Singapore Air Show

Airline Yields Still Sagging in Fast Growing Asia-Pacific

 - February 3, 2018, 7:00 PM
Boeing 737-800 operator Garuda Indonesia has deferred all aircraft deliveries for 2018, including several Max 8s. (Photo: Boeing)

The highly optimistic forecasts for traffic growth in the Asia-Pacific region by the world’s big OEMs haven’t encountered a lot of scrutiny, and few would argue with the notion that Asia ranks as the biggest market in the world over the next two decades. The prospects all look good for the OEMs, airport developers and service providers such as MRO outfits, but the airlines themselves have fallen behind much of the rest of the world in terms of profitability, raising questions about the sustainability of the region’s robust capacity growth.

According former Qantas fleet planner and Jetstar head of commercial Michael Newcombe, rising fuel prices and infrastructure deficiencies appear likely to slow the pace of growth Airbus, Boeing and others would like to see continue. Now the Singapore-based principal for global consultancy ICF, Newcombe expressed a “neutral” position on the prospects for the region, citing a disparity in the economic circumstances between, for example, North and Southeast Asia, and, in general, softening of yields due to upward pressures on costs and downward pressures on ticket prices.

“You’re starting to see fuel price and oil price creep up to a territory that we haven’t seen for a very long time, and obviously that’s going to change the operating environment for a number of carriers, especially those without strong hedging positions,” noted Newcombe. “I think the airlines need to start looking at what their futures are going to be when those headwinds hit.”

In Asia-Pacific specifically, Newcombe cited a general stability but also a failure of demand to catch up with capacity in several markets, resulting in flat yields for the last several years. “We’ve seen pockets of green shoots, but we haven’t necessarily seen anything significantly positive on the revenue side of things.”

Although Newcombe didn’t dispute the conventional wisdom that the Asia-Pacific region will account for a disproportionate share of the world’s air traffic growth over the next 20 years, he did pose questions about the speed at which the growth will occur. “It might not be a speedy as people would like it to be,” he said. “Because when you start to look at the fleet orders, they’re quite significant. And if you aggregated Indonesia, Singapore, and Malaysia, you basically get a fleet order book that’s pretty much the same size as China's...That’s an enormous amount of capacity into a region that’s already got a significant amount of capacity.”

Meanwhile, established Asian network carriers face more and more competition from Emirates Airline, Etihad, and Qatar Airways in the Middle East; Chinese hub carriers such as Air China, China Eastern, and China Southern and the growing cadre of low-fare airlines from throughout the region.

Consequently, Singapore Airlines, for example, announced a restructuring plan following its first quarterly losses in five years and established a so-called transformation office to review all its business divisions and processes. Separately, Hong Kong’s Cathay Pacific announced a restructuring early last year following its first loss in eight years. The three-year business transformation plan centered on a target to save more than HK$4 billion ($428 million) over the period and called for a cut of at least 600 jobs. In Indonesia, chronically loss-making Garuda appointed a new president in April to lead a restructuring that included deferrals of aircraft deliveries, a plan to increase aircraft utilization, and a reorganization of its Citilink low-fare unit. The plan targets a return to profitability this year.

In fact, fleet deferrals haven’t been limited to Garuda, and Newcombe sees “a distinct possibility” of more in the coming few years. “You’ve already seen it with some carriers,” he said. “If you look at some of the larger orders that have happened...Air Asia is a good example, Qantas/Jetstar is another good example. Both have put in significant orders at different points of time. Those delivery schedules were predicated on a particular kind of environment and that never happened, so they slowed down those orders or used them for fleet renewal as opposed to growth units.”

Overcapacity and 'Stabilizing' Yeilds

Brendan Sobie, lead analyst for Syndey-headquartered CAPA Center for Aviation, agreed that overcapacity has become a problem for the past “few years,” particularly in Southeast Asia, but not because growth rates haven’t continued to outpace the rest of the world. Again, he said, the problem boils down to aggressiveness on the part of some airlines to chase growth at the cost of yields. He agreed that some “stabilization” has occurred recently, but he didn’t express much confidence in a near-turn reversal.

“Yields have come down so much in the last several years. Stabilizing, especially in an environment where fuel prices are starting to creep again, is not good enough,” said Sobie. “And I should say it’s not just domestic and regional here. It’s also long haul, because you’ve got a lot of capacity being added by airlines in the Middle East, for example,” he explained.

“The Chinese expansion into the international long-haul market has affected yields significantly,” Sobie added. “If you look at Southeast Asia to America, the fares have been lower than they’ve ever been...That has been driven a lot by the Chinese carriers...[They] weren’t very big in the long-haul markets, and they didn’t have a huge presence in Europe or North America. But in the last few years, the main airlines have added a lot. You also have a lot of secondary Chinese airlines who have started expanding or launching long-haul services, as well.”

While competition from long-haul carriers from outside the region has driven down yields for Asian network carriers, the rise of LCCs has done the same in regional and domestic markets. Explosive growth in places like Vietnam and Thailand undoubtedly has benefitted those countries’ economies and populations. But the airlines that serve them haven’t managed much profitability, once they’ve added capacity to the point of saturation with cut-rate ticket prices.

“There’s still double-digit GDP growth there, but the problem is for a few years these markets were growing at 30 percent a year, and that’s not sustainable,” noted Sobie. “It’s kind of a one-off thing where you’re stimulating the market with such low fares, but once that’s done you basically have to return to normal growth, which is still good in this region—10 percent—but it’s not 30 percent.

“During these periods, the airlines were very aggressive. So you had a new LCC come in and compete with an existing LCC, and you had full service airlines as well, so they all had to respond. And because the fuel prices were so low, that obviously led to extremely low fares and capacity expansion, which obviously affects yields.”

Now, compared with the rest of the world, which has seen impressive airline profitability in general over the past two years, Asia-Pacific has lagged. Meanwhile, forces such as consolidation that helped resuscitate many of the rest of the world’s markets can’t happen as readily in a region populated with so many state owned airlines and LCCs whose fleets the manufacturers want to keep operating.

“They’re growth stories, so they attract enough capital and they attract a lot of interest from manufacturers. And the manufacturers are obviously invested in seeing these airlines grow and not fail, because they’re exposed,” explained Sobie. “Some of these airlines, without naming names, they’re going through this period where they can be taking 15 or 20 airplanes a year and they’re able to cover their costs by sale-leasebacks. So if you have 10 or 15 sale-leasebacks a year and you’ve got a good deal from the manufacturers and the lease companies give you a higher value, basically you’re funding your operations...Eventually something might give, but by the time that happens there are vested interests and nobody wants you to fail.”