A look at the aviation industry

Posted on March 8, 2014, Saturday

The recent conclusion of results for the financial year 2013 (FY13) revealed challenging times for
major Malaysian aviation players as the results were generally not up to par with the markets
expectations.
The event-filled year started off on a lighter note with market observers pegging optimistic views on
the industry in general as most aviators showed signs of improvement for the year based on their
operating statistics.
According to Malaysia Airports Holdings Bhd (MAHB) in its rcent annual report, Malaysia saw fastest
traffic growth on record in 2013 at a total of 79.6 million passengers.
This represents a growth of 18.4 per cent from 67.2 million registered for FY12, the highest growth
achieved in the last 22 years the highest in the world.
The massive growth in passenger traffic was mainly brought on by initiatives made by local carriers
such as Malaysia Airlines System Bhd (MAS) and the new entry of global and domestic airlines such
as Malindo Air.
However, while the growth in passenger traffic has been deemed as commendable, it came at a
costly price for earnings performance in the race to gain a bigger piece of the passenger volume pie
by throwing in low fares which cut into overall gross margins.
Maybank Investment Bank Bhds research unit (Maybank IB Research), which recently called 2013 a
year to forget for the aviation industry, said airlines have basically dumped fares to gain market
share and yields have collapsed to a near 2008-2009 global financial crisis (GFC) levels.
It added that profits year-on-year had suffered, which made 2013 a bleak year for the aviation
industry.
In FY13, the fight spiralled into a price war, with the domestic sectors particularly hard hit.
Major airlines such as MAS and AirAsia generally reported losses, with the former being worse hit,
said Maybank IB Research.
AirAsia X was largely unaffected because all of its routes are international and not overly bogged
down by the fare war that was plaguing the domestic sector, it added.
Fortunately, for this year, analysts are of opinion that airlines will be able to fly through the turbulence
seen in 2013.
Maybank IB Research said, We have reason to be optimistic about 2014. We expect traffic growth to
moderate to a more manageable nine to 10 per cent in 2014, premised on the fact that the industry
will add 33 per cent less aircraft than 2013.
Also, a majority of these aircraft are narrow-body with a lower seat count, while in 2013, most of them
were large wide-body aircraft with massive seating capacity.
Nevertheless, yields compression is expected to normalise in 2014 as the great
Malaysian fare war is expected to cool down slightly, with airlines adapting to the changes in the
aviation landscape.

With that, as FY14, industry players are set to place new cards on the table to up their game in the
aviation industry.
MAS: Faces many challenges ahead
Malaysia Airlines System Bhd (MAS) continues to make headlines as it struggles to manoeuvre itself
out of the on-going turbulence it currently faces.
Last month, the national carrier registered a dramatic loss of RM1 billion for its financial year 2013
(FY13), which came as a surprise, particularly given the carriers promising signs of recovery early
last year, driven by its participation in the oneworld alliance early last year and the rise in its
operations statistics.
In February 2013, MAS joined the full membership of oneworld alliance, which opened up the airlines
routes to over 842 destinations in 156 countries.
With this international access, analysts were generally optimistic on MAS momentum. To boot, the
airline reported a healthy boost in international flights for the first quarter of 2013.
RHB Research Sdn Bhd (RHB Research) in a report said, the revenue per kilometres (RPK) of its
international flights in 1Q13 expanded by 17.2 per cent year to date.
We think that its passenger growth momentum could be sustained as our market sources revealed
that the load factor for MAS international flights continues to be encouraging, it said.
Similarly, early last year, Kenanga Investment Bank Bhds research arm (Kenanga Research) viewed
that given MAS likely better loads and cost efficiency with its new aircraft, MAS is on the right
direction and expect its bottom line to improve in FY13.
For the ten month ending 2013, out of the 17.3 per cent passenger traffic growth passenger traffic
growth in Malaysia, which was the highest rate in the past two decades, MAS achieved a record load
factor of 80.8 per cent.
However, while the carriers robust passenger growth momentum was seen throughout the year, MAS
was faced with an onslaught of challenges during the year, in particular, the intense competition which
has been proven to be overwhelming for the airline, with expansions of airlines both worldwide and
domestically.
New competition
A new player is Malindo Air which made its foray into Malaysian skies in March last year, which had
naturally triggered another price war fare in the aviation industry.
Maybank IB Research viewed that major airlines such as MAS and AirAsia had overreacted with cut
throat fares which had led to the extreme yield decline in 2013.
With yields at historical low, MAS cannot afford to cut fares further as marginal revenue generated will
be outweighed by the marginal cost.
Maybank IB Research said, The key problem for MAS is insufficient revenues, and it clearly needs to
raise its yields.
MAS has managed to reduce unit cost by five per cent year-on-year in the first nine months of 2013
(9M13), which is admirable but it needs to push for at least another three to five per cent more unit
cost reduction in order to breakeven.

Furthermore, MAS load active but yield passive strategy has generally garnered mixed views, with
bias towards its probable inability to lift the airline out of its loss-making territory.
Aware of this, group chief executive Ahmad Jauhari said, We knew 2013 would be a challenging year
of intense competition which would impact yield.
Knowing this, our focus was to drive revenue. Our efforts saw the airlines revenue increase 11 per
cent, whilst traffic went up 27 per cent on capacity that increased only 17 per cent.
Our average seat factor improved 6.3 percentage points to 81 per cent compared to the previous
year.
He added, While capacity, measured in available seat kilometre (ASK), grew 17 per cent utilising
existing fleet and resources, cost grew by only 10 per cent even after absorbing higher costs from the
weakening ringgit against the US dollar and a one-off cost for aircraft redelivery. This has resulted in a
lower CASK (cost per ASK) in 2013.
With intensifying competition, we expect the pressure on yield to continue. We will intensify efforts to
reduce our costs, focusing on inherent legacy costs, while increasing utilisation to drive traffic and
revenue.
Growing its network
CIMB Research further noted that the management of MAS has said that it will also strive to
strengthen the network and increase partnerships with other airlines, renew its focus on ancillary
income and improve the customer proposition.
Most of the MAS ASK growth, it explained, will be international in nature courtesy of the large-scale
capacity additions into Australia in late-2013. To note, Sydney and Melbournes capacity was
increased by 50 per cent, Perth at 20 per cent more, and Brisbane at 40 per cent more.
Nevertheless, analyst Tan Kee Hoong of Alliance Research cautioned that in light of the sticky cost
structure, MAS may see its operating margin decline further, should the group cut fare in order to
stimulate demand.
Unlike low-cost carriers, MAS lacks the ability to generate additional revenue via ancillary income,
making the business turnaround via load active, yield passive strategy challenging.
CIMB Research further viewed that while MAS is successful at growing its international revenue per
available seat kilometre (RASK) in 2013, the outlook in 2014 is more murky, shadowed by domestic
competition from new entrant player; Malindo.
It said, Malindos capacity expansion in 2014 is focused on the international markets, having added
flights in late-2013 to cities such as Dhaka, Delhi, Mumbai, Jakarta and Bali, where it is competing
directly with MAS, and with plans to fly to Bangkok and southern China later this year.
On its domestic front, CIMB Research noted that there is a small ray of hope for the local business as
there is a demand saturation and systemic overcapacity in the domestic markets.
Our survey of the top six domestic routes in Malaysia (Kuala Lumpur to Kota Kinabalu, Kuching,
Langkawi, Penang, Kota Bahru and Miri) indicates that after massive capacity injection during 2013,
seat capacity will remain essentially flat between January and July 2014, based on the announced
schedules.
As such, there is a chance that domestic yields and RASK will improve marginally in 2014 against
2013, although we think that the improvement will be small at best, as the market is already

oversupplied and there is no evidence of active or widespread capacity management by any of the
three airlines (MAS, AirAsia and Malindo.
Maybank IB Research on the other hand, remains sceptical over the managements approach as
MAS net reduction of two aircraft (add 20 new and retire 22 old aircraft) in FY14 and capacity target
growth of 12 per cent could mean that MAS will continue with its strategy to fill up its aircraft, with a
preference of loads over yields.
This, the research firm outlined, signals MAS continuation with a strategy that has not yielded positive
results thus far.
RHB Researchs analyst Ahmad Maghfur Usman viewed that MAS should aim for the low hanging
fruit. He also said that currently its gameplan visibility is still murky at this point.
AirAsia: The battle wages on
The yields pressure affects more than just MAS as the compression also took a swipe at AirAsia Bhd
(AirAsia) performance.
Maybank IB Research said AirAsia has done a good job to fend off competition in the first nine
months of the financial year 2013 (9M13) as seen by its modest yield decline compared to the
industry.
However, in 4Q13, it has succumbed to the competitive pressures with a yield decline of 12.3 per cent
year-on-year with the industry which proves that it is an industry wide peril, and nobody is immune.
If the compression remains, CIMB Research opined that AirAsia would not be able to do much to set
the price, as the low-cost carrier is a price follower despite its capacity being larger than MAS.
Hence, if its competitors reduce their fares, in particular MAS, there is very little AirAsia can do but to
follow suit.
This is also consistent with its philosophy of being, load active, yield passive, which prioritises filling
up the plane with passengers even at lower yields, it said.
Nevertheless, analysts noted that AirAsias management were quick to act as it is already progressing
into changing its gameplan to adapt to the current environment in the industry.
In announcing AirAsias FY13 result, group chief executive officer Tan Sri Tony Fernandes
commented, We assuming fares will remain at the current level this year, hence we will continue to
focus on driving cost down by approximately 7.5 per cent.
We have already achieved 2.5 per cent in cost reduction in two months and will increase non-fare
revenues to make up in the decline in RASK.
Despite seeing signs of competitors being rational by reducing capacity on loss making routes, we
cannot take it for granted and the company needs to continue to be creative in driving margins up.
He added, In terms of cost reduction and looking for margins upside, the company will now be
focussing on capacity management by keeping a young fleet and selling its older aircraft to capitalise
on the residual value which will help strengthen our cashflow.
We have deferred seven aircrafts in 2014 and 12 in 2015 to later years with intention to swap those
aircraft with the new fuel efficient A320 neo.
Analytical view

After an analysts post-results conference with the management of AirAsia, AmResearch said,
AirAsias aircraft sale plan (or fleet renewal plan) will kickstart a progressive aircraft debt reduction
cycle.
As AirAsias aircraft loans typically entail tenure of 10 to 12 years, there will be very little debt left on
the eight to 12 years old aircraft that it plans to sell, meaning it will receive most of the cash proceeds
from the exercise.
It added, from a 15 per cent average equity in the current fleet, some of the new neos will entail 40
per cent equity coming from old A320 sales proceeds (net of US$20 million per aircraft).
The impact however, will be very gradual. The first four neos will be delivered in FY16 but the
majority will be delivered in FY17 and beyond at a rate of 24 to 34 per annum versus sales of six to
nine old A320 per annum, it said, noting that management has already identified buyers of the six
aircraft it is disposing in FY14F, comprising aircraft leasing companies.
While cost reduction will be the key drive to improve earnings, two key revenue enhancement
strategies are also in the works, which include ancillary income, and project Emirates.
AmResearch added that the group is also looking at several new ancillary initiatives to increase
ancillary revenue per pax by another RM3.
It also said that AirAsia is expected to launch its first on-board Wi-Fi service in 2H14 as well as videoon-demand services which could bring its break-even volume at an estimated one per cent of pax.
Growth plans
AirAsia is also looking to looking to grow its corporate traveller base via Project Emirates, which
could increase loads by two percentage points (ppt) to 82 per cent this year.
A key mid-term strategy is to leverage on klia2 and better connectivity from Fly-Thru services
(essentially an interlining service between AirAsia and AirAsia X, which is part of Project Emirates) to
grow its corporate traveller base from two per cent currently. The delay in klia2 completion does not
result in incremental cost to AirAsia, according to management, it said.
However, it cautioned the move could be a constraint to AirAsias capacity expansion as it has
intended to slow its capacity growth, with deferred delivery of seven A320s in FY14 and 12 in FY15;
which will be converted into neos.
Meanwhile, on its associates operations, AmResearch said the listing plans for Indonesia AirAsia
(IAA) will likely be shelved as management prefers instead to consolidate all its units under one
holding company.
However, this may take time as it requires approval and lobbying of
individual governments/regulators that AirAsia operates in.
It further said that the move to backtrack on associate listing however, raises questions as to when
AirAsias associates, in particular IAA, will take on funding of its own aircraft.
Thai AirAsia is the only unit that has started to fund its own aircraft acquisition after its listing on the
Thai Stock Exchange.
The idea in the past was for the mature associates to recapitalise and undertake their own on balance
sheet aircraft, and free up AirAsias balance sheet from further subfunding.
AirAsia India has also made recent headlines, caught at yet another roadblock as authorities in India
objects its entrance into the market.

Currently, according to a local media report, the Delhi High Court sought the response of the central
government and AirAsia India on a plea by the Federation of Indian Airlines (FIA) which is opposing
the go-ahead given to the airline to begin its flight operations in the country.
It was also reported that a political party leader challenged the clearances granted to the airline as the
proposed US$30 million joint venture airline, between Tata Sons and Malaysia-based AirAsia, had to
show before the Foreign Investment Promotion Board (FIPB) that the airline would be essentially
controlled by Indians.
Currently, the case is still ongoing and it is noted that Fernandes has been going to and fro India,
suggesting that he is still determined to see that this proposed airline would take off, after
approximately two years in the making.
Malindo: An aggressive newbie
Since 2012, news about Malindo Airways entering Malaysias aviation market has created a new
spark in the field and has made major aviation players wary of what cards it will play once it has
entered the market.
In March 2013, the new full-service airline made a ripple effect across the aviation industry with MAS
near the epicentre with it reacting at a more drastic rate than when AirAsia first made its presence in
Malaysia and eventually became MAS biggest competitor.
According to CIMB Research, MAS had responded in an aggressive way to ensure than it retains its
market share in the industry.
MAS does not want to repeat the same mistake back in 2003 to 2005 with AirAsia, when it was a bit
slow in responding to the emerging threat of a new competitor and allowed AirAsia to grow to its
present size.
But MAS thinks it can try to make life very difficult for Malindo and prevent it from taking away too
much market share, especially given that Malindos product is much closer to MAS than it is to
AirAsias, it said.
Maybank IB Research also highlighted that Malindos entry has structurally raised the competition
whereby yields and profit margins will be lower than pre-2012 levels.
However, it noted that the aviation industry should be cooling down as it soon would learn to accept
that Malindo is here to stay, and will then focus on their core markets and compete rationally going
forward.
MAHB: A race against time
While the price fares and services battle wages on in the skies, back on the ground, the clock is
ticking for Malaysia Airports Holdings Bhd (MABH) as it faces its own struggles with the much-talkedabout development of klia2.
Pressured from tenants and airlines looking to leverage on the new airport, MAHB has announced
last year that klia2 is expected to be open by May 2, after delaying its opening three times since the
announcement of its development in 2011.
Analysts were once again sceptical on the opening date of the airport when it was unveiled that the
main terminal has yet to receive the certificate of compliance with fire and safety regulations.
However, according to a recent statement by the airport operator, the contractor of the terminal has,
in fact, already received the recommendation letter from the Fire and Rescue Department to certify
that the terminal complies with the fire and safety regulations.

Currently, to facilitate the agreed opening date, the terminal building contractor has agreed to allow
commercial retailers, agencies, and airlines to start their renovation.
It further said, klia2s terminal building still remains under the responsibility of the main contractor
(UEM Construction Sdn Bhd and Bina Puri Sdn Bhd joint venture) until the Certificate of Practical
Competition (CPC) is issued by MAHB.
The contractor is currently rectifying the sewerage system in order to issue the CCC to Malaysia
Airports by April.
The Operational Readiness and Airport Transfer (ORAT) is currently ongoing to prepare for May 2,
2014 opening date.
Notwithstanding, MAHBs priority is on the safety, operational efficiency and quality of the terminal
building and we are working closely with all the stakeholders to ensure that these are achieved, it
said.
Meanwhile, on its operations in other airports, in line with the Budget 2014s effort to increase
passengers comfort, MAHB is currently undergoing various upgrades to airports across the country
and their expansions are generally expected to be completed within 2014.
On East Malaysias front, Tan Sri Bashir Ahmad Abdul Majid, managing director of MAHB in the
groups annual operations review said that Miri Airport is undergoing an expansion to increase the
aircraft parking bays at the airport.
Bekalalan Stolport, Sarawak, is also undergoing rehabilitation works at its airside. The project which
took off on March 18, 2013 is expected to be completed by June 17, 2014.
In Sabah, the existing terminal of the Sandakan Airport is being upgraded and works which took off in
May 2013 are expected to be completed by December 31, 2014.
The government has allocated a total of RM70 million for the upgrading works which among others
include the improvement of the terminal building faade with modern architecture design, additional
floor area to 11,250 square metres from existing 9,728 square metres, and the improvements of
terminal building finishing, upgrading of utilites.
The terminal will also be equipped with new baggage screening and baggage handling system (BHS),
metal-arch detector machines, public address (PA) system, flight information display system (FIDS),
master antenna television (MATV), and closed-circuit television (CCTV) upon the completion of the
upgrading works and it will also house new airport operation office, airlines office and government
agencies offices.
Kuching International Airport will expand its domestic transfer corridor in order to provide additional
waiting lounge and commercial offering area, as well as to enhance the passenger comfort level. The
project is scheduled to commence in the second quarter of 2014.
In addition to this, we are also planning to expand the apron and taxiway at the Miri Airport to provide
more aircraft parking stands, as well as to provide additional taxiway connection between the runway
and apron to improve the airside efficiency, he stated.
On an international front, MAHB had recently announced that it had successfully completed the
placement of 124 million shares via an accelerated book-build exercise, raising approximately RM980
million.
It said, the proceeds raised will be utilised to fund the acquisition of 40 per cent stakes in Istanbul
Sabiha Gken Uluslararasi Havalimani Yatirim Yapim Ve Isletme AS (Istanbul Sabiha Gken
International Airport) and LGM Havalimani Isletmeleri Ticaret Ve Turizm AS respectively.

Overall, analysts are upbeat on MAHBs move to increase its stake in the Istanbul Sabiha Gken
International Airport, as the Turkish airport is seen as a strong asset for the company and the move
would benefit it in the long run.
On the overall aviation industry, analysts were generally of opinion that MAHB is set to be the biggest
gainer despite the intense competition between local airlines as the price fare war would benefit its
airports and Visit Malaysia 2014 is set to bring in even more passengers to its airport.