Malaysia’s Budget Carrier Sets its Sights High

Despite an ailing global economy and rising costs, Malaysia’s rambunctious budget airline AirAsia is expanding aggressively against the country’s lackluster national flag carrier, Malaysia Airlines.

AirAsia’s growth, if it comes off, would make the airline group – Malaysia AirAsia, Thai AirAsia and Indonesia AirAsia – which is publicly traded on the Kuala Lumpur stock exchange, Airbus Industrie’s largest airline customer for the 180-seat A320, with a total of 175 aircraft. Undercutting MAS, which although it has had some profitable quarters recently, has gone broke periodically amid bursts of managerial incompetence, AirAsia has experienced tremendous fast-track growth since it placed its original order of 60 A320s in March of 2005.

But now, given a darkening global economic picture, rising fuel costs and budget-fare competition, AirAsia and its CEO, Tony Fernandes, are facing times that will test the airline’s management skills. Starting next Friday, AirAsia will take on MAS and Singapore Airlines (SIA) daily on the lucrative route between Kuala Lumpur and Singapore, offering about 5,000 round-trip seats per month. That is about a quarter of the combined volume of MAS and SIA. It will also be competing with two other budget airlines, Singapore’s Tiger Airways and Australia’s Jetstar on the same route.

All of them need to beat extremely convenient high-speed luxury coaches that cost about RM150 (US$46), take about five hours and leave and arrive at city centers, cutting their time against airlines. Nor is price competition just against buses. MAS and SIA have agreed to new round-trip fares of RM628 (US$191) inclusive of all taxes and surcharges, down from RM856. To counter, AirAsia is giving away 30,000 seats and Tiger Airways 15,000. JetStar has a buy-one-get-one-free offer. But when prices stabilize, it may simply mean more flights at lower prices across the board.

So far, AirAsia stands in vivid contrast to MAS, which lost RM1.6 billion in 2005 and RM136 million in 2006. One of the state-owned carrier’s big problems is that it has to fly so-called missionary routes to thinly populated parts of the country where passengers are few and revenues are low. But beyond that, MAS has repeatedly faced charges that cronies of the United Malays National Organisation, the country’s leading ethnic party which controls the ruling coalition, ran it into the ground despite consistently high ratings for comfort, on-time performance and other marks of efficient air travel.

Certainly AirAsia’s beginnings were inauspicious. Started by a Malaysian government-owned conglomerate, DRB Hicom, it incurred such overwhelming debt that Hicom sold it for 1 ringgit to Fernandes, a former Time Warner executive, who turned a profit in 2002 with low promotional fares – 1 ringgit again – that drew clients and undercut MAS. AirAsia has continued to set passenger performance records, the latest in the third quarter of 2007 with some 2.44 million passengers, a 25.5 percent year-on-year increase, with load factor remaining constant despite capacity additions of 34.7 percent. It is flying to Indonesia, Macau, Xiamen, China, the Philippines, Vietnam and Cambodia and has ambitions for long-haul routes to Australia and New Zealand.

But analysts are concerned that the airline may be expanding too fast. Certainly, the current financial crisis in the US is sending out concentric rings of trouble, and airlines often catch cold first. The International Air Transport Association’s industry outlook warned in December that a cyclical downturn is looming. It expects lower profits of US$5 billion, down from a previous forecast of US$7.8 billion.

However, the IATA report says China’s economy will be “relatively unscathed,” giving Asian and European airlines some protection. While North American airlines will remain profitable, they are likely to “bear the brunt of the fall in profits,” according to the transport association.

AirAsia’s success may depend on operational cost management like smoothing fuel costs via hedging. In the past few months, the company has been criticized for speculating on the crude oil futures market. In a report on January 9, OSK Investment Bank pointed out that AirAsia sold a call option for some 150,000 barrels of oil at US$90/bbl, with a knock-in price of US$9 per barrel, starting January this year until June 2007. If oil remains at US$100/bbl, AirAsia stands to lose as much as RM100 million annually. The airline has since said it has covered its position.

Fernandez told a local financial weekly: “Our structure, what we are trying to do, is not to benefit but to pay the current market price as it goes down…our ideal oil structure is to pay market price as it goes down.” Analysts and business journalists commented that this is “unusual” as hedging usually seeks to make cost more predictable, free from more volatile market prices.

The budget carrier’s expansion plans may also hit another glitch as the IATA report also says deliveries of aircraft will “peak when traffic slows again.” Last year, AirAsia bought 15 planes, worth about US$2.6 billion, from Airbus. With the credit crunch, raising funds to buy these planes may be prohibitively expensive. The same report says: “In the past the industry has an unfortunate record of ordering aircraft at the cyclical peak and taking delivery during the subsequent downturn.”

If Fernandes and AirAsia can avoid history, the region’s travelers may be the ones to benefit.