Issue 248: Australia bound?

Cathay Pacific and Singapore Airlines had similar seat miles costs to Ryanair and easyJet, so how could an LCC work in Asia? Luckily for 45 million passengers – up to February 2008 – who enjoy the world’s lowest airfares everyday, AirAsia’s founder and CEO Tony Fernandes never saw those reports.

But even if he had, he would have laughed them off for it has been his single minded focus of combining the Ryanair business model to Asian labour costs and work ethics that has given AirAsia today extraordinary available seat kilometre (ASK) costs of just 3. 16 US cents for its operations for the year ending June 30 2007. Excluding fuel the ASK cost was just 1. 57 US cents, down four per cent of the previous year.

AirAsia, traces its origins to 1996, when it was launched as a “me too” carrier and struggled to put the slightest bump in Malaysia Airline’s flightpath.

Fernandes and four partners purchased the fast failing AirAsia from its owner, automobile builder DRB-Hicom, for 1 ringgit, and for that sum, the buyers were proud owners of two 737-300s and liabilities of 40 million ringgit just three days before 9/11.

Lacking experience in the airline business, Fernandes, a former VP with Warner Records, enlisted Connor McCarthy, former COO of Ryanair who signed on with a five per cent stake.

After a serious low cost makeover, AirAsia was re-launched in January 2002 with three aircraft and seatmile costs, excluding fuel, of 2. 5 US cents – half that of Malaysia Airlines and Ryanair.

With those costs, the airline was an immediate hit and passenger numbers quickly climbed from 35,000 a month to 82,000 as thousands of Malaysians – including farmers – found themselves sitting in aircraft at 30,000ft rather than looking up at them from their rice paddies.

The airline’s fares started at just 39 ringgit from Kuala Lumpur to Penang compared to 40 ringgit for the bus trip, while a car trip over the same leg left an 80 ringgit hole in travellers’ pockets with tolls and petrol.

The rise and rise of AirAsia is without doubt one of the airline industry’s great success stories for the airline has had to combat one crisis after another plus manoeuvre around a host of road blocks put up by governments wanting to protect their national – and often government owned – airlines.

SARS, the Iraq war, heavy price dumping by incumbent Malaysia Airlines, the Asian tsunami and record fuel prices have all tested management’s resolve and faith in the business model. And there were plenty of knockers, including former director general of the Association of Asia Pacific Airlines Richard Stirland, who told an ING Low Cost Airline conference in 2003 that “low cost airlines will be something we read about rather than worry about. ” He went on to target Fernandes personally by saying: “I regret to say that many of those who, in the fashion of St John the Baptist, announce the imminent arrival of a saviour in the form of Richard Branson or even Tony Fernandes appear not to have considered the facts. ” The facts are for the FY06/07 year, the AirAsia Group flew 14 million passengers – more than Cathay Pacific or Emirates, served 75 destinations with over 50 aircraft operating 2149 flights a week. And the facts are that Singapore Airlines at least has set up its won LCC – Tiger Airways – to try and compete.

Perhaps the secret to AirAsia’s success can be summed up as conservative flamboyance. When asked in May 2003 about the airline’ssuccess, Fernandes said “ask me in 10 years”.

Five years on, with a successful sharemarket float under its wings in 2004, the airline is a runaway success.

That success has been built on a willingness to tackle new routes away from the main trunk routes and enter joint ventures in Thailand and Indonesia.

Growth of the group has been spectacular. In January 2002 the airline operated six routes and for the year ending June 2002, it uplifted 611,000 passengers. By June 2004 it was serving 26 routes and carrying 2. 8 million passengers.

For the year ending June 2007 the group served 78 routes cities and carried just on 14 million passengers.

In Malaysia, the airline is now the country’s dominant airline with a 51 per cent market share, while load factor has soared over 80 per cent. As recently as FY04/05 AirAsia had only 25 per cent of the domestic market.

And the financial performance has matched the spectacular growth. For the year ended June 30 2007 AirAsia reported net earnings of MYR498. 1m (A$168m) more than double the MYR201. 7 million earned in the prior 12 months. The company’s full year revenue rose 52 per cent MYR1. 6bn (A$540m).

And AirAsia kicked off the 2007-08 year more than doubling the prior September quarter profit of MYR70m (A$23. 6m) to record a MYR180m (A$60. 7m) profit on a 39 per cent increase in revenue led by new routes such as KL-Shenzhen which Fernandes described as the “best ever in the airline’s history. ” The December quarter results were due as Australian Aviation went to press but Fernandes said the numbers appear to be good and robust passenger demand had helped offset higher fuel prices. “I am very pleased with the early data” he told Australian Aviation.

Fernandes had expressed concerns to late last year that the December quarter might be squeezed by soaring fuel prices but he was now “comfortable” with his fuel hedging which now sits at 75 per cent.

While the growth has been spectacular, Fernandes has his feet firmly on the ground and debunks concerns by some analysts that he is spreading himself and the airline too thinly.

He argues strongly to the contrary, reminding doubters about the “superb team” at the airline and that his time in the first five years has been soaked up trying to break down barriers of entry into various markets, where he was battling just to be shown the back door.

“Now I am more likely to get the front door and even the red carpet,” he quips with a broad smile.

“That saves an enormous amount of time and hassle,” he says wryly. In fact, during Australian Aviation’s interview, Fernandes was interrupted twice by calls from ministers.

“Governments now realise the greater economic benefit that AirAsia can bring to their country. ” He is also bullish on the A320 and the number on order. AirAsia swapped from 737-300s to A320s with an initial commitment for up to 80 in December 2004, which was increased to 100 in March 2005. A further order for 50 was placed in January 2007.

In December 2007 AirAsia placed another order for 25 firm A320s plus 25 options, bringing the commitment of the group (Malaysia AirAsia, Thai AirAsia, Indonesia AirAsia) to 175 firm aircraft and 50 options.

As at the end of FY07 the group’s fleet consisted of 34 737s and 20 A320s.

Fernandes says the airline has contracted to receive about 18 A320s a year but there is flexibility built into the contract.

The A320 rollout plan from FY08 to FY13 calls for 27 for replacement of 737s, 73 for increased frequencies and 50 for new routes. The A320s’ unit cost is 12 per cent less than the 737-300s while its cash cost can be up to 20 per cent less. The airline expects to retire the last of the 737s later this calendar year.

The A320s are actually “attracting higher yield customers,” says Fernandes. “A number of my friends who never flew AirAsia are now flying, citing the A320s. ”“We also have great flexibility from Airbus,” and the deal the airline extracted was at the height of the downturn after SARS and 9/11. And rather than expanding into Australia as Singapore based Tiger Airways is doing,

Comment

Why AirAsia will not buy into Virgin Blue – at least not yet.

There is a simple reason why AirAsia will not get into bed with Virgin Blue.

There is possibly no-one more passionate about the low cost model principals than Air Asia’s founder and CEO Tony Fernandes and there is possibly no airline that has changed those principals – to suite changing market needs – more than Virgin Blue.

Fernandes has pursued the lowest possible costs with religious zeal because he has had to with Singapore Airlines and Cathay Pacific two of the world’s most profitable airlines on his doorstep and with the lowest costs for full service legacy airlines. Also on his radar are the even lower labour costs in China.

He has built his business and share price on having the lowest costs with net profit margins for the FY 2007 year double (17 per cent) those of the average (nine per cent) of the world’s largest and most successful LCCs.

AirAsia’s costs are 3. 16 US cents an ASK, while the average for LCCs is 5. 81 cents an ASK according to AirAsia data.

Virgin Blue’s costs – by choice – are at the higher end of the LCC range and are about to get higher as the airline pursues a higher yield corporate policy with its premium economy product.

The Embraer E-Jets and Boeing 777-300ERs add complexity and significant cost and whereas Virgin Blue is looking more for a mid-range product for its 777s, Air Asia is examining a nine-across 396 seat version of its A330s.

Some argue that Virgin Blue is being marginalised – although it argues strongly that its “new world carrier” strategy is the way to go and only time will tell.

But the new world carrier concept is not what AirAsia is about, it just wants to keep things very, very simple.

Any involvement by AirAsia in Virgin Blue would involve major structural change – something that is possibly not acceptable – at least in the short term.

This scenario could be one of the more interesting developments of 2008.

Fernandes is firmly focused on the ASEAN countries with their population of 500 million. “Our focus going forward is a maximum flight time of 3½ hours with a preferable sector length of two hours, which is the optimum. ” Longer sectors to India, Japan, Korea and Australia are being handled by the regional/long haul AirAsia X operation which started operations last year.

AirAsia franchised its brand to FlyAsianExpress (FAX), a small Malaysian domestic airline operating F50s and Twin Otters. The re-branded airline, which has a 30 year agreement with AirAsia, was announced in January 2007. The airline wonauthority from the Malaysian government to operate long haul flights on routes that Malaysia Airlines does not serve.

AirAsia X ordered 10 A330s and took five options in April 2007. At the time Fernandes said he expected the airline to be operating 25 A330s within five years. The airline also leased in an A330 to launch operations.

In August Sir Richard Branson took a 20 per cent stake in AirAsia X. At the time Branson told media he was “thrilled to be able to support them [AirAsia X] in this venture and look forward to seeing low cost, long haul travel being opened up from their base in Malaysia. ” AirAsia X’s first A330 – leased from AWAS – arrived in Kuala Lumpur on September 18 last year and the first service was on November 2 to the Gold Coast. Introductory fares including changes started at $99.

The next destination was Hangzhou in China – just one hour from Shanghai.

AirAsia X expects to announce two Australian new destinations. First announcement will be in late March and another will be made in April say sources. Services to the two new destinations will start in September this year.

The first of AirAsia X’s own A330s will arrive in August and a second in November.

In February AirAsia X sold a 10 per cent stakes to Bahrain based Manara Consortium and Japan’s Orix Corporation for a combined MYR250m (A$84m) cash consideration. Each investor received approximately 16. 7 million newly issued shares of common stock.

AirAsia X chairman Kalimullah Hassan said at the time that “Manara will allow AirAsia X greater access to the fast growing Middle East region whilst Orix will contribute its significant expertise in aviation finance and leasing. ” AirAsia X is also in talks with Airbus for an order for at least 20 A350 XWBs.

China had been softly, softly at the AirAsia Group as the airline felt its way but success is bringing expansion.

Initially Xiamen was served from Bangkok, with Macau linked to Bangkok, Kota Kinabalu and KL. The strategy has given way to a far more aggressive route structure that sees Macau, Hangzhou, Guangzhou, Xiamen and Shenzhen linked to KL, Bangkok and Kota Kinabalu. And Hong Kong, Haikon and Guilin are all on the radar for 2008.

Much of AirAsia’s expansion today is focused on increasing frequencies and simply “connecting more dots” linking current AirAsia destinations such as Kota Kinabalu, which is linked to KL, Bangkok and Macau – a strategy which has virtually no infrastructure cost.

Another example is Phnom Penh, which is connected to KL and Bangkok, while Clark in Manila is linked to both Kota Kinabalu and KL.

Frequencies are a high priority. Macau for example is served nine times a day – four times daily from both KL and Bangkok and once daily from Kota Kinabalu. Fernandes adds that there are five, seven and 10 flights a day from KL to Penang, Bangkok and Kota Kinabalu respectively.

“With more frequencies, we will have more and more low fares,” he says. He expects the airline group’s passenger numbers to hit 18 million by the end of 2008.

Fernandes, an avid Star Wars fan, likens the AirAsia story so far to Star Wars. “It’s like Star Wars part one is over, and AirAsia has established itself in the industry. ” And the force is with Fernandes as he summons his energies for the battles in the next episodes.

One battle he won recently after almost six years was access to Singapore. In Octoberlast year the Malaysian government abandoned its protection of the route and several others well ahead of the originally scheduled January 2009 date. Services on the route started Friday February 1 with two services a day for Air Asia and one each for Tiger Airways and Jetstar Asia. Unlimited access will commence in December.

Another battle yet to be won is access to Bangkok’s Don Muang International Airport as the “new Suvarnabhumi Airport is just too complicated for our operation,” says Fernandes.

He also expressed concern at Malaysia Airports Holdings. “We need to get Malaysia Airports to understand that lower charges mean more travellers. Budget travellers are currently paying about the same airport tax [at the low cost carrier terminal] (LCCT) as those who are using premium facilities at the main terminal,” he contends.

The LCCT was opened in March 2006 with a capacity for 10 million but is now near capacity but is capable of being upgraded to handle 15 million passengers.

On the next five years, Fernandes says “although the first five years were about putting our flags on as many destinations as possible, now our focus is all about frequency. But we will also expand further in Indochina, Indonesia, southern China and India. ’” A great deal of that expansion will be through the airline’s JV associates Thai AirAsia launched in February 2004 and Indonesia AirAsia, which took off in December of the same year.

However a JV with Vietnam’s state-owned Vinashin Group, which was to start this year, was killed off by the government after lobbying from Vietnam Airlines and Pacific Airlines.

On reports from Australia of a super tie-up between AirAsia and Virgin Blue Fernandes is tight lipped.

“It’s too early and no comment” greet questions of an Australian LCC operation.

However one analyst at February’s Singapore Airshow shook his head with a polite “no – not under the present [Virgin Blue] structure. ” He explained; “With so much [higher yield] business in China and India why would you. ” (See break-out box) Late in February Australian media was citing AirAsia X’s CEO Azran Osman-Rani suggesting that the airline was “definitely” keen but that a lot hinged on what happened with Toll [Holdings] and “who was going to take control of Virgin Blue. ” And Sir Richard Branson – who now has the ear of Fernandes – is seen as a key player in the control equitation.

Azran Osman-Rani added to the Sydney Morning Herald that the AirAsia group was “not actively pursuing anything” and had “no interest in buying part of Virgin Blue. ” The AirAsia group has always looked to technology to develop its distribution model with internet cafes being focal points for bookings. Now the airline is introducing electronic internet check-in and will also introduce check-in via personal digital assistants (PDAs).

On the agenda is a cargo operation to take advantage of unused belly capacity.

Fernandes expects to launch a cargo product in April.

Last year AirAsia carried just 10,800 tonnes of cargo – eight per cent of the available capacity.

And to meet the demand for pilots for growth AirAsia opened a $20 million training centre in 2004 and that facility is now taking in third party work from airlines such as Qatar Airways.

Fernandes still has challenges with the pace of liberalisation of air routes in Asia and “the over protectionism of national assets” with many authorities viewing “foreign ownership as traitorous. ” And he notes that LCCs in Asia only carry 3. 5 per cent of the traffic, whereas in Europe its 26 per cent and the US 19 per cent.

Several years ago Fernandes was coy of being hailed a success but now predicts that by the end of FY2013 the airline group will have 159 aircraft carrying 54 millions passengers a year.

Now, no one doubts the numbers.