Can South East Asia sustain so many low cost carriers?

The intense competition within the aviation sector benefited consumers in 2013. What will 2014 hold? (Photo credit: Terence Ong, Wikimedia Commons)

The intense competition within the aviation sector benefited consumers in 2013. What will 2014 hold? (Photo credit: Terence Ong, Wikimedia Commons)

By Zhen M

Airline competition had been intense during most of 2013 amid what CIMB Research describes as “overly-exuberant capacity expansion”, leading to severe yield compression for the majority of the carriers in South East Asia. As a result, industry earnings failed to meet expectations and share prices generally declined.

The airfare war in Malaysia was triggered by Malindo Air’s entry on 22 March last year, to which Malaysia Airlines and AirAsia reacted fiercely, noted Maybank Research. “Everyone was practitioners of the load-active and yield-passive strategy with devastating results.”

The low low-cost carriers’ (LCCs) pricing forced the full-service carriers (FSCs) to respond in kind, even though the latter’s cost structures do not permit such low pricing. “In 2013, we have also seen some FSCs like MAS and Philippine Airlines strangely taking the lead on pricing, forcing LCCs like AirAsia, AAX and Cebu Air to match them,” notes CIMB Research.

AirAsia, Nok, Malindo, Tiger and Scoot – these are just some of the regional LCCs. Last month, an MOU was signed to set up yet another LCC, NokScoot, while AirAsia is continually establishing new sister airlines. Can the region sustain so many LCCs?

The proliferation of new LCC tie-ups is positive for the consumer but negative for FSCs, notes RHB Research regional transport analyst Ahmad Maghfur Usman.

“It all boils down to whether there are any overlapping routes. In AirAsia’s case, I think its branding strategy has been successful and, hence, it stands a better chance of staying relevant to the consumer’s heart. SIA is trying new things with Tiger, Scoot and Nok and so much more… to the point that it does not know what it is getting itself into. When you have too many tie-ups with different booking platforms, there would be no benefit of integration, which would then only lead to higher costs. AirAsia has done well in creating a successful LCC franchise,” says Ahmad.

What can we expect in 2014?

With the focus back on profitability, carriers will be more careful about throwing discounts and hence the pressure on yields is expected to be less severe this year, says Ahmad.

“In this increasingly tough industry, maintaining a cash profit is crucial. To stay relevant, cost focus is the game of survival. While yields are subjected to competition and the supply-demand dynamics, costs, at least, are within the airlines’ control,” says Ahmad, adding that AirAsia has played its cards right by not retaliating head on with Malindo Air.

Given the non-sustainability of a prolonged fare war, analysts believe that competition will ease in Malaysia. But for some other markets, such as Thailand, they believe the situation will only intensify.

“We expect price competition to escalate in Thailand when two new competitors muscle in, and Thai Airways could respond aggressively. In Singapore, SIA is feeling the heat from the LCC competition, while long-haul Middle East carriers and more recently China Southern continue to pile on the pressure on the ‘kangaroo’ routes,” says CIMB Research.

Maybank Research forecasts Malaysian air passenger traffic growth of 9-10% in 2014, lower than last year’s 18%. “This growth should be comfortably absorbed by the market, as it is closed to Malaysia’s long-term growth rate of 8%. The yield outlook should gradually improve as the supply-demand is in balance and airlines no longer need to engage in an all-out fare war.”

“We believe that yields have adjusted to a new level of equilibrium after Malindo Air’s entry into the market. The domestic yields will be lower than the levels achieved pre-2012 going forward, but it should be above of the levels achieved in 2013. The situation should get progressively better because every airline management has acknowledged that this price war is not sustainable and they need to reverse the yield decline trend,” Maybank Research added.

Airlines should find comfort from the fact that 2014 is a Visit Malaysia Year. The Visit Malaysia Year campaign, now in its fourth instalment, had in the past boosted tourist arrivals with its various promotional activities held all year round on an international scale. The last Visit Malaysia Year, in 2007, saw tourist arrivals surge 19.5% year-on-year and tourist receipt jump 27% year-on-year.

The main downside risk for the airline sector in 2014 is fuel prices, the largest cost item, comprising 40%-45% of total costs.

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