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​ANALYSIS: Asia's risk pockets in 2019

Asia-Pacific is the world’s largest aviation market, and overall has performed strongly again this year, but there are pockets of weakness in some markets that look set to roll on into 2019.

During a recent interview with FlightGlobal, BOC Aviation chief executive Robert Martin noted that while the airline industry continues to be strong, this is being driven by the fortunes of the American and largest European carriers.

“You have some other carriers who are in the weaker developing markets who may have a foreign exchange issue,” he adds. “They are getting hit by a strong dollar, and obviously fuel is in US dollars, rising US dollar interest rates on their aircraft financing, rising domestic interest rates on their working capital financing, and they may have been hit with some [aircraft delivery] delays over the summer.”

For instance, carriers in India and Indonesia have been feeling the impact of the stronger Dollar against their local currencies, which has exacerbated costs and started draining cash.

China, as the powerhouse of the Asia-Pacific market, continues to grow strongly, but a major cloud over the trade relations with the USA – a market in which Chinese carriers have grown strongly in over the past few years - remains.

INDIAN CARRIERS REEL AS CAPACITY AND COSTS GROW

India may be one of the fastest-growing aviation markets in the world, but the last year saw carriers struggle to pass on higher costs to passengers, resulting in more strain on their balance sheets.

Stronger fuel prices in 2018 were felt particularly hard in the Indian market, with the double-whammy of a depreciating home currency which further increased fuel and other US dollar-denominated costs.

Speaking during the airline’s earnings call in October, market leader IndiGo’s chief financial officer Rohit Philip cited those higher costs for a fall to a pre-tax loss of Rs10 billion for the quarter ended September.

“Unfortunately, these higher input costs have not been recovered as fares remain low due to continued intense competition.”

He also pointed to a change in passenger behaviour over the year, which has seen fares closer to the departure date fall.

“The 0-15 day booking window remains weak with lower fares compared to the same period last year. This has been further accentuated by the significant increase in capacity in the market.”

FlightGlobal schedules data shows that capacity has grown by 18% between 2017 and 2018. Forward filed schedules for the year to November 2019 indicate that there will be at least 10% more ASMs added to the market over the next 12 months.

Those market conditions led local credit ratings agency ICRA to downgrade its ratings on IndiGo, although it has acknowledged that the budget carrier is best placed among India’s airlines to weather the storm thanks to its strong liquidity and focus on cost controls.

While backing its position, IndiGo has signalled that it is reversing earlier plans to take more aircraft onto its balance sheet, and will extend its sale-and-leaseback programme on its Airbus A320neos in order to preserve its cash.

The situation is much more challenging at Jet Airways, which has been forced to delay salary payments, seek advances on sale-and-leaseback payments, and go on the hunt for new equity.

In August, it confirmed that it had received $300 million in advance payments from lessors, likely related to sale-and-leasebacks on its Boeing 737 Max 8s. At the same time, the carrier also confirmed that it was in arrears to lessors on some of its other aircraft lease payments.

Jet has also pointed to further potential to unlock capital from sale-and-leasebacks on its 777-300ERs, operating cost improvements from its new narrowbody jets, and plans to wet-lease ATR 72s to Indian regional carrier TrueJet. However, the wet-lease deal looked to have collapsed at the end of 2018.

Adding to the carrier's pain, it confirmed on 31 December that it had defaulted on payments to a consortium of local banks, attributing the repayment delays to a "cash flow mismatch". This prompted credit agency ICRA to downgrade the carrier's long-term loans and non-convertible debentures ratings from "C" to "D".

Jet is not alone in relying on sale-and-leaseback payments to finance operations. Ratings agency Crisil revealed in October that SpiceJet’s cash was under pressure as deliveries of its own 737 Max 8s had delayed some payments, and it too had sought relief from lessors on overdue rentals on some aircraft.

Despite the challenges facing India’s airlines and the continuing growth in capacity, there is optimism that the depressed yield environment will turn around in early 2019.

“The economy is healthy in India and we continue to see demand growing in the 20% range. So, things may be out of balance a little bit in the short-term, but with that pace of demand growth we are comfortable that it is going to get back in balance really soon,” says IndiGo senior advisor Greg Taylor.

What is less certain is the fate of Air India following its unsuccessful privatisation attempt in 2018, which failed to yield a single bid for the 76% of the airline on offer. It has been reportedly seeking new capital infusions from the government and capital lines from banks as it seeks to reverse years of losses and a major debt load.

CONSOLIDATION IN INDONESIA AFTER RUPIAH ROUT

The crash of a Lion Air Boeing 737 Max 8 in late October rounded out a challenging 2018 for Indonesian carriers, largely driven by a 10% fall in the value of the Rupiah over the past year, and continuing yield pressures.

Xe.com currency data shows that the Rupiah traded around IDR13,500 to the Dollar in January, however in October that blew out to IDR15,500.

Commentators have largely blamed the decline of the Rupiah on foreign investors selling Indonesian assets spurred by rising US interest rates, and fears that emerging market risk from Turkey and Argentina could spread to other emerging economies.

Towards the end of the year, the Rupiah strengthened to around 14,500, perhaps signalling that the contagion threat is over-blown. Nonetheless, the currency is still well off the average trading range over the past few years.

For most Indonesian carriers, which sell most of their tickets revenue in Rupiah, the declines in that currency have caused fuel, leasing and maintenance costs - typically paid in dollars - to shoot up. At the same time, yields have continued softening, creating a massive headache for airlines.

Sriwijaya Air’s director of corporate planning and business development Jefferson Jauwena explained in February that air fares on some routes in the country are now cheaper than bus fares, and floor prices were not being effectively regulated.

“While there is a price floor, this is not being monitored or controlled by the government. The price war is just getting crazier every day,” he added.

Over the year, however, there was little sign of Jakarta stepping in to enforce the price floor more strictly, with most carriers still noting yield pressures.

Garuda Indonesia chief executive Ari Askhara told FlightGlobal in December that there was a need to “fix the ecosystem” in the domestic market for the benefit of all carriers.

Consolidation appears to be a major part of the answer, with Garuda announcing a tie-up with privately-owned carrier Sriwijaya Air, under which its budget unit Citilink will take over operational control of Sriwijaya and its Nam Air regional unit.

Garuda is not planning to take a stake in Sriwijaya, but will appoint five of its seven board directors and three of its seven commissioners, says Askhara, who will himself serve as chairman.

He adds that the deal will give Garuda a 51% share of the domestic market, which for many years prior had been dominated by low-cost rival Lion Air.

Maybank Investment Bank analyst Mohshin Aziz welcomed the deal, telling FlightGlobal that it would bring some much-needed sanity to the market.

"Indonesia has always needed consolidation, there are just too many airlines there. For Sriwijaya to be consolidated with another airline makes perfect sense. To be bigger is better."

Despite holding a dominant position in the domestic market, Lion Air Group also appears to be suffering due to the same conditions plaguing its rivals.

While the carrier does not disclose numbers, its strong use of sale-and-leasebacks, and some sales of on-order jets to lessors for placement with other airlines, demonstrates that it, too, has had to pull levers to ensure it has the cash to finance its day-to-day operations.

Moreover, the crash of flight JT610 shortly after take-off from Jakarta’s Soekarno-Hatta International airport on 26 October is also likely to put the carrier under renewed pressure.

While there have been concerns about the role that certain systems on the Boeing 737 Max 8 played in the crash, the initial report from Indonesia’s National Transportation Safety Committee highlighted safety deficiencies in its operations. Boeing also took the unusual step of commenting on the report, which some have interpreted as an attack on the carrier.

Lion Air Group founder Rusdi Kirana has responded by threatening to cancel hundreds of 737 Maxes it still has on order. Still, some believe that it is a tactic aimed at slowing its planned deliveries to deal with the challenges in the Indonesian market.

CHINA STRONG, BUT TRADE WARS A RISK WORTH WATCHING

China remains the world’s strongest aviation market, but there are concerns that a slowing economy - caused by a potential trade war with the USA - could have some impact on passenger demand.

To date, the impact of the simmering trade tensions has done little to unnerve the aviation industry. Any impact was expected to be felt first by air freight operators, but the tariffs that the US has put on Chinese goods to date have mostly been on commodities and other goods that are rarely shipped by air.

The risk that tariffs may pave the way for other restrictions, such as withdrawing the mutual 10 year visas available between the two countries, could have a much greater impact on passenger traffic. FlightGlobal schedules data shows that between 2013 and 2018, capacity on US-China routes grew an average of 16% - most of which was added by Chinese carriers, in some cases underwritten by subsidies by provincial and municipal governments in China.

More immediately, a number of Chinese carriers have significantly boosted their short-term debt this year. Most of that has been in ultra-short and medium-term bond issuances in the domestic market, where state-backed carriers have been able to achieve coupon rates in the 3-4% per annum range, while Hainan Airlines has accepted coupons in the 6-7% range.

The HNA Group carrier has been beset by its own challenges, brought on by swelling liabilities at its parent company during the past year, which has seen its bond rates rise. In one case, its latest $100 million overseas bond offering attracted an eye-watering 12% coupon rate.

While still profitable for the year to September, Hainan appeared to be positioning to sell stakes in some of its domestic units, with a deal struck to reduce its stake in Urumqi Air to 30% by selling a block to a unit of the provincial government.

That has been offset partially by new equity issues by China Southern, China Eastern and Air China over the past year. All three received capital injections from their parent holding companies and other state-owned enterprises. In the case of China Southern and China Eastern, privately-owned rivals Spring Airlines and Juneyao Airlines, respectively, took minor stakes in those carriers – reflecting a policy move by Beijing aimed at attracting more private capital into state-owned enterpises.

But larger reforms are occurring in the passenger market. In October, the first stages of liberalising the long-held policy of limiting most routes to one Chinese operator started, which could spur a new stage of competition among the Big Three carriers.

A litmus test of that competition will come in late 2019 when Beijing Daxing airport opens, with China Eastern and China Southern both planning to use the new airport as a major hub – providing an alternative to Air China’s dominance of Beijing Capital International airport.

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