppts to 81% as seat capacity was up only 1% and ASKs were up 3%. But average fare dropped 9% and unit revenues dropped 3% as competition intensified.

Malaysia AirAsia financial and operating highlights: 1Q2014 vs 1Q2013

AAX revenues surged by 40% in 1Q2014 to MYR749 million (USD227 million). But as with MAA, the revenue growth lagged passenger growth as yields declined.

AAX RPKs were up a staggering 63% and passenger numbers grew 67% to 1.1 million. ASKs were up 60% and seat capacity was up 63%, resulting in a 1.6ppts improvement in seat load factor to 85.8%. But average fares plummeted by 25% while unit revenues dropped by 12% on a local currency basis (or by 18% on a USD basis).

As a result AAX incurred an operating loss of MYR38 million (USD12 million) in 1Q2014 compared to an operating profit of MYR58 million (USD19 million) in 1Q2013. On a net after tax basis AAX incurred a loss of MYR11 million (USD3 million) in 1Q2014 compared to a net profit of MYR50 million (USD16 million) in 1Q2013.

AirAsia X financial and operating highlights: 1Q2014 vs 1Q2013

AirAsia X’s Australian routes suffer a sharp drop in profit

AAX was impacted by intensifying competition, particularly in the Malaysia-Australia market where both AAX and MAS significantly increased capacity. AAX’s Australian routes recorded an operating loss of MYR4 million (USD1 million) in 1Q2014 compared to a MYR53 million (USD17 million) profit in 1Q2013. Its North Asian routes recorded a 17% improvement in operating profit to MYR64 million (USD19 million).

Australian routes accounted in 1Q2014 for 39% of revenues compared to 48% for North Asia and 14% for others. AAX currently serves five destinations in Australia with 54 weekly return flights, according to OAG data. With the Mar-2014 launch of Nagoya, AAX now serves 10 destinations in North Asia – including four in China, three in Japan, two in South Korea and one in Taiwan – with 71 weekly return flights.

AAX is primarily focused on north-south routes and is increasingly promoting connections in the Australia-North Asia market as the local Malaysian market is not large enough to absorb the huge influx in capacity added over the past year.

AAX considers its markets to the west to be non-core. These currently include Sri Lanka, Nepal and Saudi Arabia, as the Maldives was dropped in Mar-2014. (Maldives was unprofitable and likely drove the drop in operating profit recorded in 1Q2014 for AAX’s “other” routes.)

AirAsia X route performance by segment: 1Q2014 vs 1Q2013

AirAsia X’s recent very high level of capacity expansion is seen as a one off

The yields and average fares recorded by AAX in 1Q2014 are clearly not sustainable over the long term. But there is an expectation that over time the capacity added to the market will become fully absorbed, enabling higher yields.

As most of the capacity added was a result of deliveries from 2H2013, AAX capacity will again be up significantly in 2Q2014, with projected year over year growth of 48%. On a quarter over quarter basis ASKs in both 1Q2014 and 2Q2014 are roughly at the same levels as 4Q2013. There will be some quarter over quarter growth again in 2H2014 as aircraft are added to the fleet but the year over year figures will start to trend down.

AirAsia X quarterly ASK growth and quarterly ASKs: 1Q2013 to 4Q2014

The AirAsia X Group is slated to take seven A330-300s in 2014, but four of these are being allocated to new affiliates with Thai AirAsia X having already received two and Indonesia AirAsia X to receive two in 2H2014. This leaves the Malaysian operation with a net growth of three aircraft, compared to a net growth of seven aircraft in 2013. But as a majority of the deliveries in 2013 were in the second half the biggest capacity growth has occurred in 2014.

For the full year in 2014 ASK growth will be up by 41% at the Malaysian operation, compared to 19% in 2013. But AAX expects to moderate growth in Malaysia from 2015, with 20% growth expected in 2015 and 16% growth in 2016. The airline has stated that annual ASK growth is not likely to exceed 20% again.

AirAsia X annual ASK growth: 2013 to 2016

The capacity growth taking place this year is strategic as AAX looks to leverage its leading position in Asia-Pacific’s emerging but fast-growing medium/long-haul low-cost sector. AirAsia X’s strategy has emphasised market share with the quest of being the largest Southeast Asian LCC in its five core markets (Australia, northern China, Japan, South Korea and Taiwan) as well as the largest carrier overall in these markets from Malaysia.

AirAsia X succeeds at growing transit traffic with its focus on Australia-North Asia

To fill up the huge growth in seats, AAX has been engaging in heavy discounting to stimulate sufficient demand. AAX has particularly been aggressive at promoting North Asia-Australia itineraries using its transit product.

AAX is now selling transfer itineraries on an origin and destination pricing model rather than the traditional sum of sectors approach for LCCs, resulting in more competitive fares. It also has made a push into new distribution channels, in particular Chinese online travel agencies (OTAs) such as Ctrip and eLong.

AAX says it has started selling in five OTAs based in its core markets and is also now in the Amadeus and Travelport global distribution systems (previously AAX and AirAsia overall only sold through Expedia). These initiatives have helped drive up AAX’s share of passenger in the Australia-North Asia market from only 5% in 1Q2013 to 16% in 1Q2014.

AirAsia X share (% of passengers) of Australia-North Asia market: 1Q2014 vs 2H2013 and 1Q2013

As AAX’s Australia-North Asia passenger figures have soared its share of transit traffic has naturally increased significantly.

In 1Q2014, 47% of AAX’s passengers connected at Kuala Lumpur onto other AAX or MAA operated flights, up from 43% for the full year 2013 and only 27% in 2011.

AirAsia X transit traffic portion: 2011 to 1Q2014

As CAPA reported in Apr-2014, AAX had been targeting 46% transit traffic for the full year 2014, so the 47% figure achieved for 1Q2014 indicates it is ahead of this target. As AAX’s initiatives to push transit traffic continue to gain traction, a 50/50 mix is possible for 2014 – a world leader for an airline of its type and very high even by full service network airline standards.

See related report: AirAsia X drives 43% transit traffic at Kuala Lumpur's KLIA. Can Singapore follow the same recipe?

The AirAsia and AirAsia X move to KLIA2 opens up new opportunities

AAX believes the 9-May-2014 move from Kuala Lumpur International Airport’s old low-cost carrier terminal (LCCT), which was operating well above capacity, to the new LCC terminal at KLIA2 will further drive transit traffic as KLIA2 provides a much improved passenger and transit experience compared to the LCCT. KLIA2 features larger space for transit passengers, an airside hotel, better facilities including paid-for lounges and aerobridges.

MAA also has high hopes for KLIA2 unlocking transit traffic growth opportunities as it plans to introduce by the end of 2014 a transit product at KLIA2 which will involve short-haul to short-haul connections. AirAsia’s Fly-Thru product is currently only available at Kuala Lumpur on connections involving AirAsia X (long-haul to short-haul or long-haul to long-haul) although TAA began offering the Fly-Thru product for short-haul to short-haul connections at Bangkok in late 2013. Passengers are of course free to self-connect between MAA short-haul flights but this is an inconvenience for many passengers and particularly disincentives business passengers.

Short-haul to short-haul connections should drive a new segment of growth for MAA and Malaysia Airports. This is particularly important as Malaysia Airports will need a new source of traffic to offset any potential declines in MAS as the flag carrier restructures.

Malaysia Airports recorded 18% traffic growth in 2013 and again in 1Q2014, with Kuala Lumpur International Airport (KLIA) traffic growing 19% in 2013 and 16% in 1Q2014. Maintaining this growth rate will be nearly impossible but promoting connections at KLIA2 could enable the figures to stay in the double digits.

See related report: Kuala Lumpur International traffic surges another 16% in 1Q2014. Is the growth sustainable?

AirAsia plans a new premium product for KLIA2

KLIA2 is also enabling AirAsia (MAA and AAX) to launch a new premium product from 20-Jun-2014 that will package priority baggage drop and pick-up with already offered priority boarding and the flexibility to make flight changes. AirAsia also hopes to include express security and immigration in the new “Premium Flex” package.

The AirAsia Group believes the new premium product along with the “comfort” of aerobridges and the convenience of rail access (unlike the old LCCT, KLIA2 is linked to the express rail line into central Kuala Lumpur) will generate more business sales and help push up yields.

Ironically AirAsia has complained repeatedly over the years about the inclusion of aerobridges at KLIA2, as well as about its inability to bring its own self check-in system that had been installed at the LCCT. MAA and AAX have been required by MAHB to use the common check in systems that have been supplied at KLIA2 by SITA.

AirAsia finds the system to be costly and states that it does not cater to Interpol screening, passport verification, baggage drop or self-tagging. But AirAsia also stated in its 1Q2014 results presentation that there is no impact from the cost of the system as well as the cost of the aerobridges because these costs are simply being passed on to passengers in the form of higher passenger facility charges (PFCs) for KLIA2.

It will be some time before the true impact of the move to KLIA2 – from both a cost and revenue perspective – can be accurately calculated. While there are new revenue opportunities and in theory the extra costs are passed onto the consumer, there could be an impact on price sensitive passengers who typically take into account the total cost of tickets including PFCs when making their purchase decisions.

Tigerair Singapore for example said it had to lower fares after the budget terminal at Singapore Changi was closed in late 2012 because the higher cost of the PFC was not being absorbed by its passengers.

From a cost perspective there could also be an impact on manpower costs because AirAsia saw 35% self-tagging at the LCCT while self-tagging is not available at KLIA2. AirAsia also has so far experienced a reduction in kiosk usage from 30% at the LCCT to 10% at KLIA2.

Yields in the Malaysian market should start improving as MAS restructures

Ultimately what direction fares and yields take at KLIA2 will depend mostly on market conditions. MAA and AAX are hopeful that the declines in fares recorded in recent quarters will start to trend in a positive direction. A combination of capacity constraint and overall rationalisation in the market should enable this to occur, with potentially the new services at KLIA2 being a further contributor.

As AAX’s capacity growth starts to slow down it should have the ability to gradually push up yields in both the local and transit markets. AAX is confident it will see an improved performance as capacity growth levels are reduced to a more rational 20%. But AAX’s ultimate success at improving yields and hence profitability will largely depend on what unfolds over the next several months at its biggest home competitor, MAS.

As CAPA recorded on 16-May-2014, MAS is now working on an adjusted capacity plan for 2014 as well as preparing another restructuring plan. MAS reported on 15-May-2014 a net loss of MYR443 million (USD134 million) for 1Q2014 compared with a net loss of MYR279 million (USD90 million) for 1Q2013.

Yields were down by 9% year over year as RPKs increased by 18% but revenues increased by only 2%. MAS’ load factor dropped in 1Q2014 by 0.2ppts to 76.4%. But the carrier’s load factor was down year over year in Mar-2014 and will likely be down in 2Q2014, while pressure on yields continues, as the carrier’s bookings have been impacted further by the MH370 tragedy, mostly affecting 2Q.

See related report: Malaysia Airlines 1Q loss widens. Capacity growth to be adjusted, followed by restructuring

MAS ASKs for the full year are still expected to be up by 10% to 12%. But this is driven by capacity added in 2013 and reflects a reduction from the original plan to increase ASKs by 19% on a year over year basis.

MAS ASKs were up 17% in 2013 while RPKs increased by 27% as the carrier pursued an aggressive fare strategy aimed at stimulating demand and improving load factors at the expanse of yield. This had a negative impact on its competitors, resulting in yield and profitability declines for every carrier in the Malaysian market – and significant losses by MAS itself. The same pricing strategy has continued so far in 1H2014 but the upcoming reduction in capacity, which is expected to be announced and implemented within the next few weeks, could be the impetus for a return to more rational pricing in the Malaysian market.

The outlook for AAX and MAA should improve as MAS inevitably cuts capacity. But the size of the improvement will depend on how much MAS cuts and how quickly. So far MAS management has indicated a rather small adjustment for 2014 is likely and has said Australia, where the carrier added significantly in late 2013, will still be up and account for virtually all international ASK growth for the full year. If this holds AAX may not see a significant improvement in market conditions this year.

But MAS may be forced to accelerate the capacity cut as it looks to reduce losses and avoid (or at least delay) a potential bankruptcy or substantial bail out from the Malaysian government, which for now does not seem receptive to pumping in further capital. Regardless of what happens, there will certainly not be a repeat of the 29% passenger growth that MAS recorded in 2013. The question is whether growth becomes flat or the expansion from last year is unwound, leading to a reduction in passenger numbers and the return to 2012 capacity levels. Under the latter scenario, AAX and MAA could be in the position to accelerate expansion.

Lion Air's Malindo may also respond to an MAS restructuring

MAA has not only been impacted by MAS’ rapid expansion and aggressive pricing strategy but also by the launch of new Lion Air Group Malaysian subsidiary Malindo Air, which commenced operations in Mar-2013. The outlook for MAA is heavily contingent on what happens with MAS as well as Malindo, which also has been slowing down expansion this year.

Malindo, which has not expanded its 737-900ER fleet so far this year, is a wild card. The Lion Group could potentially accelerate expansion at Malindo if there are opportunities in the aftermath of the MAS restructuring. But for now Lion is focusing more on expansion in the larger and better performing Indonesian and Thai markets. (Malindo has slightly expanded its ATR 72-600 fleet in 2014 but these are much smaller aircraft and are based at the old city airport of Kuala Lumpur Subang and compete primarily against MAS regional subsidiary Firefly.)

MAA initially responded to Malindo’s launch and MAS’ expansion aggressively with its own capacity increases, adding eight A320s in 2013 for a total 72 aircraft. But MAA and the AirAsia Group have made significant adjustments since the beginning of 2014 and now has a much more rational and conservative approach to growth in Malaysia as well as in other Southeast Asian markets, which have seen some of the same competitive pressures and overcapacity.

AirAsia plans a significant slowdown in growth as six more A320s are sold

In releasing 4Q2013 earnings in late Feb-2014 AirAsia announced it was deferring seven deliveries that were initially slated for 2014 and 12 deliveries that were initially for 2015. It also announced at the same time plans to sell in 2014 six of its oldest A320s.

See related report: Southeast Asia low-cost airline fleet to expand by almost 20% in 2014. Are more deferrals needed?

The group stated in its 1Q2014 results presentation on 20-May-2014 that it now intends to sell another six A320s in 2014 for a total of 12 aircraft. AirAsia plans to take a one-time MYR141 million (USD43 million) charge related to the disposal of these 12 aircraft, the first six of which are being removed from the group’s fleet during 2Q2014. The group also stated that it has sub-leased one A320 to a third party.

All 12 aircraft being sold are coming out of the fleet of MAA. But MAA is taking 16 aircraft, or two-thirds of the group’s 24 deliveries, in 2014 resulting in a net growth of only four aircraft. Of the other eight deliveries for the group, six are now earmarked for TAA, one for PAA and one for AirAsia India.

In the previous version of the 2014 fleet plan, announced in Feb-2014, MAA was earmarked to take 14 deliveries while selling six aircraft and moving four to AirAsia India. As a result there is no change in the net figure for MAA due to the most recent adjustment. AirAsia likely does not want to implement further fleet cuts in Malaysia given the pending restructuring at MAS.

AirAsia India has seen the biggest adjustment compared to the Feb-2014 plan as it no longer is planning to take the four aircraft from MAA (these aircraft are instead being sold). The group’s newly revised fleet plan currently allocates only one aircraft to AirAsia India, which has already been delivered and is being used for proving flights. The group could still again adjust its fleet plan to free up additional aircraft for AirAsia India, which was previously expected to take at least five aircraft in 2014, but for now the plan envisions not expanding in India beyond one aircraft until 2015. Much of the fleet planning decision will depend on if and when India's new government removes the 5:20 requirement, which would permit AirAsia India to operate internationally; at present the rules permit only domestic service.

The outlook for AirAsia India will be analysed in a separate report to be published by CAPA shortly.

The other main adjustment with the latest fleet plan has occurred with TAA, which is now slated to take six aircraft in 2014 (two in 1Q2014 and four in 2H2014) instead of the original plan for eight aircraft (two in 1Q2014 and six in 2H2014). This was already announced by TAA as part of its 1Q2014 earnings statement.

AirAsia plans to defer another 19 deliveries that were slated for 2015 to 2018

AirAsia also stated in its 1Q2014 results presentation that it is now discussing with Airbus deferring seven more deliveries intended for 2015 for a total of 19 deferrals when including the 12 deferrals for 2015 that were announced in Feb-2014.

This latest adjustment would give the group only 10 deliveries in 2015 compared to a current figure of 17 and an earlier figure of 29 (prior to the Feb-2014 announcement).

In addition AirAsia stated it is now discussing deferring six A320 deliveries now slated for 2016, 11 deliveries slated for 2017 and eight deliveries slated for 2018. This gives the group a relatively modest 20 to 22 aircraft per year after only 10 deliveries in 2015.

AirAsia Group revised A320 delivery schedule: 2015 to 2018

Having only 10 deliveries for 2015 is particularly a very conservative figure as it suggests there will be very limited or potentially zero fleet growth at the four existing affiliates in 2015. AirAsia India, which plans to launch services in 2H2014, could take most of these deliveries as it should be in the spool up phase in 2015.

Reducing fleet growth for the medium term is logical given the challenging market conditions in Southeast Asia and the fact that from 2016 the more efficient A320neo will be available. As was the case with the seven deferrals agreed to earlier in 2014, all the new deferrals for 2015 and 2016 and some of the deferrals for 2017 involve aircraft that were initially to be taken as A320ceos and will be now be taken as A320neos.

AirAsia plans to start taking A320neos in 2H2016. Originally it planned to take a mix of A320ceos and A320neos in 2017 but under the latest plan all the A320ceos that were slated for 2017 will be deferred, giving the group only A320neo deliveries in 2017. The significantly improved operating economics of the A320neo is clearly a driver – perhaps an even bigger driver than the challenging market conditions – as AirAsia wants to avoid having a large quantity of late model A320ceos, with the expected drop in value as the neos arrive.

But AirAsia faces the risk of competitors growing faster. The Lion-AirAsia battle is set to intensify

The AirAsia Group (excluding AirAsia X) ended 1Q2014 with a fleet of 157 A320s. The group now expects to end the year with a fleet of 167 aircraft. The newly revised fleet plan means the 200-aircraft figure will now not be reached until early 2017.

In comparison, the Lion Group currently operates 142 aircraft consisting of 107 737NGs, 33 ATR 72s and two 747-400s, according to the CAPA Fleet Database. Lion’s current fleet plan will see it reach the 200-aircraft figure in 2015. The Lion Group narrowbody jet fleet alone (737NGs and soon A320s) is now slated to reach the 200-aircraft figure in 2016, beating the expected timeframe for AirAsia’s A320 fleet reaching 200 aircraft. (The AirAsia X Group fleet, which is projected to reach 50 aircraft in 2018, is excluded from these figures.)

Competition between the AirAsia and Lion groups has intensified considerably over the past year as Lion has launched affiliates in Thailand and Malaysia. Lion has repeatedly stated it has no plans to defer deliveries or slow down expansion of the group. As a result the timeframe for Lion overtaking AirAsia has moved up considerably.

In an indication of the increasingly bitter rivalry between the two groups, AirAsia stated in a chart within its 1Q2014 results presentation that Lion has been grounding six to 10 aircraft at each hub, providing an indication of over ordering. Lion not surprisingly rejects the statement made by AirAsia, saying it is “completely untrue”. Lion says the group’s entire 737NG and ATR 72 fleets are currently in service except six 737s and three ATR 72s that are currently in heavy maintenance and that its average utilisation rates remain about 11hrs per day. (As CAPA previously reported, Lion did phase out its remaining 737 Classics earlier this year.)

See related report: Lion Air has opportunity to accelerate LCC growth in Indonesia after modest traffic gains in 2013

AirAsia is likely to re-accelerate fleet expansion at some point

It will not be surprising to see AirAsia eventually re-accelerate expansion. During previous downturns the group has announced large deferrals but in subsequent years re-accelerated, taking back some of the delivery positions that had been deferred. AirAsia’s strong relationship with Airbus gives it the considerable flexibility to make adjustments as its requirements and market conditions change.

Current market conditions dictate a more conservative approach. But Asia is a highly dynamic market and AirAsia is always ready to pounce if new opportunities emerge. In its home market of Malaysia these opportunities could come soon as MAS prepares to restructure. MAS is scarcely its only competition, but the group will derive a lot of comfort from being able to generate better profitability in what is still its anchor market.

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