Coronavirus Complicates Singapore’s Future

Madhu Unnikrishnan

February 18th, 2020 at 9:00 AM EST

  • It’s an unhappy time for airlines in East Asia. Last year, the giant Chinese economy slowed, the region’s export markets shrank due to tariffs, a street rebellion erupted in Hong Kong, and tensions flared between Japan and Korea. This year, less than two months in, East Asian airline markets are in shambles as the Covid-19 coronavirus spreads from China, largely shuttering the country’s economy.

    Outside of China, the country with the most Covid-19 cases is Singapore, putting businesses there under great pressure. One of those businesses is Singapore Airlines, which unsurprisingly says demand to mainland China is severely affected. At the start of this week, it was operating just a few mainline frequencies to Beijing, Shanghai, Guangzhou, and Chongqing. All other markets, and all of its low-cost Scoot flights, are temporarily suspended through March.

    This giant demand shock unfortunately pours cold water on a fairly encouraging set of financial results that Singapore Airlines reported for 2019. Its 7% operating margin won’t win it any awards. But this was its highest figure since way back in 2010. Most of the 2010s were indeed tough for what was once one of the world’s most profitable airlines. It faced waves of competition from Gulf carriers and low-cost carriers alike, and overcapacity in the ASEAN region more generally.

    In 2019, though, many of its rivals were in retreat or struggling financially, including the neighboring zombie companies Malaysia Airlines and Thai Airways. Cargo was most definitely a rough area. And Singapore faced plenty of other challenges, including exposure to the MAX crisis, problems with its Rolls-Royce Dreamliner engines, lossmaking stakes in foreign airlines (Virgin Australia, Vistara, and NokScoot), rising labor costs, fuel hedge losses, and the unrest in Hong Kong. Note also that in 2019, Scoot incurred $57m in operating losses, while full-service narrowbody unit Silk Air lost a bit of money too.

    But offsetting these negative developments was strength in the critical intercontinental premium market, and strong passenger demand more generally. Singapore only provides detailed earnings commentary twice a year and last week provided only limited information about its calendar fourth-quarter results. They seemed strong, with operating margin hitting 10%, up a point from the same quarter a year earlier. The airline’s earnings aren’t highly seasonal, but they do tend to be highest in calendar Q4. Revenues for the period rose 3% y/y while operating costs were up just 2%. ASK capacity network-wide rose 5%, with mainline growing 7%, Scoot growing 2%, and Silk Air shrinking 8% as its six MAXs stood idle.

    Scoot and Silk both earned small operating profits during the quarter, while the group’s maintenance unit contributed positively as well. Cargo surely suffered losses, though Singapore no longer breaks out its cargo performance.

    Along with easing competition, the airline is apparently doing well on U.S. routes following a big expansion. It opened Seattle nonstops last year, complementing ultra-longhaul nonstops to Los Angeles and Newark. Routes like these allow it to chase traffic flows like U.S. West Coast to India and U.S. East Coast to Australasia.

    In a major move announced late last month, Singapore and ANA plan to form a comprehensive joint venture. Singapore already has close ties to SAS, Virgin Australia, Air New Zealand, and Lufthansa. It’s now cooperating closely with Malaysia Airlines as well. At the same time, India’s Vistara, in which Singapore Airlines holds a 49% stake, is expanding internationally, soon with B787-9s.

    Might it buy Air India? While it contemplates that opportunity, Singapore is busy integrating Silk Air into mainline and outfitting its narrowbody planes with lie-flat seats. Mainline flights to Brussels start in October. Growing its loyalty program and related online retail shop are top priorities.

    As for its fleet, B787-10s are now arriving, to be followed by B777-9s. It’s also densifying A380s. The airline didn’t say anything about current bookings for future travel, other than to highlight the big demand shock on China routes. That alone will weigh on calendar Q1 results. But if premium demand to places like North America, Europe, and Australasia hold up, Singapore Airlines might yet be able to sustain its recent earnings momentum.  

Asiana is in Deep Trouble

  • Korea’s Asiana published its 2019 financial statements, without any accompanying commentary. Its nearly $600m net loss, however, makes it pretty clear that this is an airline in deep trouble. Operating margin for the year was negative 6%, which by inference means operating margin for just the fourth quarter was (ouch) negative 16%.

    Asiana faces the same upheavals as its archrival Korean Air: Severe cargo distress, collapsed demand on Japan routes, exposure to Hong Kong and a slowing Chinese economy, cost inflation tied to won weakness, and so on. But unlike Korean Air, Asiana doesn’t have a powerful shareholder and partner like Delta.

    It does have new local owners, though, and will try to right its ship through efforts like offering unpaid leave to workers. It’s already cut many routes, including big ones like Chicago. It hasn’t yet disclosed 2019 results for its two LCCs Air Busan and Air Seoul

Norwegian Disappoints

  • A few months ago, Norwegian excitedly showed signs of a turnaround in the making. For the summer quarter that ended in September, operating margin reached 19%, up from 11% during the prior summer. But alas, its peak period potency didn’t carry over into the offpeak winter.

    Norwegian last week disappointedly reported a negative 13% operating margin covering October through December, leaving it with a slightly below-breakeven operating margin for all of 2019. Q4 revenues only declined 7% y/y despite slashing capacity with a meat cleaver. ASKs contracted 19%.

    But cutting costs commensurate with capacity reductions proved difficult, and total Q4 operating costs declined only 11%. So yes, costs are in fact falling faster than revenues at Norwegian, but not yet fast enough to declare victory in its struggle to become a financially viable company. Its balance sheet remains thinly capitalized relative to its liabilities. Cash holdbacks by credit card processors remain a threat to liquidity. Europe’s weak currencies continue to complicate cost cutting efforts. And the carrier’s risky longhaul flying to the U.S. still incurs losses on a year-round basis.

    Norwegian has also faced double-trouble as both a big B737 MAX customer and a big Rolls-Royce B787 engine operator. Management estimates the MAX crisis alone caused an estimated $110m in lost earnings last year. The Rolls-Royce disruption, still not fully resolved, caused another $82m (including lost cargo revenue).

    Don’t accuse Norwegian of being timid in its efforts to forestall bankruptcy. While rejecting an IAG takeover bid, it divested shares in a bank it partly owned, sold and deferred aircraft, hired a new CEO to replace founder Bjorn Kos, sold its Argentinian airline to Indigo’s JetSmart, raised lots of new capital, and closed shorthaul bases in Madrid, Palma, Dublin, Rome, and Edinburgh. It closed more than 50 shorthaul routes overall, along with ending all transatlantic flying from Stockholm, Copenhagen, and Dublin. Going forward, its U.S. flying will operate mostly from just Oslo, London Gatwick, Paris Charles de Gaulle, Rome Fiumicino, and Barcelona (Madrid-Los Angeles, Athens-New York JFK, and Amsterdam-New York JFK also remain in the schedule for now). It’s exited airports like Oakland and Newark in favor of San Francisco and JFK, respectively.

    Some of its biggest shorthaul cuts were in Sweden and Finland, both loss-making markets for Norwegian. Oslo and Copenhagen shorthaul flying, by contrast, is currently profitable. And Norway remains its largest source market by revenues. The U.S. is number two, helpfully generating lots of dollar revenue.

    After ripping out about $250m in costs with its Focus 2019 plane, the carrier under new CEO Jacob Schram is now implementing a new plan called NEXT (Norwegian Excelling Together). It entails a 13% to 15% reduction in ASK capacity this year, following growth of 1% in 2019 and 37% growth in 2018.

    Among its goals are improving punctuality, developing partnerships with easyJet and JetBlue, growing ancillary revenues, reducing operational complexity, and improving network connectivity. Does it expect to earn a profit in 2020? Yes, assuming it gets its 18 grounded MAXs back in the air this fall.   

Will Mexican Airlines Consolidate?

  • Like Norwegian, Aeromexico endured severe operational headaches from the MAX grounding last year. Nevertheless, its 4% operating margin, though hardly robust, marked its best annual showing since 2016. It can thank cheaper fuel, a stronger peso, and its own efforts to drive more revenue. Chief among these efforts: developing its close alliance with Delta. It’s also sporting a new set of branded-fare products and improved services for Mexican business travelers.

    The favorable fuel and forex trends were even more pronounced in just the final quarter in the year, when Aeromexico’s operating margin jumped sharply, to 10%, from just 1% in 2018’s fourth quarter. For most big MAX operators, the plane’s grounding has created huge operational, strategic, and cost management setbacks. That’s certainly been true for Aeromexico.

    But Aeromexico, unlike others, has not seen an associated rise in unit revenues. Indeed, its Q4 unit revenues declined y/y, even as the absence of its six B737-MAX 8s caused ASK capacity to contract 5% (it was supposed to have ended the year with 14 MAXs). Total revenues dropped even more, falling 7%. So how did Q4 margins increase so sharply? The answer was a massive 20% decrease in total operating costs, with help from a 16% drop in fuel outlays. Labor costs fell 15%. A 3% appreciation in the peso-dollar exchange rate helped. And included in the cost figures is partial MAX compensation from Boeing.

    Longer-term, management expects further unit cost reductions from three key sources: 1) The eventual return of the MAX; 2) joint efforts with Delta in areas like purchasing; and 3) productivity gains tied to labor contracts.

    Why wasn’t Aeromexico able to increase its unit revenues despite cutting capacity so much? In the words of CEO Andrés Conesa: “We continue to see aggressive capacity growth, particularly from domestic LCCs who collectively grew capacity over 15% in spite of a softening economic environment.” He’s specifically referring to Volaris and VivaAerobus, both taking lots of new A320/21 NEOs. Fare pressure, it said, remains in 2020.

    Aeromexico in fact did not reduce capacity domestically last quarter. Instead, its cuts came from narrowbody shorthaul flying. Gone were several U.S. routes like Boston and Portland. It also fortuitously exited the Shanghai route, though only at the very end of the quarter. Intercontinental routes flown with widebodies though (this covers Europe, deep South America, and northeast Asia), were healthy overall. Parts of Central America, the Caribbean and upper South America were rough by contrast.

    Management admits to over-expanding in markets like Belize, Colombia, and the Dominican Republic. But the key U.S. market is much better than it was in the aftermath of an open skies agreement several years ago. U.S. LCCs like Southwest and JetBlue have since retreated from Mexico City.

    What Aeromexico would really love is for the Mexican market to shrink from four to three major airlines, just like in Brazil. That’s becoming increasingly likely with Interjet reportedly looking for a buyer or merger partner; VivaAerobus seems a candidate. “We continue to be of the view that we will see consolidation soon in the market,” Conesa said, “because there is no way that this can continue going forward.”

    If consolidation does happen, it would help Aeromexico feel less preoccupied with other frustrations, including a big Mexico City airport project that was abandoned mid-construction, a loyalty plan that it wants to repurchase but can’t, government acquiescence to a new Emirates flight from Barcelona, a Mexican economy that contracted last quarter, and of course its missing MAXs. This year, it will hold capacity roughly flat, assuming for now that MAXs return by September. 
  • Here again is another airline upended by the MAX crisis: Panama’s Copa. It has six MAX 9s sitting on the ground, plus another seven built and waiting to be delivered. The MAXs are a key part of its strategy to both lower unit costs and take advantage of new route opportunities. They featured lie-flat seats for long routes like San Francisco and Buenos Aires, cities that B737-NGs sometimes have trouble reaching unless seats are blocked from sale to lower weight.

    The good news is, Copa as usual made a lot of money last quarter and last year, supported by favorable demand conditions throughout much of the Americas. Operating margin for Q4 rose to 16% from just 9% a year earlier, with revenues rising 4% y/y but operating costs dropping 3%. A 13% decline in fuel outlays was a huge help. But so arguably, was the 5% ASM capacity reduction caused by the lost MAXs.

    This indeed resulted in lost revenue opportunities on routes like San Francisco but also tightened supply conditions and drove up yields and load factors. For all of 2019, Copa’s operating margin was 16%, up from 12% in 2018. In 2020, ASM growth be just 1%. But more importantly, it still expects extraordinarily high profits, forecasting an operating margin between 18% and 20%. Yes, it still plans to phase out E190s but will slow this down in light of the MAX disruption. Yes, it still plans to form a joint venture with United and Avianca, but this is delayed while Avianca sorts out its financial restructuring.

    In the second half of this year, Copa plans to start offering basic economy fares, something it would have done sooner were it not for IT limitations. Also in the second half, it’s moving into new terminal facilities at Panama airport. Copa, furthermore, is improving its ability to merchandise ancillaries, growing its ConnectMiles loyalty program, densifying B737-800s, and expanding its Colombian low-cost unit Wingo by upgauging from B737-700s to -800s.

    Demand, it says, still looks good, minus a few pockets of weakness like Chile. Some markets like Argentina are improving thanks to steep industry capacity cuts. Copa’s newest market is Paramaribo, Suriname. 

A Mideast Shift

  • There’s a big shift underway in the Middle East’s Persian Gulf region. For years, the Big Three Gulf carriers bought planes and added routes like there was no tomorrow. But this phenomenon largely ended after the oil bust of 2015, and now the region’s growth champions are its low-cost carriers. That’s certainly true of Air Arabia, a Sharjah-based LCC that just ordered 120 A320 NEO-family jets.

    And why not? It’s performing remarkably well, posting a sky-high 20% operating margin for all of 2019. In 2018, its 12% margin included a rough fourth quarter, burdened by a jump in fuel prices and losses linked to investments in a collapsed Dubai-based private equity firm called Abraaj.

    With oil prices currently down, the hydrocarbon-rich Middle East and North Africa region isn’t growing much economically. GDP expanded less than 1% last year, according to Air Arabia. Global trade wars and ongoing political instability, including tensions between the U.S. and Iran, are also weighing on growth.

    But for LCCs, economic distress can sometimes be a good thing as belt-tightening companies and households prioritize low fares over services and amenities. Air Arabia doesn’t subscribe to the high-density theory adopted by most LCCs.  Its A320s have just 168 seats (easyJet and others have some with 189). It’s not too aggressive on the ancillary front either. And its load factors are relatively low (83% last quarter). But it’s otherwise a typical no-frills carrier, in a region with lots of price-sensitive tourist, family-visit, and migrant labor traffic.

    Things got really good last quarter, when demand was strong, fuel prices down, forex trends more favorable, and key rival FlyDubai struggling with MAX problems. So never mind that Q4 is typically loss-making for Air Arabia. In 2019, Q4 produced a remarkable 17% operating margin. Revenues rose 12% y/y while operating costs declined 4%. Scheduled ASK growth was 7%, according to Cirium.

    FlyDubai’s MAX-related contraction is particularly helpful because Air Arabia’s Sharjah base is an alternative airport for Dubai. Of course, Qatar Airways remains unable to serve most Gulf markets due to a Saudi/UAE-led embargo. In the meantime, conditions in Egypt have greatly improved, enabling its Egyptian joint venture to grow. Air Arabia has a JV in Morocco too. Systemwide, the LCC opened 16 new routes last year, only four of them from Sharjah. The rest involved Morocco and especially Egypt where it’s attacking the prized Cairo market.

    Back on the Arabian Peninsula, Air Arabia is using long-range A321 LRs to reach markets like Kuala Lumpur from Sharjah. Part of its new Airbus order includes some XLRs as well. To be clear, the carrier grew its fleet by just two planes last year.

    But that doesn’t capture the breadth of its ambition. Most daringly, it’s opening a new low-cost airline venture with Etihad in Abu Dhabi that’s hoping to launch next quarter. There, it will compete with Wizz Air’s new Abu Dhabi venture. Recall that a previous venture called Air Arabia Jordan never managed to survive.

    The carrier is of course now watching the coronavirus and its impact on travel in the region. For now, Air Arabia sees a strong Q1. In October, Dubai will host the Expo 2020 event, which should stimulate demand. It’s making investments in its brand, loyalty plan, and inflight services. It’s hedging about three-quarters of its fuel needs. It’s getting a few more A321 LRs this year. And it operates a collection of auxiliary businesses including a tour operator. 
  • If Air Arabia is doing so well, then surely its Kuwaiti rival Jazeera is thriving too. Well, sort of. It did have a good 2019, registering a 14% operating margin. But in Q4, often a money-losing quarter for Gulf LCCs, losses were heavy. Operating margin was negative 13%, with revenues up 12% y/y, operating costs up 14%, and scheduled ASK capacity up 27% (Cirium).

    Why the big capacity increase? After many years content with flying just a handful of A320 CEOs to Egypt and within the Gulf region, Jazeera is now aggressively adding A320 NEOs. It now has 13 planes, with five more NEOs expected this year. Along with its fleet ambitions, Jazeera ambitiously added a Kuwait flight to London Gatwick. On routes other than London and Cairo, it’s eliminated business class cabins in favor of an all-coach configuration, thus “reinforcing its LCC DNA.”

    This seems a more appropriate strategy for the lowish-yield Indian subcontinent market which Jazeera is now pursuing with vigor. It counts at least 15 additional Indian routes that it would launch today if it had the planes. At the same time, the LCC is introducing a new branded fare strategy. Ancillaries are up, including cargo sales. Jazeera has fortified its management team with new executives as it looks to hire a new sales chief.

    Once just as active in aircraft leasing as in air transport, it now gets auxiliary revenue from a profitable new terminal it owns and runs at Kuwait’s airport. But it also complains about intense yield pressure owing to fierce competition and “capacity surpassing demand on many routes.”

    Rival Gulf carriers are its chief competitors, though hometown rival Kuwait Airways remains an eternal mess. This quarter, also offpeak, is affected by a temporary “downturn in sentiment” related to the coronavirus. Geopolitical troubles in the region remain an issue as well.  

Jeju on a Crowded Field

  • Jeju Air, a promising independent LCC from Korea, couldn’t escape the ravages of a demand meltdown on Japanese routes last quarter. This left it with a gruesome negative 15% operating margin, dragging its full-year figure into the red (negative 2%). With the Chinese market also weakening even before the current virus scare, and with overcapacity on Korea-ASEAN routes, Jeju saw Q4 international yields plummet 23% y/y. That brought total revenues down 3% despite 17% more ASK capacity. Operating costs increased 14%.

    This year, Jeju will cool things off with seat growth of 5% at most. That depends on whether it gets its first two MAXs later this year as planned. It started this year with 45 B737-800s. The Japan market by the way, went from 26% of Jeju’s total revenues in Q4, 2018 to 11% last quarter. Now it’s forced to suspend most of its China flying due to the coronavirus. And other destinations like Singapore, Bangkok and Taipei are affected in conjunction with government travel warnings.

    Will there be any relief? Consolidation could provide some help, and rumors of tie-ups are sure enough appearing. Jeju, for example, was said to be briefly interested in buying Air Busan from Asiana. It then pursued a deal to buy another LCC rival called Eastar Jet. There are no fewer than seven LCCs flying from Korea: Jeju, Jin Air, Air Seoul, Air Busan, Eastar Jet, T’way Air and Fly Gangwon.

And North America’s Regionals?

  • In the U.S. regional sector, Mesa Air is earning handsome margins by offering some of the lowest-cost CRJ and E-Jet feed to United and American. Its Q4 operating margin was 15%. Its full-year 2019 margin was 16%. Mesa’s operations improved after a rough summer, and revenue growth will continue as another 20 E175s start arriving in May.

    These will be part of a 12-year capacity purchase agreement with United, for which it will fly 80 E175s in total. For American, Mesa operates CRJ-900s. The Phoenix-based company is separately pursuing cargo opportunities, surely encouraged by Sun Country’s recent deal to fly packages for Amazon.

    But it sees more opportunities to grow with United and American as well. At the moment, it explains, finding new pilots isn’t a problem because mainline carriers have temporarily slowed hiring while MAXs are grounded.

    Like SkyWest, Mesa placed a conditional order for Mitsubishi’s SpaceJet, just to ensure a position in the delivery book. But it’s uncertain what product will ultimately replace the industry’s plentiful CRJ-900s and E175s. Embraer was hoping to deliver a solution with its re-engined E2-E175. But at current specifications, it will be too heavy to comply with pilot scope clause agreements. 
  • Providing regional feed is a good business in Canada too. Chorus, otherwise known as Jazz earned a hearty 15% operating margin for both Q4 and all of 2019. It flies about 80% of Air Canada’s regional network, in a commercial arrangement similar to those found between U.S. airlines and their regional partners.

    Air Canada makes all the commercial decisions including where to fly and how much to charge, while paying for key items like fuel and airport fees. Chorus and Air Canada had a few years of strained relations as the latter strived to cut the cost of its regional feed. Today, though, Air Canada is a minority shareholder in Chorus, and the two extended their partnership all the way through 2035. Just as comforting is an assurance from pilots not to strike for the next 15 years. The relationship is growing with additional CRJ-900s and Dash 8 turboprops.

    In the meantime, Chorus is helping Air Canada manage its MAX mess, as well as its domestic competitive challenge from WestJet’s Swoop. All the while, Chorus is building an unrelated leasing business that includes A220 rentals. It’s looking at E2-Ejets as well. ◄

Madhu Unnikrishnan

February 18th, 2020 at 9:00 AM EST