ANALYSIS: Tiger faces financial risks with Indonesian, Philippine units

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Tiger Airways' plans to expand its affiliate carriers in Indonesia and the Philippines are likely to drag on its finances for some time.

The carrier has released its third quarter results for the 2012/13 financial year, which showed an overall net profit of Singapore dollars (S$) 2 million ($1.6 million). Tiger noted in its results statement that its 33% stake in Indonesia's Mandala Airlines and 40% stake in Philippine carrier Seair "are unlikely to contribute positively to the group's performance" for the financial year ending 31 March.

Analyst David Lau of CIMB Securities says that given the relatively young state of the two carriers, it is understandable that they will make losses in the short term.

"It usually takes about three years for a startup to reach a profit," he says.

Nevertheless, Tiger has indicated that it intends to grow both airlines in their respective regions, with plans to introduce new routes and form distribution partnerships to increase its market penetration.

The budget carrier group says that the "longer-term potential of the Indonesia and Philippines air travel market is promising."

But Lau expresses some doubt about that promise, especially as more carriers such as AirAsia enter the market.

"I think the potential of those markets is overplayed," he says.

Analyst Rigan Wong from Citi Research says that while the markets have "huge hinterland potential", Tiger's lack of scale against the likes of Lion Air in Indonesia and Cebu Pacific Air in the Philippines "may translate into a period of unprofitable expansion".

Mandala has a fleet of five A320s, with plans to increase that to up to 25 A320s by 2015, while Seair operates a fleet of two Airbus A319s and three A320s.

By comparison, Lion Air has a fleet of 84 Boeing 737s, while Cebu operates 10 A319s, 24 A320s and eight ATR 72s.

Wong adds that Mandala and Seair will face difficulties that fast growing low-cost carriers (LCCs) have not faced in Europe, particularly in countries such as Indonesia and the Philippines where Mandala and others are using low fares to attract new air travellers.

"LCC demand in high-income countries comprises a higher proportion of passengers who 'trade-down' from legacy carriers, while LCC demand in low-income countries comprises a higher proportion of passengers who are stimulated by cheaper fares and who would otherwise not travel if airfares were higher," he says.

He adds that this gives carriers in the region little ability to pass on higher variable costs - such as fuel prices and airport charges - to passengers.

Wong's comments echo those made recently by DVB Bank's managing director of aviation finance, Bertrand Grabowski, who says that many of the budget carriers in the region have placed massive orders for aircraft based on their ability to stimulate traffic growth.

"It is a dangerous race, trying to anticipate growth potential," he says.

Wong believes that Tiger's focus on the expansion of Seair and Mandala will put major pressure on the parent company in the coming years.

"We believe Tiger's pursuit of a Pan-Asia footprint may over-stretch its financial resources and dilute its management focus," he says.

That could lead it to head back to the markets and raise more equity to strengthen its balance sheet, which has been largely propped up by selling and leasing back its aircraft, Lau says.

Tiger has already provided loans of S$48 million, and Wong believes that this may need to be increased, or even forgiven in future to support the two airlines.

Overall, Wong says that Tiger's woes in the coming years will reflect a more challenging time overall for LCCs as they expand across the region.

"In short, bottom lines of Asian LCCs may disappoint over the next decade, despite ample reasons to be optimistic on top-line growth," he says.