02-Nov-2017 8:28 AM

Garuda Indonesia seeks a halt in aircraft delivery as focus shifts to utilisation, profitability

Analysis

Garuda Indonesia is aiming to halt all aircraft deliveries for two to three years as part of an initiative to improve its financial position. The group still intends to grow capacity by 10% to 12% per annum by improving utilisation of its existing fleet, which will result in lower unit costs and higher efficiencies.

Garuda has begun negotiations with manufacturers to defer A320neos, A330-900neos, 737 MAX 8s and ATR 72-600s. The group has set an objective of not taking delivery of a single new aircraft in both 2018 and 2019, including aircraft for its LCC subsidiary Citilink.

However, the objective seems unrealistic, particularly for most of the 2018 deliveries. Citilink will likely take three A320neos in 2018 as initially planned, since the buyer-furnished equipment has already been acquired. Garuda may, similarly, not succeed at entirely halting 737 MAX 8 deliveries after taking its first of the type in Dec-2017.

Garuda attempts to improve profitability

Garuda has been working on reducing costs and improving its profitability since the appointment of a new executive team in Apr-2017. In the first three quarters of 2017 the Garuda Indonesia Group incurred an operating loss of USD109 million and a net loss excluding extraordinary times of USD76 million. In the same period of 2016 the group had an operating profit of USD4 million and net loss of USD44 million.

Garuda expects to end 2017 in the red, marking the first annual net loss since 2014 and only the second annual loss this decade. However, the group's new executive team is confident that profitability can be restored in 2018. Garuda also expects to turn a profit in 2H2017, although this is not necessarily a good indicator because the second half of the year is typically much stronger than the first half for Indonesian airlines.

Over the past few months Garuda has cut costs by renegotiating contracts with suppliers, has improved efficiencies by boosting aircraft utilisation levels, and enhanced revenues by improving load factors, increasing seat density on 777s and implementing new revenue management systems. Garuda has also raised new capital by spinning off its maintenance business, and has conserved cash by shelving plans for expanding the international network.

Garuda aims to complete 30 contract renegotiations

Garuda is now stepping up efforts to reduce cost and improve efficiencies in order to meet its target of returning to full year profitability in 2018. The group stated in its 3Q2017 results presentation that it aims to complete contract renegotiations, further improve aircraft utilisation rates, and pursue a "solution" for its CRJ and ATR regional aircraft fleet.

Garuda has been seeking for a couple of years to reduce - or, ideally, phase out - its fleet of Bombardier CRJ1000 regional jets. A reduction in the ATR 72 turboprop fleet or order book is also possible.

The renegotiation of aircraft contracts - with both leasing companies and manufacturers - is a major component of the attempted turnaround, but is never an easy task. Garuda stated in its 3Q2017 results presentation that it aims to complete the renegotiation of 30 contracts with lessors and manufacturers by the end of 2017. As of the end of 3Q2017, it had completed the renegotiation of only nine contracts.

Garuda leases most of its current fleet and has contracts for additional new aircraft with three manufacturers - Airbus, ATR and Boeing. As of the end of 3Q2017, the group reported that it had operating leases on 178 aircraft.

Garuda seeks to defer all 2018 and 2019 aircraft deliveries

Garuda's director of production and board member Puji Nur Handayani told CAPA on the sidelines of the 25-Oct-2017 AAPA Assembly of Presidents that the group intends to halt all aircraft deliveries for two to three years "subject to negotiations". She said Garuda still plans to take its first 737 MAX 8 in Dec-2017, but the intention is to defer all additional 737 MAX 8s until at least 2020, and possibly 2021. Garuda also intends to defer delivery of its first batch of A330-900neos, as well as additional A320neos and ATR 72-600s.

Garuda currently has 103 aircraft on order, consisting of 50 737 MAX 8s, 30 A320neos, 14 A330-900neos and nine ATR 72-600s. The group's order book will be reduced to 100 aircraft by the end of 2017, as its fleet plan includes one 737 MAX 8 delivery and two ATR 72-600 deliveries in the last two months of the year.

The group's active fleet will grow to 194 aircraft by 31-Dec-2017, consisting of 10 777-300ERs, 17 A330-300s, seven A330-200s, 73 737-800s, 1 737 MAX 8, 45 A320ceos, 5 A320neos, 18 CRJ1000s and 18 ATR 72-600s. All the A320s are operated by Citilink, while the CRJ1000s and ATR 72-600s are under the regional brand Garuda Explore (but under the Garuda operator's certificate).

Garuda Indonesia Group fleet summary: as of 31-Oct-2017

Aircraft	In service	On order
Airbus A320-200	45	0
Airbus A320-200neo	5	30
Airbus A330-200	7	0
Airbus A330-300	6	0
Airbus A330-300E	11	0
Airbus A330-900neo	0	14
ATR 72-600	16	9
Boeing 737-8	0	50
Boeing 737-800	73	0
Boeing 777-300ER	10	0
Bombardier CRJ1000NG	18	0
Total:	191	103

Garuda has a large commitment for 737 MAX aircraft

The biggest impact from the aircraft deferral initiative will be on the 737 MAX 8, given that the MAX accounts for half of the group's total order book.

Garuda placed orders for 50 737 MAX 8s in 2014. It signed a letter of intent for another 30 737 MAX 8s in Jun-2015, which - if confirmed - would lift the commitment to 80 aircraft.

However, the 2015 deal, which also included 30 787-9s, was never completed, and at this point it is unlikely these aircraft will be converted to a firm order. In Jun-2015 Garuda also signed a letter of intent for 30 A350-900s, which was similarly never converted to a firm order.

Garuda was intending to grow the 737 fleet in 2018 and 2019

Garuda was initially planning to take several 737 MAX 8s in both 2018 and 2019 as part of a fleet plan that included a consistent stream of new-generation narrowbody aircraft for the next several years. However, most of the initial aircraft were earmarked for growth, while replacements for the existing 737-800 fleet were planned for next decade.

Garuda's 737-800 fleet is relatively young, with a current average age of only six years, according to the CAPA Fleet Database. Of the 73 737-800s in the Garuda fleet, 70 are eight years old or younger, while three aircraft are much older - approximately 16 years old. The entire fleet is leased.

Garuda has only one 737-800 lease expiring per year in 2018, 2019 and 2020, according to the group's financial filings. The rate of 737-800s coming off lease accelerates in 2021, when five aircraft are due to be returned.

Garuda may have a hard time negotiating near term 737 MAX 8 deferrals

Therefore, in order to meet its new objective of not growing the fleet over the next two to three years, Garuda needs to push back all 737 MAX 8 deliveries until 2H2020 or 2021. Negotiating deferrals will be challenging, particularly for the aircraft that were due be delivered in 2018. While other 737 MAX customers may be willing to accelerate deliveries and take Garuda's slots, some of these aircraft are already in production, with interiors likely already acquired.

Garuda could potentially negotiate early returns of 737-800s to offset 737 MAX deliveries. This would, in some respect, be more sensible as operating just one 737 MAX 8 for two to three years would be inefficient, and deferring deliveries of aircraft already in production could have cost implications.

However, negotiating early lease returns would also be challenging, and likely have near term cost implications, making it more difficult for Garuda to meet its target of returning to profitability in 2018.

A330neo deferrals can be more easily pursued

Deferring A330-900neos is a much easier proposition because Garuda is not planning to begin taking the new type until 2019. Other A330neo customers can potentially assume Garuda's 2019 and 2020 slots, particularly if there are delays in the A330neo programme.

Garuda placed orders for 14 A330-900neos in Apr-2016, and intends to use these aircraft mainly as A330ceo replacements.

Garuda's A330 fleet is eight years old, on average, but it has six older model A330-300s that are 20 to 21 years old. The rest of its A330-300s are one to four years old, while its A330-200s are all less than seven years old.

Garuda does not need to expand the widebody fleet

Garuda is not eager to expand its widebody fleet, since long haul expansion has proven to be challenging. Over the past several years Garuda has deferred, multiple times, its plans to launch more long haul flights, and has sensibly shifted capacity to charters, which are less risky and generally profitable.

Garuda now relies heavily on religious pilgrimage flights to Saudi Arabia (Hajj and Umrah) to keep its widebody fleet occupied. Ms Puji said Garuda currently has the equivalent of four 777-300ERs and four A330s allocated to the Saudi Arabia market. Garuda has also been operating regular charter flights to China.

Garuda recently phased out its 747-400 fleet, which was only used for Saudi Arabia over the past several years. Garuda has substituted 777s and A330s to replace the capacity the 747s generated, enabling it to improve utilisation of its widebody fleet. In its 3Q2017 results presentation, Garuda reported an average utilisation rate for its widebody fleet of 10hr58min as of Sep-2017, compared to an average rate of 10hr05mins as of Dec-2016.

Garuda's long haul scheduled operation has typically been the least profitable segment. Garuda is striving to improve the performance by adjusting existing routes and shelving plans for new routes. For example, on 31-Oct-2017 the airline dropped the Singapore stop on the Jakarta-London route and has retimed some Australia flights, resulting in convenient Australia-London one-stop connections.

Garuda still stops some Jakarta-Amsterdam flights in Singapore. However, Ms Puji said that the company was hoping to operate all its Jakarta-Amsterdam flights nonstop at some point next year, contingent on the completion of a runway resurfacing project at Jakarta.

Garuda retrofits 777s; removes first class in all but two aircraft

Amsterdam, London and Tokyo Haneda are the only international destinations other than Saudi Arabia now served with the 777-300ER fleet. Over the past few months Garuda has retrofitted six 777-300ERs, removing the first class cabin and adding 79 seats.

Eight 777-300ERs are now in high density 393-seat two class configuration, with 367 economy and 26 business class seats. The remaining two aircraft are in a low density 314-seat three class configuration, with 268 economy, 38 business and eight first class.

Garuda took delivery of its first eight 777-300ERs in three class 314-seat configuration, but in 2015 decided to take the last two aircraft in two class 393-seat configuration. These two aircraft have since been used for Saudi Arabia flights, and Garuda has opted for the same 393-seat configuration in retrofitting six of the original eight aircraft.

It would be sensible for Garuda to retrofit the last two 777s, which would improve efficiencies and make it easier to swap aircraft. Garuda is likely maintaining a first class cabin in the tiny sub-fleet for political reasons.

London is the only regular route now served with the 777s operating three classes. The retrofits enable Garuda to reduce unit costs and generate more revenues in the Amsterdam, Tokyo and Saudi Arabia markets.

Garuda re-evaluates international network expansion

Meanwhile, Garuda has shelved plans to launch services to Moscow and Los Angeles. Moscow and Los Angeles were initially in the network plan for 2017. At the beginning of this year Garuda was also considering the launch of Frankfurt or Paris in 2018.

CAPA stated, in its last analysis report on Garuda published in Mar-2017, that the international expansion plan was overambitious and not sensible, given that the airline was again unprofitable. "Garuda's management has determined that long haul expansion is strategically necessary, and it is willing to weather a prolonged period of losses. However, the reality is that Garuda does not need a long haul operation to succeed - or to raise its international profile", CAPA stated. "A much better and lower risk strategy is for Garuda to rely more on partnerships to cover long haul markets, and focus more on the opportunities closer to home."

Ms Puji said Garuda's international network expansion plan is now being "re-evaluated". The launch of new destinations, including Moscow and Los Angeles, has been postponed for the time being.

Garuda to continue growing capacity

Ms Puji added that Garuda still plans to expand international capacity over the next few years, despite not growing its fleet. However, this does not necessarily require new long haul destinations, since Garuda may instead choose to focus on expansion in existing markets.

She said the group expects overall ASKs will grow at a 10% to 12% rate per annum over the next three years, driven by aircraft utilisation improvements.

Similar growth is expected in both the domestic and international markets.

International capacity growth to accelerate slightly in 2018

International ASK growth of 10% to 12% represents a slowdown compared to 2016, when Garuda's international ASKs were up 20%. However, it represents a slight acceleration compared to 2017.

Through the first three quarters of 2017, Garuda's international ASKs were up by 7%. RPKs were up at a faster rate, resulting in a 4.3ppts improvement in load factor, although the airline's international load factor is still relatively low by global standards, at only 75.4%.

The 20% growth pursued under the previous management team in 2016 was overambitious, and significantly impacted profitability as both load factors and yields declined. Garuda cut international capacity in 2015 as part of an earlier restructuring following two years of double digit growth.

Garuda Indonesia international ASKs: 2010 to 9M2017

Domestic growth to be driven by Citilink

The 10% to 12% per annum capacity growth projected for the domestic market is a group figure. Garuda mainline is not planning to pursue significant domestic expansion over the next three years, whereas Citilink plans to continue expanding and to account for most of the group's domestic capacity expansion.

Garuda began slowing domestic expansion at the parent airline in 2016, following several years of rapid growth. Garuda's domestic ASKs were up by only 3.6% in 2016, and by just 1.5% in the first three quarters of 2017.

Garuda Indonesia domestic ASKs: 2010 to 9M2017

Ms Puji told CAPA that domestic market conditions had become "very tough" and the group's LCC brand is better placed to expand domestically, given the current environment.

Citilink's ASKs were up 22% in 2016 and have increased by at least 20% every year since 2011, when it took delivery of its first A320 and began accelerating expansion.

However, the rate of expansion has slowed this year, with Citilink's ASKs increasing by only 9% in the first three quarters of 2017. Citilink currently only operates schedule services in the domestic market, but it operates charters to China and Saudi Arabia and serves Timor Este on behalf of Air Timor.

Citilink ASKs: 2010 to 9M2017

Citilink has been planning to take 30 additional A320neos by 2021

The 30 A320neos on outstanding order are all intended for Citilink, which took delivery of its first A320neo in Feb-2017 and currently operates five of the type.

Garuda initially ordered 10 A320neos for Citilink in 2011, along with 15 A320ceos. In 2013 the group ordered another 25 A320neos.

Deliveries of the 35 aircraft are spread out from 2017 through 2021, but start with a relatively modest five aircraft in 2017 (already delivered) and just three aircraft in 2018. These eight aircraft are all from the original order from 2011. The rate of delivery is expected to accelerate from 2019 as the aircraft from the larger 2013 order are fulfilled.

See related reports:

Objective to defer 2018 A320neo deliveries is not realistic

Garuda's objective of deferring the three A320neos slated for 2018 is not realistic. Other A320neo customers could be interested in the slots, but Citilink has already acquired the buyer-furnished equipment (BFE) for these aircraft.

Citilink is also already in the process of completing sale leaseback transactions for its 2018 deliveries. Citilink leases most of its fleet, which consists of 45 A320ceos along with the five A320neos. Citilink has sold and leased back all five A320neos from Avolon, according to the CAPA Fleet Database.

Citilink initially operated 737 Classics and started transitioning to an Airbus fleet in 2011. The average age of the Citilink fleet is less than five years.

Most of Citilink's A320ceos were delivered new, although eight were leased as secondhand aircraft. Five 737-300s and three 737-500s are also still listed under Citilink in the Garuda Indonesia Group fleet figures - although these aircraft have been parked for several years - in order to meet Indonesian requirements, which stipulate that airlines must own at least 10 aircraft.

Garuda Group focuses on improving aircraft utilisation

Citilink has an opportunity to generate additional capacity through aircraft utilisation improvements - as is the case with the full service parent airline. Citilink's average aircraft utilisation rate is expected to improve in 4Q2017, but is still slightly less than 10 hours.

The average aircraft utilisation rate for the parent airline's single-aisle fleet (737-800s, CRJ1000s and ATR 72-600s) is approximately nine hours. Garuda has improved this rate slightly since the beginning of 2017, and is aiming for more significant improvements in 2018.

However, Garuda's ability to boost utilisation of the existing single-aisle fleet hinges on its success at deferring 737 MAX and ATR 72 deliveries.

If it ends up expanding its fleet, Garuda will have the difficult choice of accelerating capacity expansion or not meeting its utilisation target. Both would impact profitability, making it difficult to complete the attempted turnaround.