Turbulence will hurt Southeast Asia’s airlines in 2017 as overcapacity bites

Published January 2017 in Airline Leader: Issue 38

Southeast Asia is a region with enormous growth potential but a relatively cloudy outlook for airlines given the intense competition and overcapacity concerns. Demand is on the rise, boosted by a growing middle class, rising discretionary incomes and relatively strong economies.

Nearly every country in Southeast Asia continues to post GDP growth above the global average. The Philippines, Vietnam, Myanmar and Cambodia have been particularly strong with GDP growth in the high single digits.

However, GDP growth slowed to less than 5% in the rest of Southeast Asia in 2016 and is expected to only pick up slightly in 2017. In several Southeast Asian markets, capacity has been growing faster than demand, impacting yields as competition has intensified. With an order book that equals the size of the current active fleet and several airlines pursuing strategic expansion, capacity may again be added at a rate exceeding demand in 2017.

Lower oil prices have provided a cushion to the reduction in yields, enabling Southeast Asia’s airline sector to eke out profits. However, as oil prices inch up profitability could decline as it will be nearly impossible for airlines to increase fares or yields given the competitive environment.

Southeast Asia’s airlines returned to profitability in 2015 following a dismal 2014, when overcapacity and political instability in some markets led to a collective loss. In 2016 profitability improved further, aided in part by lower fuel prices. Restructuring initiatives also aided profitability with several airlines reducing their losses significantly and a few airlines returning to profitability.

But profit margins were still small in 2016, particularly for what should have been a standout year – with very low fuel prices, political stability and relatively strong economies. The profitability of the Southeast Asian airline sector significantly lagged the global average and the Asia Pacific average. Southeast Asian airlines underperformed in 2016 compared to their peers in North Asia, Australasia, Europe and North America.

The financial outlook for 2017 is not as bright as 2016 – both globally and in the Southeast Asian region. Profits are expected to fall. For airlines in Southeast Asia the fall will be from a very small base, resulting in a reduction in margins which are already miniscule – or perhaps putting the sector back into the red.

Traffic will again grow in 2017 by healthy levels. But capacity growth will be faster than demand growth and in some markets the rate of traffic growth could slow.

Over the last two years the Thailand and Vietnam markets have experienced some of the fastest growth in the world. The Philippines also enjoyed a resurgence, with growth approaching the double digits the last two years on the back of a booming economy. Southeast Asia’s other seven markets have grown at a slower clip, generally in the low to mid single digits.

The rate of passenger growth in Thailand, Southeast Asia’s largest international market, slowed from over 20% in 2015 to approximately 10% in 2016. Thailand will likely see a further slowdown in 2017. Growth in visitor numbers slowed significantly in 4Q2016, particularly from China. Domestic and outbound demand meanwhile has been impacted by relatively slow economic growth and the death of Thailand’s beloved King.

Thailand’s domestic market is now approaching saturation after three years of rapid growth driven by LCC expansion. Thailand now has four LCCs competing in the domestic and regional international markets and two long-haul LCCs. Thailand’s LCC fleet has tripled in size over the last four years to over 120 aircraft.

Thailand’s international market is also flooded with capacity from foreign LCCs – over 25 serve Thailand – and Gulf carrier capacity. Bangkok is now the third largest destination for Emirates and Qatar Airways and the second largest for Etihad. Qatar Airways just launched its third destination in Thailand and plans to launch its 4th in 2017, giving it more than any foreign airline based outside Southeast Asia.

Newfound profitability at restructured Thai Airways could be at risk as competition continues to intensify. Thai Airways is resuming expansion, including in the extremely competitive Thailand-Europe market while its full service regional subsidiary Thai Smile is pursuing rapid growth in the regional international market.

Thai Airways is also preparing to launch nonstop services to the US, potentially by the end of 2017, a risky proposition that could further impact the group’s profitability.

Thailand LCC fleet growth (number of aircraft): end 2012 to end 2016*

Airline End 2012 End 2013 End 2014 End 2015 Dec-2016*
Thai AirAsia 27 35 40 45 51
Nok Air 15 17 24 28 33
Thai Lion 0 2 8 18 24
Thai AirAsia X  0 0 2 5 6
NokScoot 0 0 0 3 3
Thai VietJet 0 0 1 1 3
TOTAL 42 54 75 100 120

Bangkok Airways and Thai AirAsia have been among the most profitable airlines in Southeast Asia over the past two years but could see margins compress in 2017. Thai AirAsia is particularly impacted by a slowdown in the Thailand-China market as China accounts for 11 of its 28 international destinations. Thai AirAsia plans to add another five A320s in 2017 and is trying to reduce its reliance on China by pursuing expansion in India and regionally within Southeast Asia.

Nok Air has been unprofitable for the past three years due mainly to aggressive domestic expansion from Thai Lion Air. Nok is predominantly a domestic airline and is starting to turn its attention to the international market, with an initial focus on Myanmar and Vietnam and potential new routes to China and India in 2017. However international expansion comes with higher risk and in all of its potential new routes Nok will have to overcome intense competition.

As a result, Nok could struggle to achieve its target of returning to profitability in 2017. Its long-haul sister LCC, NokScoot, also continues to face challenges due to continued restrictions preventing all Thai airlines from expanding in Korea or Japan and a slowdown in the China-Thailand market.

Thai Lion will also not likely meet its target of becoming profitable in 2017. The Lion Group affiliate has expanded rapidly since commencing operations at the end of 2013 and plans to continue adding eight to 10 aircraft per annum.

After initially focusing on the domestic market, where it is now almost as big as Nok and AirAsia, Thai Lion is starting to focus more on international expansion. However, like Nok, international expansion comes with higher risks for Thai Lion, particularly given its relatively unknown brand, and in all the new markets it enters, competition with other LCCs will be fierce.

Thailand’s domestic market has already been suffering from overcapacity along with several regional international trunk routes such as Bangkok-Singapore. Overcapacity will spread to more routes in 2017 as Thailand’s LCCs continue to expand – and as Thai Airways enters more secondary international markets using Thai Smile.

Vietnam will likely continue to grow at a double digit rate but the domestic market is starting to approach saturation after doubling in size in just three years, led by rapid LCC growth. Potential new entrants in 2017 could break up the Vietnam Airlines Group-VietJet Air duopoly, pressuring already low yields and impacting profitability.

VietJet is also starting to focus more on international expansion, after relying almost entirely on the booming domestic market in its first five years. However, international expansion comes with higher risks and huge challenges, particularly given VietJet is not a familiar brand outside its home market.

VietJet, which plans to continue adding aircraft in 2017 at a rate of approximately one per month, may be hard pressed to maintain profitability after a planned initial public offering.

Vietnam Airlines and LCC subsidiary Jetstar Pacific were also profitable in 2016 with Jetstar Pacific recording its first profit in its nine year history. Both airlines are again planning double digit capacity growth in 2017 with Jetstar Pacific expanding faster than the parent brand. The LCC is slated to take several additional A320s in 2017 as the Vietnam Airlines Group uses the brand to respond to aggressive competition from VietJet. Jetstar Pacific has doubled in size over the last two years but VietJet has nearly tripled in size while Vietnam Airlines has grown by over 30%.

Vietnam’s airlines ranked by annual passenger numbers (in millions): 2012 to 2016*

Airline 2012 2013 2014 2015 2016*
Vietnam Airlines 13.6 15.0 15.6 17.6 20.5
VietJet Air 1.0 3.2 5.6 10.0 15
Jetstar Pacific 1.8 2.0 2.6 3.6 5.0

All airlines in Vietnam will be impacted as competition continues to intensify in 2017 – with potential new entrants making it an even more challenging environment despite relatively strong demand.

Vietnam Airlines has warned that it expects a decline in profitability in 2017, echoing projections made by airlines throughout the Southeast Asia region.

Market conditions in the Philippines remain relatively more favourable but infrastructure constraints in Manila limit growth opportunities. Cebu Pacific Air and Philippine Airlines (PAL) have been forced to focus growth in secondary cities. Both airline groups should remain profitable in 2017 although margins are expected to narrow.

Philippines AirAsia will find it difficult to achieve its objective of posting a profit in 2017 for the first time in its five year history. The LCC completed a restructuring in 2016 and is aiming to resume expansion in 2017 with four additional aircraft. It will focus on international routes including China from secondary cities in the Philippines due to the infrastructure constraints at Manila.

Fleet growth at Cebu Pacific and PAL will be modest in 2017 as both airlines wait for the A321neo, which is not slated to be delivered until 4Q2017. Cebu Pacific plans to use 220 seat single class A321neo to upgauge existing routes from the smaller 180 seat A320, enabling it to add 40 seats on flights from slot constrained Manila. Cebu Pacific is also upgauging some regional routes in early 2017 using two additional A330-300s – one of which was delivered at the tail end of 2016 and the other is slated to arrive in May-2017.

PAL already operates A321ceos, limiting upgauge opportunities, but plans to use the improved range of the A321neo on long and medium-haul routes including to Australia and India. In Australia, nonstop flights to Brisbane and a second daily frequency to Sydney may be introduced by the end of 2017. PAL’s North American capacity will also be significantly up in 2017 as it uses the two additional Boeing 777-300ERs delivered in late 2016 to add frequencies and upgauge existing flights.

PAL will also continue to pursue domestic expansion in 2017 with a focus on secondary hubs, including Cebu and Clark. Cebu Pacific will grow domestically with new point to point routes using its new ATR 72-600 fleet. The Philippines domestic market has experienced double digit domestic growth in the past two years, following a two year period of flat traffic. The Philippines economy remains strong but another year of double digit traffic growth is not likely.

Indonesia, Southeast Asia’s largest domestic market, has experienced tougher market conditions in the past two years than other countries in the region. Relatively slow economic growth and regulatory constraints have impacted demand.

Growth in the Indonesian domestic market has slowed to the low single digits. Indonesia’s domestic market doubled in size from 2008 to 2012, becoming the world’s fifth largest domestic market, but in the subsequent four years has grown by less than 20%. Market leader Lion Air slowed growth considerably in 2016, partially because of regulatory constraints, leading the group to accelerate expansion in its overseas joint ventures. The group’s Indonesian full service subsidiary Batik Air also has continued to expand rapidly and is planning to purse even faster growth in 2017.

Indonesia’s much smaller international market has huge potential but has so far not delivered the anticipated increases in demand, dragged down by a weak local currency. Garuda Indonesia was back in the red in 2016 due mainly to overambitious international expansion.

The outlook in Indonesia for 2017 is relatively cloudy – similar to most of Southeast Asia. While Indonesia expects rapid growth in inbound tourism this is on a low base and local demand is not likely to see a rapid recovery. Competition between the Garuda and Lion groups is fiercer than ever, resulting in overcapacity.   

Malaysia is the Southeast Asian market to keep an eye on in 2017. All of Malaysia’s airlines are planning to expand, leading to a dogfight and pressuring already low yields.

Growth in Malaysia resumed in 2016 with passenger numbers up approximately 5% after a growth of less than 1% in 2015. Passenger growth will likely accelerate further in 2017 but at the expense of yields and profitability as the market will almost certainly experience overcapacity.

Market leader AirAsia is planning to accelerate expansion as it strategically responds to a reinvigorated Malaysia Airlines and an extremely ambitious Malindo Air. The group’s Malaysia-based short-haul affiliate is planning to add seven aircraft in 2017, ending a nearly three year hiatus from fleet expansion.

Malaysia AirAsia’s capacity was relatively flat in 2016, enabling it to improve load factors to record levels (approximately 90% in 2H2016). Yields also improved in 2016 but will come under pressure in 2017 as capacity expansion accelerates and competitors also pursue expansion.

Malaysia Airlines plans to resume capacity expansion in 2016, with ASK growth of 5% to 6%. Passenger numbers are likely to grow by up to 10%, driven partially by load factor improvements, ending two years of steep declines as the airline restructured its network.

Malaysia Airlines recently launched new domestic point to point routes which were exclusively served by AirAsia and is planning to add eight destinations in China in 2017. Seven of these destinations are served by AirAsia or AirAsia X.

With even bigger ramifications, Malaysia Airlines has introduced a new pricing strategy aimed at boosting its load factors and competing more effectively with LCCs. The new lower fares are permanent rather than promotional and will be rolled out across all the overseas markets in 2017.

Meanwhile Lion Group’s Malaysian JV, Malindo, is planning another year of rapid expansion in 2017. Malindo was one of the fastest growing airlines in Asia – and the world – in 2016 as it added 15 aircraft. Malindo also launched a staggering nine new international destinations in 2016. Eight of these are served by AirAsia or AirAsia X and six by Malaysia Airlines.

Malindo plans to add at least 10 more aircraft in 2017 – and could potentially again add 15 aircraft. Malindo also plans to rebrand in 2017, adopting the Batik Malaysia brand which reinforces its full service model.

Malindo is planning new routes to Australia, China, Indonesia and Saudi Arabia in 2017 but the focus will be on adding capacity to existing destinations, resulting in improved connectivity. Malindo needs to add frequencies in order to meet targets for increasing transit traffic as well as interline and codeshare traffic. Malindo started interlining with foreign airlines in mid-2016 and expects to expand its portfolio of interline partners in 2017 as well as start codesharing with sister airlines in the Lion Group, starting with Indonesia’s Batik.

Almost 30% of Malindo’s traffic is now transit, an impressive figure for an airline that is less than four years old. Malindo aims to achieve a 45% transit traffic ratio, which is close to the ratio of Malaysia Airlines.

Malindo is also quickly closing in on Malaysia Airlines in terms of overall passenger numbers. Malindo aims to double traffic in 2017 and handle at least 12 million passengers. Malaysia Airlines carried approximately 13.5 million passengers in 2016, down 20% from 2014, and expects to grow passenger traffic by one million in 2017.

AirAsia X, which Malindo surpassed in 2015, also has resumed growth. Traffic at AirAsia X was up nearly 30% in 2016 as the medium/long-haul LCC returned to profitability. AirAsia X is looking at potentially resuming services to London in 2H2017, which would put pressure on Malaysia Airlines as London is the flag carrier’s only remaining European route. AirAsia X is also planning to launch services to Honolulu, which would be the group’s first US destination, in mid-2017.

Resuming services to Europe is strategically critical but is risky, particularly as it involves adding a new aircraft type, and could impact profitability. AirAsia X already faces the prospect of new competition from Malaysia Airlines and Malindo in several of its markets.

Malaysia’s airlines ranked by annual passenger numbers (in millions): 2012 to 2017*

Airline 2012 2013 2014 2015 2016* 2017*
AirAsia 19.7 21.9 22.1 24.3 26.4 29.0
Malaysia Airlines 13.4 17.2 17.0 15.0 13.5 14.5
Malindo Air N/A 0.9 2.5 3.7 6.0 12.0
AirAsia X 2.6 3.2 4.2 3.6 4.6 5.3
Firefly 1.7 2.0 2.2 2.2 2.0 2.0
MASwings 1.6 1.5 1.6 1.4 1.3 1.4

AirAsia and AirAsia X are confident they can remain profitable despite the challenges ahead. Meanwhile, Malaysia Airlines is confident it can achieve its target of significantly narrowing its losses in 2017 and be profitable from 4Q2017. However, a setback in the Malaysia Airlines turnaround plan, which envisions full year profitability from 2018 and a relisting in 2019, would not be surprising given the irrational level of capacity being added to the Malaysian market. Malaysia Airlines has made significant headway in restructuring and reducing costs but with the anticipated overcapacity and mounting yield pressures it may struggle to meet its revenue and therefore profitability targets.

In Singapore, growth has resumed but at relatively modest levels and overcapacity is again a concern. Passenger traffic was up approximately 6% in 2016, the highest rate of growth in four years. Back in 2010 to 2012 growth in Singapore was consistently in the double digits, driven by rapid short-haul LCC expansion that proved too overambitious, leading to overcapacity and unprofitability.

However, growth slowed to the low single digits in 2013-2015.

Singapore’s two short-haul LCCs, Jetstar Asia and Tigerair, are now back in the black while medium/long-haul LCC Scoot had its first profitable year in 2016. Tigerair and Scoot plan to merge in 2017, which should drive synergies and lead to a surge in transit traffic. The latter is key as there are limited opportunities for growth in the local Singapore market.

Scoot is pursuing aggressive expansion in 2017 with four additional 787s being used to launch services to Europe, starting with Athens in Jun-2017 with one or two more European destinations to be launched by the end of the year. Meanwhile Tigerair (or Scoot as the Tigerair brand is expected to be dropped by the end of 2017) is resuming narrowbody fleet expansion in 2H2017 after a three year hiatus from growth.

The rapid expansion at Tigerair/Scoot, including the relatively risky launch of long-haul flights to Europe, could make it challenging for the newly merged LCC to maintain profitability.

Singapore Changi passenger traffic (millions) and year on year growth: 2008 to 10M2016

Singapore Changi passenger traffic and year on year growth: 2008 to 10M2016

Singapore Airlines (SIA) also continues to experience declining yields due to intensifying competition in the Southeast Asia to Europe and North America markets. Gulf airlines have been particularly aggressive, adding capacity in Singapore and other Southeast Asian markets, resulting in record low fares from Southeast Asia to Europe and North America. Aggressive expansion from some North Asian airlines has also lead to overcapacity and very low fares in the Southeast Asia-North America market.

The SIA Group is relying on its LCC subsidiaries, as well as on regional full service subsidiary SilkAir, for growth and long term profitability. However, 2017 will be challenging for all of its brands. SIA should be able to stay in the black – it has never had an unprofitable year – but margins will fall further and the short to medium term outlook is cloudy.

Jetstar Asia has not grown its fleet in three years and plans to again not pursue any fleet growth in 2017. Jetstar Asia believes the Singapore market continues to suffer from overcapacity – although not as severely as two to three years ago – and is concerned the overcapacity situation will take another turn for the worse in 2017.

Jetstar Asia is trying to avoid dogfights with other LCCs by restraining from capacity growth and focusing on higher yielding connecting traffic from its interline and codeshare partners, a sensible strategy in a challenging market.

Jetstar Asia is an exception in a region filled with airlines pursuing aggressive strategic expansion. LCCs are the biggest culprit but full service airlines have also pursued rapid expansion in Southeast Asia. This includes full service carriers from North Asia and the Middle East as well regional full service expansion from airline groups based in Southeast Asia.

In fact, full service carrier capacity expansion within Southeast Asia was faster than LCC capacity expansion in both 2015 and 2016. The LCC penetration rate within Southeast Asia therefore has slipped for the first time since the LCCs entered the Southeast Asian market at the beginning of the century. The LCC penetration rate to/from Southeast Asia has continued to grow, from a much smaller base, due to expansion from medium/long-haul LCCs and from short-haul LCCs in the Southeast Asia-China market.

Southeast Asian LCC fleet and order book by airline/group: as of Nov-2016

Airline Group No. of LCCs Fleet size Orders
AirAsia/AirAsia X 7 192 476
Lion Group 3 187 451
Cebu Pacific 2 55 49
Garuda (Citilink) 1 41 39
VietJet 2 36 199
Singapore Airlines (Scoot/Tigerair) 2 35 47
Nok 2 35 10
Jetstar 2 32 (99)
TOTAL 21 613 1,271*

Southeast Asian LCCs have slowed expansion over the past two years, deferring deliveries in some cases, contributing to the reduction in the short-haul LCC penetration rate. LCCs have continued to grow, but at a much slower clip while full service carrier expansion has in many cases been in the double digits (including at Batik, Garuda, Malindo, SilkAir, Thai Smile and Vietnam Airlines).

However, the Southeast Asian LCC sector remains committed to very rapid growth over the medium to long term. LCC groups based in Southeast Asia have nearly 1,300 aircraft orders compared to an active fleet of just over 600 aircraft. Southeast Asian full service carriers have slightly more than 500 aircraft on order, most of which are intended as replacements, and an active fleet of approximately 1,200 aircraft. Southeast Asia and the Middle East are the only regions or sub-regions that currently have as many aircraft on order as current fleet.

The huge LCC order book indicates that the current overcapacity situation is not about to go away anytime soon. Some of the aircraft on order will inevitably end up outside the region – AirAsia and Lion now have leasing companies while AirAsia has affiliates in India and soon Japan – but the bulk will end up in the already crowded Southeast Asian market.

The relatively cloudy profit outlook for 2017 could persist in 2018 and beyond. Southeast Asia needs consolidation, but will not get it. While the fundamentals of the market are attractive – including rapid economic and middle class growth – the level of competition is at times extreme and the capacity levels irrational.

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