Asian Airlines Take Bumpy Ride to Rehabilitation

Business World
Wednesday, December 16, 1998

Focus (First of Three Parts)
By PATRISHA JOAN F. DE LEON

Reporter

To say it has been a difficult year for the Asian airline industry is not as simple as it seems.

The experience of national flag carrier Philippine Airlines, Inc. (PAL) — Asia's oldest airline — has shown the worst-case scenario for the region's carriers which struggled with the financial crisis.

But even as the airlines claim 1998 was their "toughest year ever," their passenger and revenue figures send mixed signals on the real situation.

Based on figures from the Association of Asia-Pacific Airlines (AAPA) – grouping 19 carriers based in the region – total passenger traffic for both international and domestic operations continued to grow in the 1997-98 fiscal year (October to September), but profitability suffered.

As of last September, AAPA said the total number of passengers its members carried rose to 215 million from 191 million in 1996-97, a 12.6% year-on-year growth.

Despite this, AAPA figures also show combined passenger revenue of members for the 1997-98 fiscal year slipped 4.5% to only $37.869 billion from $39.670 billion a year ago.

In fact, the airline organization reported that the consolidated net income of its members plummeted by as much as 175.6%, or a net loss of $843.81 million from last year's net income of $1.116 billion.

Based on the 1997-98 AAPA income statement, the steep drop in the Asian airline industry's profitability was largely due to the $2.674-billion "other expense" item deducted from the carriers' $2.187-billion operating profit.

Industry sources said these usually represent taxes; however, they said it may also include indirect costs such as "perks" given to executives and employees.

Business World computations show these expenses resulted in an industry loss of $487 million, while taxes paid during the fiscal year was lower at $357 million.

In an interview, AAPA Director-General Richard Stirland told Business World an airline's present state is determined, to some degree, by its "history."

In the case of Asian airlines, the rapid growth of passenger traffic in the mid-‘90s set up the industry's fall when the financial crisis hit.

Mr. Stirland said the "phenomenal” growth in traffic during the pre-crisis years impressed both the International Air Transport Association (IATA) and aircraft manufacturers to a point where they predicted that by 2010, more than 50% of the world's air traffic will come front the region.

He said this assessment was attributed mainly to the growth of the middle class in such countries as Indonesia, Malaysia, Korea and Taiwan.

AAPA officials said the increase in passenger traffic reflected the significant growth in the gross domestic product (GDP) of host countries. Based on the Asian Development Outlook report of the Asian Development Bank (ADB), the 1996 GDP growth for Southeast Asia stood at 7.1%.

Mr. Stirland said increased spending on "discretionary expenditures” saw more Asians choosing to travel by air, adding the seemingly unstoppable pre-crisis economic boom also gave way to a boom in business travel.

Another factor, said Mr. Stirland, was the recent liberalization of “outbound travel," particularly for Taiwanese and Korean nationals who were previously required to secure government permits before crossing international borders.

Mr. Stirland noted the industry's growth was further sustained in the second half of the ‘90s by the rise in domestic and regional tourism as more Asians opted to explore neighboring countries.

He said banks and other financial entities had then built up confidence in the Asian economic miracle that they “misdirected” their investments into supposedly lucrative ventures. "People were prepared to lend money without evaluating precisely what it was getting into."

He added it took time for investors to realize their losses due to the lack of transparency in most Asian businesses.

CRISIS

The Asian crunch was first felt in the middle of 1997, but it was not until yearend that its full impact was realized. By end 1997, the ADB had pegged GDP growth in Southeast Asia at only 3.9%, almost half of the 1996 performance.

But newly industrialized countries (NICs) Hong Kong, South Korea, Singapore and Taipei were able to contain the damage as combined GDP growth fell only a percentage point to 6%.

Just the same, the ADB estimated that by yearend, GDP growth among the NICs will significantly slow to 2.2%, while GDP in Southeast Asia is expected to contract by 0.4%.

Mr. Stirland said the crisis resulted in lower revenues for several Asian airlines mainly due to the devaluation in their local currencies.

With Asian passengers paying fares in their respective local currencies, he said airline yields dropped considerably when these payments were converted into US dollars. This, he said, explains the dramatic 175.6% drop in profitability.

Like PAL, the AAPA said most members have had to freeze or reduce employee pay, and retrench managerial and shop-floor staff.

Among those who laid off workers was Cathay Pacific Airways Ltd., which earlier retrenched 800 employees worldwide as a cost-cutting measure.

Last June 30, Cathay posted a HK$175-million “interim loss" the first time in 20 years. During the year, Cathay also closed down its Sapporo route in Japan to reduce its frequencies.

Mr. Stirland said Cathay's financial woes were due mainly to the sharp rise in its costs which were mostly US or Hong Kong-dollar denominated.

With revenue yields from regional operations declining due to the currency devaluation, Cathay found itself in a tight spot as the Hong Kong dollar maintained its strength.

At the same time, Hong Kong tourism also suffered late last year as it posted a 60% drop in Japanese traffic amid news that hotels in the former British colony were overcharging Japanese nationals. But even as Cathay struggled with its finances, it was able to keep its 62-aircraft fleet intact.

Such was not the case for Indonesian flag carrier Garuda Indonesia, which saw its fleet expansion plans go awry due to political problems and a virtual "collapse" in the local economy.

With a projected net loss of $40 million by yearend, Garuda announced last August it was laying off "several thousand workers" from its 13.000-strong work force.

Mr. Stirland said the Indonesian government's stake in Garuda later proved as its saving grace, particularly in settling a $200-million foreign debt. If it wasn't a government airline, it might have gone out of business by now."

However, government support may not last as the Indonesian government announced last October it will sell its stake in the airline by 2000. Garuda is undergoing a restructuring program with a leaner fleet of 45 aircraft, from the original 57 planes, by next year.

The AAPA said a number of its members have either deferred or cancelled their aircraft orders, while others sold their planes to co-members. The airline organization said Australia-based Qantas Airways bought at least two aircraft from its "less fortunate" AAPA colleagues who reduced their fleets.

By end-September, the AAPA reported major aircraft manufacturer Boeing Co. had 34 aircraft in storage — majority of which were ordered by Asian carriers. Meanwhile, competitor Airbus Industrie had taken back a number of Airbus A-330s and A-340s "from the two worst-affected carriers" – one of which was PAL.

RESTRUCTURING

Apart from reducing capacity, the AAPA said several members had undergone route restructuring programs.

Korean carriers Asiana Airlines and Korean Air both discontinued their Seoul-Europe and Guam-Saipan passenger services. Asiana laid off a number of its Korea-based and offshore staff and implemented a compulsory two-month unpaid leave for its staff.

Even other Asian carriers considered to be least hit by the crisis, such as Ansett Australia, Air New Zealand and Qantas, also underwent route restructuring. The AAPA said all three dropped flights to Korea at a short notice.

Mr. Stirland said since regional airlines grew at a rapid pace, they also saw their unit cost, or cost per available ton kilometer, significantly drop.

"It's very easy when you expand an airline ... like any business, the bigger you get tends to drive down your unit costs because some of ... (these) remain constant no matter how big or how small the operation is," he said

Mr. Stirland said the common mistake was while these airlines were posting lower costs, only a few bothered to increase their savings. “When the airline contracts and gets smaller, then obviously the unit costs shoot up. And then, you will really have to make a big effort to cut the costs and increase productivity."

He said each airline has varying ways to deal with the crisis. He said the industry's problems were not caused by overexpansion or mismanagement, rather it was a simple case of bad economic fundamentals.

Mr. Stirland said the consistent growth in passenger traffic could be the starting point to recovery for the crisis-hit carriers. “Any economic downturn would affect the airlines ... (But) the traffic, in many respects, is still there ... It's not really a question of getting back the traffic or increasing the frequencies again or capacities. It’s really a question of taking measures which will increase the (airline's) profitability.

But with most countries in the region expecting negative GDP trends for 1998 and 1999, he said regional carriers will be "hesitant" to project substantial growth until passenger load and revenue yield "promise profitable expansion.”

If there is any lesson at all, Mr. Stirland said: “Some will most certainly be leaner and fitter after this (crisis), and probably more cautious in the future – and more aware of the limitations to growth."