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Low Cost Airlines

Is the Overly Optimistic LCC Bubble in Southeast Asia about to Implode after a Splurge of Speculative aircraft orders and a Spree of new LCC’s Recklessly adding too much capacity too quickly ?

Too much of a good thing is not always good in the long run, in Southeast Asia you have LCC’s (low cost carrier) that have over expanded and added to much capacity and ordered too many aircraft and signs of trouble are now popping up, and fast.  The rise of low cost travel in SE Asia (Southeast Asia) has grown tremendously over the past few years, with large 600 million inhabitants and a geography ideal for air travel as the surrounding waters of the region make any other form of travel outdated. The region has at last count 47 LCC’s and another 12 in the works as I speak, this has driven up aircraft orders to new highs, a dangerously high order bubble that may seem like a good thing for Boeing and Airbus as they rev up production to new high, but speculative orders, which a lot of the LCC orders are WILL bring about some cancellations at some point and requires a fast reduction in production rates, causing a serious crisis for both OEM’s (original equipment manufacturers). Those 47 LCC’s operate 1,036 aircraft of which 916 are either B737’s/A320’s with 1,479 on order for the region a backlog to fleet ratio of 1.42 and carried 236 million passengers in 2013 or 29.4% of the passengers carried in Asia Pacific last year.

llc-lion air 900

Indonesia’s Lion Air carried 34 million passengers in 2013 with a fleet of 93 B737-800/900’s and ATR-72-600’s, it has 539 Airbus A320’s and Boeing B737’s on order, 5.8 times its current fleet !

 

Last year both OEM’s delivered 1,274 single aisle and widebody aircraft, a fabulous year, and deliveries are expected to boom up to 1,700 aircraft per year as deliveries increase 6% to meet the planned delivery of 16,500 aircraft over the next 10 years, as new generation single aisle B737MAX, A320NEO start to be delivered and now that the B787 is going out the door with the A350 soon to follow and the new B777X several years behind that. The sad thing is that we all know what goe sup, also comes down, we have seen large corrections before, late 1990’s to 2001 demand went down, production cut 9%, in in 1991 production cut 10% I still remember the ‘white tails’ sitting in Seattle, aircraft produced but no customer-not good, as companies like leasing company GPA speculated on its orders and Boeing lost. In fact the airline industry goes through a down turn every 8-10 years, now some of those are industry specific and some are man mind like the 1stand 2nd Gulf War, 9/11, US banking crisis of 2008, but they do occur.

llc-air asia

Malaysian based Air Asia is the LCC pioneer in Asia and while it is experiencing some difficulties it still has 337 Airbus A320’s on order.

 

The big boom in orders is for the new generation of single-aisle B737MAX (2,107 as of today) and A320NEO (2,652 as of today) models, much of that driven by the LCC market, especially in SE Asia, where you have overly optimistic orders from airlines, such as relative up-start Lion Air (Indonesia) which carried 34 million passengers in 2013 with orders for 236 A320’s/A321’s AND 303 Boeing 737’s (yes, 539 aircraft on order + 27 ATR-72-500’s for its regional subsidiary Wings Air), Air Asia (Malaysia (337 A320’s), money loosing Air AsiaX (39 A330’s, 20A350’s), upstart VietJet Air (63 A320’s), etc. The backlog of new aircraft orders at 13 airlines in SE Asia is greater than their current fleets ! even Lufthansa with its huge 295 aircraft backlog (203 single-aisle, 92 widebody aircraft B777-9X’s and A350-900’s) has only 0.47 backlog/current fleet ratio (LH as 433 aircraft and 194 at its Group members Austrian and Swiss, for a total of 627 aircraft), andmuch of that is replacement of older single-aisle aircraft.

llc-vietjet

Vietnam’s 5th airline, VietJet has 63 A320’s on order and expanding quickly and setting up a subsidiary in Thailand’s over crowded LCC market, almost became a Air Asia partner, but but went on to do it alone.

 

At the current order backlogs of SE Asian LCC’s now Lion Air has a backlog/current fleet ratio of 5.9 (5.9 times current fleet), Air Asia (5.0), VietJet (6.8), Scoot (4.0), Mandala (3.0) and CityLink (2.2) so they are expecting huge growth over the next few years which is fine, but if they do not meet their growth targets, those overly optimistic at Airbus and Boeing can play havoc with production rates. Another way to look at this is compare traffic growth to capacity growth, and in Asia we have 4.2% growth in traffic but a planned capacity growth of 6.0%, not good, capacity added exceed traffic growth leads to over capacity, and we have seen in North America what that does to airline profitability, thank god the US airline shave smarted up and reduced capacity in the US market the past few years and load factors have gone up along with yields for a better RASM, and 2013 was a very good year (except United).

llc-citlink 320

Indonesian LCC Citylink is national flag carriers answer to the LCC competition, a totally separate airline presently operating 25 A320’s it has 50 on order and serves 23 domestic routes and 2 international, while carrying 8.3 million passengers in 2013.

 

In the Middle East they have lots of aircraft orders, but traffic growth of 14% is above the 12.5% capacity growth of the new orders and that is very healthy sign as they have few aircraft retirements while in North America, traffic growth of 2% is below the capacity growth of 3.5% but many older aircraft are going to be replaced in the next few years. How does an airline like Lion Air, a rather new LCC upstart (though in business since 1999) from Indonesia and in all respect to its incredible CEO and founder Mr. Rusdi Kirana, how did it pull of an order for 539 commercial airliners, worth somewhere in the tune of $45 billion ? yes its a big country of 240 million, and lots of islands separate the country, so air travel is huge, traffic last year was 72.5 million up from 60.2 million a 20% increase, but to me its a huge speculative order. If the airline will have 600 aircraft one day (roughly 100,000 seats) and each aircraft flies say 3,600 block hours per year at an average sector say of 1:20 so roughly 2,700 sectors per aircraft a year, or 448,200 seats per year and say 85% load factor, then Lion Air will need to carry around 228 passengers ! Yes, its quick rough calculation but hello does anyone see the problem ? am I the only one who dares to say the emperor has no clothes ?

I think that between Air Asia and Lion Air the two big LCC’s in SE Asia there is intense rivalry its two strong personalities, Air Asia’s founder and CEO Tony Fernandes versus Lion Air’s founder and CEO Rusdi Kirana have a little war going. Goes back to when Air Asia entered Indonesia it tried to buy local operator Batavia Air, that did not go through and Batavia went bankrupt, Lion Air went to Malaysia and set up hybrid LCC Malindo (in-flight entertainment, snacks, free food, 32″ pitch seating) in Malaysia to take on Air Asia at home and added ATR-72-600 turboprops to the B737-900’s there, while Air Asia now competes heavily in and out of Indonesia, and they have battled to out order each other as well.

Also, note that in Asia, they have rather new fleets so unlike North America and Europe, they have few replacements, so its all new capacity where in the above case of Lufthansa, a lot of the new orders are to replace older aircraft being retired. So while airline’s like Lion Air grow capacity 25% a year and passenger numbers increased only 10.4% in 2013, they expect to increase capacity at current rate for the next 5 years (150% increase in capacity anticipated), what happens if they don’t grow so fast ? adding more 25% capacity and only 10.4% more passengers a year can only work for a very short period before trouble happens and anyway new competitors will move in, then too much capacity, yields go down and then ?

The BIG issues that few talk about in regard to SE Asia is the shortage of airport capacity in the region, the major airports are crowded by the huge influx of millions new passengers that were never forecasted by the airport developers, new landing slots are hard to come by and there are very few’secondary’ airports to use like in Europe or North America that LCC use frequently as a competitive tool for lowering airport costs and quicker turnarounds that are a must if you are going to fly the 12 hours a day per aircraft needed to bring those current monthly lease rates down for new aircraft (A320 +/- $360,000 per month and B73-800 +/- $380,000 per month). There is a huge pilot and AME (aircraft maintenance engineer) shortage in SE Asia, especially in Indonesia where the local CAA (civil aviation authority) is overwhelmed, a country that has its share of accidents, one just needs to look at Lion Air’s recent crashes/events (like landing short of the runway into water) and questionable pilot training and how will they will deal with a 500% increase in its fleet over the next 8-10 years.

We already see signs of trouble with several LCC’s in Asia, Singapore based Tigerair had a $41.5 million loss for last year, not doing well in Singapore (Singapore Airlines is part owner, but also owns Scoot and Silk Air ??), Indonesia, blames overcapacity and is in trouble, share price down 30% in the last 12 months after 3 years of losses, replaced its CEO, grounded eight A320’s, cancelled 9 A320’s that were due in 2014/2015 and will see NO capacity growth for 3 years. Well when you add 25% to capacity in one year then you can expect the load factor to drop to 78% from 84% while yield drops 10% and then the ever so important RASM (LF x yield) takes a dive and break-even load factor is now at 86.7% (NOTE: B/E load factor = CASM/yield). High flying Asian LCC Air Asia has a also got into some trouble, and deferred 19 A320’s over the next 2 years, Batik Air cancelled its B787’s,  so there is a worrying scenario unfolding as ‘mature’ LCC markets like Malaysia and Singapore see growth slowing down while new LCC markets like Indonesia and the Philippines show continued growth.

lcc-cebu 330

The Philippines based Cebu Pacific operates Airbus A330’s to Taipei and soon on long haul LCC services to Saudi Arabia and Australia, the jury is out on LCC long haul viability.

 

This one of the reasons that we are seeing the emergence of long/medium haul LCC in Asia, with Scoot in Singapore, NokScoot and Cebu Pacific with flights to Europe, Middle East, Australia and Hawaii, the problem is, and I will explore that in a coming article, that long haul LCC’s do not have the competitive advantage as with short haul, the frills people pay for on short hops are a must on long haul, food, drinks, leg room, in-flight entertainment, plus no quick turnarounds and really no way to increase utilization without very odd hours of departure or arrival, yes B787 and A350 will help, but many FSC have those on order as well.

The jury is out, but Air AsiaX has ye yet to make money after several years of effort. You do not have to be a genius to see the unfolding problems in Asia, one only needs to look at latest 1st  Quarter (2014) operating and net profit margins, and you see trouble for several carriers both LCC and big FCS airlines in SE Asia:

Spicejet (India) (operating margin -20%, net margin – 20%)

Tigerair (-18%/-27%)

Garuda (Indonesia, owner of LCC CityLink) (-21%/-17%)

Air AsiaX (long haul LCC tied to Air Asia) (-5%/-3%)

Philippine Airlines (4%/-4%)

Nok Air (Thailand) (0%/1%)

Cebu Pacific (Philippines)(4%/3%)

Air Asia (6%/1%).

The above is not a rosy picture of the financial performance of Asia’s airlines, yes they are growing, but not really making money. In fact the only good performing Asian airlines right now are (Hainan) (China (14%/14%) and revitalized and very well restructured Japan Airlines (9%/13%) both FSC, with Air Asia the best performing LCC in Asia. As I write this, in India, SpiceJet is rumored to be in BIG trouble, off course look at the above margin, -20% ? it has lost $52 million in 1Q/2014 and $170 million the last 3 quarters, its liabilities are greater than assets, thus negative shareholder value and a recent audit is quoted as reading “material uncertainty regarding the company’s ability to continue as  going concern”. The airline runs 37 x B737-800’s, 6 x B737-800’s and for Bombardier, more bad news it has 15 x Q400’s with 15 on order. The salvation for this Indian LCC is Qatar Airways, maybe ! still showing that India is a bad place to do business still, and yes Air Asia India just began flying there with extremely low introductory fares, which is the last things India’s money loosing airlines need, at least LCC Indigo reported a $127 million profit last year, wow, while Air India is expected to loose $620m and Jet Airways is being bailed out by Etihad Airways which seems to be on a mission to rescue many dying airlines (more on that strategy soon) like Alitalia, Air Berlin, JAT now Air Serbia, though hats off to Air Seychelles which is finally profitable thanks to Etihad Airways.

2lcc-Batik

Indonesian based Batik Air is owned by LCC LION Air, and its a FSC (full service carrier) set up by a LCC ! reversed course to what is ahppening everywhere else where FSC are setting up LCC. The airline has both economy and business class operates 6 of the above B737-900’s but also has BIG ambitions, as it has ordered 4 Boeing B777-300ER’s and 5 Boeing B787 dreamliners for future long haul services, very interesting and something worth watching as how Lion Air manages its own FSC.

 

The problems of the LCC market in SE Asia is not detouring others from entering the market, South Korea’s Asiana is looking to start its own LCC to join 5 others (Jeju Air, Air Busan, Jin Air, T’way, Eastar Jet), a very crowded market, NO way will 6 LCC survive in a small country like South Korea, we shall see who survives. In China, Juneyao Airlines has received the ok to set up LCC Jiuyuan Airlines, while Hainan and China Eastern will convert their subsidiaries West Air and China United into LCC’s expect Air China to do the same soon. China’s LCC Spring has launched its Japan operation while in Taiwan TransAsia Airways is launching LCC V Air and China Airlines is partnering with struggling Tigerair to form Tigerair Taiwan.

The largest activity is in Thailand where Thai Air AsiaX started operations with A330’s and NokScoot will start B777-200 operations in a few months, while Vietnam’s VietJet Air has partnered with local Kan Air to form a local LCC like recently launched Thai Lion Air. Problem here is the latest military coup in Thailand, which will keep many tourist away and business confidence and interest in Thailand will be lowered significantly, from already a low due to the political instability of the last few months in Thailand. While in Hong Kong troubled QANTAS and China Eastern are waiting for their AOC for Jetstar Hong Kong as Cathay Pacific, Hong Kong Express and Hong Kong Airlines oppose it, while 6 A320’s stay in storage back at Airbus waiting for the AOC.

llc-spicejet

India’s SpiceJet has lost $170 million in the past 3 Quarters, has negative shareholder value and its questionable if it will survive, it could be the biggest LCC bankruptcy yet anywhere, as it operates 37 B737-800’s (plus 42 B737Max on order), 6 B737-900ER’s (4 on order) and 15 Bombardier Q400’s (15 on order). India is a tough market and the recent arrival of Air Asia in the Indian market will not make things any easier for any airline competing in the Indian market, more failures surely to come there.

 

The situation in SE Asia will be very interesting to watch, there will be failures and the OEM’s and the lessors need to pay close attention to the situation, never say never, who would have guessed the demise of Kingfisher Air and it doe snot take too many airline failures to shake up the whole industry, especially with so many orders from that region. I do believe that the huge orders have been driven by speculation by several of the bigger LCC, be it egos or pride, but such orders need high growth rates to profitably assimilate the new capacity on order, and when Air Asia starts to ground aircraft and delay or even cancel some of its 329 Airbus A320’s on order in early 2014, then their is BIG troubles ahead as more airlines are starting up which means more competition with more capacity is coming, which will affect yields and load factors, just look at Tigerair the past 3 years, I see trouble ahead for many LCC’s in the rgion, which will affect lessors which today provide 38% of commercial aircraft and then the OEM’s themselves.

In closing this splurge of speculative aircraft orders has created a situation where if an airline has no backlog of new aircraft today, it has to turn to either the 1. the leasing companies for aircraft 2. buy aircraft on the open market- good luck, pricing for new aircraft is high and 3. turn to other manufacturers like ? Comac C919 ? Irkut MS-21 ? or Bombardier CS300 ? well if anything Bombardier may get a few orders because there is no other way of getting any new aircraft quickly, its a sad reason buy any commercial aircraft because there is no availability of the aircraft everyone wants, well at least Bombardier takes comfort in the fact they “dominate” the 100-148 seat market with their 203 orders ! more on that ridiculous marketing  ‘spin’ later.

Till next time, thank you.

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About Aviation Doctor - Helping aviation companies to transform the present into a more profitable tomorrow

I am a Canadian and EU national with an MBA and 33+ years experience in aviation business development with 20 years overseas and work in 25+ countries. A former investment/merchant banker (mergers and acquisitions to corporate turnarounds). airline and OEM senior executive and past owner of 6 successful aviation companies in 3 countries (executive jet charter/management companies, aircraft sales, aircraft broker, airline/aerospace consulting to aircraft insurance). I have a very diverse aviation background with 75+ aviation companies (45+ airlines of all sizes, OEM's, airports, lessors, MRO to service providers) as consultant, executive management, business analyst and business development adviser. Excellent success track record in International Business Development. Most work with airlines is with new start-ups and restructuring of troubled carriers. I sold new business jets, turboprops and helicopters for Cessna, Raytheon, Gulfstream to Eurocopter as an ASR as well as undertaking sales and marketing of commercial aircraft for Boeing, de Havilland, Dornier, Saab and Beechcraft. Brokered everything from LET-410's to B747's and from piston PA31 to G550 business jets. I look beyond the headlines of the aviation news and analyze what the meaning and consequences of the new information really means. There is a story behind each headline that few go beyond. Picked the name Aviation Doctor, as much of my work has been with troubled companies or those that want and need to grow profitably. I fix problems be in the business, and help with restructuring for a better tomorrow. You can reach me with comments or suggestions at: Tomas.Aviation@gmail.com and I comment a lot on Google+, my Facebook and LinkedIN.

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