Malindo Air Part 2: new all economy 737 MAX fleet results in more direct competition with AirAsia

In this half of the report CAPA will examine in detail how the 737 MAX 8 fits into the Malindo network and should improve its performance on several medium haul routes.

See related report: Lion Group's Malindo Air opts for single class configuration on 737-8 as MAX deliveries begin

Malindo's network consists of 50 routes

Malindo operates nearly 50 routes across a network of 33 international and 13 domestic destinations (based on OAG schedules for the week commencing 17-May-2017). This includes 11 turboprop routes (nine domestic and two international) and 38 jet routes (six domestic and 32 international).

Its main hub at Kuala Lumpur International Airport (KLIA), where Malindo bases its entire 737 fleet, features 34 routes (28 international and six domestic) and a high portion of transit traffic. Malindo bases its entire ATR 72 turboprop fleet and focuses on local point-to-point traffic at Kuala Lumpur's close-in secondary airport, Subang, which features eight routes (seven domestic and one international). Malindo also a limited number of point-to-point routes bypassing Kuala Lumpur, including three Penang-China routes, Kota Kinabalu-Taipei, Malacca-Pekanbaru (Indonesia), Malacca-Penang and Johor Bahru-Ipoh.

Malindo has expanded rapidly since commencing services in Mar-2013. It added 10 international routes in 2016, and so far in 2017 has added another seven international routes (Kuala Lumpur to Chittagong, Guangzhou, Yangon; Kuala Lumpur to Brisbane via Bali; Kuala Lumpur to Jeddah via Ahmedabad; Kota Kinabalu-Taipei; and Penang-Haikou), while suspending one international route (Kuala Lumpur to Chiang Mai).

It has also suspended two domestic routes from KLIA, to Johor Bahru and Miri, which had been relaunched in 2016. Malindo has added frequencies on several existing routes, which has more than offset capacity reductions on a few routes.

Malindo expanded its fleet by 15 aircraft in 2016. In 1H2017 Malindo is adding another seven 737s, including three 737-800s in 1Q2017 and four 737 MAX 8s in 2Q2017. The first 737 MAX 8 was delivered on 16-May-2017 and will enter service on 22-May-2017, as CAPA highlighted in the first part of this report.

Malindo operates more than 12 medium haul routes of over four hours

Malindo has always provided a full service product with complimentary meals, drinks and checked luggage on all its jet flights. It will continue to offer the same full service product on routes served by the new 737 MAX 8 fleet, although these aircraft will be the first jets in the Malindo fleet without a business class cabin and (initially) without any IFE.

Turboprop flights have a lower baggage allowance and do not offer meals, IFE, or a business class cabin, but are all very short in duration. Malindo's longest ATR route is only 1hr 20min and most of its turboprop flights are less than an hour.

Malindo's longest 737 routes are approximately six hours - Kuala Lumpur to Lahore and Bali to Brisbane. Lahore was launched in early 2016, and the Bali-Brisbane route was launched in late Mar-2017 as a tag to one of its four daily Kuala Lumpur-Bali flights.

Malindo has more than 10 other routes of four hours or longer - including five of its six India routes, three of its five China routes, Kathmandu, Taipei, Perth and both legs of its Kuala Lumpur-Ahmedabad-Jeddah service. (Ahmedabad is not counted as one of Malindo's six destinations in India as Malindo does not pick up any passengers in Ahmedabad, only using the airport as a fuel stop.)

Malindo's other two China routes (to Haikou and Sanya on Hainan Island in southern China), its other India route (Tiruchirappalli), both its Bangladesh routes, Hong Kong and Colombo are three to four hours long. Its domestic and regional routes within Southeast Asia are all three hours' duration or less.

Malindo Air number of weekly departures by flight length: 15-May-2017 to 21-May-2017

Source: CAPA - Centre for Aviation & OAG

Malindo also operates a large number of short routes

Approximately half of Malindo's flights are one hour or less but this figure is skewed by the turboprop operation, which provides a high level of frequencies on short domestic routes from Subang, but much less capacity proportionally.

Four of Malindo's six domestic jet routes from KLIA are also less than an hour long as they are to destinations within peninsular Malaysia (that are also served from Subang with turboprops). Its other two domestic routes from KLIA - Kuching and Kota Kinabalu in east Malaysia - are significantly longer, but still under three hours.

KLIA to Singapore and Medan are Malindo's shortest international jet routes. Both have block times of approximately one hour.

Malindo is launching a second route to Singapore, from Penang, on 22-Jun-2017. Malindo plans to operate this route with 737-800s and is offering a business class product, despite the short length.

Malindo now uses a mix of 737-800s and 737-900ERs on its four daily Kuala Lumpur-Singapore flights. As highlighted in the first half of this report, Malindo only intends to use the single class 737 MAX 8 on the Kuala Lumpur-Singapore temporarily and will primarily use the new type on longer routes, where the fuel savings are much more pronounced compared to the 737NG.

Malindo sets launch dates for first 737 MAX flights to Dhaka and Lahore

Malindo has scheduled some Kuala Lumpur-Singapore and Kuala Lumpur-Langkawi 737 MAX flights through Jun-2017 but these are likely for training and operational purposes. Typically with a new aircraft type an airline will operate several short sectors before transitioning to longer routes.

As CAPA highlighted in the first report in this series, Malindo is planning to use its initial fleet of four aircraft to serve Dhaka in Bangladesh, Kathmandu in Nepal and Lahore in Pakistan. On 17-May-2017 (after the first part of this report was published) Malindo set a 23-May-2017 launch date for 737 MAX flights to Dhaka and a 1-Jun-2017 launch date for 737 MAX flights to Lahore.

A launch date for 737 MAX flights to Kathmandu has not yet been set but will likely be set later once Malindo has firm delivery dates for its third and fourth aircraft. These aircraft are now slated to be delivered in Jun-2017 and should enter service by early July-2017, enabling the launch of 737 MAX flights to Kathmandu and to secondary destinations in China and India.

Kuala Lumpur-Dhaka performance will improve with 737 MAX

Malindo's decision to go with a single class configuration on some of its 737s is not too surprising, in that it has several markets where it has struggled to fill its business class cabin. After four years of operations Malindo should have a good grasp of which market would benefit financially from an all economy operation.

For example, Dhaka was Malindo's very first international route, having been launched back in Aug-2013. Malindo began serving Dhaka with one daily flight and has consistently added capacity, with some seasonal fluctuations.

Malindo now serves Kuala Lumpur-Dhaka with three daily 737-800 flights, generating 3,402 weekly one way seats. Malindo is the market leader with a 29% share of Kuala Lumpur-Dhaka seat capacity, compared to 23% for Biman Bangladesh, 19% for Malaysia Airlines, 11% for AirAsia, 9% for Bangladesh's Regent Airways and 9% for US Bangla Airlines.

All three Bangladesh based airlines and Malaysia Airlines also operate two class 737NGs on the Kuala Lumpur-Dhaka route, whereas AirAsia uses single class A320s.

Kuala Lumpur-Dhaka one way weekly seat capacity by airline: Sep-2011 to Nov-2017

Source: CAPA - Centre for Aviation & OAG

Switching from the 737-800 to 737 MAX 8 will enable Malindo to increase capacity on each Dhaka flight by 11% while reducing trip costs as a result of the significant reduction in fuel burn. This should enable Malindo to compete more effectively in an extremely competitive price sensitive market now served by six airlines, resulting in an improved financial performance.

AirAsia and Malindo fares on Kuala Lumpur-Dhaka start at slightly more than USD200 return including taxes. Malaysia Airlines and the three Bangladeshi carriers also offer return fares starting at less than USD300. Malindo generally offers the best value, given that it often has the lowest fare among the full service competitors, and also sometimes undercuts AirAsia.

Malindo offers 35kg of checked bags on this route (more than any other airline), food, and drinks. However with such low fares and a roomy full service product this route may not be profitable. With the 737 MAX 8, Malindo will reduce its unit costs on the route, potentially enabling it to turn a profit, even with the very low fares it needs to offer to fill up the more than 3,000 one way seats it now has in this highly competitive market.

Malindo could retain a business class product on some Dhaka flights

Malindo will lose 12 business class seats for each Dhaka flight that transitions to the 737 MAX - or up to 252 one way business class seats per week. However, these seats have not been selling well, and the yield premium Malindo generates for business class does not justify offering business class unless at least half the business class cabin can be filled. Malindo is better off trying to sell the 30 additional economy class seats per flight that the 737 MAX 8 will generate.

Malindo is retaining a business class product in the Dhaka market by continuing to operate one of its three Dhaka flights with 737-800s. Two of Malindo's Dhaka flights operate within two hours of each other - providing an ideal scenario, initially, to upgrade one flight to the MAX 8 while retaining the two class 737-800 on the other flight.

By switching one of these flights to the MAX 8 it is easy to reaccommodate those passengers already booked on business class by switching them to the other flight. Maintaining at least one Dhaka flight with business class also enables Malindo to continue competing with Malaysia Airlines (and the three Bangladeshi competitors) for premium passengers, while competing more effectively against AirAsia for economy passengers.

737 MAX could also improve Malindo's position in the Kathmandu market

Malindo will likely later transition to the MAX 8 one of its two daily flights from Kuala Lumpur to Kathmandu. As is the case with Dhaka, retaining one Kathmandu flight with 737-800s or 737-900ERs would enable Malindo to maintain a premium presence.

Malindo now uses a mix of 737-800s and 737-900ERs on the Kathmandu route. Switching from the 737-900ER to the smaller 737 MAX 8 would enable Malindo to maintain total seat capacity but increase economy capacity by 11% and reduce trip costs, while removing business class.

As is the case with Dhaka, there is relatively limited premium demand in the Kathmandu market. Most Kuala Lumpur-Kathmandu (and Dhaka) passengers consist of migrant workers and ethnic traffic. Malindo also attracts significant transit traffic beyond Kuala Lumpur, but most of these passengers are also migrant workers or price sensitive leisure passengers heading to Nepal for holiday. Malindo's business class fares on Kuala Lumpur-Kathmandu start at less than USD600 return.

Kuala Lumpur-Kathmandu has been a successful route for Malindo, and Malindo upgraded the route from 11 to 14 weekly frequencies in Apr-2017. Malindo is now the market leader, with a 37% share of seat capacity, compared to 22% for AirAsia X, 16% for Malaysia Airlines, 16% for Himalaya Airlines and 9% for Nepal Airlines. All five competitors have small business class cabins on their Kuala Lumpur-Kathmandu flights.

Kuala Lumpur-Kathmandu one way weekly seat capacity by airline: Sep-2011 to Nov-2017

Source: CAPA - Centre for Aviation & OAG

An all economy product would enable Malindo to compete more effectively and justify the low fares it now offers in this market. Malindo is offering Kuala Lumpur-Kathmandu fares starting at approximately USD350 return, while AirAsia X and Malaysia Airlines fares start at approximately USD400.

Kuala Lumpur-Lahore route is an ideal test for the 737 MAX

Kuala Lumpur-Lahore, the other South Asia route Malindo is planning for its initial fleet of 737 MAX 8 aircraft, is a bit more challenging as it is only served with five weekly flights. Therefore, Malindo will stop offering a premium product in this market entirely when it introduces the MAX on the Lahore route on 1-Jun-2017, and will have to to refund, or reaccommodate in economy, those passengers who have already booked business class.

However, Lahore has limited premium demand and therefore, not many passengers will be impacted. Kuala Lumpur-Lahore is also an ideal route for the MAX given its long length - it is more than two hours longer than to Dhaka, and more than one hour longer than the Kathmandu route.

Malindo is keen to test out the MAX on a route of five hours or longer to fully assess the fuel burn savings the new aircraft can generate. Boeing and other future 737 MAX operators will also be keen to view the results.

Malindo was serving Lahore daily until end Mar-2017. The recent reduction to five weekly flights indicates the route may be performing poorly. The switch to the 737 MAX 8 could significantly improve its long term viability.

Malindo competes in the Kuala Lumpur-Lahore market against Pakistan International Airlines (PIA), which only offers one weekly nonstop flight on the route using 777s. However, PIA is also able to offer a one stop product via Karachi two days per week. Malindo and PIA offer return fares in the Kuala Lumpur-Lahore market starting at approximately USD400; Thai Airways also has similar fares in this market via Bangkok.

Tiruchirappalli and Kochi could be next for the 737 MAX

Routes to secondary cities in India would be logical routes for the all economy 737 MAX as they also have limited premium demand. Tiruchirappalli would particularly be appealing as Malindo operates three daily flights to Tiruchirappalli, making it easy to transition one or potentially two frequencies from the 737-800 to 737 MAX 8 while maintaining a small premium presence in the market.

Malindo increased Tiruchirappalli from 18 to 21 weekly flights in Apr-2017. At almost the same time AirAsia added a fourth daily flight from Kuala Lumpur to Tiruchirappalli. A switch to the all economy MAX 8 would enable Malindo to compete better in this growing and relatively large ethnic market (a large portion of the Indian community in Malaysia has ties to this part of India).

AirAsia and Malindo both offer return fares of only slightly more than USD100 in the Kuala Lumpur-Tiruchirappalli market. They are the only nonstop competitors, but the relative high level of capacity means the competition is cut throat.

Kuala Lumpur-Kochi would also be a logical route for the all economy aircraft, given that it has limited premium demand and AirAsia is the only nonstop competitor. Malindo decreased Kochi from 11 to seven weekly flights effective 15-May-2017 - an indication that the route may be struggling with the current two class configuration. AirAsia operates the route with two daily flights. Fares on Kuala Lumpur-Kochi are similar to those on Kuala Lumpur-Tiruchirappalli, starting at slightly more than USD100 return on both AirAsia and Malindo.

Malindo's other two secondary destinations in India are served less than daily, making it a bit harder to switch to the MAX 8 if Malindo wants to maintain a premium product on some frequencies. Amritsar is currently served with five weekly frequencies and Trivandrum with four weekly flights. Malindo is the only airline operating nonstop flights in these smaller markets.

Malindo also serves Delhi and Mumbai, but it should maintain these services with two class aircraft as there is more premium demand in the metros. There are also seat capacity limits on routes to Indian metros under the India-Malaysia bilateral, which would force Malindo to reduce frequency if it goes with higher density aircraft. Malindo currently serves Delhi with 11 weekly flights and Mumbai with eight weekly flights.

Secondary cities in China are also likely destinations for Malindo's MAX

Malindo may also use its initial batch of 737 MAX 8s to serve secondary cities in China. It currently serves four secondary cities in China - Guiyang, Haikou, Sanya and Wuhan. It also serves Guangzhou, but Guangzhou is a much larger market with premium demand, and therefore will continue to be served with two class aircraft.

Guiyang, Haikou, Sanya and Wuhan are served with two or three weekly flights each, while Guangzhou is served daily. Haikou, Sanya and Wuhan are served from Penang, while Guiyang and Guangzhou are served from Kuala Lumpur. All of Malindo's China routes except Guangzhou are almost entirely block booked by Chinese travel agents. The agents working with Malindo on these flights would likely prefer a higher density all economy product, since they are offering Malaysia holiday packages to price sensitive Chinese residents, with limited premium demand.

Malindo has been looking at launching services to other secondary cities in China such as Kunming, which also has relatively limited premium demand. AirAsia serves the Kuala Lumpur-Kunming route along with the Chinese LCC Lucky Air.

No airline competes directly with Malindo on the Penang to Haikou, Sanya and Wuhan routes or Kuala Lumpur-Guiyang, but AirAsia X recently launched Kuala Lumpur-Wuhan. Malaysia Airlines also launched Kuala Lumpur-Haikou in early 2017 and is launching Kuala Lumpur-Wuhan in Jun-2017 as part of a major expansion to secondary cities China.

Malindo's only other routes to North Asia are Kuala Lumpur to Hong Kong and Taipei and Kota Kinabalu to Taipei. The Kuala Lumpur-Hong Kong and Kuala Lumpur-Taipei routes have relatively strong premium demand, and would not be suitable for single class aircraft. However, Kota Kinabalu-Taipei and potential new routes from Kota Kinabalu to North Asia are leisure focused routes that would be well suited for all economy aircraft.

Malindo needs higher density aircraft to compete effectively

The decision to go with a number of all economy aircraft is sensible, given the overall environment in the Malaysian market. Intensifying competition in Malaysia - and regionally - has pressured yields. Switching to an all economy configuration enables Malindo to compete more effectively, particularly against AirAsia and other LCCs.

Malindo has a low cost structure, particularly so for a full service airline, but AirAsia's costs are even lower, and are generally considered to be the lowest in Asia. Operating all economy aircraft enables Malindo to narrow the gap with AirAsia on select routes. The routes where Malindo will operate the 737 MAX have extremely low fares and limited premium demand, making it nearly impossible to be profitable with the current roomy two class configuration.

Several Asian LCCs are opting for higher density aircraft as new generation narrowbodies are introduced. For example, AirAsia has increased seating density from 180 to 186 seats with the A320neo, which it began taking in 2016. AirAsia will also take delivery of A321neos, which will be able to seat up to 240 passengers, from 2019.

Malindo may feel a need to respond with a higher density configuration of its own. Malaysia Airlines has also been evaluating the conversion of some of its 737-800s to a single class configuration, which would be used primarily on new secondary routes to China.

Instead, Malindo should have opted for single class configuration on some 737NGs

However, Malindo's decision to opt for a single class configuration on its 737 MAX 8s, rather than on some of its existing 737NGs, is somewhat surprising. A single class 737-800 or 737-900ER would offer more flexibility and also allow Malindo to provide a single class product on short routes where there is limited premium demand, as well as on medium haul routes to South Asia and China.

For example, Malindo could improve its financial performance on several domestic routes, and leisure focused regional international routes such as Bali and Phuket, if it could go with a higher density all economy configuration. Malindo would also be able to consider resuming several short haul routes that have been suspended. For example, Kuala Lumpur to Johor Bahru and Miri, which were suspended for the second time earlier this year, could be more viable with single class aircraft.

Using the MAX 8 on short routes would be uneconomical, and a waste of an asset that is more expansive to acquire or lease than the 737-800. Malindo is sensibly planning to use the MAX 8 only on longer routes, where it is able to extract the efficiency benefits of the re-engined aircraft better, and cover the higher monthly lease rates. However, at least for the time being, this means that Malindo has to retain a business class product across all its short haul routes, including short haul routes that would benefit from a denser single class configuration.

Malindo may need more configurations to optimise its network fully

Malindo also has, potentially, six to seven and a half hour routes which have premium demand but cannot be launched, therefore. These routes are out of the range of Malindo's two class 737NGs; there are within the range of 737 MAX 8, but an all economy product would not be viable. Some of these potential new routes are also too thin for Malindo's future fleet of A330-300s, which will be delivered from 4Q2017 in two class configuration.

With the addition of the A330-300 and 737 MAX 8, Malindo will be operating four types of jets in four different configurations by the end of 2017. This will provide a better range of options to meet supply and demand compared to the current fleet of dual class 737-800/900ERs, which works well on some routes but is not ideal for other routes.

Malindo should look at taking delivery of some future 737 MAX aircraft in dual class configuration as this would enable it to pursue new routes (primarily to North Asia, including South Korea and Japan) with premium demand. While Malindo has decided on a single class configuration for all four of its 737 MAX 8 deliveries in 2017, there will be an opportunity to configure 737 MAX aircraft that will be delivered in 2018 with two classes. The Lion Group has not yet allocated its 2018 deliveries, but Malindo will likely receive several additional 737 MAX aircraft, including larger 737 MAX 9s.

Malindo should also examine retrofitting some of its existing 737-800s and 737-900ERs to being all economy seating, or take delivery of additional 737NGs in an all economy configuration. This will provide more flexibility and enable Malindo to compete more effectively with AirAsia on short haul routes.

Juggling several 737 configurations may not be easy. However, in the current highly competitive and low yield environment it is necessary to do everything feasible to reduce costs and improve load factor. Malindo has reached the size - with a relatively large and diverse international network - to justify a mixed fleet.