AirAsia X: Long-haul aspiration and reality Jan/Feb 2016

AirAsia X’s mission is: “to further solidify our position as the global leader in long-haul, low-cost aviation and create the first global multi-hub low-cost carrier network.” So far however it has failed to find a profitable operating model and has reported heavy losses for the past three years. The stock price has been in continuous decline since the company was floated on the Bursa Malaysia in July 2013 at RM1.25, trading at RM0.25 at the end of February 2016.

AirAsia X was established in 2007 as part of the AirAsia Group, and is based at Kuala Lumpur, at the low cost terminal KLIA2 which was opened in 2014. It currently flies to 18 destinations in Asia (Sapporo, Tokyo, Osaka, Seoul, Busan, Taipei, Xian, Beijing, Hangzhou, Chengdu, Shanghai, Colombo and Kathmandu), Australia (Sydney, Melbourne, Perth, and Gold Coast) and the Middle East (Jeddah). It operates a core fleet of 26 A330-300s, each configured with 12 Premium Flatbeds and 365 Economy seats. Average sector length is about 4,800km or 5.5 flying hours per sector.

Towards the end of 2015 the airline declared in a presentation to analysts that its turnaround plan had started to bear fruit and that the airline was on its way to profitability. Indeed, fourth quarter results for 2015 were promising, even taking into account that this is the peak travel period for the carrier — pre-tax profit of RM151.6m on revenues of RM853m compared to a loss of RM168.5m on revenues of RM816.8m in the previous year.

Nevertheless, AirAsia X remains very unprofitable — unaudited results released at the end of February showed a loss for 2015 of RM360.2m ($86m) at the PBT level on revenues of RM3.06bn ($728m), representing a margin of -14.2%, which was somewhat better than the -20.6% margin recorded in 2014. Results from the parent company, AirAsia Berhad (the Malaysia-based A320 operations plus equity accounting for the various overseas associates), were also not particularly brilliant — a pretax profit of RM215m ($51m), representing a 3.4% margin on revenues of RM6.3bn ($1.5bn). The operating result actually was strong at RM1.09bn, but there were heavy losses from all of the associates.

Despite net proceeds of RM391m from a rights issue last summer, AirAsia X’s balance sheet remains weak. Long-term debt as at December 2015 was RM1.4bn and net current liabilities totalled RM1.2bn; Non-current assets totalled RM3.2bn, leaving book equity of RM621m, but its assets include RM520m of deferred tax assets, which only become useful when/if the airlines starts to make substantial profits.

Erratic route development

It is impossible to identify which, if any, of its routes AirAsia X is making money on. However, the regional breakdown provided by the company shows that on the two major route regions AirAsia X made huge losses, loss margins at the PBT level of -33.2% on North Asia and -25% on Australia, relying on an ill-defined “others” profit margin of 43% to bring the overall system to a loss of -14.2%.

AirAsia X’s network evolution is summarised in the maps. In its early years the airline attempted to build a European network, operating to London and Paris, but after suffering heavy losses AirAsia X was forced to abandon this operation in 2013. It appears to have been unable to find a niche between the Middle East super-connectors capturing price-sensitive traffic on Malaysia-UK routes on the one side and flag carriers, BA and MAS, filtering off premium traffic on the other. AirAsia X then concentrated on a major expansion into Australia, Japan, South Korea and China, again suffering major losses as it came up against low cost competition in the form of Jetstar (see pages 8-13) and “irrational competition from industry peers”, by which it meant that MAS, despite, its de facto bankrupt state, was not cutting capacity as rapidly as it should have.

Although the core Malaysian operation was deeply problematic the airline persisted with its strategy of setting up long-haul associate carriers alongside the short haul associates in Indonesia and Thailand. IAAX and TAAX’s results are not included in those of AirAsia X bhd but they made a combined net loss of $31m in the first three quarters of 2015.

As part of what it describes as “strategic capacity management”, AirAsia X in 2015 closed down routes to Tokyo Narita, Nagoya and Adelaide, and downsized Colombo and Chongqing to A320s. Frequencies were cut on Sydney, Melbourne, Perth, Gold Coast and Hangzhou. On the other hand, it launched Sapporo and announced the re-launch of Delhi for February 2016. New Zealand, dropped in 2012, was reinstated, this time as a tag to Auckland from the Gold Coast.

Overall seat capacity was reduced by 6% between 2014 and 2015 but passengers carried fell by 15% from 5.15m to 4.85m with the result that load factor dropped from 82% to 75% — a serious deterioration especially for an LCC, though the company was able to report a 83% load factor for the fourth quarter, up from 81% in the same period of 2014.

A fundamental issue for AirAsia X appears to be establishing a core of profitable routes on which it can base its expansion. This has been a pre-requisite for the successful short-haul LCCs — they didn’t just succeed because of their lower costs but also because they had defensible niches (Southwest’s monopoly on intra-Texas services is the classic example). Finding such a niche in long-haul markets characterised by multi-airline competition is proving very difficult.

There has been speculation about AirAsia taking over AirAsia X to assure connecting traffic for its short-haul LCCs — a sort of reversal of the European network model where loss-making short haul feed is required for the long-haul network.

Still an LCC?

It could be argued that LCC strategy is coming to resemble more that of a network/legacy carrier than that of an LCC.

Looking at the make-up of AirAsia X’s revenues, the airline is relying more and more on traditional long-haul charter as it cuts back its scheduled network — RM422m or 14% of its revenues came from charters compared to 6% in 2014. Perhaps more significant is the amount of revenue generated from leasing A330s out to other parts of AirAsia — in 2015 this accounted for RM275m or 9% of revenues, and the increase in this income source between 2014 and 2015, RM185m, was just about equivalent to the reduction in PBT losses between the two years.

Capacity restraint with the aim of increasing yields and reducing capex is at the core of the strategy. Last year the airline cancelled 12 A330s which had been due for delivery during 2016-18, leaving two remaining A330ceos on order for 2016 which will probably go to Indonesia AirAsia X and Thai AirAsia X, so the core airline will have no growth for the next two years. There are still 55 A330-900neos on order but the delivery schedule is being pushed further and further out: the first two A330neos are now slated for late 2018, then 5-8 per year up to 2026.

There was a surge in yields in the third quarter of last year, particularly on China and Australia, which seems to have been sustained into the fourth quarter, but the airline is also facing cost pressure. Particularly worrying is the upward trend in unit costs excluding fuel, up 30% in the fourth quarter compared to the same period in 2014. This is largely due to the steep devaluation of the Ringgit versus the US dollar, which has impacted A330 rentals. With no growth in the system it will be difficult for AirAsia X to manages its unit costs; rather it plans to focus on improving yields by concentrating sales in stronger currency markets like Australia.

The other element in AirAsia X’s strategy is driving connections with the rest of the AirAsia network. Currently about 56% of it passengers are connecting — 29% self-connecting and 27% paying fees for the “Fly-thru” product. Fly-thru facilitates transfers for both International to International and Domestic to International at KLIA2, with through-baggage services. Minimum connecting time is 90 minutes though the maximum can be 18 hours. The aim is increase Fly-Thru passengers by 10% a year, hopefully avoiding the yield dilution effects of a connecting hub operation.

Looking forward, AirAsia X development is looking less like that of an LCC and more like, well, MAS. MAS’s strategy is now to focus capacity on the Asia-Pacific, maintaining competitive pressure on AirAsia X. One solution might be to grow outside the Malaysian base market, though Indonesia and Thailand are proving to be problematic markets, not least for regulatory reasons. The future at least partly depends on MAS itself; if its turnaround does not work out by 2017-18, the Malaysian government might well conclude that it would be a good idea for a merger to take place. This could create an MAS3.0 brand which could be politically acceptable as the MAS name would be retained, but the management of the new hybrid carrier would pass to AirAsia. Maybe the best solution for both sets of shareholders?