This article first appeared in The Edge Malaysia Weekly, on March 7 - 13, 2016.

IT is amazing what a little competition can do.

Few thought much of AirAsia Bhd back in 2001, when it was burdened with a debt of RM40 million, owned just two old aircraft bought at a laughable bargain of RM2 and boasted the famous tagline, “Now Everyone Can Fly”. The skies in Asia, after all, were reserved for established institutions — the full-service carriers (FSCs) — and air travel was mostly for the higher-income group.

But AirAsia appealed to an untapped Asian market. By 2003, the low-cost carrier (LCC) had expanded its operations to a second hub in Johor Baru and made its first international flight to Phuket, following a joint venture with Thailand’s Shin Corp. A year later, it bought into Indonesian airline PT AWAIR and was listed on the Main Market of Bursa Malaysia. Through joint ventures, it now has bases in the Philippines, Japan and India.

Some observers claim that Air­Asia’s rapid expansion contributed to the gradual demise of national carrier Malaysian Airline System Bhd (MAS). By most accounts, the two airlines operated on different cost structures and served separate, distinct market segments. But MAS found its market share slowly being chipped away as consumers gravitated towards AirAsia’s no-frills, low-budget business model.

Based on Malaysia Airports Holdings Bhd data, MAS had a 49.1% share of passenger movements at the Kuala Lumpur International Airport (KLIA) in 2006 compared with AirAsia’s 13.1%. By 2014, MAS’ share had shrunk to 30.4% while AirAsia’s had grown to 40%.

The national carrier responded by lowering fare prices and increasing capacity, which hurt both companies. But after years of losses and two air tragedies, MAS was forced to restructure. A new management started to rationalise its routes, which led to a capacity reduction and put an end to price dumping. The carrier rebranded itself as Malaysia Airlines Bhd.

AirAsia seems to have come up on top in that rivalry but there is a sense of relief too that years of confrontation with FSCs in a cost-conscious industry has finally come to an end. 

AirAsia CEO Aireen Omar tells The Edge that pricing discipline post the MAS restructuring is “good overall for the whole industry”. “There is now better discipline and revenue management. You see less price dumping. This means we are not killing everybody and ourselves,” she says.

As Malaysia Airlines tries to find its feet, AirAsia, the “World’s Best Low-Cost Airline” for the seventh year running, is facing competition of a different kind. “The landscape has changed since the MAS restructuring,” says Daniel Wong, an analyst with Hong Leong Investment Bank Research.

Competition with FSCs is less direct now. More airlines are establishing their own low-cost divisions to get a slice of the growing LCC pie in Asia without sacrificing their brands or profit margins. For instance, Singapore Airlines has Tigerair and Scoot under its wing while Garuda Indonesia’s budget wing is called Citilink.

“Since Malaysia Airlines, FSCs have realised that they cannot compete directly with an LCC like AirAsia. That is why you see some of them establishing subsidiaries to introduce an LCC. It differentiates them but still puts them in a position to benefit from the growing market,” Wong says.

The skies are getting crowded with more LCCs. CAPA Centre for Aviation reports there were 23 LCCs in Southeast Asia in 2015, with the number of aircraft growing 13%. In the last three years, the number of aircraft in the region has increased from 400 to 600.

In AirAsia’s stronghold — Malaysia — new entrants like Rayani Air are trying to stake a claim in the LCC space.

Hybrid airline Malindo Air — a joint venture between National Aerospace and Defence Industries of Malaysia (51%) and Lion Air of Indonesia (49%) — is growing its presence. It is worth noting that in 2014, Malindo Air saw the biggest growth in international passenger movement at KLIA, growing 854.6% year on year and moving over 698 million passengers. In terms of overall domestic traffic, Malindo came in third, growing 5.5% y-o-y.

AirAsia was second, behind Malaysia Airlines, but its growth slowed to 3.7%. And the landscape could get more challenging as growth in passenger traffic is slowing in Malaysia. In 2015, MAHB recorded passenger traffic of 83.7 million, which was a growth of only 0.4% y-o-y, compared with 4.6% the year before.

Aireen, however, points out that AirAsia’s biggest and most obvious advantage is its vast network.

“Malindo is not just working against AirAsia Malaysia but the whole (AirAsia) group. It is the whole network that they are coming up against … whatever network they [LCCs] have built will have to come up against the whole of the AirAsia network. So, that is something that competitors need to consider when you compete in this region,” she says.

“It is the size of the network — the number of routes and destinations that we have, the frequencies and the main and secondary hubs. Each hub creates its own connectivity, whether domestic or international, and that builds the strength of the network.”

Together with its long-haul sister company AirAsia X Bhd, AirAsia flies to 88 destinations and has a fleet size of 202. This year, it will take delivery of nine A320neo to replace older aircraft or add to its fleet and has deliveries lined up until 2028.

But such a vast network leaves AirAsia fighting on all fronts and at high cost. Each national aviation market, Wong says, has different dynamics that AirAsia must come to terms with. Access to technology and internet service is a problem in Indonesia because AirAsia tickets are mostly sold online. In the Philippines, AirAsia is a fairly late and small entrant, contending with local favourites such as Cebu Pacific Air. In India, regulatory hurdles and opposition from local firms can impede the early stages of a business’ growth. Confronting these challenges will require time.

Of the six geographical segments it operates in, only AirAsia Malaysia and AirAsia Thailand are profitable. For the financial year ended Dec 31, 2015 (FY2015), AirAsia registered a net profit of RM540.9 million on the back of RM6.3 billion in revenue, compared with FY2014’s net profit of RM82.8 million and revenue of RM5.4 billion.

Investors are clearly happy with the news. Since the FY2015 results were announced on Feb 28, AirAsia’s share price has improved 4.29%. Last Friday, it closed at RM1.73, rising a sharp 34% year to date. 

However, Indonesia AirAsia recorded a core loss of RM332.4 million and another RM465.4 million of unabsorbed losses from the previous year. In the Philippines, AirAsia incurred a loss of RM77.9 million while its Indian and Japanese associates lost  RM29.7 million and RM28.6 million respectively in FY2015.

Aireen aims to turn all of AirAsia’s associates around by the end of the year. “We are confident that we have seen the worst and all our associates will do better. The aim is to turn it profitable [this year].”

One reason for her optimism is that operation costs have fallen, thanks to low jet fuel prices. Based on the company’s unaudited income statement for FY2015, AirAsia spent about RM250 million less on fuel than a year ago. Another indicator is that AirAsia Malaysia’s cost per available seat kilometre (CASK) fell 4% y-o-y to 12.61 sen, although CASK-ex fuel rose 9% in FY2015 to 7.26 sen.

A Maybank Research note says AirAsia will enjoy “a significant step-down lower fuel cost” as expensive fuel hedges in 2015 have expired (50% at US$88 per barrel). AirAsia has hedged roughly 30% of its fuel requirements at an average price of US$52 per barrel for 2016.

Another factor is that foreign exchange fluctuations will have less of an impact on its financials this year. Not only has the ringgit stabilised against the US dollar but Air­Asia had also hedged half its forex exposure at 3.22 for its long-term liabilities. This is important because a significant portion of AirAsia’s borrowings is denominated in US dollars. As at Dec 31, 2015, its US dollar debt stood at RM10.9 billion while total debt was RM12.62 billion. Debt and payables due in 2016 amount to RM4 billion, higher than its cash balance of RM2.4 billion.

At the same time, AirAsia still wants to expand and has plans for new routes and destinations, to increase frequencies on existing routes and to develop new secondary hubs. It made Langkawi its latest secondary hub after successfully negotiating a 70% reduction in airport charges.

Aireen says the outlook for AirAsia is “positive” this year and for the longer term. That is likely to be true if it can hold its ground against its regional competitors.

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