Saturday 22 February 2014

Turbulence in the skies — the options left for MAS

Malaysian Airline System Bhd’s (MAS) latest earnings results for the last quarter of 2013 underscore our previous opinion that simply boosting capacity and load factor without a concurrent — and huge — cut in operating costs would not be sufficient to turn the company around.

MAS reported a net loss of RM343 million in 4Q2013 and a cumulative loss of RM1.17 billion for the whole of 2013, compared with a net loss of RM432.6 million in the previous year.

This is despite the company raising the available seat kilometres (ASK) and revenue passenger kilometres (RPK) by 17% and 27% respectively. Its load factor also increased to 81% from 74.7%.

These statistics show that MAS flew more flights and passengers, and filled more of its seats. And yet, it lost money big time.

So, what needs to be done for MAS to break even?

We analysed its latest earnings results, ran the numbers and came up with three options, including one that is rather interesting, plausible and, most certainly, controversial.

Option 1: Boosting load factor to 96.7% on current capacity

For all our scenarios, we assumed a consistent 40:60 fixed-to-variable cost structure (excluding interest expense), and average yield based on total revenue per RPK for the sake of simplicity.

In the first scenario, we conclude that MAS can achieve breakeven at the pre-tax level if it boosts its load factor to 96.7% on its existing capacity (ASK) of 58,381 million seat kilometres.

Casting aside the practical impossibility for any airline to maintain such a high load factor, this scenario also requires that the average revenue or yield remains unchanged at 31.74 sen per RPK. This is highly doubtful.

Consider this — MAS’ yield fell from 36.87 sen per RPK in 2012 to 31.74 sen last year in order to lift its load factor from 74.7% to 81%. That is a load factor increase of 6.3%.

To raise the load factor further to 96.7% means another hefty increase of 15.7%. It is safe to say that to attract this many more customers, MAS would have to reduce its pricing. But as prices (yield) fall, even a load factor of 96.7% would not return the company to the black.

More importantly, AirAsia Bhd, one of MAS’ biggest competitors, has a much lower cost structure. Its operating cost per RPK is almost half that of MAS’ — about 17.5 sen compared with MAS’ 33.3 sen. Thus, even if MAS decides to reduce prices, AirAsia could well match it — and still come out ahead.

Option 2: Cut cost by RM1.1 billion

A more viable option is to cut cost. To be fair, MAS has been doing this over the past year, except that it was just not deep and fast enough to outpace the even steeper decline in yields. The average operating cost per RPK fell 12% while average yield fell an outsized 14% in 2013. In absolute terms, total operating costs rose by RM1.7 billion or 11.7%.

Based on last year’s earnings results, the company would need to shave off another RM1.1 billion in total operating cost (excluding interest expense) — equivalent to a roughly 7% reduction across the board — to break even.

While the figure does not appear too daunting, it should be noted that a good portion of its costs is beyond its control. This includes fuel costs, and handling and landing charges. Others such as depreciation and amortisation are, by and large, fixed. For those costs that are somewhat more flexible, we did a back-of-the- envelope calculation of the quantum of reduction required for one possible combination.

To save RM1.1 billion, MAS could cut staff and aircraft maintenance costs by an average of 11%, and commission and all other expenses by an average of 25%.

To say this is a tough task would be putting it mildly. The quantum of cost cutting required is certainly not impossible but the political will to execute and see through such a painful exercise is highly questionable. Indeed, this option has been articulated in the past but never fully implemented.

To be sure, there are many other possible permutations to lower costs. For the current year, MAS is focusing on increasing assets utilisation (reducing the aircraft downtime) and swapping older planes for more fuel-efficient ones. But these are longer-term solutions that would require time before any material impact is felt.

Another option would be to reduce net interest expense — which totalled RM323 million in 2013 — either by refinancing its loans at a lower rate or raising equity through another cash call. Both alternatives appear unlikely. Globally, interest rates are on the rise and MAS had just raised some RM3.1 billion in rights issue in July last year.

Option 3: Dumping the competition out of the skies

MAS’ latest results underscore the fact that boosting the load factor without any major new investments is not a solution.

Our calculations show that it would have to raise its load factor all the way to 96.7% just to break even. This is practically impossible and yields will keep falling anyway as competitors such as AirAsia have lower cost structures. Slashing cost deeply may work but if history is any guide, the political will to execute such a plan is weak.

This leaves us with one last possible scenario — dumping the competitors out of the skies, for good.

MAS could go on an expansion binge. Armed with the increased capacity, it could then move aggressively to capture market share by throwing prices. It would suffer greatly in the near term as losses would balloon — although the average cost will drop with expenses spread over a larger capacity, yields will fall even faster.

But it would outlast its competitors in the bloodshed because it is funded by cheap government money. After it has finished off its main competitors, the company would be free to raise prices again and start making money.

By any definition, this option will qualify as an anti-competitive practice subsidised by the government. But it is nonetheless, a plausible move.

Extreme measures in extreme circumstances, when all else have failed?

We can already hear Tony Fernandes screaming his head off!


  1. Nothing about employees productivity?

  2. It is very clear that MAS being an organisation in trouble financially, it is not in a position to adopt the growth strategy to expand its market share by dropping prices as it is neither the cost leader nor it is an operational excellence organisation.

    The sensible approach is to apply the retrenchment strategy to reduce to overall size of the operations to cut expenses with the goal of becoming a more financial stable business. MAS should downsize and use customer segmenting and targeting markets precisely and then tailoring offerings to match exactly the demands of those niches.
    However, being the national carrier clouted by political consideration, the irrational decision to throw good money after bad hoping to make a beneficial turnaround will be an uphill task especially when you carry excessive baggage.

    Running a commercial set-up with political obligations will run counter to the objective of creating value for shareholders. Air Asia will continue to under-perform if the current price war were to continue.

    I belief Tony and his team will survive and come back stronger.

  3. One would think Mas is another charity work .. Just like proton ..
    At one point it has quite a lot of cash under the previous CEO ,, this new CEO obviously needs to be fired for underperforming . I wonder under such huge losses does Mas still give bonus to the mgmt and staff which will basically tell them that it's ok to continue make losses. The biggest loser in this is khazanah nasional and epf which holds most of the shares. they shld restructure Mas , cut cost , compete in profitable routes , and look at their fuel hedging policies . If all else fail , then shld just try to find a buyer or white knight Or hand it over to syed mokthar as the gov always does

  4. Option 3 = tyranny. Surely you're not seriously advocating this, "extreme circumstances" notwithstanding...

    1. The option was included for completeness of analysis, rather than a recommendation. Clearly, using public funds to bully and crowd-out private sector is wrong.

  5. Air Asia has huge debt with CIMB and MAHB. If Air Asia goes down, CIMB and MAHB will also go down. That will be a big hit across the board and will be very bad for Malaysian economy. Will the government allow it?

    Option 4: Sell MAS to whoever. Basically UMNO will not be able to do that. Which PM will have the balls to do it? Unless is from PR.

  6. The one One Option to rescue MAS, hire SIA's CEO and give him full power and complete autonomy to run it!

  7. These commentators are either being facetious or have only a cursory knowledge of the airline industry.

    The travails of Qantas down under, and the hard-nosed attitude of Australian PM Tony Abbott, should be an object lesson to those calling for yet another bail out, using public funds, of MAS.

    How silly is this?