Optimism about aviation markets tempered by Asian jitters

Asia’s growing middle classes and their desire to travel are making the region home to some of the world’s fastest expanding aviation markets.

For example, Airbus expects China to replace the US as the most valuable market in the world for passenger jet deliveries by about 2030, and several other Asian countries – including India and Indonesia – have huge potential for aircraft orders.

But at the Singapore air show, which starts on Tuesday, this optimism about the long-term future of Asia’s aviation markets will be tempered by concerns about slowing economic growth and currency turmoil, and whether this could result in the region’s airlines cancelling orders with Airbus and Boeing.

The last strong year for Asian airlines was 2010, when the continent overtook North America to become the largest source of passenger traffic, having overtaken Europe several years earlier.

By 2030, 49 per cent of all traffic will originate in Asia, compared with 37 per cent currently, according to Boston Consulting Group.

BCG estimates 1bn people in Asia will have annual earnings of at least $15,000 by 2030, and will therefore be able to afford to fly. “The vast majority of these ‘next billion’ travellers will come from China, India, Indonesia, Japan and South Korea,” says Vincent Lui, a BCG partner.

Twitter Chat

Asian turbulence ahead for aerospace? Join our chat on Tuesday 11 February noon GMT, using #FTaero

However, these attractive long-term growth prospects contrast with recent performance. The International Air Transport Association (Iata) estimates that Asian carriers have seen net profits fall from $11.1bn in 2010 to $3.2bn in 2013.

The biggest factor behind Asian carriers’ declining earnings has been the weak state of the air cargo market since the onset of the global financial crisis.

After a brief rebound in 2010, the cargo market has been shrinking and this hit Asian carriers hard because they account for about 40 per cent of the world’s freight traffic by value, as their cargo fleets fly high-priced products made in the region to western countries.

Asian carriers’ average freight charges – called yields – have been pushed down by excess capacity, in part as a result of airlines expanding their passenger fleets.

“Yields for cargo have been falling quite sharply partly because of the success of the passenger business, which has brought on new aircraft to serve passenger markets with cargo capacity in the hold,” says Brian Pearce, chief economist at Iata.

“That has led to more and more capacity chasing less and less cargo volume, forcing prices down and damaging profitability in [the cargo] part of the business.”

But it would be wrong to think of Asia as one homogeneous travel market.

Rather, it is a series of discrete – mainly country-specific – markets that are expanding at different rates.

Iata estimates that China’s domestic passenger traffic increased 11.7 per cent last year, reflecting robust, albeit slowing, economic growth. This was well ahead of global traffic growth of 5.2 per cent.

By contrast, Indian domestic traffic increased by 4 per cent, as growth slowed markedly and the country’s airlines struggled with poor infrastructure and high fuel taxes. Kingfisher Airlines, which was grounded by regulators in 2012, is seen as emblematic of the financial problems affecting Indian carriers.

“The Indian market has huge potential, but has been a bloodbath for carriers for several years,” says Andrew Herdman, director-general of the Association of Asia Pacific Airlines.

Countries in the Association of Southeast Asian Nations (Asean), whose members include Indonesia, Malaysia, the Philippines, Singapore and Thailand, have taken several steps towards a liberalised aviation market that supports more flights between big cities. This initiative has underpinned the emergence of AirAsia as the region’s largest low-cost short-haul carrier.

But Kuala Lumpur-listed AirAsia, founded by Tony Fernandes, the flamboyant entrepreneur, faces intensifying competition from other budget airlines. Last year, Lion Air, a low-cost carrier based in Indonesia that has placed large orders with Airbus and Boeing for short-haul passenger jets, started a business in Malaysia.

Rising competition in Asia is not confined to short-haul routes. Some airlines that focus on long-distance routes are also under pressure.

Singapore Airlines spoke of “intense competition” as it reported a 3.5 per cent fall in average fares in the first half of its 2013-14 fiscal year compared with 2012-13. This competition involves fast-growing Gulf carriers, led by Emirates Airline, which are flying between Asia and Europe.

Andrew Lobbenberg, analyst at HSBC, says Singapore Airlines is the company “most exposed” to Gulf carriers because of its large Europe-Australia business, but he also highlights Malaysia Airlines and Thai Airways as vulnerable.

With more liberalisation in the offing, there are likely to be more entrants in Asian aviation markets. And the liberalisation will not just be within the region – through the proposed completion of the single aviation market between Asean members – but also on routes outside Asia.

For example, the European Commission, the EU’s executive body, is hoping to negotiate an agreement with the Asean countries that will enable EU carriers to do more flying to this bloc.

Consultants say that, in the long term, there is a compelling case for consolidation involving Asian airlines, but they acknowledge that it will probably be contingent on some governments being willing to relinquish control of their flag carriers – and even letting some of them go out of business.

Alex Dichter, a director at McKinsey, the global consultancy, says: “While we admit that the cultural, political and regulatory barriers to consolidation in Asia are significant, we see no way round this end-game.

“The combined pressures of Mid-East carrier growth and intra-Asia market liberalisation, alongside increases in labour costs, airport charges and fuel, will eventually be too much to bear.”

Meanwhile, some analysts are questioning whether Airbus and Boeing may have to cut production of their aircraft – several of which are being made at record rates – if emerging-market economies suffer a crunch similar to the Asian financial crisis of the late 1990s.

Asia accounts for a third of manufacturers’ order backlogs – larger than any other region – and analysts say any drawn-out crisis could reduce air travel and force some airlines to cancel orders or defer deliveries.

Nick Cunningham, analyst at Agency Partners, does not see the current weakness in developing countries’ financial markets as being likely to lead to reduced production by Airbus and Boeing in the short term.

Rather, he sees as a more plausible scenario that reduced Asian economic growth will accentuate a predicted slowdown in orders for the aircraft makers, that, in the medium to long term, could result in production cuts.

“If we are going to see the impact of any significant [short-term] weakness in Asia or emerging markets generally,” he says, “it will be as a weakening of order intake rather than an impact on [aircraft] deliveries.”