The majority of Southeast Asia's legacy carriers had a lacklustre 2017 as fierce competition and aggressive capacity expansion put pressure on yields, and 2018 looks likely to be equally challenging should fuel prices continue climbing.

Of the 10 legacy carriers in Southeast Asia, only half make their finances public because of listing requirements. Of these, three made losses in the first nine months of 2017 and are expected to stay in the red for the full year.

While Vietnam Airlines was profitable, posting a consolidated pre-tax profit of D2.3 trillion ($101 million) for the nine months, this was an 11% slip from a year ago.

Singapore Airlines is the only bright spot, but just barely. It saw a 30% improvement in its net profit for the first half of its 2017-2018 financial year, but yields continue to suffer. A wide-ranging review of its business was flagged last May, as net profit plunged 55% to S$360 million ($270 million) for the year ended 31 March.

The worst performer is probably Garuda Indonesia, which saw its attributable net loss balloon to $222 million in the first nine months of the year, from a $44 million loss a year ago. The Indonesian flag carrier is battling yield pressure from strong competition, and says its five aircraft-type fleet has also been a drag on its finances.

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A new chief executive has been put in place to clean up the financial mess, and he has made deferring of aircraft on order his first priority.

Philippine Airlines and Thai Airways International also swung into losses for the nine months. Despite the higher revenue from growth in passenger and cargo traffic as well as ancillary revenues at PAL, this was outpaced by a more than 27% jump in expenses, partly attributed to the higher fuel price.

Thai similarly dipped to a net loss of Bt3.88 billion ($120 million), reversing the Bt1.47 billion net profit a year earlier. It blamed this on a steep foreign exchange loss, as well as a sharp jump in costs associated with the company's transformation plan.

The figures are telling: the airline industry has never been more competitive and legacy carriers are facing increasing pressure from the growing number of budget carriers, all with lower cost structures.

FlightGlobal schedules data shows the region's tremendous LCC growth over the past decade. In 2017, LCCs accounted for 53.7% of all seats flown within Southeast Asia, far more than 28.1% a decade ago

lcc marketshare

Corrine Png, chief executive of transport equity research firm Crucial Perspective, says low-cost carriers have been the nemesis of legacy airlines since their cost structures are typically 50% lower, enabling them to stimulate demand and win market share from the incumbents.

"Given the aggressive capacity expansion, particularly the low-cost carriers, the industry has been suffering from overcapacity which has driven the legacy airlines to discount more to fill up their planes, which ultimately hurts their profit margins," she adds.

The message is clear: passengers are no longer relying on legacy carriers for air travel. Gone are the days when inefficient state-owned carriers could operate without a sound business case, simply flying the national flag.

The problem is that full-service carriers, especially state-owned ones, are often bloated and bogged down by legacy issues. The inefficiency and bureaucracy also make them less competitive and agile than their younger, privately owned low-cost peers.

Png believes that legacy carriers need to behave more commercially by trimming unprofitable routes "more aggressively", rationalising the workforce, and divesting non-core assets. Those that have not launched low-cost subsidiaries should jump in, to defend market share and ride on the growth of the budget travel boom.

SIA has perhaps been most aggressive in this space, having first held a majority stake in Tigerair before eventually taking over fully after years of losses. It also went a step further and set up long-haul low-cost unit Scoot, and has since merged Tigerair into its fold. Scoot's financials for the first half of the financial year 2017-18 shows an operating profit of S$5 million.

SIA chief executive Goh Choon Phong is well aware of the importance of the budget business, and has said there will be more interaction between its premium and budget brands. Much of the group's ongoing review also looks at legacy practices and will include organisational restructuring.

Garuda meanwhile saw no choice but to launch Citilink, as Indonesian low-cost giant Lion Air grew quickly to dominate the market. Interestingly, Lion has now taken the road less travelled, setting up full-service unit Batik Air to break Garuda's monopoly on the Indonesia premium market.

Vietnam Airlines, increasingly challenged by aggressive upstart VietJet Air, works closely with its 70%-owned Jetstar Pacific unit. The pair codeshare extensively and also co-ordinate schedules. Nonetheless, over-stimulation of the market in recent years has hurt yields, although capacity growth moderated in 2017.

Philippine Airlines made PAL Express its low-cost alternative as it got pushed into a corner by the popular Cebu Pacific. While Thai Airways has a share in Nok Air, it has yet to set up its own budget arm to combat the multitude of LCCs in the Thai market.

At Malaysia Airlines, the priority is to work through its restructuring after twin air disasters in 2014 brought it to the brink of collapse. It faces the formidable AirAsia at home, but appears to have no clear low-cost strategy.

Distinctions between the different business models are, however, becoming increasingly blurred as airlines adopt hybrid strategies, says Andrew Herdman, director general of the Association of Asia Pacific Airlines.

"Regardless of the chosen business model, aviation is always a highly competitive industry," he says. "Airlines have to constantly review their route networks and fleet deployments in line with changing patterns of travel demand, and optimise revenue generation through dynamic pricing strategies, whilst seeking operational efficiencies and other cost-reduction measures."

Shukor Yusof, founder of aviation advisory Endau Analytics, has harsher words for the old-timers. "Legacy carriers need to focus on what the market wants and appoint people who understand the industry to manage the business," he says. "Airlines must operate on a fully commercial basis, not for national service.

"Government interference must cease. LCCs have comprehensively changed the game and legacy airlines are no longer a necessity if they don’t serve what the market needs."

Looking ahead, Herdman says the outlook for continued growth in both passenger and air cargo demand remains positive in 2018. Market conditions are expected to stay highly competitive, but yields appear to be stabilising, reflecting the cost impact from modestly higher oil.

Should fuel price continue to climb, however, profit margins are expected to slip. Hedging could thus play a key role should there be serious fluctuations in oil prices due to market demand or geopolitical unrest.

Besides SIA, most Southeast Asian carriers have limited or no fuel hedging. Any drastic uptick in fuel prices could thus hurt profits.

Crucial Perspective expects capacity growth to moderate in Thailand, Indonesia, Malaysia, Cambodia and Laos this year, which should have a more "favourable" earnings outlook for airlines there. Png says. Low-cost carriers will, however, be the key beneficiaries because the easing of yield pressure will lift profitability, considering their competitive cost structure.

Capacity growth is expected to continue in markets such as Singapore, the Philippines, Vietnam and Brunei, and airlines there could face greater pressure to discount fares to fill excess seats, says Png.

Besides competing with low-cost peers typically on regional and domestic routes, these legacy carriers also have to contend with Chinese carriers that are expanding aggressively to Europe and North America, as well as the Middle Eastern carriers with reputations for offering good value for money.

Shukor believes Thai Airways and Garuda will struggle most in the year ahead, feeling the impact of higher interest rates and fuel prices, as well as keen fare competition.

For all legacy carriers, he warns: "LCCs will continue to grab more of the market while legacy airlines will struggle in the face of intense pressure, overcapacity, lack of strategic clarity and inept management."

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Source: Cirium Dashboard