Refer to important disclaimers at the end of this report DBS Group Research Asian Insights Office 28 February 2017 Overall Outlook Record US$356 billion net profit for 2016; US$298 billion expected in 2017 The International Air Transport Association (IATA) announced in December 2016 that it expects the global aviation industry to post a record profit of US$356 billion in 2016 (revised down from June s projection of US$394 billion due to demand slowdown and rising fuel costs in the 2016 second half) IATA also expects total airline profit in 2017 to decline to US$298 billion, mainly on higher fuel costs, though 2017 would represent the eighth consecutive year of profit for the industry, and the third consecutive year the sector will make a return on invested capital (79%) that is higher than the weighted average cost of capital (69%) The 2017 forecast is based on an average Brent crude oil price of US$55 a barrel (jet fuel of US$65 a barrel) Growth in global passenger traffic expected at 51% this year, backed by 25% global GDP growth According to IATA, passenger carriage as measured in revenue passenger kilometres (RPKs) is expected to increase 51% in 2017 as global GDP growth is projected to accelerate from 22% in 2016 to 25% in 2017 This compares to 63% on-year growth in RPKs in 2016, which was partly stimulated by lower oil prices and, thus, lower airfares Over the past ten years, apart from the dip in 2008 to 2009 caused by the global recession, world passenger traffic has outperformed world real GDP Load factors reach another record high and are expected to remain firm World passenger load factor reached a record 803% in 2015, rising by 06 percentage points from 2014, and hit an even higher 805% in 2016 With capacity growth of 56% in 2017 (down from 62%) outpacing demand growth of 51% slightly, load factor is expected to dip to around a still firm 80% in 2017 Yields expected to stabilise on stronger global economic growth and higher oil prices While load factors are expected to ease slightly and exert some pressure on yields, stronger global economic growth as well as higher costs (led by higher fuel prices) should mean that yields for 2017 remain stable, following four consecutive years of decline in yields (calculated in US dollar terms) The decline in yields in recent years can be explained by a combination of lower fuel prices, a stronger US dollar and faster growth for the low cost carrier (LCC) segment According to IATA forecasts, passenger yield fell by 8% in 2016 and is expected to stay flat in 2017 Global in-service fleet grew to 24,024 aircraft in 2016, from 23,133 in 2015, an increase of 39% on-year This is based on data from the Centre for Asia Pacific (CAPA) and includes wide-body jets, narrow-body jets and regional jets According to Airbus, it received orders for 731 aircraft in 2016 and delivered a record 688 aircraft, resulting in a backlog of 6,874 aircraft (over US$1,000 billion at list prices) as of end-2016 Meanwhile, Boeing recorded 668 net orders in 2016 and delivered 748 aircraft, with a backlog of 5,715 aircraft As of 27 February 2017, the in-service global fleet has grown to 24,200 aircraft Breakdown of in-service fleet: February 27 2017: 24,200 (15,138 narrow-body; 5,274 wide-body; 3,788 regional jets) December 31 2016: 24,024 (15,026 narrow-body; 5,253 wide-body; 3,745 regional jets) Page 1
Asia Outlook Diagram 1: System-wide net profit of global commercial airlines (US$ billion): System-wide global commercial airlines (Net profit in US$ billions) 2008 2009 2010 2011 2012 2013 2014 2015 2016E 2017F Global -261-46 173 83 92 107 137 353 356 298 Regions North America -197-27 42 17 23 74 112 215 203 181 Europe 0-43 19 03 04 1 1 75 75 56 Asia Pacific -47 27 92 5 58 23 19 78 73 63 Middle East -03-06 09 1 1 03 04 11 09 03 Latin America -14 05 1 02-02 2 0-17 03 02 Africa -01-01 01 0-01 -05-08 -09-08 -08 Source: IATA Middle East and Asia Pacific to continue to lead growth but profitability varies widely Demand, as measured by RPKs, grew by 92% in 2016 in the Asia Pacific region, the highest among the three largest regions globally meanwhile demand in North America and Europe grew by 32% and 46% respectively Load factor was a firm 797% for Asia Pacific, improving 08 percentage points as capacity rose by a slower 81% The Middle East carriers had the strongest growth of all regions, improving by 112% on-year, maintaining its leading pace for the fifth year in a row Load factor for Middle Eastern carriers fell 16% to 747% as capacity rose by 135% Among major regions, the Middle East has, by far, the lowest average load factor and, while growth has been strong, the capacity addition has been even more aggressive We believe this suggests overcapacity in this region is fairly substantial and profitability could be under threat Notably, IATA projects profitability in the Middle East region to dip to just US$03 billion in 2017 on higher fuel prices While Asia Pacific s share of global RPKs is 35 times that of the Middle East region, its profitability is much higher at over 8 times (estimated) for 2016 and forecast at over 18 times for 2017 Airlines in the Asia Pacific region are expected to generate a net profit of $63 billion in 2017 (down from $73 billion in 2016) for a net margin of 29% China s domestic passenger market, which accounted for 87% of global RPKs in 2016, grew 117% in 2016, outstripping supply growth of 108% with load factor at 83% India s market saw phenomenal growth in 2016, with a 233% on-year increase in passenger demand, with capacity growing by a similar 214%, and load factor sustained at a high 838% Note that China s domestic market, based on 2016 industry figures, is around 67 times that of India s domestic market, and about 58% of the US domestic market Global aviation growth is expected to be centred in Asia IATA expects that global air passenger travel demand will grow at a compound annual growth rate (CAGR) of 48% from 2015 to 2035, led by strong growth in emerging economies, and backed by an expected global GDP CAGR of 29% over the same period Airbus posts similar growth expectations, projecting 45% CAGR from 2015 to 2035, with growth being led by the Asia Pacific region at 57% CAGR In particular, China is projected to grow very quickly and overtake the US to become the largest domestic aviation market by 2030 India is another market with huge long-term growth potential Robust long-term outlook for ASEAN airlines The ASEAN bloc posted the highest historical CAGR for the past eight years and is expected to outpace developed countries RPK figures in the next 20 years ASEAN airlines are on track to deliver significant improvement in earnings driven by both topline growth (favourable economic outlook and vibrant tourism demand) and lower jet fuel prices (a key operating cost for airlines) Rising affluence and doubling of the region s middle class population by 2020 will also drive the region s propensity to travel ASEAN is thus set to continue to be home to some of the busiest flight routes in the world; the region has a substantial number of entries in the list of top 50 routes in the world Page 2
Diagram 2: Southeast Asia Air Traffic Forecast into 2020 Source: Boeing Current Market Outlook 2015-2034, DBS Bank Short-term outlook for ASEAN airlines is a little cloudy Following substantially low fuel prices, earnings for ASEAN airlines reached a peak in 2016, and are projected to ease off in 2017, in line with IATA s forecasts for airline earnings globally Oil prices have moved substantially off the bottom seen in in the 2016 first quarter and, along with a less favourable supply-demand dynamic as carriers add new capacity, margins will be under pressure in 2017, leading to lower overall earnings for 2017 Page 3
Jan/2004 Jan/2005 Jan/2006 Jan/2007 Jan/2008 Jan/2009 Jan/2010 Jan/2011 Jan/2012 Jan/2013 Jan/2014 Jan/2015 Jan/2016 Jan/2017 US$/bbl Industry Outlook Key Industry Drivers and Trends 1 Jet fuel prices rebounding off 2016 lows Jet fuel prices have been fairly volatile in recent years The average jet fuel price fell by 21% on-year in 2016 to US$51 per barrel from US$65 per barrel in 2015, but has since rebounded to average US$66 per barrel in the first two months of 2017 The combination of lower fuel costs and lower fares from lower fuel costs stimulating travel demand helped airlines maintain strong earnings in 2016, but with oil prices having significantly rebounded off lows in early-2016, airline margins and profitability are expected to ease in 2017 DBS Research s assumption for jet fuel is around US$65 per barrel for the FOB Singapore spot in 2017 Diagram 3: Jet Fuel FOB Singapore 200 180 160 140 120 100 80 60 40 20 0 Daily Price 3-month average Source: ThomsonReuters, DBS Bank Hedging should help to offset some, but not all, of the higher fuel prices Carriers in ASEAN under DBS Research coverage have generally hedged at least one third of their fuel requirements at around US$60 per barrel to US$65 per barrel This should help to offset some of the higher cost of fuel but also leaves room for airlines to benefit should oil prices move lower Diagram 4: Jet fuel hedge, as forecast for 2017 fiscal year FY17F hedge % (inc planned) Approximate hedge price (US$/bbl) Asia 74% 60 AirAsia X 74% 60 AirAsia 74% 60 Bangkok Airways 38% 57 Cebu Air^ 41% 65 Garuda Indonesia Up to 50% - Singapore Airlines*^ 32% 65 Thai Airways 43% - * FY18F end-march ^includes hedges of Brent crude Source: Companies, DBS Bank, AllianceDBS 2 ASEAN Open Sky: Indonesia and Laos ratified the ASEAN Open Sky Policy, also known as the ASEAN Single Market, in May 2016, and this is expected to liberalise air travel and trade between member countries in ASEAN This current agreement allows carriers of ASEAN countries third, fourth and fifth freedom rights but is still not as liberal as Europe s open skies, which allows for seventh freedom rights In addition, the ASEAN Open Sky Policy also requires international airports to be fully opened up to other ASEAN countries, without restrictions on Page 4
frequency and capacity However, some countries such as Indonesia, Laos and the Philippines have all placed restrictions on access to some of their airports In the longer term, we expect to see further progress and development in the liberalisation of the sector in ASEAN discussions on liberalisation of ownership and control of carriers of ASEAN countries is scheduled to take place in 2016 to 2020 In October 2016, the European Union and ASEAN were set to start negotiations for a landmark aviation agreement (the first ever bloc-to-bloc agreement) that would further improve market access The ongoing liberalisation introduces more competition for all airlines operating in ASEAN while the longer term winners would be those with more substantial scale and capital 3 Rise of the middle class: The disposable income of Asia s growing middle class will also impact growth of air travel demand in the next decade The shift toward greater consumption, driven by an increasingly affluent population seeking to upgrade their living standards, will be bullish for services industries such as finance, aviation, hospitality and tourism A 2013 forecast by McKinsey indicates that at least 75% of urban consumers in China will earn between US$9,600 and US$37,000 annually by 2022 This is approximately a two- to eight-fold jump from current levels of disposable income per capita This trend is likely to increase individuals propensity to spend and consume, and air travel is one area that could benefit Outbound trips from China increased by 18% to 98 million in 2013 Morgan Stanley expects a CAGR of 135% in China s outbound tourism to 233 million in 2020 and 23% to 338 million in 2025 Chinese outbound travel has been fuelled mainly by a desire to shop, with a finding by IPSOS, a global research company, indicating that expenditure on shopping comprised 58% of total outbound expenditure in 2013 Vietnam is another country that has experienced a rise in per capita GDP from US$9803 in 1990 to US$1,910 in 2013 This has been accompanied by a boom in the middle and affluent classes in Vietnam, which is forecast to double in size between 2014 and 2020, or from 12 million to 33 million Indonesia and the Philippines are also fast approaching the income levels that the World Bank currently classifies as upper middle income (gross national income per capita of between US$4,126 and US$12,735) Diagram 5: ASEAN gross national income per capita (US$) Source: World Bank 4 Loosening visa restrictions: Complex, lengthy and costly visa application processes are a major hindrance in promoting intra-asia travel, discouraging potential visitors who are put off by the arduous requirements In recent years, positive steps have been taken by countries to relax visa restrictions and application processes for inbound visitors with the intention of boosting tourist and visitor numbers in their domestic economies: In 2014, Japan relaxed both multiple and single entry visa restrictions for Filipino, Vietnamese, and Indonesian visitors Page 5
From mid-2014, Vietnamese tourists to South Korea can enjoy a shorter wait of three days for visa applications instead of the previous seven-day wait In March 2015, Indonesia waived visa requirements for 30 countries including South Korea, Japan, China, and the US in a bid to encourage tourism in the country China and Australia inked a bilateral deal in January 2015, which allows more passenger flights from Beijing, Shanghai and Guangzhou All these point toward an increase in the number of travel destinations and a potential increase in length of stay in each country, acting as a shot in the arm for Asian passenger traffic numbers and air traffic growth in Asia Diagram 6: Propensity to Travel in ASEAN5 Markets (2015) Source: World Bank, CAPA, DBS Bank 5 LCCs dominate in ASEAN LCCs have been successful in stimulating demand for air travel by providing no-frills products and lower airfares to price-sensitive customers This has helped to boost tourism and hospitality-related sectors, which rely on air travel as an important distribution channel As such, the stance of governments toward LCCs is generally positive, and they have, in many cases, provided valuable support through arrangement of lending facilities, reduced import tariffs, less stringent regulations, building dedicated infrastructure for LCCs, providing subsidies, etc Over the past decade, LCCs in ASEAN have expanded rapidly on the back of air route liberalisation, with a phenomenal 215% CAGR in seat capacity According to the Centre for Asia Pacific (CAPA), the capacity share of LCCs has grown from 32% in 2007 to over 56% in 2015; nearly 20,000 flights in Southeast Asia are now operated by LCCs each week Diagram 7: LCCs market share in ASEAN Source: CAPA Page 6
Risks 1) Fleet overcapacity Based on Boeing s 2015 to 2035 market outlook, nearly 40,000 new airplanes are expected to be added globally between 2015 and 2035, with nearly 40% of demand coming from Asia If more capacity is added than demand requires, we will see downward pressure on yields and profitability Diagram 8: Growth of global fleet Source: Boeing, DBS 2) Airlines vulnerable to higher fuel prices While airlines globally are expected to record an eighth consecutive year of profit in 2017, net margins remain razor thin (41% forecast for 2017, and an estimated 51% in 2016) in the industry With fuel prices accounting for 15-40% of total operating costs (187% for the global average), it remains the single largest cost item for most airlines and higher fuel prices, thus, pose a real threat to the profitability of airlines 3) Insufficient airport infrastructure It is imperative that airport infrastructure in Asia grows in tandem with the expected rise in air traffic and travel activity in Asia However, development of airport infrastructure has not always kept pace with air travel growth Utilisation rates for various airports in major Asian cities have exceeded 100%, including Beijing, Jakarta, Hong Kong, Bangkok and Manila As a result, passengers face long queues for take-off and flight delays are now increasingly common In 2013, only 57% of flight departures in Asian airports were on schedule, which was significantly lower than North American and European airports with 79% and 73% of departures adhering to original timings The lengthy period of five to ten years from need recognition to implementation of runway and terminal projects represents a significant gestation period that can potentially harm the number of travellers in Asia 4) Restrictions on foreign ownership While ASEAN agreements provide for intra-regional ownership of airlines across member nations (ie AirAsia owning Thai AirAsia), each ASEAN country retains the right to deny approval to any carrier seeking to enter its domestic market The ASEAN timeline to commence discussions on liberalisation of ownership and control of carriers of ASEAN Member States, including the concept of an ASEAN Community Carrier, is scheduled to take place from 2016 to 2020 It is anticipated that many ASEAN countries will be unwilling to surrender even partial control over their flag carriers and other state-owned entities 5) Security and reputation Asian carriers lost passenger trust in 2015, a year where airplane disasters were concentrated in the region TransAsia Airways Flight 235, Malaysia Airlines MH370, Malaysia Airlines MH17, AirAsia Indonesia QZ8501 and the recent Trigana Air disaster in Papua According to a recent International Civil Organization report, a third of airplane accidents in the Asia Pacific region involved regulatory oversight while 27% were due to deficiencies in safety management These reputational risks are likely to affect consumers choice of carriers and destinations Page 7
References http://wwwiataorg/pressroom/pr/pages/2016-12-08-01aspx http://wwwiataorg/pressroom/pr/pages/2017-02-02-01aspx http://wwwiataorg/whatwedo/documents/economics/central-forecast-end-year-2016-tablespdf http://wwwiataorg/whatwedo/documents/economics/passenger-analysis-dec-2016pdf http://wwwdbscomsg/treasures/aics/templatedata/article/generic/data/en/gr/022017/170210_insights_asian_ aircraft_lessors_on_the_risexml http://wwwdbscomsg/treasures/aics/templatedata/article/generic/data/en/gr/072016/160720_insights_the_g reat_tourism_drivexml http://wwwdbscomsg/treasures/aics/templatedata/article/generic/data/en/gr/022017/170210_insights_flying _a_little_lowerxml http://wwwhfwcom/asean-liberalisation-open-skies-achieves-full-ratification-may-2016 Page 8
We Cover Air Asia AirAsia X Bhd Airports of Thailand Asia Bangkok Airways PCL Beijing Capital International Airport BOC Cebu Air China Aircraft Leasing China Oil Garuda Indonesia Malaysia Airports SIA Engineering Singapore Airlines ST Engineering Thai Airways Our In-House Expert Paul Yong paulyong@dbscom +65 6682 3712 Please note that DBS Bank Ltd may have research coverage in the companies mentioned in this industry report, that have been produced prior to or subsequent to its publication Please refer to the links below for the latest specific equity research reports published on below-mentioned companies and the accompanying disclaimer/disclosure of DBS interest in the companies mentioned in the respective reports Page 9
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