Asian airlines face capacity surplus

Despite a looming global recession and softening demand, Asian airlines continue to increase capacity, hurting profits.
Economists often say that recessions are good for business. They help companies cut the boom-year excesses, and those that survive, come out stronger and nimbler on the other side. But while US airlines are proactively cutting flights, Asian air carriers remain set on capacity growth even as the credit crunch intensifies.

Airlines worldwide are being slammed on two fronts. The global credit crunch has reduced passenger demand, especially that of lucrative business travellers. At the same time, fuel prices have risen dramatically, averaging $113 per barrel over the first eight months of the year, according to the International Air Transport Association (IATA). As US lawmakers debated a $700 billion banking industry bailout last week, the per barrel oil price for October delivery fluctuated from $104.55 at the opening Monday to as high as $130 at one point and remained over $100 throughout the week.

ôThe toxic combination of high oil prices and falling demand continues to poison the [airline] industryÆs profitability,ö says IATAÆs director general and CEO Giovanni Bisignani. IATA predicts global 2008 airline losses to amount to $5.2 billion.

Already US airlines have announced plans to ground a combined 512 aircraft this autumn in reaction to rising oil prices and the credit crunch. The combined number is equivalent to the size of Northwest Airlines, the sixth largest airline in the US, and represents 11%-12% of total domestic capacity, according to J.P. Morgan.

While the global credit crunch is the worst in the US and Europe, passenger demand in Asia is also falling. Following 6.8% passenger traffic growth in Asia-Pacific in 2007, IATA has revised down growth projections for 2008 to 3.3%. But despite a significant drop in passenger traffic growth over the first eight months of the year, capacity growth has continued unabated. IATA predicts 4.1% growth in Asia-Pacific capacity this year.

The capacity expansion reflects optimism among Asian airlines and a belief among some market watchers that the market will recover by 2009 or 2010, allowing the additional capacity to be absorbed. In the meantime, the airlines are accelerating the retirement of older aircraft and using delivery delays from both Airbus and Boeing to their advantage.

However, high capacity growth and nearly flat passenger traffic will impact profitability in the near-term. According to IATA, Asia-Pacific airlines reported a combined first-half operating profit of $1.15 billion, but a net loss of $207 million. IATA goes on to predict that the airlines will post a combined net profit of only $300 million for the year, down from $900 million in 2007.

HSH NordbankÆs head of aviation, John Francis, attributes the drop in Asian passenger demand over the summer to a combination of travel restrictions in China, the global credit crunch and strong capacity increases. ôSome airlines had pushed up capacity especially for increased traffic during the [Olympic] Games. These calculations have proved seriously wrong, especially for the Chinese carriers, which were hardest hit,ö says Francis.

But Francis is not very concerned about a US-style reaction to overcapacity. He agrees that Asian airlines have too much capacity in the short- to medium-term but not for the long-term. ôIn the short- and medium-term, given the capacity coming to the market, [the Asian market] will be very competitive and profits will remain under pressure. After 2009 or 2010, the market should improve again and capacity will be absorbed,ö he says.

In the meantime, airlines throughout Asia are beginning to act. Hong KongÆs Cathay Pacific Airways quickly adjusted flight schedules after its first-half loss of HK$663 million ($85 million) to better meet demand. The airline will cut frequencies to North America, while increasing services to Australia and Europe. However, in August, Cathay PacificÆs passenger growth was a negligible 0.5%, while the airline posted capacity growth of 14% year-on-year.

ôThe industry is now in the middle of a major crisis and itÆs unlikely that we are going to emerge unscathed,ö said Cathay Pacific CEO Tony Tyler in an employee newsletter. ôWe have put a clear plan in place to tackle this [industry crisis], which includes redeploying capacity, getting fares and surcharges up and reshaping our fleet.ö

In contrast to TylerÆs statement, however, Cathay Pacific announced last Thursday that it will reduce its per passenger fuel surcharges by $4.50 for short-haul flights and by $11.80 on long-haul routes.

Cathay PacificÆs analyst ratings reflect a cautious attitude. Citi and Goldman Sachs rate the airline sell or sell/cautious. Credit Suisse, Nomura and UBS all have a neutral recommendation on the stock.

Singapore Airlines, the first Asian airline to start commercial flights with the super jumbo Airbus A380 aircraft, also saw higher growth in capacity than in passenger traffic in August, posting a 2.2% rise in passenger traffic versus 8.2% capacity growth. Earlier in the summer, Singapore Airlines reported a net profit of S$359 million ($251.5 million) for its April to June first quarter.

Slow passenger growth is not putting a dent in Singapore AirlinesÆ growth plans though; the carrier recently announced new flights to Dubai, Istanbul and Riyadh.

Analysts are slightly more favourable towards Singapore Airlines. DBS and UBS rate the airline a buy, while Citi and Goldman Sachs have the same sell and sell/cautious ratings as they do for Cathay.

Francis at HSH Nordbank feels Cathay Pacific and Singapore Airlines both face possible short-term pressure on yields due to the ôweaker economic situationö.

Meanwhile, in China, the hoped-for spike in passenger air traffic during the Olympics failed to materialise. The mainlandÆs three major carriers û Air China, China Eastern Airlines and China Southern Airlines û all posted double-digit drops in passenger traffic for August and remain cautious in their outlooks for the remainder of 2008.

Shanghai-based China Eastern, which was the least exposed to Olympic-related travel, had the largest fall in passenger traffic with a precipitous 23.1% year-on-year drop in August. Beijing-based Air China carried 16.3% less traffic despite a 0.9% capacity reduction and China Southern, the mainlandÆs largest airline in terms of passenger numbers, saw monthly passenger traffic drop 16.2%.

ôThe biggest problem we are facing now is the continuous decline of domestic demand,ö China Eastern board secretary Luo Zhuping told webzine ATW. ôThe winter is coming and uncertain economic prospects make it difficult for domestic demand to rebound in the short term.ö

In addition to falling domestic demand, analysts cite the strengthening renminbi as another reason for declining passenger traffic.

Analysts give Air China and China Southern largely neutral and cautious ratings. China Eastern earns an almost unanimous sell recommendation. Additionally, UBS Global Equity Research reports that the book values of mainland airlines could be overstated by 39%-308%.

Japanese airlines All Nippon Airways (ANA) and Japan Airlines (JAL) both reported falling traffic and revenues in the first quarter (April to June) of their 2009 fiscal year. ANA reported a 5% drop in year-on-year international passenger traffic on a 63% rise in capacity. Despite the drop, the airline posted a Ñ6.6 billion ($62.4 million) net profit for the quarter, down 94.2% from the same period 2007.

JAL passenger traffic dropped 5.7% year-on-year on a 3.5% decrease in capacity in the first quarter. The airline was unable to maintain its fiscal 2008 profitability and reported a Ñ3.4 billion ($32 million) loss.

Analyst ratings for both ANA and JAL are mixed. UBS gives both airlines a sell rating, while Deutsche Bank and Nomura Securities have hold or neutral ratings.

In Korea, Asiana Airlines and Korean Air both bucked the Asia-wide trend of passenger traffic declines and posted increases in the second quarter. Asiana saw a 6.9% year-on-year rise in traffic on a 10.6% increase in capacity. The airline posted a W19.2 billion ($18.9 million) loss for the period. Korean Air saw less passenger growth over the period with a 2.1% rise in international traffic on a 3.9% rise in capacity. Korean Air also led in terms of losses, reporting a W288.9 billion ($278 million) net loss, 34.7% larger than in the same period last year.

Foreign bank analysts largely have sell recommendations on the two Korean airlines, while analysts at domestic banks rate them hold or buy.

In India, following years of double-digit passenger traffic growth, especially in the low-cost sector, the airline industry experienced only a 7.5% rise in passenger traffic during the first half. And this growth was offset by the countryÆs high jet fuel taxes and infrastructure deficits. IATA predicts that Indian airlines will lose a combined $1.5 billion in 2008, up from $1 billion in 2007 and second globally only to the US.

The largest private airline, Jet Airways, bucked the trend with a 58% year-on-year rise in passenger traffic in August, higher than its capacity growth of 54.5%. The carrier, which is able to charge more for its service on the grounds that it is widely regarded as the best airline in the country, reported a Rs1.43 billion ($30 million) net profit for the quarter ending in June.

Air India and Kingfisher Airlines, IndiaÆs next largest carriers, are both privately held and do not report financial results.

Indian growth is expected to continue apace. However, as the IATAÆs Bisignani points out, the countryÆs airline industry has yet to find a consistent profitability model. After a rapid proliferation of low-cost carriers since 2004, the past two years have been dotted with mergers, including that of national flag carriers Air India and Indian Airlines. In the private sector, Air Sahara has merged with Jet Airways, and Air Deccan has merged with Kingfisher Airlines.

IATA remains optimistic on Asia-Pacific airlinesÆ growth. Pointing out that the region is only one of three where he expects passenger traffic to grow in 2008, Bisignani continues to see China and India as regional drivers of that growth. Most, if not all, forecasts point to a recovery in passenger traffic by 2010 or 2011.

The Airports Council International (ACI) predicts a modest recovery in 2009 passenger traffic growth to 6.9%, rising to 8.2% in 2010 and maintaining an average annual growth rate of 6.3% through 2027. The ACI predicts Asia-Pacific will surpass North America as the largest passenger airline market by 2017.

In the meantime, some shake outs may occur. Chinese and Indian airlines almost undoubtedly face new rounds of consolidation, especially cash-strapped China Eastern. Few changes are expected at the regionÆs semi-national flagship carriers, including Cathay Pacific and Singapore Airlines.

Over the long-term, investors can expect the dual global credit crunch and fuel price hike to make AsiaÆs airlines stronger û good ôholdö stocks û while over the short-term, business travellers can look forward to the return of open middle seats.
¬ Haymarket Media Limited. All rights reserved.
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