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Profits Elusive For Asia’s Long-Haul LCCs

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The Asia-Pacific region has become the epicenter of the long-haul, low-cost airline trend. But despite the rapid growth of these carriers—and with much more pending—it is still yet to be proven that the model can be successful.

In many ways Asia has been the perfect petri dish for the long-haul low-cost carrier (LCC) experiment. Growth of the middle class in huge population bases is creating new leisure travel demand, and markets in the region are often separated by vast distances. This has prompted the development of AirAsia X, based in Kuala Lumpur, Scoot in Singapore, and the long-haul unit of Jetstar which is based in Australia but focused on Asia. All three operate widebody aircraft in contrast to the traditional budget carrier reliance on narrowbodies.

Financial success has remained elusive, however. The long-haul LCC operations are either yet to breakeven, or have not come close to the levels of profitability of their affiliated short-haul LCCs. This is in large part because they are still in expansion or fleet modernization mode. It also must be recognized that beyond the numbers, they have great strategic value to their airline groups. But in each case, the carriers are fine-tuning their formulas with the expectation that they must become sustainably profitable.

There is undoubtedly potential in the long-haul LCC model, as evidenced by the proliferation of joint-venture franchises being set up by the three main players. And more of the short-haul LCCs are also branching into long-haul operations, such as Cebu Pacific.

But the biggest vote of confidence is the fact that many of Asia’s long-haul LCCs are subsidiaries of the giant full-service airlines. Jetstar was created by Qantas, and Scoot is wholly owned by Singapore Airlines. The majors have not been slow to recognize the threat—and opportunity—presented by the new type of LCC.

AirAsia X—the largest of the long-haul LCCs—is not linked to a full-service carrier. It is an independently traded company, although it remains affiliated to the broader AirAsia LCC group. AirAsia X has in many ways been the standard-bearer for the long-haul LCC model in Asia.

While AirAsia X has not achieved solid profitability, this is only because of the rapid growth it has undertaken since it was founded in 2007, says CEO Azran Osman-Rani. He emphasizes that the business model itself is extremely sound, and the airline’s financial results will soon prove this as its early expansion phase levels out.

The airline now has a fleet of 23 Airbus A330-300s, including two each in a pair of offshore joint ventures. The total has more than doubled from the 11 aircraft the carrier had at the end of 2012.

Osman-Rani says the underlying economics are just as valid as those of short-haul low-cost carriers, which have well and truly proven their ability to succeed financially in markets all over the globe.

However, one major difference between short-haul and long-haul LCC models is that it takes more time for long-haul routes to reach maturity, Osman-Rani says. When short-haul low-cost routes are launched, there is often already a strong base of regular travelers, including commuter traffic. That is not the case for long-haul routes, which must rely more heavily on irregular holiday travel.

This means it can take 12 months for a low-cost long-haul route to fully mature, says Osman-Rani. And if more routes are added quickly, their first-year losses tend to offset the early profit margins from routes that are starting to mature. So the financial results tend to be “skewed by the amount of new capacity while in investment mode.”

Because of this effect, Osman-Rani believes a carrier needs up to 75% of its routes to be mature before it can be profitable. AirAsia X “is not quite there yet,” he says.

AirAsia X deliberately undertook “aggressive expansion” following an initial public offering in 2013. The airline could see that new long-haul LCC rivals were emerging, and it wanted to ensure it had scale and early mover advantages, says Osman-Rani.

The much larger AirAsia X short-haul carrier went through the same sort of expansion phase in 2007-08, and at the time many questioned the strategy when its profits took a beating. But now the original AirAsia has become one of the industry’s financial success stories, Osman-Rani says.

Likewise, AirAsia X decided to “bite the bullet and expand,” says the CEO. He notes that if the carrier wanted to be judged solely by profit margins, it would have been very easy to simply not add capacity. But if it had opted for this approach, it would have been overtaken by other long-haul LCCs within 2-3 years.

AirAsia X has now begun to ease off its growth rate, having achieved its initial market expansion objectives. Capacity increases in 2015 will be a fraction of what they were in 2014, Osman-Rani says. This will allow the airline to increase yields, strengthen profitability, and build up its cash balance.

The effects of this change will likely be seen in the fourth-quarter 2014 results, which have yet to be announced. After three consecutive quarters of losses, the carrier is expected to report an operating profit for the most recent quarter. Osman-Rani says this aligns with the 12-month route maturity concept, as AirAsia X added a large tranche of capacity in the fourth quarter of 2013.

There will still be non-operating items that may prevent a quarterly net profit, but “on a core business basis, [the airline] will be back in profit,” says Osman-Rani.

External forces have also helped contribute to the decision to slow growth. The twin Malaysia Airlines tragedies in 2014 dampened overall long-haul demand, with Chinese tourist traffic into Southeast Asia particularly affected. It has yet to be seen how December’s Indonesia AirAsia crash might further harm demand.

As it steps back from expansion, AirAsia X has decided to slow down its aircraft delivery stream. The airline was scheduled to receive eight A330s in each of the next three years, but it now plans to sell two of its 2015 orders, and defer four due in 2016 and another three scheduled for 2017.

Most of the deferrals have been converted to A330neo orders. AirAsia X recently placed a firm order for 55 A330neos, which it expects to begin receiving in 2018. The airline has previous orders for 10 A350s, but delivery dates have not been locked in. The imperative to get the A350s as soon as possible is lessened due to the A330neo deal, Osman-Rani says. The A330neos will be a higher priority for capital commitment, at least initially.

The confirmation of the A330neo order demonstrates that while short-term growth has been slowed,
AirAsia X still sees much potential for long-term expansion.

AirAsia X and other LCCs now account for 30% of traffic on routes from Malaysia longer than 4 hr. Osman-Rani notes that the LCC traffic share in short-haul markets often stabilizes at 50%, so there is still room for expansion on existing routes. “On routes we’ve already flown for a while, we know we could easily reach that 50% mark.”

A major part of the growth plan is based on building up secondary hubs outside Kuala Lumpur, using the airline’s overseas joint ventures. Thai AirAsia X launched in Bangkok in June, and Indonesia AirAsia X began flying from Bali in January. The six A330s due to be delivered to AirAsia X this year will all be allocated to these joint ventures.

AirAsia X will be able to increase its footprint significantly by linking the new hubs to cities already served from Kuala Lumpur. This multi-hub approach is a core element of AirAsia group strategy, Osman-Rani says. It allows carriers to grow by increasing the density of the existing network, compared to a single-hub operation that would have to continually add more destinations in order to expand.

Through these two approaches—building up current routes and adding connections between existing destinations—AirAsia X has enough latent demand for a fleet of up to 90 aircraft, Osman-Rani says. And that is without factoring in any new destinations.

But AirAsia X does have some additional markets on its radar. The carrier has often discussed the possibility of a return to European destinations London and Paris, both of which the airline served until 2012 using Airbus A340s.

At the time, some industry observers believed the cancellation of the Europe services demonstrated that there was a limit to how far people were willing to fly on an LCC. However, Osman-Rani says the decision to cut the routes had nothing to do with their physical distance, and he notes that closer destinations such as Mumbai, India, were suspended at the same time.

The fact that AirAsia X’s London flights had load factors of 80% or more showed that people were willing to fly there on an LCC, says Osman-Rani. But the carrier recognized it did not have the necessary scale in either Europe or India to take full advantage of these markets, and it was dwarfed by larger players.

So AirAsia X decided to redeploy the capacity from its suspended routes to its core markets in North Asia and Australia. “It is better to be a big fish in a few ponds than a small fish in many ponds,” says Osman-Rani.

Another factor was that Europe’s recession was biting deeper. Many international airlines were also pulling back from Europe at the same time, but Osman-Rani wryly points out that nobody used that fact to question the full-service long-haul model.

Any resumption of European flights would have to wait for the arrival of the A330neos, says the AirAsia X CEO. But even then it is far from certain. It will depend on the condition of European markets at that time, and it may transpire that the A330neos would be better deployed on Asian routes.

“We’re not obligated or fixated on a return to London,” Osman-Rani says. European routes will be relaunched “only if it makes sense relative to the other growth opportunities we have.”


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