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Vietnam: sowing the seeds for future growth

THE VIETNAMESE MARKET IS POISED FOR TRANSFORMATION and growth as pressure mounts for a more liberal operating environment. The upcoming launch of new low-cost carrier VietJet Air, expansion at Jetstar’s Vietnamese affiliate, the planned initial public offering (IPO) at flag carrier Vietnam Airlines and the anticipated entrance of Emirates will transform Vietnam’s aviation market. The result will be a period of incredible growth and the emergence of a market that is significantly closer to the rest of Southeast Asia.

Vietnam is now lagging behind the other five major members of ASEAN – Indonesia, Malaysia, the Philippines, Thailand and Singapore – in just about every aviation category. Among these six countries, Vietnam has the smallest aviation market in terms of fleet size and capacity, although it has the third largest population. It has the lowest penetration rates for LCCs and Middle Eastern carriers – two sectors which have played a critical role in driving recent growth across most of the region. Among the six major flag carriers of ASEAN, Vietnam Airlines is also the only flag carrier to remain entirely government-owned and is the only one to not yet establish a second budget brand.

 

All of this is about to change. Vietnam Airlines is preparing for an IPO, which is likely to take place in 2012 and serve as an impetus to liberalisation that will benefit all of the country’s carriers. Vietnam Airlines is also planning to launch by 2014 an LCC subsidiary or unit, although such plans could be scrapped if Vietnam Airlines takes over the Government’s stake in Jetstar Pacific.

Jetstar and VietJet are betting Vietnam is about to become sufficiently liberalised to support rapid LCC growth. IATA expects Vietnam over the first half of the current decade will be the world’s second fastest growing market after China, with 11% p/a domestic growth and 10% p/a international growth. These projections could prove to be conservative if the LCC sector truly takes off, stimulating rapid growth through lower fares. Even with a relatively limited LCC presence, Vietnam’s market was able to grow by about 20% in 2010 to 21 million passengers.

VietJet, which is moving forward with plans to launch services in Dec-2011 despite AirAsia’s Oct-2011 decision to pull out of a planned joint venture with the new carrier, is particularly bullish. By early next year, VietJet plans to have a fleet of five A320s operating both domestic and international routes. By the end of 2014, the carrier expects to have a fleet of 15 A320s and capture about 20% of the domestic market. Subsequent growth of five additional aircraft per year is envisioned.

VietJet plans to follow the same pure no-frills LCC model as Vietnam’s first and only existing LCC, Jetstar Pacific. But VietJet is confident it will be able to pursue faster expansion than Jetstar because it is 100% privately owned. VietJet believes having government ownership can be a barrier to pursuing rapid growth because any expansion proposal at a government-owned company, including new routes or aircraft, must go through a lengthy approval process.

Jetstar’s expansion in Vietnam has been painfully slow since the Australia-based group acquired in 2007 a 27% stake (later increased to 30%) in the country’s smaller government-owned carrier, Pacific Airlines, helping it adopt the low-cost model. Jetstar initially expected rapid expansion for its new Vietnamese affiliate, which at the time was only operating four B737s, in both the domestic and international markets as well as a quick transition to new A320s. But Jetstar Pacific instead pulled out of the international market and has since been only operating domestically. The carrier has also been slow in expanding and renewing its fleet, which now consists of five ageing B737-400s along with only two A320s, and has yet to turn a profit.

Expansion was put on hold in 2009 due primarily to difficult economic conditions as the devaluation of the Vietnamese dong cut into discretionary incomes and impacted demand at the lower end of the market. Jetstar Pacific’s expansion also stopped in early 2010 as the Government conducted an investigation into the carrier’s fuel hedging losses. During Jetstar Pacific’s periods of stagnation, Vietnam Airlines continued to expand rapidly. As a result, Jetstar Pacific’s share of the Vietnamese domestic market – and therefore the overall LCC penetration rate – dropped from 24% in 2008 to only 19% in 2010. Jetstar Pacific’s market share has slipped even further this year, reaching only 16% based on capacity figures for Nov-2011.

Vietnam Airlines continues to expand at a faster rate than Jetstar Pacific. A new full service regional airline, Air Mekong, also entered the domestic market in Oct-2010 and now accounts for 7% of domestic capacity in Vietnam, taking away market share from both Jetstar Pacific and Vietnam Airlines.

 

But confident of better market conditions ahead and encouraged by the Government’s recent decision to de-regulate the fare cap, Jetstar Pacific is now finally planning to accelerate expansion. Its latest fleet plan envisions the phasing out of the B737-400s and operating 10 A320s by the end of 2013. However, this still represents a much slower rate of expansion than Jetstar’s Singapore-based subsidiary and VietJet, which could quickly overtake Jetstar Pacific as the largest Vietnamese LCC.

VietJet was also impacted by the difficult economic conditions of late last decade, deciding to put on ice plans to initially launch in 2008. But like Jetstar, VietJet’s majority owner, Sovico Holdings, is confident the conditions are now ripe for the Vietnamese market to fully embrace the LCC model.

LCC growth far from assured

Vietnam’s Government needs to take additional steps to remove onerous fare regulations and caps which have so far made it difficult for LCCs to grow and compete against Vietnam Airlines. Airport expansion projects need to be accelerated to ensure there is sufficient infrastructure to support the growth. Budget carriers would particularly benefit from a proposed LCC terminal at Ho Chi Minh, which is the hub for Jetstar Pacific and VietJet.

VietJet’s multiple attempts to secure government approval to use the AirAsia brand failed, prompting AirAsia to pull out of the project and its planned 30% investment in the venture. VietJet is confident it can succeed without the AirAsia brand, believing the VietJet brand can gain traction in the Vietnamese market. However, clearly the powerful AirAsia brand and website would have helped VietJet, particularly on international routes. The Malaysia-based AirAsia Group is the largest foreign airline group serving Vietnam, with a 5% share of Vietnam’s international market. AirAsia’s success in establishing affiliates in two other ASEAN countries, Indonesia and Thailand, illustrates the benefits a pan-Asian brand can bring in the international market. But the success of other LCCs in the Indonesian and Thai domestic markets also shows local LCC brands can thrive at least domestically.

The Vietnamese Government also previously suggested Jetstar Pacific would need to adopt a more local brand. So far, Jetstar has been able to keep its branding in Vietnam – a point VietJet is likely to bring up as it is forced to compete against Jetstar without the AirAsia brand. The Government needs to ensure an equal playing field between public, semi-private and fully private carriers and be more open to adopting the looser regulations of its neighbours when it comes to cross-border ventures. Following other ASEAN countries in allowing the use of foreign airline brands would ensure the success of Vietnam’s LCC industry. Jetstar Pacific needs to continue using the Jetstar brand to succeed, particularly as it looks to expand in the international market, and VietJet should have the freedom to similarly adopt a new brand after it launches – potentially the AirAsia brand under a resumed partnership or the brand of another Asian LCC.

LCCs have already helped drive economic growth and boost tourism numbers in Vietnam. But so far the impact has primarily been limited to regional international routes within ASEAN operated by non-Vietnamese LCCs. LCC penetration figures on international routes linking Vietnam with other ASEAN countries are now significantly higher than Vietnam’s domestic LCC penetration rate.

LCC carriers have even driven down fares between Ho Chi Minh and Singapore, Vietnam’s largest international route, to a point that they are typically below fares between Ho Chi Minh and Hanoi. Ho Chi Minh is now among the top three destinations for Singapore’s LCCs, Tiger Airways and Jetstar Asia, which combined operate seven daily flights on the route and account for more than half of total capacity between the two cities. This provides a taste of the impact LCCs can have in Vietnam if given the opportunity to compete in more markets.

Four foreign LCC groups now serve Vietnam – AirAsia, Jetstar, Tiger and Cebu Pacific. Combined they account for 14% of total international capacity. But there are currently only 11 international routes in Vietnam with LCC service and 10 of these are within Southeast Asia, showing LCCs in Vietnam have barely scratched the surface.

 

North Asia is not yet at all linked with Vietnam by LCCs. The Vietnam to China, Taiwan, South Korea and Japan markets all have huge LCC potential. Vietnam’s central geographic location in Asia makes it ideal for LCC services as almost all of the region’s destinations are within narrowbody range.

The Vietnam-China market is particularly promising. There are only 24,000 round-trip seats per week provided in the Vietnam-China market. The Vietnam-Singapore market has twice as many seats and even Vietnam-Taiwan has 25% more seats than Vietnam-China. Low fares are key to unlocking the tremendous growth potential of the Vietnam-China market as it would stimulate demand from China’s growing middle class, which is increasingly starting to take their holidays overseas. Vietnam is extremely well positioned to take advantage of the expected boom in the outbound China tourist market given its proximity to China, the appeal of its tourist destinations and the low cost of holidaying in the country.

China is in VietJet’s radar as it plans to begin international services within a few months of launching domestic operations. The carrier is now analysing several potential international routes, focusing on greater China and Singapore.

The China market was also a driver in Vietnam Airlines’ recent decision to start preparations for its own budget brand. Vietnam Airlines now serves four destinations in mainland China but believes it needs a budget product to tap the market’s tremendous growth potential, particularly secondary cities where there is little business demand. This second budget brand could end up being Jetstar Pacific if the Government decides to transfer its 70% stake in Jetstar Pacific to Vietnam Airlines. Such a move is under consideration and would improve Vietnam Airlines’ position ahead of its IPO.

Jetstar Pacific has already been looking at the greater China market as it plans to resume international services, potentially next year. The carrier aims to leverage the existing infrastructure of sister Jetstar Asia, which will be serving 12 airports in greater China by the end of this year. Jetstar Pacific could allocate a large portion of its additional capacity to the international market, with China the most likely first destination when it resumes international flights.

Jetstar Pacific currently only serves six domestic routes, compared with nearly 40 domestic routes for Vietnam Airlines and more than 10 for Air Mekong. Air Mekong is the only entirely privately owned carrier in Vietnam, with a 30% stake held by US regional SkyWest Airlines. SkyWest is providing Air Mekong with its initial fleet of four CRJ900s, pilots and some management personnel primarily in the areas of flight operations and maintenance.

While Air Mekong has focused primarily on regional routes, including a couple of routes not operated by Vietnam Airlines, about 80% of Jetstar Pacific’s capacity is now allocated to the country’s three main trunk routes. But the LCC penetration rates on these routes are still much lower than similarly sized domestic routes in other Southeast Asian countries. Confident Vietnam’s domestic trunk routes can absorb more LCC capacity, VietJet is planning to initially focus on the Ho Chi Minh-Danang-Hanoi corridor. Greater LCC capacity should stimulate demand and result in more Vietnamese trading in long bus and train journeys for airplanes when travelling between the country’s three main cities.

Train travel in Vietnam is very slow and will not speed up anytime soon, as Vietnam has delayed any consideration of high-speed rail. Hanoi-Ho Chi Minh is a particularly gruelling bus or train journey, now taking more than 24 hours to cross the 1100km between Vietnam’s two main cities. The Hanoi-Ho Chi Minh route is already the third largest route in Southeast Asia and the 14th largest globally, just behind Los Angeles-San Francisco. The prospect of more low-fare seats and the rapid commercial development now taking place in both cities should make this route even bigger. An expanding middle class will also help support the expected boom in domestic LCC traffic.

The prospect of three LCCs may seem too much for a domestic market which last year consisted of only about 10 million passengers, but is reasonable when considering the rapid economic growth in the country and the relative small size of its LCC sector thus far. Without a major LCC presence, domestic capacity in Vietnam has more than doubled since 2007, reaching almost 13 million seats last year. With more LCCs and a supportive government, even faster growth is feasible.

A market consisting of three LCCs, a legacy carrier and a regional carrier is also reasonable when considering other Southeast Asian markets. In the similarly sized Philippines there are already three LCCs in the domestic market with two more about to launch. Major international routes in the region such as Singapore-Bangkok now also support three LCCs.

Vietnam’s carriers are also guaranteed there will not be any new start-ups to contend with as the Vietnamese Government has promised it will not approve any new airline applications until at least 2015. The Government is keen to prevent the market from over-heating but is eager to have a manageable increase in LCC capacity as it will help the country’s overall economy and tourism industry.

The only potential new entrant besides VietJet is Indochina Airlines, which has an existing licence but has not operated since suspending services in late 2009. Indochina was a privately owned full service carrier which operated wet-leased B737-800s on the three main domestic routes for one year before shutting down. Indochina Airlines has been looking at re-launching and adopting an LCC model. Its prospects for returning to the market seem unlikely, but a Vietnam Airlines-Jetstar Pacific tie-up could provide an opportunity. Under that scenario a re-launched Indochina would be Vietnam’s third LCC rather than a less feasible fourth LCC.

VietJet and Jetstar Pacific are not concerned about over-capacity or the prospect of too many LCCs. “Competition is common and we’re ready for that,” VietJet deputy general manager Nguyen Duc Tam told Airline Leader. “I think it’s a huge market. The market is there.”

Jetstar Group CEO Bruce Buchanan told Airline Leader that Vietnam “is a rapidly growing market” with “very strong, bright prospects” and should be able to absorb additional capacity as the country’s middle class expands. “There’s a great opportunity there but it’s a long road,” Mr Buchanan warns. “The Vietnamese market is tightly controlled. It’s not an easy market to succeed in. It’s taken a number of years to get our business to where we are now.”

Vietnam is in a position for massive LCC growth in domestic and regional international markets. Vietnam’s long-haul market is also incredibly underserved, with big prospects for additional capacity from both Vietnam Airlines and other flag carriers.

Over 40 foreign carriers now serve Vietnam, but only seven are from outside Asia Pacific. These seven carriers combined operate 38 weekly frequencies, including only 14 non-stop flights (the other 24 frequencies make stops in larger Asian hubs before reaching their final destinations in Europe, the Middle East and North America).

Vietnam market underserved by Gulf carriers

Vietnam is the only major ASEAN country not served by all three Gulf carriers. Only Qatar Airways serves Vietnam, providing less than 10,000 seats per week. In comparison, the three Gulf carriers combined now operate about 30,000 seats per week to the Philippines and about 70,000 seats per week to Thailand.

 

Emirates, however, is expected to finally launch services to Ho Chi Minh and Hanoi over the next couple of years. UAE-based carriers were unable to serve Vietnam until earlier this year, when the UAE and Vietnam signed their first bilateral agreement. Etihad may also eventually launch flights to Vietnam, although for now the Abu Dhabi-based carrier has decided instead to take advantage of the new bilateral by forging a codeshare with Vietnam Airlines using Bangkok as an intermediary point.

While Emirates would be a boon for Vietnam’s tourist industry, it would also represent new competition for Vietnam Airlines and other Asian carriers that now serve the Vietnam-Europe market on a one-stop basis. Vietnam Airlines only serves three destinations outside Asia Pacific: Frankfurt, Moscow and Paris. But the carrier is launching services to London Gatwick in Dec-2011 and has ambitions to enhance its long-haul network over the medium to long term.

US flights have also been on the drawing board for several years but have been repeatedly pushed back. Vietnam Airlines recently decided against moving forward with earlier plans to begin trans-Pacific flights in 2012 as it focuses next year on resolving internal issues, including a pilot shortage. The SkyTeam carrier, which has been profitable for several consecutive years, is also focusing on an IPO that could lead to a new phase of growth.

Proceeds from the IPO will likely be used to help fund expansion of Vietnam Airlines’ fleet and network. The carrier operates 67 aircraft and already has another 59 on order, including 10 A350s and 16 B787s which have encountered serious delivery delays but will eventually be used to pursue expansion of the long-haul network. Additional orders are likely, with the A380 included, as Vietnam Airlines envisions a fleet of 170 aircraft by 2020.

While competition will intensify, the Vietnamese market can clearly support a significantly larger flag carrier. Vietnam Airlines is small compared with its Southeast Asian rivals and relies almost entirely on local traffic. It will certainly benefit as tourism and the Vietnamese economy continues to grow rapidly.

The prospect of eventually developing Ho Chi Minh into a transit hub could further accelerate Vietnam Airlines’ growth. Ho Chi Minh’s Tan Son Nhat Airport, which opened a new international terminal in 2007, is approaching capacity. Congestion is likely to become a serious problem over the next few years. But plans have been approved for a new airport, which is slated to open in 2020 with initial capacity for 25 million passengers. Long Thanh International Airport is designed to eventually feature four runways and accommodate up to 100 million passengers p/a, making it a major hub and allowing Vietnam Airlines to be a big player in transit traffic as well as keep up with the anticipated massive local growth.

The ingredients are all in place for Vietnam to emerge as the next major Asian aviation market. Liberalisation has been painfully slow but there are indications the Government is moving in the right direction. There is always a risk that conditions could worsen and the Government could take a step backwards. But over time the market will almost certainly open up and the result should be a thriving flag carrier with a second budget brand, along with independent LCCs stimulating demand and bringing unquantifiable economic benefits to an increasingly important emerging market.

Protectionism is no longer an option. The IPO at Vietnam Airlines should lead to more liberal and less protective policies, which are needed for Vietnam’s promising aviation market to reach the level of its Asian peers.

 

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