There’s an air of optimism in the Asian airline industry following the International Air Transport Association’s (IATA) proclamation that airlines in this region will make a profit of USD9 billion in 2018.
IATA expects 2018 to be the fourth consecutive year of sustainable profits with a return on invested capital (ROIC) of 9.4%. This figure exceeds the industry’s average cost of capital of 7.4%.
Collective net profit for all airlines is expected to rise to USD38.4 billion in 2018 (from USD34.5 billion projected in 2017). Here’s IATA’s industry economic performance.
According to IATA passenger market conditions vary across Asia Pacific. IATA’s latest figures also corroborate what we have seen – intense competition in the low cost segment that continues to put pressure on profits, assuming some of these LCCs are making money.
One bright spot for the region is in freight. A strong uptick in the cargo markets has provided support for Asia Pacific carriers as they account for almost 40% of global cargo capacity. Anticipated growth in demand of 7% is going to surpass capacity increases of 6.8%.
World’s strongest market
There is no doubt Asia Pacific is the world’s strongest aviation market today and will continue for the foreseeable future. The Association of Asia Pacific Airlines (AAPA) in October noted an 8.3% increase in the number of passengers ferried by Asia Pacific carriers, or a combined total of 26.4 million. Demand in revenue passenger kilometres (RPK) grew almost 10%.
Read the AAPA release here.
While we generally concur with IATA and AAPA on its findings and see 2018 as generally strong for some carriers, many things can go wrong quickly in this business.
Oil remains an unknown next year. Our friends in the energy market say oil prices will probably stay along the same range as they did in 2017, or move at most 3%-5% higher.
We don’t quite believe that. We have a hunch it could get very sticky for those airlines that haven’t had the foresight to hedge (at least 50%) beyond 12 months when jet fuel was trading in the 60s per barrel.
But some are weak in a strong market…
The earnings numbers of some regional flag carriers suggest that while oil prices had stayed relatively low in 2017, many airlines have not quite profited from it.
Thai Airways International (THAI) in November reported a 3Q17 (Jul-Sep) operating profit of THB739 million (USD22.5 million). That’s nice compared to the THB836 million loss for the same period in 2016. But THAI reported a net loss of THB1.8 billion for the 3Q, wider than the THB1.6 billion a year ago. The Bangkok Post has all the details here.
THAI is 51% owned by the government. Like Malaysia Airlines and Garuda Indonesia, political interference and poor management have plagued THAI. Just look at its fleet: many aircraft types that need massive maintenance costs. All 10 of its Airbus A340s are grounded . THAI also flies six A380s, each with 507 seats.
Although the International Civil Aviation Organisation (ICAO) recently dropped its red flag for Thailand, problems at THAI persist, largely due to lack of leadership and ideas. Thailand had been under ICAO’s red alert since 2015 when an audit raised significant safety concerns about Thailand’s oversight of carriers, especially when it comes to the award of air operator certificates (AOC).
That led to the closure of Thailand’s Department of Civil Aviation and gave rise to the new Civil Aviation Authority of Thailand. Read it here.
The lifting of the red flag is good news for THAI and other carriers in Thailand but it also means everyone’s going to start applying for new international routes and competition will heat up and costs will rise.
THAI shares have been trading under THB22 for the past six months, and under THB17 this past week. Airline stock is not necessarily a good gauge of how a carrier is performing and investors are not naturally attracted to airlines.
Indonesian flag carrier Garuda is another perennial underperformer. Much of the good work done by ex-CEO Emirsyah Satar appear to have been eroded in the past two years. Garuda lost USD222 million in the 9M17 period, while operating revenue soared to USD3.11 billion (from USD2.9 billion during 9M16).
The huge losses were partly attributed to higher fuel costs (only 20% hedged, the rest bought via spot) and a one-off tax amnesty payment of USD137 million. In 2016 Jakarta launched a nine-month tax amnesty scheme aimed at bringing billions back into the country.
According to Garuda, 3Q forex losses were USD16 million while tax losses were USD53 million. The carrier stressed that 3Q17 saw a net profit of USD19.6 million (down 12% YoY). Much of the revenue came from hajj and umrah pilgrim charter flights that airline officials said will remain a key source of income for Garuda.
New CEO Pahala Mansury’s focus is on cost-cutting and he has deferred deliveries of aircraft until 2019 including Boeing 737 MAX and Airbus 320neos for its low cost subsidiary Citilink. Garuda has a fleet of 199 planes, of which 177 are on lease.
Aircraft utilisation is an area Garuda would need to drastically improve on. The airline’s B737 planes run just over nine hours a day while 18 of its Bombardier CRJ1000s and 12 ATR-72s clock an appalling five to seven hours daily. Likewise, Garuda’s load factor internationally is quite dismal. Load factor to London (via Amsterdam) is just 65%.
Garuda is struggling financially. Income is growing at 6% but costs are up 21%. Productivity is low, and on some domestic routes it competes with its own unit, Citilink. Pahala has made Garuda integration with Citilink a priority in 2018 but intense competition with Lion Air, which controls 55% of the local market, means it has to continue to dump fares.
What lies ahead?
It’s never easy to guess what the year ahead holds for airlines. Crude prices will, as always, determine the plight of many carriers. Intense competition among airlines, especially within Southeast Asia, will continue to dampen airfares. Full service carriers have little choice but to compete head-on with LCCs, resulting in many different types of fares being offered.
Asia Pacific will see up to 3% rise in 2018 pricing. As IATA has stated, domestic demand in India and China will rise. Weakness in airport infrastructure in Indonesia and Vietnam will become more apparent as growth in both markets exceeds 5% in the next 2-3 years.
Having seen failures in Europe in 2017 (AirBerlin, Monarch), it’s possible one or even two Asian carriers could end up in a similar fate in 2018, mainly due to very intense competition, lack of funds, higher fuel prices, safety issues or a combination of all factors.
The last Asian airline to fold was Taiwan’s TransAsia Airways in November 2016.