VietJet Air SWOT: rapid success and growth in booming Vietnam, but future challenges

STRENGTHS

A) Vietnam has emerged as one of the world's fastest growing markets

VietJet's timing was impeccable: it launched just as Vietnam was on the cusp of rapid economic growth. Vietnam's GDP has grown by at least 5% every year since VietJet's launch, with 6%-plus growth achieved in 2015 and 2016.

Income levels and the middle class population have expanded, putting air travel within the reach of a significantly higher proportion of Vietnam's 93 million citizens. Demand has been further stimulated as air fares, which were already relatively low, have been reduced to levels that are now, on most domestic trunk routes, similar to bus or train fares.

The Vietnamese population, which is young and increasingly urban, has naturally traded in long bus and train journeys for domestic flights. Vietnam is a long and thin country with poor highway and rail infrastructure, making for long and arduous journeys between most cities.

Vietnam has been one of the fastest growing markets in Asia - and the world - since VietJet launched. The domestic market has grown from only 12 million passengers in 2012 to 28 million passengers in 2016, which equates to a staggering average per annum growth rate exceeding 30%.

The total Vietnamese aviation market (including international traffic) has more than doubled in size, from 25 million passengers in 2012 to 52 million passengers in 2016. The Civil Aviation Authority of Vietnam reported passenger traffic growth of another 20% in 1H2017, to 30.3 million.

Vietnam aviation market size in annual passengers (millions): 2011 to 2016

Source: CAPA - Centre for Aviation and CAAV.

VietJet has driven a large portion of the growth, particularly in the domestic market. However, its local competitors, and foreign airlines, have also expanded rapidly and benefitted from the surging demand.

VietJet has not had to entice away passengers that were already flying with other more established airlines. It has relied mainly on attracting first time and infrequent fliers, and has been able the ride the coattails of a booming market by offering lots of seats at low fares. VietJet has accounted for approximately 70% of the growth in the domestic market since 2012.

B) VietJet has quickly captured significant market share

VietJet has evolved from start-up to market leader in an incredibly quick time frame. In 2016 VietJet flew as many domestic passengers as Vietnam Airlines, with both capturing approximately 42% shares of the domestic market.

For a medium sized domestic market (over 20 million passengers), capturing a leading share in just five years is a remarkable accomplishment. In the similarly sized Philippine domestic market it took the LCC Cebu Pacific more than a decade to overtake Philippine Airlines. Even AirAsia took six years to capture a leading share of the domestic market in Malaysia (which at the time was much smaller).

While VietJet is not the first LCC in Vietnam it essentially has first mover advantage, which has proven to be a critical attribute in virtually all Asian markets. Jetstar Pacific became Vietnam's first LCC in 2008 as the former Pacific Airlines rebranded and adopted the LCC model. But it languished for several years, and did not start pursuing any expansion until 2013, at which point VietJet had already become Vietnam's largest LCC.

In 2016 Jetstar Pacific captured only slightly more than 14% of the domestic market. VietJet had nearly three times as many domestic passengers, and hence captured nearly a 75% share of the LCC market. Jetstar Pacific and Vietnam's only other airline - the turboprop operator VASCO - are both part of the Vietnam Airlines Group, which has generally been a weak competitor. Vietnam Airlines has continued to grow in the domestic market, but was initially very slow to respond to VietJet.

Vietnam domestic market share by airline: 2011 to 2016

Note: Air Mekong suspended operations in 2013.
Source: CAPA - Centre for Aviation, company reports and CAAV.

In 2016 VietJet captured a less than 10% share of the Vietnamese international market and a 27% share of the total Vietnamese market. Vietnam Airlines still has a much larger share of the total market, since it is much larger than VietJet in Vietnam's international market.

However, VietJet is starting to focus more on international expansion and could eventually overtake Vietnam Airlines in this category as well.

Vietnam total market share by airline: 2013 to 2016

Source: CAPA - Centre for Aviation, company reports and CAAV.

VietJet carried slightly more than 14 million passengers in 2016, including approximately 12 million in the domestic market. Its traffic was up another 22% in 1H2017, to 8.3 million. VietJet expects to carry 17 million passengers for the full year in 2017, carry 25 million passengers in 2018, and reach the 30 million milestone in 2019.

VietJet Air annual passenger traffic: 2013 to 2019*

Note: *2017, 2018 and 2019 figures are projected.
VietJet carried approximately 1 million passengers in its first 13 months of operations (Dec-2011 through Dec-2012).
Source: VietJet 2Q2017 financial report

C) Low unit costs

VietJet has one of the lowest unit costs in Asia - and the world. In 1H2017 its CASK was less than USD4 cents.

VietJet Air CASK and ex fuel CASK (in USD cents): 2013 to 1H2017

	2013	2014	2015	1H2016	1H2017
CASK	5.30	5.04	4.14	3.81	3.89
Ex fuel CASK	2.57	2.48	2.42	2.43	2.25

Of the publicly listed short haul LCCs, only AirAsia, Wizz Air, Ryanair and Cebu Pacific have CASK at, or under, USD 4 cents.

VietJet expects to reduce its CASK further as it expands its fleet. A larger fleet generates higher economies of scale, but more significantly, VietJet is upgauging its fleet to higher density narrowbodies.

It has mainly taken A321ceos over the past two years and was the launch operator of a new 230-seat configuration. It plans to start taking delivery of its first batch of A321neos in late 2017 or early 2018. From 2018 the A321neos will be delivered in a new 240-seat configuration.

Low costs are crucial in Vietnam, as it is generally a price sensitive market with very low yields. As competition in Vietnam intensifies, and new LCCs potentially enter, VietJet's scale and very low costs will be an important competitive advantage.

The low costs have enabled VietJet to establish profitability at a very early stage. It has been profitable since mid 2013, and profits have since increased steadily. VietJet reported a doubling of its pre-tax profit for 2016, to VND2.239 trillion (USD106 million). In 1H2017 its pre-tax profit increased by another 45%, to VND1.907 trillion (USD84 million).

D) Ancillaries

Ancillary revenues, which are a key component for most successful LCCs, have also helped VietJet achieve profitability at an early stage.

Ancillaries now account for over 23% of VietJet's revenues. A small number of LCCs rely on ancillaries for more than 30% of total revenues, but 23% is a very respectable showing for a relatively new airline, particularly in Asia, where ancillaries are typically lower.

VietJet ancillary revenues as portion of total revenues: 2013 to 1H2017

2013	2014	2015	1H2016	1H2017
16.4%	17.3%	22.3%	22.6%	23.3%

Source: CAPA - Centre for Aviation and company reports.

In 1H2017 VietJet generated USD13.60 in ancillary revenue per passenger. This represented a 20% increase over 1H2016, when it generated USD11.30 in ancillary revenue per passenger.

VietJet has a typical no frills model and charges for extras such as checked bags, food, drinks and seat assignments. In 2015 it also launched a premium product, SkyBoss, aimed at business passengers, which provides preferred seating, priority boarding and lounge access.

Approximately 80% of its ancillaries are generated from ancillary fees. Cargo, the sale of advertisements on its aircraft, and inflight merchandise (including duty free on international flights) account for the remaining 20%.

VietJet believes it can continue to increase ancillary revenue as it expands its offering to include more non core or non flight items. VietJet is particularly keen to develop new ecommerce platforms that will enable passengers to book flights and other items using social media and partners such as Google and Facebook.

E) Strong local brand and distribution

VietJet has quickly established a strong and well recognised brand in Vietnam. A study the airline commissioned in 2015 concluded that the airline had 96% brand awareness in Vietnam, with an overall satisfaction rating of 88%. VietJet is working on launching a loyalty programme, which should further improve VietJet's position in its home market.

Effective use of social media, sponsorships and publicity stunts such as the inflight bikini show from 2012 (which was a hit on Youtube) have helped VietJet succeed in the domestic market. VietJet also has a strong local distribution through a network of 1,300 local agents.

The travel agent network is key, as most passengers in Vietnam still use agents rather than booking directly on the Internet. Agents account for more than two thirds of all VietJet bookings.

As the network of agents is managed directly by VietJet without involving GDSs, the cost is low. VietJet also stopped paying commissions to agents in 2015. It still pays incentive fees to agents, and those fees account for approximately 0.3% of its total costs. However, this is manageable, and VietJet's total cost of distribution is very low, enabling it to keep its costs down and offer very low fares.

WEAKNESSES

A) JV strategy

From an early stage Vietjet discussed with potential JV partners the establishment of LCCs in other Asian markets. However, several potential JVs failed to materialise, and the only JV it has so far forged (in Thailand) has encountered multiple setbacks.

Thai VietJet was initially established in 2013, but only launched scheduled services in Sep-2016. The new airline was initially delayed for one year before launching charter flights in late 2014, and was delayed for nearly another two years in securing approval for scheduled flights. In the meantime, VietJet had a falling out with its initial local partner - the Thai regional airline Kan Air.

Kan sold its majority stake to a new group of Thai investors in early 2015. In 1H2016 VietJet also sold most of its stake to a new Vietnamese investor. VietJet now only has a 9% stake in Thai VietJet, making it essentially a passive investor.

Thai VietJet is a tiny player in a crowded LCC market. It currently operates three aircraft and three domestic routes, with plans to add a fourth route in late Oct-2017.

Thai VietJet will have to overcome stiff competition from Thailand's three more established short haul LCCs to succeed. Domestic trunk routes and most of the main international regional routes now suffer from overcapacity. Thailand is a huge and growing market, but VietJet is a latecomer to the Thai market, and has a relatively unknown brand in Thailand.

VietJet continues to consider JV opportunities in other countries. However, it will face challenges virtually anywhere it sets up shop as LCCs already have significant presences in all major Asian markets. VietJet seems to want to adopt a similar JV strategy to those of the leading Southeast Asian LCC groups - AirAsia and Lion. It needs other markets in order to place all of the nearly 200 aircraft it has on order.

VietJet Group fleet and order book: as of 4-Oct-2017

Aircraft	In Service	Inactive	On Order
Airbus A320-200	28	0	0
Airbus A320-200neo	0	0	42
Airbus A321-200	15	0	19
Airbus A321-200neo	0	0	31
Boeing 737-8 200	0	0	100
TOTAL	40		192

Note: excludes wet leased aircraft.
Source: CAPA Fleet Database.

However, the reality is that there is not enough room for a third pan regional group. The LCC sector in Asia has become extremely crowded and fiercely competitive. VietJet had impeccable timing for Vietnam, but is too late to join the party in other countries.

B) Low fares and poor yield management

Vietnam has some of the lowest domestic fares in the world. Fares were already low before VietJet's entry, due in part to government regulations, and have become even lower as VietJet has expanded.

VietJet's average fare in 2015 dropped by 17%, to only VND815,725 (USD36), as domestic competition intensified. Its average fare has since increased slightly in 2016, driven by a larger international operation. Domestic fares remain extremely low.

Domestic fares in Vietnam are very low across all buckets, including fares for last minute bookings. Fares typically only reach rational levels during peak periods such as the Vietnamese New Year, Tet. However, even during the Tet 2017 travel period VietJet had to offer 40% discounts to stimulate demand.

Fares are unlikely to increase anytime soon, given the intense competition and capacity situation. Vietnamese airlines also do not seem to have much interest in pursuing more sophisticated yield management techniques in the domestic market.

VietJet has a simple reservation system that further limits its ability to maximise ticket revenues. The system is so basic that when a new destination is added it is sent to the bottom of the list on its web booking engine, rather than appearing in alphabetical order.

C) Weak brand and distribution outside Vietnam

As CAPA has highlighted in the last section on strengths, VietJet has a strong local brand and distribution network. However, outside Vietnam the situation is the opposite, and the airline is a relatively unknown commodity.

As VietJet starts to expand more in Vietnam's international market it will have to overcome this weakness. There are huge opportunities in the international market, but Vietnam is a bigger inbound, rather than outbound, market. In 2016 there were 10 million inbound visitors and 5.6 million outbound travellers (includes visitors and travellers which did not arrive or depart by air).

VietJet can leverage its local brand and distribution network to sell outbound international tickets, and several of its initial international destinations are large outbound markets. However, in order to meet its ambitious growth target, it will have to succeed at penetrating the inbound international market.

So far, it has relied heavily on charters to serve inbound focused international markets - in particular, mainland China. Charters have been attractive, as they do not require local distribution and have no risk. VietJet will start to take on more risk as it adds more scheduled services in markets that have limited outbound traffic.

Establishing its brand and developing a distribution network in overseas markets will be expensive and challenging. It will need to rely more on GDSs, which are expensive. It will also have to overcome stiff competition from foreign airlines, which are also expanding rapidly in Vietnam.

Foreign airlines carried approximately 12 million passengers to and from Vietnam in 2016, up more than 20% compared to 2015. Several foreign airlines are planning to expand in Vietnam and have the advantage of stronger brands - in their home markets, as well as in sixth freedom markets beyond their hubs.

D) Sale and leasebacks

VietJet has relied almost entirely on sale and leasebacks since late 2014, when it began taking aircraft directly from Airbus. VietJet has since taken 28 aircraft from its order with Airbus, and has sold and leased back nearly every aircraft.

Sale and leasebacks are typically attractive to LCC start-ups as they generate an immediate profit. However, over the long term they can turn into a weakness, since airlines profiting from sale leasebacks end up paying higher than average rental rates as their aircraft age, and are saddled with high one time costs when it comes time to return the aircraft.

VietJet's profits have surged since 2015 as the number of sale and leasebacks deals completed has increased. VietJet reported a gain of VND518 billion (USD23 million based on current exchange rate) from sale and leasebacks in 2015, which accounted for 33% of its total operating profit. The airline generated a gain of VND581 billion (USD26 million) from sale and leasebacks in 1H2016, which accounted for 41% of its total operating profit. (Figures for 2H2016 and 1H2017 are not available.)

VietJet might not have been profitable the past three years if it had not been for low fuel prices, low maintenance costs and the sale and lease back profits. Maintenance accounted for less than 3% of VietJet's total costs in 2015 and 2016. At other LCCs in the region maintenance generally accounts for over 5% of total costs, and in some cases over 10%.

VietJet does not seem to be accruing maintenance costs for future heavy checks as its fleet units - which are currently, on average, less than four years old - age, or for work required to meet lease return conditions. Maintenance costs will likely increase significantly over time, along with aircraft lease costs and fuel costs. These higher costs, as well as inflationary pressure on wages and the depreciation of the Vietnamese dong, could offset the anticipated reduction in unit costs generated as the airline increases the average size of its fleet by focusing more on higher gauge A321s.

OPPORTUNITIES

A) Tourism and international growth

Vietnam has emerged as a popular tourist destination. Visitor numbers surpassed 10 million in 2016, and were up 26% compared to 2015.

Visitor arrivals were up another 30% in the first nine months of 2017, to nearly 9.5 million. Visitor arrivals have more than doubled since 2010 and will likely double again over the next few years.

Vietnam visitor arrivals and year-over-year growth (%): 2009 to 9M2017

Source: CAPA - Centre for Aviation and General Statistics Office of Vietnam.

VietJet will benefit as more foreigners visit Vietnam. Its domestic operation will benefit as Vietnam's tourist destinations are spread across the country. Its international operation will benefit as VietJet is able to reach eight of Vietnam's 10 largest source markets with its narrowbody fleet.

VietJet already operates scheduled flights to South Korea, Taiwan, Malaysia, Thailand and Cambodia - all top 10 source markets for Vietnam's fast growing tourism industry. It now has multiple destinations in both South Korea and Taiwan.

China, the largest and fastest growing source market, is now served with several charter routes and will, in future, also be served with scheduled flights. Vietnam recorded 51% growth in Chinese visitor numbers in 2016 to 2.7 million. Chinese visitor numbers were up another 48% in the first three quarters of 2017 to 2.9 million.

Chinese visitor arrivals to Vietnam and year-over-year growth (%): 2009 to 9M2017

Source: CAPA - Centre for Aviation and General Statistics Office of Vietnam.

The airline also plans to serve Russia and Japan, the third and sixth largest source markets, in the near future. Japan has emerged as a key strategic market, after VietJet forged a partnership with Japan Airlines in Jul-2017.

See related report: Japan Airlines partners with VietJet to boost Southeast Asian feed for trans-Pacific network

Australia and the US, the remaining two top 10 source markets for Vietnam, would require widebody aircraft (along with most destinations in Russia). For three years VietJet has been considering the launch of a long haul operation and will eventually make a move, although for now its focus is on opportunities in the fast growing regional international market.

Vietnam's top 10 source markets (% of total visitors): 2016

Source: CAPA - Centre for Aviation and General Statistics Office of Vietnam.

B) Network traffic

VietJet has so far relied entirely on the point-to-point market, as is typical for a new LCC in its first stage of development. However, it is keen to start pursuing sixth freedom traffic, which could unlock a new phase of growth as the local market starts to become more saturated. Vietnam is well positioned geographically for passengers travelling between Southeast and Northeast Asia.

Offering connections at Ho Chi Minh is challenging, given the current layout of the airport and the infrastructure constraints. However, the government is positioning the new airport planned for Ho Chi Minh as a hub.

Meanwhile, VietJet is adding international flights at Hanoi and several secondary cities. Several of the planned new international routes may only be viable if VietJet is able to attract connecting traffic.

VietJet urgently needs to invest in a transfer product and technology - including a new or upgraded reservations system - to improve support of its transit traffic.

C) Interlines and codeshares

VietJet also has a strategy of pursuing interlines and codeshare partnerships.

Vietnam is served by a fast growing number of foreign airlines, several of which could benefit from domestic feed. Foreign airlines looking to improve their connectivity in the vast Vietnamese market have little choice as Vietnam's domestic market is a duopoly - consisting of the Vietnam Airlines Group and VietJet.

Vietnam Airlines is a member of SkyTeam, leaving VietJet potentially to work with members of oneworld and Star, as well as some unaligned airlines. VietJet could even emerge as a member of Star's new connecting partner programme.

VietJet is keen on two-way codeshares, which is unusual for LCCs. Selling flights on other airlines would give VietJet the ability to extend its network beyond East Asia. At least for the foreseeable future, VietJet plans to stick to an all narrowbody fleet, and believes there are opportunities to sell long haul flights operated by other airlines.

Perhaps most importantly, interlines and codeshares would diversify VietJet's revenue base and should improve yields. Given the low yields and intense competition for local passengers, VietJet would benefit significantly from carrying foreigners arriving in Vietnam - or other East Asian countries - on other airlines.

Again, VietJet urgently needs to invest in a new or upgraded reservation system and technology to better support of interline and codeshare traffic. This is critical for VietJet in reaping the benefits of the new partnership with Japan Airlines and forging deals with other potential partners.

THREATS

A) New competition

Southeast Asian leading airline groups, AirAsia and Lion, are both aiming to launch new affiliates in Vietnam. On 31-Mar-2017 the AirAsia Group announced the signing of a new joint venture agreement with Vietnamese investors, while Lion is still looking to secure a partner in Vietnam.

See related report: AirAsia initiates third attempt to launch Vietnamese JV; Vietnam maybe overburdened with LCCs

Another proposed Vietnamese start-up, VietStar, already has a business licence and is preparing to launch services in late 2017 or 2018. Any start-up activity in Vietnam's domestic market would lead to overcapacity, pressuring already weak yields.

VietJet is the market leader domestically, giving it a huge competitive advantage. However, AirAsia and Lion are much bigger in the broader Southeast Asian market and have the ability to put a lot of resources into a new JV. They are also extremely aggressive competitors.

VietJet already faces increased competition from Vietnam's only other LCC, Jetstar Pacific. Jetstar Pacific was Vietnam's first LCC, launching in 2008, but after several years of not pursuing any growth it began accelerating expansion in 2014. Jetstar Pacific is now a more formidable competitor and a key component of the overall Vietnam Airlines Group strategy.

The Vietnamese market may not be able to support a new start-up - certainly not two start-ups. If the AirAsia Group succeeds at launching Vietnam AirAsia, and Lion Group succeeds at launching Batik Vietnam, a blood bath will likely ensue.

B) Slower domestic growth

Vietnam's domestic market is unlikely to continue growing at the high double digit rate (20% to 30%) experienced from 2012 to 2016.

Domestic growth has already slowed in 2017 and is likely to slow further, possibly to the single digits. Slower domestic growth will pressure VietJet, forcing it to rely to a higher degree on the more challenging international market. The possibility of slower domestic growth is particularly a concern, since competition is likely to intensify, including from potential start-ups.

Slower domestic growth is inevitable, given how much the market has been stimulated over the past few years. Most Vietnamese citizens have already traded bus and train journeys for flights when travelling from one part of the country to another.

Average air fares are now cheaper than average rail and bus tickets for travel between the three main cities of Ho Chi Minh (in the south), Hanoi (in the north) and Da Nang (in the central region). In 2013, for the first time, there were more domestic air passengers than train passengers. In 2016 there were nearly eight times more domestic air passengers than train passengers.

Demand for domestic travel will continue to rise as the population and economy grow. However, domestic passenger growth of four to five times the rate of GDP growth cannot be sustained. Growth of double the rate of GDP is more realistic in the near to medium term, and could slow even further, given the infrastructure constraints.

C) Airport congestion

Ho Chi Minh Airport is now operating well above its designed capacity. Runway slots and terminal space are now at a premium, particularly during peak hours.

Ramp space is not sufficient to support more overnighting aircraft, forcing airlines to base additional aircraft in other cities. While regional airports can accommodate the aircraft, flights from regional bases are generally less profitable and it can be difficult to hire crews.

An upgrade project at Ho Chi Minh has started, which could increase the airport's capacity to 40 million passengers. However, there is a limited footprint, and Ho Chi Minh will eventually require a new airport. A new airport further from the city centre is being designed to handle 100 million annual passengers eventually, but a contract for the first phase has not yet been awarded. It will be at least eight years before the first phase is completed.

Upgrades at Hanoi and Da Nang are well under way, which should enable Vietnam's second and third largest airports to keep up with demand. A second runway and new terminal are also planned for Nha Trang, and a new terminal for Haiphong.

Hanoi, Da Nang, Nha Trang and Haiphong are already bases for VietJet. However, Ho Chi Minh is Vietnam's largest city and most important commercial centre, by a wide margin. Most demand is concentrated in Ho Chi Minh, and the prospect of several years of infrastructure constraints would have a major impact on VietJet's ability to grow.

D) Over-ordering

VietJet could struggle to place the nearly 200 aircraft it has on order, given the infrastructure constraints and the anticipated slower growth in Vietnam's domestic market. The international market is more promising, and has become a focus for VietJet in 2017, but is highly competitive and challenging.

VietJet does not have the portfolios of AirAsia or Lion. It has a strong position in Vietnam, but the Vietnamese market may not be able to support more than 100 aircraft.

VietJet's decision, in 2016, to order 100 737 MAX aircraft from Boeing particularly raised eyebrows. Having two types of narrowbody aircraft is unusual for an LCC the size of VietJet.

Once the 737 MAX deliveries begin in late 2019, VietJet plans to accelerate its rate of fleet growth. How VietJet copes with approximately 30 deliveries per year in the next decade is a concern.

The short to medium term fleet plan seems relatively reasonable. VietJet plans to expand its fleet by 14 aircraft in 2018 and by 12 aircraft in 2019. The biggest challenges for the fleet - and the biggest overall threats - will come over the long term.