Southeast Asia Outlook: Lower growth and improved profitability for the second consecutive year

Southeast Asia has experienced remarkable growth over the last decade, particularly in the short haul sector, as low cost carriers (LCCs) rapidly expanded. Seat capacity within Southeast Asia has more than tripled over the last 12 years - and LCCs account for about 75% of the additional seats.

After Southeast Asia's dynamic LCC sector recorded remarkable 30% seat growth in 2013, growth slowed to about 14% in 2014 and 9% in 2015, according to OAG. Full service carriers grew seat capacity within Southeast Asia by 14% in 2015, marking the first time the FSC growth rate exceeded the LCC growth rate since the first wave of LCCs launched in Southeast Asia shortly after the turn of the century. As a result the LCC penetration rate within Southeast Asia dipped from a high of 57% in 2014 to about 56.5% in 2015.

A maturing LCC penetration rate is hardly surprising given that the nearly 60% penetration rate for Southeast Asia is already higher than any other region or sub-region, including Western Europe and North America. 2016 will likely see the penetration rate remain roughly flat as most of the LCC groups maintain a relatively disciplined approach to capacity growth.

AirAsia in particular has slowed growth significantly. Total passenger traffic across all AirAsia-branded carriers grew by less than 10% in 2014 and again in 2015, representing the first time in the group's history that growth was in the single digits.

The combined AirAsia/AirAsia X fleet in Southeast Asia declined slightly in 2015 as the group deferred deliveries, sold or returned several aircraft and improved utilisation rates. The combined AirAsia/AirAsia X fleet in Southeast Asia is expected to grow by less than 10 aircraft in 2016 due to another string of deferrals and aircraft sales or returns.

AirAsia X is only planning to add one aircraft in 2016 as the long haul LCC group attempts a turnaround after two years of heavy losses. Malaysia AirAsia and Thai AirAsia plan to grow their fleets by three and four aircraft respectively - relatively modest figures given they were the only profitable AirAsia carriers in 2015 and the opportunities for expansion in their home markets.

Neither of Singapore's short haul LCCs, Tigerair and Jetstar Asia, are planning to grow their fleets in 2016, while Philippine LCC Cebu Pacific is only planning to add one aircraft.

Overall, CAPA projects the Southeast Asian LCC fleet will grow by approximately 80 aircraft in 2016 including 75 single aisle aircraft and five widebodies. Southeast Asia's 23 LCCs ended 2015 with slightly over 600 aircraft, including about 50 widebodies. The region's LCC fleet has grown 50% since the end of 2012, when there were only about 400 aircraft in operation across the region's LCCs.

While the rate of growth has been slowing the order book suggests at some point the rate of LCC growth in Southeast Asia will reaccelerate. Southeast Asian LCCs currently have over 1,100 orders, including almost 90 widebody aircraft. LCCs currently account for about 75% of orders among Southeast Asian airlines but only about 33% of the active fleet.

Even when factoring in replacements the size of the LCC fleet should more than double over the next decade. While some of the 1,100 plus orders will end up at affiliates outside the region - or in the case of Lion Group at full service subsidiary Batik - these should be roughly offset by growth at LCCs relying on the acquisition of second hand aircraft and growth at Jetstar using aircraft not included in this order book. (As Jetstar is not based in Southeast Asia its order book of nearly 100 aircraft are not included in the chart above.)

Lion has the largest order book in Southeast Asia and has not yet made any moves to reduce its rate of expansion. Lion's portfolio of four LCCs added about 40 aircraft in 2015 and are expected to add a similar number in 2016. Lion therefore accounted for about 50% of the total fleet growth by the Southeast Asian LCC sector in 2015 and will likely again account for about 50% in 2016.

All four of Lion Group's LCC affiliates or subsidiaries - Lion Air, Indonesian regional carrier Wings Air, Thai Lion and Malaysia's Malindo Air - will each see growth of roughly 10 aircraft in 2016. Garuda Indonesia subsidiary Citilink and Vietnam's leading LCC VietJet Air are planning a similar rate of rapid fleet expansion in 2016 with eight and about 12 additional aircraft respectively.

Vietnam is well placed to see faster growth than most other Southeast Asian markets as it still has a relatively low LCC penetration rate. Over the last couple of years Vietnam and the Philippines have been the only Southeast Asian markets where generally demand has been aligned with capacity. But as VietJet continues to expand rapidly while Vietnam Airlines LCC subsidiary Jetstar Pacific accelerates expansion the Vietnamese market could start to overheat.

Thailand's domestic market has been plagued with overcapacity since the launch of Thai Lion at the end of 2013. Thai Lion has since expanded rapidly, adding nearly 20 aircraft in two years while Thai AirAsia and Nok Air responded by also accelerating expansion. Competition in Thailand is likely to remain fierce and at times irrational in 2016. In the international market conditions are more favourable but could start to see overcapacity as several LCCs expand rapidly.

Malaysia's short haul market is also likely to remain challenging. AirAsia and Lion's Malindo continue to grow despite relatively weak demand while Malaysia Airlines plans to maintain or slightly increase domestic and regional international capacity. The ailing flag carrier has slashed capacity to Europe and Australia as part of its restructuring but elected against making the short haul reductions its competitors had been expecting.

Indonesia's domestic market, which has experienced a dip in demand over the last two years, will similarly not get any easier in 2016. In addition to intense competition at the bottom end between Lion and Citilink, the battle at the top end between Batik and Garuda is intensifying. Garuda has grown domestic ASKs by at least 10% for at least five consecutive years and plans to again pursue double digit domestic expansion in 2016. Batik added 15 aircraft in 2015, making it the fastest growing airline in Southeast Asia, and plans to take another 16 aircraft in 2016. (Note: Batik's fleet figures are not included in the Lion Group LCC numbers from earlier in this report as Batik is a full service carrier.)

Southeast Asian full service airline groups are focusing growth mainly on the regional market. As already mentioned, Malaysia Airlines plans to maintain or if anything slightly grow its short haul capacity in 2016 while Garuda plans double digit domestic growth. The Philippine Airlines Group also plans to expand domestically for the second consecutive year. Roughly 10% growth is also expected for Singapore Airlines (SIA) full service regional subsidiary SilkAir and Thai Airways regional subsidiary Thai Smile. As a result FSC capacity expansion within Southeast Asia could again match or exceed LCC capacity expansion in 2016.

The regional focus is a practical strategy for the region's full service carriers given the challenges of the medium/long haul sectors, including overcapacity on Southeast Asia-Australia and extremely intense competition with Gulf carriers on Southeast Asia-Europe. SIA is reducing long haul capacity as it rolls out premium economy on more routes with the aim of ceding low yielding economy passengers to Gulf carriers and other competitors.

Thai Airways is planning roughly to maintain its long haul capacity in 2016 after completing a restructuring in 2015. Malaysia Airlines has already cut its long haul network to the bare minimum with London its only remaining European destination. Garuda, Philippine Airlines and potentially Vietnam Airlines will pursue some long haul growth in 2016 but the expansion will be relatively modest and on a low base.

Partnerships are playing an increasingly critical role as Southeast Asian airlines struggle to find profitability in a challenging long haul market. Singapore Airlines' joint venture with Lufthansa and Malaysia Airlines' tie-up with Emirates will be implemented in 2016, representing a potentially game changing new approach for the region's flag carriers. Similar partnerships from other Southeast Asian flag carriers could be forged in 2016 as the sector responds to the structural changes facing the industry.

The new partnerships could unlock some growth. SIA for example is launching services to Dusseldorf in 2016, its first new destination outside Asia since 2011. But generally these partnerships are not about growth but improving profitability, responding to changes in the competitive landscape and providing passengers with more attractive offline networks.

Southeast Asian airline sector profitability has been well below global averages over the last few years as overcapacity and intense competition - and rapid growth - have pressured yields. The sector overall returned to profitability in 2015 aided by lower fuel prices, slower capacity growth and an improvement in market conditions including a more stable political environment in some countries. But the profits were modest and represented less than 20% of the total profits for Asia Pacific and only about 2% of the profits globally. About half of Southeast Asia's publicly traded airlines or affiliates remained loss making in 2015 including eight LCCs.

There should be further improvements in 2016 as most of the region's airlines have adopted a relatively rational approach to capacity. The overall outlook for the Southeast Asian aviation market is bright given the anticipated growth in consumer spending as the region's economy and middle class population expand.

But overcapacity remains a concern given the region's huge order book and temptation by some airlines to continue or resume strategic expansion. Consolidation and more significant adjustments will ultimately be needed for the sector to achieve sustainable margins.