Business

Saturday September 12, 2009

Continuity under new stewardship

Stories by B.K. SIDHU


Malaysia Airlines’ new MD and CEO Tengku Datuk Azmil Zahruddin plans to reinforce the building blocks that are in place under the company’s Business Turnaround Plan.

MALAYSIA Airlines (MAS) has a new captain in Tengku Datuk Azmil Zahruddin but his task in flying this airline is not going to be easy given the challenges the industry faces and despite the fact that he has been with the airline for more than four years.

The economy remains delicate and its recovery even more so, yields are under pressure and waning passenger demand coupled with volatile oil prices and the A(H1N1) flu outbreak are some of the immediate challenges facing the airline industry globally.

Tengku Datuk Azmil Zahruddin

Cathay Pacific CEO Tony Tyler was not exaggerating when he referred to the current global crisis as the “most destructive economic downturn in recent memory” with “no end in sight”.

The IATA (International Air Transport Assocation), a body with a membership of 230 airlines which fly 93% of international air traffic, said recently that the global airline industry lost a staggering US$6bil in the first half of the year. It predicts that the industry will lose US$9bil this year from a loss of US$8.5bil in 2008.

“Times are bad. Traffic has collapsed, yields are poor and the balance sheet is ripped right now. The low cost carriers may have a bigger advantage,” says an industry analyst.

That pretty much wraps up what Azmil will need to do from here on. He knows that too, but wisely enough, has set his horizon beyond the medium term’s gloom and doom.

“It is going to be challenging. Things are not going to improve just over the next month. It is a matter of how we manage our way out of the crisis right to the end, address the immediate issues and position ourselves to take advantage of the upturn,” Azmil tells StarBizWeek in an interview.

He plans to reinforce the building blocks that have already been put in place and clearly articulated under the company’s Business Turnaround Plan (BTP), of which there are two. BTP 1, launched in 2005, was all about survival as the airline was on the brink of bankruptcy. In two years, ahead of schedule and much to sceptics’ utter surprise, MAS turned around, posting a record net profit of RM851mil for the financial year ended Dec 31, 2007 (FY07).

“It is quite ironic. In the beginning, sceptics used to say: ‘The two jokers (Jala and Azmil) are not from the aviation industry but they are trying to run an airline.’ They thought we were too optimistic with our targets. After that, they were more convinced and sometime early last year, when we were being cautious with our targets, they accused us of being too pessimistic,” says Azmil.

The second phase, or BTP 2, kicked off in January last year, focusing on resilience and turning the airline into a five-star value carrier.

Reinforcing plans

“I’m here to reinforce (the existing plans). That is my key message when I engaged the staff last week. Of course, we’ll need to tweak (the plan) as we go along but that’s less important than reinforcing. The main problem for carriers is the shortfall in revenue,” he says.

But rather than mull over the current bleak scenario, Azmil has resisted the all-consuming tendency to be short sighted. He’s got his eye on growth which he predicts may happen sometime second half of next year.

“We are consciously spending a lot to improve. 2010 will be our platform for growth but we don’t want to jump the gun too much,” he says.

And he is not going to stray away too much from the BTP 2, continuity is the key word for him.

The airline will continue its efforts on product enhancement which includes improving food quality, raising service standards, and more cost cuts, to boost value and sales. It will continue to run its promotional campaigns which means adspend will go up, mostly for markets outside Malaysia.

A new initiative to be up and running by end November will enable travellers to buy tickets, check-in and get flight details via mobile phones. “That’s a significant adjustment. It enhances the product and in the long run, reduces our cost and helps us increase revenue while customers get more satisfaction. This is what we will be investing in,” he says.

However, he is quick to add: “The one thing we do not want to do is (compromise on quality and service). One airline took caviar out of its first class menu and we think that is a mistake. The cost of caviar is far too small. We want to improve our service and not give our first class passengers an excuse not to fly with us,” he elaborates.

Not surprisingly, cost cutting will continue. The airline has saved some RM2bil in recent years through aggressive cost cutting measures, but Azmil says there is still room to trim costs further.

“The airline has been around for 60 years. It has accumulated a lot. Cost cutting is something we will continue to do. When you take out the cost, a large chunk goes to consumers and through pricing (lower fares). We cannot do that if cost is not down. We need to be lean and mean,” he says, adding that this year, the company hopes to further cut costs by RM700mil.

Some tweaking to the BTP 2 is necessary to ensure MAS is truly a five-star airline that gives good value. “We do not want to be the number one airline. That is not our game and no one can afford it. It defeats the purpose. SwissAir is one good example of a good product but it was not managed properly (so we will stick to what we do best),” Azmil says.

Flying through the storm

The signs of an economic rebound has pushed energy prices up in August with jet fuel prices above US$80 a barrel. Azmil says a major challenge when the economy recovers is the possibility of oil prices trending upwards.

To protect itself, MAS has hedged a portion of its fuel requirements. Provisions of RM3.8bil has been made and even though it made some RM556mil hedging losses in the first quarter, it managed to recover that and more in the second quarter.

Sadly, at operating level, MAS made a loss of RM420mil in the second quarter. In the first half ended June, it chalked up revenue of RM5.3bil compared with RM7.31bil a year ago.

Azmil admits that “revenue short fall” is a big issue which needs to be addressed. It has opted for discounted fare pricing but must do more to boosts revenue.

Airlines are struggling to get passengers as traffic has collapsed. Most of the full service carriers have problems filling their front end of the cabin and have slashed prices to compete with low cost carriers (LCCs). Major players, namely Qantas, British Airways, Cathay Pacific, Singapore Airlines and Air France-KLM, have been impacted and are reporting huge losses.

“Malaysia and Asean have been relatively resilient. The problem is we have a lot of capacity to Australia, Europe, and the United States as traffic has been hit badly. If we were predominately based in Asean, then our figures would be better,” he says.

Passenger load factor for August has somewhat improved to 80% for MAS. As Cathay’s Tyler puts it: “We keep waiting for signs of the green shoots of recovery. We’re in Asia so I’ll use an appropriate analogy. When we look at the rice-paddy we see only one or two green shoots rising out of the watery mud. Certainly not enough to fill a rice bowl. The very best we can say is that things have stopped getting worse but a real and sustained business upswing still seems like a distant dream.”

MAS has cut capacity by 12% and this does not include it’s KL–Stockholm–New York–KL route. It has also grounded three B747 aircrafts while rival SIA is expected to ground 13 and Cathay Pacific six, with five more by year-end.

Azmil says there are no immediate plans to cut more capacity other than the US route but a review of the network is on-going. The airline is looking for more code-sharing arrangements.

Furthermore, he says, the airline has the option to return to the Big Apple or any other US city any time it deems fit since there is an open-skies arrangement between both countries.

“We may increase or decrease frequency depending on flight and destination. From 2010, we will be growing and putting back some capacity but not the full 12% capacity,” he says.

Recovery

Amidst such challenging times, what is in store for the industry? Well, the IATA says recovery is under way but the industry will be volatile and weak. Azmil’s take is that 2009 will remain tough for airlines; competition will intensify as airlines fight for customers. At best he expects a recovery only next year. “Perhaps it will pick up in the second half, just in time for our deliveries,” he says.

By then Azmil believes MAS will have a refreshed product, many more new destinations, a host of new capacity with new aircraft deliveries and additional frequencies.

An analyst from Affin Research expects MAS to remain operationally in the red for 2009 and 2010 to the tune of RM1.2bil and RM650mil respectively. In a report, he says heavy fare discounting via its Everyday Low Fares, MH Stimulus Package and Get-the-Deal has pressured yields severely, especially international traffic.

Although load factors have improved, it is insufficient to return MAS to profitability. Every 1% reduction in yield leads to an 8% decline in bottomline vs a 5% improvement for every 1% increase in load factor. The analyst reckons MAS will post a derivative gain of RM768mil in FY09, narrowing its net loss to RM307mil.

“Stripping off the unrealised gain from its fuel hedges and only incorporating actual realised fuel hedges, we forecast a core net loss of RM1.87bil, which we believe is more reflective of MAS’ underlying earnings momentum,” he says.

For FY10, the analyst expects MAS to post a derivative gain of RM786mil (based on crude oil price forecast of US$75/barrel) and to revert to profitability with a net profit of RM190mil.

When will MAS see better cashflow? Azmil is optimistic: “The load factor is quite good. Our planes are filling up and we do not sell so many discounted fares. Yields will go up but 2009 will remain tough. We see next year as a better year.”

Self cannibalisation?

Critics say that MAS’ strategy to cut fares to keep up with competition may have cannibalised its own target segment, hence, also its yields. As at end June, MAS’ yields stood at 26.3 sen per revenue passenger km, which compares well to Singapore Airlines’ 26.8 sen/km. Years ago, the gap was wider when MAS’ yields were in the teens.

Falling yields has been a major concern for airlines worldwide and more so in the past months. No doubt, it remains a major concern for Azmil. To keep its planes flying, MAS has had to cut fares. But its strategy of heavy fare discounting has prompted critics to say that MAS was behaving like a LCC.

Not true, says Azmil. “You cannot compare us with AirAsia. You have to look at the regions we fly into. We are into six continents and we are a full service carrier. Our product is far superior.

“We also cannot ignore the fact that LCCs are here and we need to adapt to (the way they do their business),” he adds.

There are three tiers in the air passenger segment – low cost, full service economy and first/business class. MAS’ target is the middle – the full service economy passengers – and that is where competition is most intense.

Whenever MAS runs its Everyday Low Fares campaigns, sales spike, which indicates that while some people buy low cost tickets, there are others who are willing to pay higher prices for their travel.

“Not everyone wants cheap tickets. But for those who are not going to change their minds and don’t need the flexibility, cheap tickets would be sensible,” he explains.

“It is hard to say that we are cannibalising on our yields. Yields fall in any economic cycle and you cannot compare the yields from last year as the operating environment then was different.”

MAS has cut fares but he says, the move is in line with other global carriers that have to compete in an environment where LCCs exist.

“Why should we leave ourselves out of that market? If there is no capacity, then it is alright but if the plane is still empty, why not sell the seats,” he says.

Fleet management

New planes that are more fuel efficient are needed to replace its ageing fleet. An order for 35 new B737-800 aircraft has been made, which it will use for long haul trunk routes.

The first delivery is expected in the fourth quarter of 2010. MAS will also take delivery of the first of six A380 planes in 2011. It has also leased three B737-800.

MAS is one of the few airlines that has ordered aircraft during a downturn. In a downturn, managing additional capacity poses a major challenge, which explains the move by most airlines to ground their planes.

“Many within the industry repeat the same mistakes of ordering aircraft during peak and get it in bust times. We did not want to be in that position as it is very difficult to manage capacity in an oversupply situation. We avoided that as we want to grow when the economy goes up,’’ Azmil said.

The IATA predicts that globally about 4,000 aircraft are scheduled for delivery in the next three years, which is 17% of the current fleet.

Experts say the airline industry is structurally unprofitable, with excess capacity and that even if traffic picks up, carriers will have to rein in aircraft purchases.

What’s in store

When Jala was at the helm, the duo managed to steer MAS out of its worst. Without a doubt, the big clean up has been done but the job is far from over. MAS faces new challenges from volatile crude oil prices, heavy discounting due to brutal competition, disease outbreaks, further liberalisation of the skies and more.

For Azmil, he will soon realise that there’s a huge difference between being part of a team and leading one. He can only be thankful that he’s had a good teacher.

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