Winter 2012

x x x Aviation Primer

A guide to navigating Asia’s increasingly busy skies

Important disclosures, including any required research certifications, are provided on the last two pages of this report. Aviation Primer Winter 2012

Table of contents

Introduction 1

I Getting off the ground 3

II Choosing the right places 15

III Assessing aircraft options 23

IV Money matters: buy or lease? 49

V Devising the right sales strategy 57

VI Plane spotting: future trends in Asia 69

VII Picking the winners 83

VIII How to score an upgrade 91

Appendix 95

Aviation Primer Winter 2012

Contributing Daiwa Analysts Summary

The battle over Asia’s skies is intensifying. As GDP and disposable income rise in countries around the region, more people are getting the opportunity to fly. Tapping into the demand are the full-service , low-cost carriers, and niche players.

We look behind the ‘glamour’ of the industry to see what makes it tick. How important is it for an to be linked to a global distribution system, what Kelvin Lau (852) 2848 4467 strategies are working best in the various markets of Asia, and which aircraft [email protected] is right for a particular route? These are questions all airlines face, from established flag carriers to fledgling low-cost carriers.

In the Aviation Primer, we look at the factors that airlines need to consider when operating their fleets and expanding their networks. It’s a constant balancing act, but we trust that the insights provided will put investors on the right flight path in terms of investing in the industry.

I would like to thank Paul Sheridan of Ascend for his invaluable contribution on aviation-industry financing, and Daiwa’s aviation analyst, Hitotsuyanagi Hajime Hitotsuyanagi Hajime, for his insights into the sector. (81) 3 5555 7025 [email protected] Kelvin Lau Senior Analyst, Aviation

Paul Sheridan is the head of consultancy for Asia at Ascend. He joined the

company in January 2010 after 10 years of working in the aviation industry.

Guest Author Ascend, a Flightglobal advisory service, is a leading provider of expert advisory and valuations services to the industry. It provides specialist, independent services that inform and shape the strategies of aviation businesses worldwide, helping them to compete successfully in today’s global market. Companies large and small rely on Ascend to take their business to the next . Ascend’s aviation expertise and experience is backed by unique access to robust industry data. Paul Sheridan, Head of Consultancy Asia, Ascend Ascend offers an unrivalled breadth and depth of aviation expertise and experience, backed by unique access to robust industry data. It provides an impartial yet informed perspective to help organisations direct and manage their investments to deliver the very best returns. As part of Flightglobal,

Ascend can also offer a single point of access to the industry’s most trusted news, data and analytics services.

Paul Sheridan is an independent contributor as part of Daiwa's guest author programme, which is separate from the firm's normal research coverage. The views expressed by the guest author herein represent the opinions of the author only, and do not necessarily reflect the opinions of Daiwa, the other authors of this report, or the author’s employer.

- 1 - Aviation Primer Winter 2012

Introduction

The aviation industry is a highly volatile one, with many airlines globally struggling to make a profit. In Asia, where the industry started later than in the US and Europe, the operating environment is better, resulting in the airlines there achieving a better net-profit margin over the past five years than many big players in the US and Europe. We believe airlines in Asia have learned some lessons from the US and Europe, and have also benefited from the fast-growing economies in the region. We consider Asian airlines, albeit with their smaller fleet sizes, to be much more attractive investments than their US and European peers.

In the future, we expect the major divergences to persist within the industry, with the low-cost carriers (LCCs) focusing on the low-end market, and the premium carriers (full service carriers [FSCs]) that target business travellers focused on the high-end market. But, several new issues for the industry are set to emerge in Asia over the next decade, including ‘open skies’ in ASEAN, the Emission Trading Scheme (ETS) of the EU, the development of biofuels, all of which are likely to play a key role in changing the competitive landscape.

As this traditionally capital-intensive industry is highly cyclical with low net-profit margins, every decision is crucial to profitability. In addition, there are numerous external factors, such as economic growth, government regulation, the industry cycle, and jet-fuel price movements that affect financial results.

Airlines globally ranked in terms of net-profit margin (2011) Rank Country Company Bloomberg code Net profit margin (%) Net profit (US$m) ROE (%) 1 Japan Japan Airlines 9201 JP 15.5 2,360 63.6* 2 Ireland Ryanair Holdings RYA ID 12.8 780 17.9 3 AirAsia AIRA MK 12.4 182 14.5 4 Philippines Cebu Air CEB PM 10.7 84 19.6 5 600221 CH 10.3 407 19.5 6 Russia Russian Airlines AFLT RM 9.8 525 40.1 7 Japan Skymark 9204 JP 9.6 97 25.6 8 China 753 HK 6.7 1,096 16.2 9 UK Easyjet PLC EZJ LN 6.5 361 14.0 9 Chile Latam Airlines LAN CI 5.7 361 23.4 10 US Alaska Air Group ALK US 5.7 245 21.5 Source: Bloomberg. Note: Only listed companies included.*Japan Airlines was listed on 19 September 2012

World’s largest airlines in terms of fleet size (2011) Rank Country Airline Fleet size Orders Total 1 US United 1,256 270 1526 2 US 898 177 1075 3 US 775 127 902 4 US SkyWest 720 n.a n.a 5 US 698 342 1040 6 696 356 1052 7 and -KLM 586 182 768 8 China 444 256 700 9 China Air China 432 219 651 10 China 377 282 659 Source: , Boeing, companies

World’s largest airlines by market capitalisation Rank Country Company Bloomberg code Market cap (US$m) 1 Chile LATAM Airlines Group LAN CI 11,690 2 SIA SP 10,024 3 China Air China 753 HK 9,807 4 Ireland Ryanair Holdings RYA ID 8,890 5 Japan Japan Airlines 9201 JP 8,722 06 US Delta Air Lines DAL US 8,309 7 Japan 9202 JP 7,336 8 Germany Deutsche Lufthansa LHA GR 7,160 9 Cathay Pacifc 293 HK 7,127 10 US United Continental Holdings UAL US 6,732 Source: Bloomberg. Note: Only listed companies included

- 2 - Aviation Primer Winter 2012

- 3 - Aviation Primer Winter 2012

Preparing for take-off

Overview

The growth of an airline is highly dependent on numerous external factors, such as economic growth, population, income levels, and industry-specific factors, including competition and the regulatory environment. Even though many airlines’ founders prefer to set up their airline in their home country due to their greater familiarity with local market conditions, understanding these external factors enables them to assess future risks and opportunities.

Economic growth

According to our regression analysis, traffic growth (as represented by revenue passenger kilometres [RPKs]) is highly related to economic growth. We estimate that every 1% increase in GDP annually leads to a 1.5-2.0% YoY rise in traffic growth. For example, air-traffic growth rates in China and Japan are very different, reflecting the differing levels of economic growth. For 1992-2011, GDP increased at CAGRs of 10% in China and was flat in Japan. This could explain why the CAGR in RPK in China was 15% over the period, while in Japan it was only 1.2%. A new airline being set up in a market with mature economic growth is likely to find it hard to expand, especially as there will be competition from incumbent carriers.

China: GDP growth vs. RPK growth Japan: GDP growth vs. RPK growth (YoY % ) (YoY % ) (YoY % ) (YoY % )

16 50 10 15 14 8 40 10 6 12 30 10 4 5 20 2 8 0 10 0 6 (2) (5) 0 4 (4) (10) 2 (10) (6) 0 (20) (8) (15) 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

GDP (LHS) RPK (RHS) GDP (LHS) RPK (RHS) Source: CEIC, CAAC Source: CEIC

Domestic competition

Almost every country in Asia has a national carrier backed by the government. The national carrier often has a long history and sometimes receives preferential treatment from the government. As a result, the level of dominance of the national carrier in a country will determine whether or not there is room for competitors to survive. Some countries restrict traffic rights in order to avoid competition among domestic carriers on a particular route. When that is the case, new entrants may be forced to fly on secondary routes where traffic demand is weak. It is only when the aviation market is deregulated (ie, allows new entrants) and the incumbent carrier (mostly state-owned) is inefficient that there is more room for new players.

- 4 - Aviation Primer Winter 2012

National carriers and their respective domestic market shares Country Airlines Market share (%) 87 30 China Air China 22 France Air France 56 Germany Lufthansa 53 Hong Kong 53 India 23 36 20 Japan Japan Airlines 37 Malaysia 53 Netherlands KLM 47 New Zealand 79 Philippines 48 Singapore Singapore Airlines 40 54 29 89 United Arab Emirates 65 UK 11 66 Source: Government Statistics Bureaux, various media

Population and income

The size and distribution of the population of an airline’s base country naturally affects potential demand. For example, as Singapore has a small population of about 5.2m, the country needs to develop fifth- and sixth-freedom rights (see pages 20-21) aggressively in other countries to remain a major player in the industry. This partly explains why start-up airlines in , where the population is just 500,000-600,000, have failed. One example of this was Viva Macau, which went bankrupt less than five years after being set up, in 2006.

Disposable income and a population’s willingness to travel is reflected in per-capita income and the demographics of a city or nearby area. A high per-capita income level means a high affordability level. In addition, a country with a large population in the 30-50 age range would tend to feature a large number of people with a strong desire to travel, as this age group also generally has a of disposable income.

Asia: population and growth rates (persons m) Australia China Hong Kong India Indonesia Japan Korea Malaysia Philippines Singapore Taiwan Thailand 2005 20 1,304 7 1,140 227 128 48 26 86 4 23 67 2006 21 1,311 7 1,157 230 128 48 27 87 4 23 67 2007 21 1,318 7 1,174 232 128 48 27 89 5 23 68 2008 21 1,325 7 1,191 235 128 49 28 90 5 23 68 2009 22 1,331 7 1,208 237 128 49 28 92 5 23 69 2010 22 1,338 7 1,225 240 127 49 28 93 5 23 69 (YoY %) Australia China Hong Kong India Indonesia Japan Korea Malaysia Philippines Singapore Taiwan Thailand 2005 1.3 0.6 0.4 1.5 1.2 0.0 0.2 2.0 1.9 2.4 0.4 1.0 2006 1.5 0.6 0.6 1.5 1.2 (0.0) 0.3 1.9 1.8 3.2 0.5 0.9 2007 1.8 0.5 1.0 1.5 1.1 0.0 0.3 1.7 1.8 4.3 0.4 0.8 2008 2.0 0.5 0.7 1.4 1.1 (0.1) 0.3 1.7 1.7 5.5 0.3 0.7 2009 2.1 0.5 0.4 1.4 1.0 (0.1) 0.3 1.6 1.7 3.1 0.4 0.6 2010 1.6 0.5 0.9 1.4 1.0 (0.1) 0.3 1.6 1.7 1.8 0.2 0.6 Source: World Bank, Taiwan National Statistics

- 5 - Aviation Primer Winter 2012

Asia: per-capita income and population Country Age profile (%) Population Per-capita income 0-14 15-64 (30-49) 65 and above (m people) (US$) Australia 19 68 13 22 38,708 China 19 72 8 1,338 3,746 Hong Kong 12 76 (34) 13 7 28,134 India 31 64 5 1,225 1,207 Indonesia 27 67 6 240 2,372 Japan 13 64 (28)23 127 37,986 Korea 16 72 (34)11 49 18,077 Malaysia 30 65 (26)5 28 6,545 Philippines 35 61 4 93 1,889 Singapore 17 74 (25)9 5 33,902 Taiwan 16 74 (33)11 23 16,413 Thailand 21 71 9 69 3,805 Source: World Bank, Taiwan National Statistics

The power of the unions

We believe that the more unionised the aviation industry is in a country, the less flexibility there is in terms of wage and staff adjustments during a downcycle, which therefore limits the efficiency and profitability of the aviation industry in the country. This is part of the reason why airlines in Asia often have lower staff costs per available seat kilometres (ASK) than the US and European carriers, even in mature economies. In addition, in terms of RPK, ASK, and revenue per employee, the ratios are higher for Asian carriers, which implies greater efficiency.

International airlines: comparison (2011) RPK per employee ASK per employee Revenue per employee Staff cost per ASK Company (m) (m) (US$m) (US$m) US Alaska Air 2.81 3.32 0.48 0.12 Delta Air Lines 2.46 2.99 0.45 0.09 GOL Linhas Aereas Inteligentes (Brazil) 1.68 2.44 0.37 0.08 Southwest Airlines 2.15 2.66 0.35 0.10 United Continental 2.39 2.90 0.43 0.09 US Airways 2.26 2.75 0.41 0.07 Europe Air France-KLM 1.67 2.01 0.33 0.08 Deutsche Lufthansa-Reg 1.68 2.17 0.35 0.08 Easyjet 7.94 8.97 0.72 0.08 Ryanair n.a n.a 0.72 0.07 Asia AirAsia 4.10 5.08 0.29 0.03 Air China 5.05 6.19 0.50 0.06 All Nippon Airways 1.79 2.65 0.52 0.09 Cathay Pacific 4.90 6.09 0.61 0.09 China Airlines 3.02 3.88 0.43 0.11 China Eastern Airlines 1.69 2.14 0.22 0.02 China Southern Airlines 1.71 2.11 0.20 0.02 EVA Airways 2.31 2.96 0.37 0.04 Japan Airlines 1.70 2.54 0.50 0.09 Qantas Airways 3.27 4.08 0.44 0.11 Singapore Airlines 3.90 5.04 0.52 0.08 Source: Bloomberg, companies Note: Based on FY11 data

- 6 - Aviation Primer Winter 2012

International airlines: power of the unions vs. profit margins (2011) Company Net-profit margin (%) Union US Alaska Air 5.66 Strong Delta Air Lines 2.43 Strong GOL Linhas Aereas Inteligentes (Brazil) n.a Strong Southwest Airlines 1.14 Strong United Continental 2.27 Strong US Airways Group 0.54 Strong Europe Air France-KLM n.a Strong Deutsche Lufthansa-Reg n.a Strong Easyjet 6.52 Strong Ryanair 12.76 Strong Asia AirAsia 12.35 Weak Air China 6.74 Weak All Nippon Airways 1.99 Medium Cathay Pacific 4.79 Medium China Airlines n.a Weak China Eastern Airlines 3.36 Weak China Southern Airlines 3.70 Weak EVA Airways 0.18 Weak Japan Airlines 15.49 Medium Qantas Airways 1.68 Strong Singapore Airlines 2.48 Weak Source: Bloomberg, companies Note: Based on FY11 data

- 7 - Aviation Primer Winter 2012

Getting the timing right

Beware of the peak in the profit cycle

From deciding to set up a new airline to accumulating the financial and human resources necessary usually takes a few years. Over that period, many external factors – such as the jet-fuel price, interest rates, and the demand- supply cycle – are likely to have changed significantly. This was the case in 1998, 2001, 2003 and 2005-06, when a relatively large number of new airlines were set up during the Asia financial crisis (1998), the bursting of the Internet bubble (2001), the outbreak of SARS (2003), and the high fuel price as a result of the Gulf crisis (2005-06). It could be said that these periods were not the best time to set up an airline.

However, interest rates were low in those years, and RPK growth had been strong in previous years, resulting in strong profits for the established airlines. The availability of financing is generally high when the industry cycle is on an uptrend. This facilitated the entry of a large number of newcomers into this capital-intensive industry over the 1998-2006 period. In addition, the increasing adoption of the LCC model globally stimulated a rise in the number of new airlines being set up.

Establishment of new airlines globally vs. US interest rates/jet-fuel price/GDP (%) (Units) 8 16

6 12

4 8

2 4

0 0 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

US interest rate (LHS) World GDP (LHS) Newly set-up airlines (RHS) Jet fuel (RHS)

Source: Bloomberg, CEIC, IMF

- 8 - Aviation Primer Winter 2012

Company background makes a difference

Government support still crucial in this industry

Government support often comes from a few areas, such as a reduced tax rate, low interest costs given strong state-owned enterprises as a guarantor, capital injections, and rebates. Some governments may restrict traffic rights to a limited number of airlines to avoid competition. In Asia, there are many players with strong government backgrounds. In addition to the national carrier, other airlines – such as China Southern Airlines and China Eastern Airlines, which are also state-owned – receive government funding as well.

We believe private airlines find it hard to survive if a government’s policy stance favours the state-owned airlines. For most of the time during an economic downturn, privately-owned airlines face the biggest difficulties as they mostly have weaker balance sheets, and a government may not be willing to bail them out unless they are large in scale. For a state-owned airline, a government is likely to be able to provide funding or at least act as a guarantor for financing. Government support is especially important on the financing side during a downcycle.

Government ownership and policy support Country Government-owned airlines % Government policy support China Air China 51 The PRC Government opened its civil-aviation sector to private sector investment in China China Southern Airlines 53 2005. China China Eastern Airlines 50 State-owned airlines have been receiving capital injections from the government since 2008. The government has started to relax its policy on route permits. Singapore Singapore Airlines 55 The Singapore Government has been operating an ‘open skies' policy since 1997 In 2008, third- and fourth-freedom rights between ASEAN capitals came into effect. In 2010, unlimited fifth-freedom rights between ASEAN capitals came into effect. India Air India 49 India’s aviation sector was deregulated in 2005. Indonesia Garuda Indonesia 86 There is full support from the government. Gained full support from the government to become the country's leading airline, eg, Thailand Thai Airways International 51 the government places restrictions on other domestic airlines for some routes. Ireland 25 Received direct financial support from government. Oman Group 100 Received government financial support. UAE The Emirates Group 100 UAE deregulated the aviation industry. Source: Companies, flightglobal, various media

- 9 - Aviation Primer Winter 2012

Airlines that have ceased operation Before 2003 Year Ownership 2003-04 Year Ownership 2005-07 Year Ownership Air L.A 1995 Private 2003 Private Champagne Airlines 2005 Private Air South 1997 Private Alisea Airlines 2003 Private Air Paradise 2005 Private 1998 Private 2003 Private Bouraq Indonesia Airlines 2005 Private Air Great Wall 2000 Government Airborne Express 2003 Private Express Airlines 2005 Private 2001 Private 2003 Private Harlequin Air 2005 Private 2001 Private China Airlines 2003 Government Nakanihon Airlines 2005 Private 2001 Private Air Lib 2003 Private Legend Airlines 2005 Private 2001 Private 2003 Government 2005 Private AOM French Airlines 2001 Private 2003 Private Air Shenpix 2005 Private Access Air 2001 Private China Airlines 2003 Government 2005 Private Penair 2002 Private Airlines 2004 Government Air Hokkaido 2006 Private China Southwest Airlines 2002 Government 2004 Private Air Efata 2006 Private China 2002 Government Air Vegas 2004 Private Independence Air 2006 Private Air Sicilia 2002 Private 2004 Private QuikAir 2006 Private 2002 Private Japan Air System 2004 Private CR Airways 2006 Private 2004 Mixed Japan Airlines Domestic 2006 Private 2004 Private 2006 Private Fairinc 2004 Private 2006 Private Canada West Airlines 2004 Private 2006 Private Orange Cargo 2004 Private 2007 Private 2004 Private Baxter Aviation 2007 Private 2007 Private Hapag-Lloyd Express 2007 Private Hapag-Lloyd Flug 2007 Private RegionsAir 2007 Private SkyValue 2007 Private 2007 Private Skybus Airlines 2007 Private

2008-09 Year Ownership Since 2010 Year Ownership Hansung Airlines 2008 Government 2010 Private Aloha Airlines 2008 Private Network 2010 Private Air Midwest 2008 Private 2010 Private 2008 Private Arror Air 2010 Private 2008 Private Deer Jet 2010 Private Heli-Express 2008 Private Freedom Airlines 2010 Private NAC Air (North American Charters) 2008 Private 2010 Private 2008 Private 2010 Private 2008 Private 2010 Private Oasis 2008 Private Viva Macau 2010 Private 2008 Private 2010 Private Airspeed Aviation 2009 Private ANA & JP Express 2010 Private Alitalia - Linee Aeree Italiane 2009 Government 2011 Government LTU International 2009 Private ItAli Airlines 2011 Private Corporate Express 2009 Private Jade Cargo International 2011 Mixed MyAir 2009 Private Airlines Cargo 2011 Mixed JetAmerica 2009 Private 2012 Private USA3000 Airlines 2012 Private Source: Companies, various media

- 10 - Aviation Primer Winter 2012

Mode of operation: LCC vs. FSC

Overview

The two major airline-business models are FSC and LCC. We see the LCC model as being more attractive recently due to the low penetration rate of passengers in Northeast Asia. Many traditional FSCs, such as Singapore Airlines (SIA), Qantas (QAN), All Nippon Airlines (ANA), Japan Airlines (JAL) and China Eastern Airlines (CEA), have announced plans to set up an LCC subsidiary to attract low-income travellers. Among the FSCs, the most successful ones are those focused on premium travellers, such as Cathay Pacific (CX). We see both models producing winners and losers. We examine the success factors below. Over the near term, we believe the FSC winners will be CX with AirAsia the leader among the LCCs.

FSCs vs. LCCs LCCs FSCs Simple product Complex product Fares Low, simple - one-way Round trip - complex Minimal restrictions Numerous restrictions Distribution Avoids travel agents Depends on travel agents Aims for 100% direct: either online or through call centres Owns ticket offices /call centre In-flight Mostly one cabin class 2-3 classes High-density seating Low seat density No seat assignment Assigned seats No meals or free drinks In-flight catering Simple operation Complex operation Aircraft Single type - maximum two Multiple types - aircraft tailored to routes served High utilisation rate (11 hours/day) Low utilisation rate on short sectors Sectors Short – 500-1,000km From very short to long distances Point-to-point Hub-and-spoke network No hubbing or connecting flights Passengers/flights connect at hub Schedules Used to shift demand Responds to current demand Airports Secondary or uncongested (where possible) Focus on large airports 20-30 minute turnaround 1 hour turnaround on short sectors Staff Competitive wages High wages Profit-sharing Minimal profit-sharing High productivity Over-staffed Source: Flying off course by Rigas Doganis Note: In the mid-2000s some legacy carriers, in response to low-cost competition, began to adopt several low-cost features, eg, no paper tickets, one-way fares, online selling

The factors necessary to be a successful LCC

1) Large low-income population. The larger the low-income population, the bigger the market potential for LCCs. Traffic growth is likely to be limited by individual wealth; so when fares reach a very low level, such as those offered by LCCs, this can stimulate demand. 2) Low-cost environment. This is crucial for the LCCs to be competitive and maintain high net-profit margins, given that their fares are very low. There are many ‘low-fare’ carriers but these are not necessarily ‘low- cost’ carriers. 3) Incumbent airlines are not dominant. We believe that if the existing players are operating efficiently, there is less likelihood of new entrants, including LCCs, being established. 4) Government support. Some countries implement measures to encourage the development of LCCs, such as providing discounts on landing and take-off charges, and constructing a dedicated terminal for budget airlines.

Given this, we see as being an ideal place for LCC development. The low-cost environment and government support for infrastructure is better than in the countries in Northeast Asia. In terms of demand, we see strong potential given the large low-income population. This also explains why we saw a higher penetration rate for LCCs in Southeast Asia for 1H12 (close to 50% of all the airlines operating in terms of market share) compared with Northeast Asia (only 10-20%). We believe Southeast Asian LCCs such as AirAsia benefit from the abovementioned factors.

- 11 - Aviation Primer Winter 2012

Global LCC penetration rate (%) 60

50

40

30

20

10

0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Nov-12

Asia Pacific Europe N. America SE Asia N.E Asia

Source: CAPA Note: as of 7 November 2012

Supportive measures for LCCs Japan Some airports provide incentives for LCCs, eg, ’s Kansai International Airport waives landing fees for LCCs The government stimulated the domestic air-travel market by increasing landing slots and working towards lowering landing fees in 2005. The aviation market was deregulated in 2008, though restrictions remained on the amount of discounting allowed.

India In 1992, the government liberalised the aviation sector, which had long been dominated by the national carriers. In 2000, the government eased restrictions for new airlines entering the industry. To protect local budget airlines, the government closed four large and high-potential cities, , , and , to non- Indonesia Indonesian budget airlines in 2005. The Malaysian government supported the establishment of AirAsia in 2001. Malaysia Built a low-cost air terminal in 2005, which will be replaced by a larger budget terminal in 2013.

Philippines Domestic routes were deregulated in 1995. In March 2011, the government introduced a more liberal aviation policy designed to improve the country's competiveness as a tourism destination and investment location. Under the new policy, the aviation authorities plan to pursue open-skies agreements, eliminating capacity restrictions in regulated markets and offering fifth-freedom rights for overseas carriers.

Singapore The government established a budget airline terminal at Changi in 2005 and lowered passenger taxes to attract LCCs. Thailand The airline industry was deregulated and the government adopted an Open Skies policy in 2001 to attract more new entrants. Europe In 1992, deregulation in Europe gave carriers from one EU country the right to operate scheduled services between other EU states. Full deregulation of the aviation industry was implemented in Europe in 1997. In 1989, Ryanair was granted the sole carrier licence on some routes by the Irish government to protect it from predatory pricing by rivals on certain routes.

US Deregulation in 1978, lowered federally controlled barriers for new airlines. Source: Financial Times, companies, various media

Asia: per-capita income and population by country (2010) Population Income per capita (m people) (US$) Australia 22 38,708 China 1,338 3,746 Hong Kong 7 28,134 India 1,225 1,207 Indonesia 240 2,372 Japan 127 37,986 Korea 49 18,077 Malaysia 28 6,545 Philippines 93 1,889 Singapore 5 33,902 Taiwan* 23 16,413 Thailand 69 3,805 Source: World Bank, *Taiwan National Statistics

- 12 - Aviation Primer Winter 2012

The factors necessary to be a successful FSC

1) Large population with high disposable income. Unlike LCCs, demand for FSCs requires a certain level of spending power in the population, as these airlines do not often use low fares to stimulate passenger traffic. 2) Niche market. FSCs operating in niche markets that are protected from foreign competition, such as China, benefit from less competition. 3) Business-traffic demand. This is highly dependent on commercial activity in the city or hinterland. The financial industry seems to be the most important sector for business travel. Capital cities, such as and , see more government-related travel. 4) Minimising costs. The operating costs of FSCs are generally higher than for LCCs due to higher catering expenses, ground-handling expenses, and staff costs. However, successful FSCs are still careful about spending, and try to increase fleet utilisation rates as much as possible. Many FSCs are emulating parts of the LCC model to improve their cost efficiency. 5) Well-developed revenue-management system. Successful FSCs generally have well-developed revenue-management systems that allow them to understand market demand and the impact of their promotional fares. The requisite IT investment means these systems are usually employed by airlines of a certain scale, which have a large number of aircraft and destinations, and therefore are able to enjoy high economies of scale on the IT investment. 6) Government support. Rather than offering discounts on landing fees, government support for FSCs often involves limiting new entrants and government-backed financing. This is usually the case for state-owned airlines.

LCCs and FSCs: comparison of utilisation rates, costs and load factors (2011) Company Air China China Southern CEA CX SIA QAN AirAsia Tiger Airways ANA JAL Skymark Bloomberg code 753 HK 1055 HK 670 HK 293 HK SIA SP QAN AU AIRA MK TGR SP 9202 JP 9201 JP 9204 JP Type FSC FSC FSC FSC FSC + LCC FSC + LCC LCC LCC FSC + LCC FSC LCC Net-profit margin (%) 6.74 3.70 3.36 4.80 2.50 1.68 12.35 (16.87) 1.99 15.49 9.60 Average daily utilisation (hours per day) 9.58 9.80 9.80 12.30 n.a n.a 12.30 n.a n.a n.a n.a PLF (%) 81.47 81.00 78.90 80.40 77.40 80.10 80.00 81.50 65.80 66.9 81.90 Cost per ASK (US$) 0.09 0.09 0.10 0.09 0.07 0.11 0.04 0.05 0.16 0.15 0.08 Yield per RPK (US$) 0.11 0.10 0.11 0.09 0.09 0.11 0.07 0.06 0.21 0.21 0.16 Source: Bloomberg, Companies

LCCs and FSCs: comparison of utilisation rates, costs and load factors (2011) Garuda Air New Company Korean Air Asiana Thai Airways Malaysia Air China Airlines EVA Airways Indonesia Cebu Pacific Zealand Bloomberg code 003490 KS 20560 THAI TB MAS MK 2610 TT 2618 TT GIAA IJ CEB PM AIR NZ Type FSC + LCC FSC + LCC FSC + LCC FSC + LCC FSC FSC FSC LCC FSC Net-profit margin (%) (2.55) 0.31 (5.20) (18.10) (1.37) 0.18 2.98 10.70 1.87 Average daily utilisation (hours per day) n.a 12.43 11.90 10.90 n.a n.a 8.24 12.74 9.92 PLF (%) 76.93 76.50 65.40 75.00 78.00 78.03 75.20 86.30 83.40 Cost per ASK (US$) 0.07 0.07 0.08 0.09 0.11 0.11 0.08 0.06 0.09 Yield per RPK (US$) 0.16 0.16 0.09 0.07 0.09 n.a 0.10 0.06 0.13 Source: Bloomberg, Companies

- 13 - Aviation Primer Winter 2012

Summary of major players’ strategies

Developing countries are performing the best

In our selected pool of airlines, Air China (AC) and AirAsia are based in China and Malaysia, respectively, which are developing countries with high traffic growth, while CX, SIA, ANA, JAL and QAN are based in the mature markets of Hong Kong, Singapore, Japan and Australia, respectively. This is reflected in the higher passenger traffic growth for the former two over the past five years (CAGRs of 15-29% YoY) compared with the latter three (CAGRs of 0-8% YoY).

Overall, we regard AC’s operating environment as being better than that of its peers, given the high growth potential of outbound traffic from the country, a regulated market where competition can be limited, and strong government support in the event of any difficulty in financing.

In our view, the toughest operating environment is in Australia, where passenger traffic growth is relatively low, there is intense competition on international routes, there are powerful unions, and the country is a good distance from the major economic powers in Asia (eg, China, Japan, Korea, and India).

Key macro metrics for Asian carriers AC AirAsia CX QAN SIA ANA JAL Economic growth (2011 GDP, (YoY %) 9.2 5.1 5 2.2 4.9 0.0 0.0 Competition (local) Dominated by the big Mainly between Dominant position in Dominant position in Dominant position Mainly between Mainly between three airlines Malaysia Airlines and Hong Kong Australia in Singapore, but ANA, JAL & ANA, JAL & AirAsia the market is open Skymark Skymark to foreign competition Local market share (2011) (%) 24 55 51 87 37 49 40 Population in home country (m people) 1,338 28 7 22 5 128 128 Income per capita (US$) 3,746 6,545 28,134 38,708 33,902 37,986 37,986 GDP per capita 4,428 8,373 31,757 65,497 41,120 45,920 45,920 GDP growth (past five years)(%) 11 5 4 3 7 (1.52) (1.52) Traffic growth (RPK) (past five years) (%) 15 29 8 4 1 0 0 Strength of union power Weak Weak Medium Strong Weak Medium Medium Getting the time right (year established) 1988 1993 1946 1920 1947 started in 1952 Started in 1953 Company background State-owned Private Private Private State-owned Private Private Mode of operation FSC LCC FSC FSC + LCC () FSC + LCC ( FSC + LCC (e.g. FSC (but will have and Tiger Airways) Peach and AirAsia LCC JV - ) Japan) Source: Companies, World Bank, government websites, Daiwa

- 14 - Aviation Primer Winter 2012

- 15 - Aviation Primer Winter 2012

Key factors in deciding on destinations

Overview

For an airline, deciding on where to fly is a crucial step, as the wrong choice of destination can lead to long-term issues unless there is flexibility about launching and cancelling of a route. Also, management needs to consider the operating constraints, such as traffic rights and slots (the availability of landing and take-off times at an airport). Factors that airlines look at when deciding to operate on a route include the population at the destination, income levels for the destination, extent of competition on the route, and the related regulatory constraints (eg, visa restrictions).

Comparison of population, per-capita income, dominant airlines and visa restrictions Population Per-capita income Competition Visa restrictions (m people) (US$) Major domestic airlines Visa-free countries Australia 22 38,708 QAN 166 China 1,338 3,746 AC, China Southern Airlines, CEA 40 Hong Kong 7 28,134 CX 149 India 1,225 1,207 Air India 53 Indonesia 240 2,372 Garuda Indonesia, Cebu Pacific Air 11 Japan 127 37,986 Japan Airlines, ANA 170 Korea 49 18,077 Korean Air, Asiana 163 Malaysia 28 6,545 Malaysia Airlines, AirAsia 158 Philippines 93 1,889 Philippine Airlines 41 Singapore 5 33,902 SIA, Tiger Airways, SilkAir 164 Taiwan* 23 16,413 China Airlines, Eva Airways 127 Thailand 69 3,805 Thai Airways 63 Source: World Bank, *Taiwan National Statistics

- 16 - Aviation Primer Winter 2012

Population and income levels

Determining the imbalance of traffic demand

As discussed in Chapter 1, the population and income level in an airline’s home country affects passenger demand. Similarly, the population and income level of the destination and its hinterland affects the passenger demand coming from there. Some routes with weak passenger traffic from the destination city may still be warranted given the potential for strong traffic from the home country. Such destinations often cater to leisure travellers. For example, the route from Hong Kong to Xi’an (the home of the terracotta warriors) caters mostly to passengers originating in Hong Kong. So, the population and income level of the destination is more relevant when the demand in an airline’s home country is not sufficient to fill a certain number of seats.

Passenger traffic on selected routes in terms of citizenship (No. of passengers) From Beijing Hong Kong Shanghai Taiwan To Beijing 434,223 n.a. 282,751 Hong Kong 264,456 176,091 2,156,760 Shanghai n.a. 479,536 632,464 Taiwan 91,753 764,033 95,261 Source: Shanghai Tourism Bureau, Tourism Bureau of Taiwan

- 17 - Aviation Primer Winter 2012

Competition

Competition on a route and at nearby hubs

On international routes, there is usually at least one foreign competitor on the same route due to reciprocal traffic rights. Gaining an understanding of the intensity of competition on a route or within a region requires a close examination of the number of airlines flying the route, as well as the market-share split among competitors on specific routes. In addition to direct competition on a route, an airline’s management needs to consider whether there are nearby destinations that compete with the route. For example, the airports in , , and Hong Kong compete to some extent with each other as they are very close geographically.

Airports in the Pearl River Delta region

Guangdong

Guangzhou Shenzhen

Zhuhai Hong Kong

Macau Shenzhen Airport Baiyun Airport

Hong Kong International Airport

ZhuhaiAirport

Macau International Airport

Source: Airports, Daiwa

- 18 - Aviation Primer Winter 2012

Asia: number of competitors on major passenger routes Hong Kong Singapore Tokyo Delhi Beijing Shanghai Taipei Hong Kong n.a Tiger, Jetstar, HK Delta, HKA, JAL, , CX AirAsia, , CSA, HKA, AC, HKA, CEA, HKA, CAL, EVA, Jin Air, Korea Air, Air, SIA, United, ANA, United, CX MAS, CX QAN, CX, Dragonair, CX SHA, CX, Dragonair Asiana, CX, CX Virgin Aus. CX, Dragonair Thai Air Singapore Tiger, Jetstar, n.a Delta , JAL ,SIA , SIA ,Air India,Jet AirAsia, BA, QAN, SIA Jetstar, AC, SIA SIA, CEA Tiger, Jetstar, Korea Air, HKA, SIA, United, ANA , United Airways Tiger, Jetstar, SIA, EVA, CAL Asiana, SIA CX SIA, MAS Tokyo Delta, HKA, JAL, Delta , JAL ,SIA , n.a JAL AirAsia, BA, QAN, SIA Jetstar, AC, SIA SIA, CEA Tiger, Jetstar, Korea Air, ANA, United, CX ANA , United Tiger, Jetstar, SIA, EVA, CAL Asiana, SIA SIA, MAS Delhi Jet Airways, CX SIA ,Air India,Jet JAL n.a MAS n.a n.a CEA n.a Asiana Airways Kuala AirAsia, MAS, CX AirAsia, Tiger, MAS, JAL MAS n.a AirAsia, MAS MAS, AC MAS, CEA AirAsia,MAS, CAL AirAsia, Lumpur Jetstar, SIA, MAS Korea Air, MAS Sydney Virgin Atlantic, BA, QAN, SIA QAN, JAL n.a AirAsia, MAS n.a AC CEA, AC, QAN n.a Korea Air, Asiana QAN, CX, Virgin Aus. Beijing CSA, HKA, AC, Jetstar, AC, SIA AC, CEA, PIA, n.a MAS, AC AC n.a AC, Juneyao HNA, AC, CAL, CSA, Korea Air, Dragonair, CX ANA, CSA, JAL, Airlines, CEA, EVA AC, Asiana Delta HNA, CSA, SHA, SZA Shanghai HKA, CEA, SHA, SIA, CEA CEA, SHA, AC, CEA MAS, CEA CEA, AC, QAN AC, Juneyao n.a CSA, AC, CEA, CSA, CEA, SHAr, CX, Dragonair ANA, JAL, Delta Airlines, CEA, HNA, CAL, EVA Korea Air, Asiana CSA, SHA, SZA Taipei HKA, CAL, EVA, Tiger, Jetstar, EVA, ANA, n.a AirAsia, n.a HNA, AC, CAL, CSA, AC, CEA, n.a Korea Air, Thai CX, Dragonair SIA, EVA, CAL CAL, JAL, Delta, MAS, CAL EVA CAL, EVA Air, Asiana, EVA, United, CX CAL, CX Seoul Jin Air, Korea Air, Korea Air, Asiana, Korea Air, Asiana, Asiana AirAsia, Korea Air, Korea Air, Asiana CSA, Korea Air, CSA, CEA, Korea Air, Thai n.a Asiana, CX, Thai SIA ANA, United, MAS AC, Asiana SHA, Korea Air, Air, Asiana, EVA, Air JAL, Delta Asiana CAL, CX Source: Companies Note: BA: British Airways, CAL: China Airlines, CEA: China Eastern Airlines, Delta: Delta Air Lines, Eva: EVA Airways, HNA: Hainan Airlines, HKA: Hong Kong Airlines, JAL: Japan Airlines, MAS: Malaysia Airlines, SHA: , Tiger: Tiger Airways, United: United Continental

Asia: frequency of flights on major passenger routes Hong Kong Singapore Tokyo Delhi Kuala Lumpur Sydney Beijing Shanghai Taipei Seoul Hong Kong n.a 23 25 2 13 6 27 48 48 12 Singapore 23 n.a 144 40 10 7 9 9 9 Tokyo 25 14 n.a 1 2 2 14 26 2132 Delhi 2 4 1n.a 2 n.a n.a 1 n.a 1 Kuala Lumpur 13 40 2 2 n.a 3 3 3 3 3 Sydney 6 10 2n.a 3 n.a 1 3 n.a 2 Beijing 27 7 14n.a 3 1 n.a 51 514 Shanghai 48 9 26 1 3 3 51 n.a 15 24 Taipei 48 9 21n.a 3 n.a 5 15 n.a 12 Seoul 12 9 32 1 3 2 14 24 12 n.a Source: Companies, Skyscanner

On domestic routes, which are often not open to foreign airlines, the competitive landscape is determined by a country’s policy on granting traffic rights. Some countries limit the number of airlines operating on the same route to avoid competition, while other routes are open to any new domestic entrants.

Policy on airline ownership and attitude towards foreign competitors Country Policy Afghanistan International air carriers are able to operate freely in the domestic market. Australia Foreign ownership of domestic airlines is set at 49%. Brazil Foreign ownership of domestic airlines is set at 20%. Canada The government suspended flights by Emirates to protect Canadian carriers. China Foreign ownership of domestic airlines is set at 25% India Foreign airlines permitted to take a stake of up to 49% in local carriers as at September 2012. Japan Foreign ownership of domestic airlines is set at 33%. Kenya Foreign ownership of domestic airlines is set at 49%. New Zealand Foreign ownership of domestic airlines is set at 49%. Peru Foreign ownership of domestic airlines is set at 49%. Saudi Arabia Considering opening its domestic market to airlines from other Gulf Cooperation Council member nations, to improve its aviation market. Korea Foreign ownership of domestic airlines is set at 50%. Taiwan Foreign ownership of domestic airlines is set at 33%. UAE The government has no open-skies policy for international airlines. US Foreign ownership of domestic and international US airlines is restricted to no more than 25% of voting shares. Source: CAPA, Flightglobal, various media

- 19 - Aviation Primer Winter 2012

Traffic rights and airport slots

Increased liberalisation

Traditionally, traffic rights have been limited in most Asian countries and are considered by governments as important resources for airlines. The governments state clearly which airlines can use the traffic rights granted and some include frequency or capacity limitations. In the past, incumbent airlines tried to keep out new entrants by holding on to all the traffic rights on the major routes. However, many of the countries in Asia are encouraging tourism in order to boost their economies, and so are moving towards an ‘open-skies’ policy (such as ASEAN), in which there is no limitation on traffic rights, by 2015. Holding on to traffic rights to prevent the entry of newcomers is becoming less effective nowadays.

‘Open skies’ refers to the liberalisation of the rules and regulations of the aviation industry among countries in order to create a free-market environment for airlines to expand. The primary objective is to allow airlines to expand flights freely within the region and therefore be able to promote air-traffic growth and tourism, which will benefit the economies of the countries involved.

In the past, some airlines had to pay royalties to receive traffic rights. This was most often the case when the airline was the sole operator of a route. Following the spread of liberalised aviation policies over the past 20 years or so, such payments have become much rarer.

Nowadays, most countries are willing to provide third- and fourth-freedom rights. However, fifth-freedom rights and those above are still restricted, especially those involving domestic markets. This is mainly due to the objections of the incumbent airlines in a country.

Traffic rights: first- to fifth-freedom rights

Source: Daiwa

- 20 - Aviation Primer Winter 2012

Traffic rights: sixth- to ninth-freedom rights

Source: Daiwa

Traditional bilateral and open-skies agreements: comparison Traditional bilateral agreement Open skies agreement Market access Airlines can fly only to specified points Open access: airlines can fly between any two points* Limited fifth-freedom rights granted Extensive fifth-freedom rights granted Charter rights are not included Unlimited charter rights granted Designation Single or multiple airlines Multiple airlines Airlines must be 'substantially owned and effectively controlled ' by nationals of the designating state (this is true for both agreement types) Capacity Capacity agreed or shared 50:50 No frequency or capacity limitations Need for negotiation on future capacity/frequency increases Tariffs To be agreed using IATA procedures Country of origin rules Source: Flying off course by Rigas Doganis Note:*While US 'open-market' bilateral agreements give US airlines the right to fly from any point in the US, foreign airlines are restricted to flying from only a handful of named points in the country

In addition to traffic rights, airport slots are an important asset for an airline, especially at busy airports such as those in Beijing, Shanghai, Tokyo, Hong Kong and Singapore. Airport slots are limited, as most airlines prefer to have the same time daytime slot, and dislike operating evening or ‘red-eye’ flights as they are usually unprofitable (expect for freighters). In Asia, some airports are close to or already exceed their design capacity, meaning further infrastructure spending is needed. Such spending is essential for an airport to maintain its hub status.

Asia: current and future airport capacity Designed passenger- Passenger throughput Utilisation rate Planned capacity Year due to Airport Name throughput capacity (m) in 2011 (m) (%) (m) be completed Beijing Capital Airport 82 79 90% 120 2015 Singapore Changji Airport 66 47 71% 82 2017 Korea Incheon Airport 62 35 54% 100 2020 Shanghai (Pudong) Airport 60 41 68% 80 2020 Hong Kong International Airport 55 54 93% 97 2030 Guangzhou Baiyun Airport 45 45 91% 75 2020 Thailand 45 48 95% 65 2016 Shanghai (Hongqiao) Airport 40 33 78% 60 2015 Indonesia Soekarno Hatta Airport 35 49 126% 62 2014 Taiwan Taoyuan Airport 32 25 78% 60 2018 Shenzhen Airport 18 28 147% 45 2012 Hainan Meilan Airport 9 10 94% 30 2016 Sanya Airport 7 12 143% 20 2020 Tokyo Narita Airport* 220 183 96% 300 2012 Source: Companies, various media Note:*In terms of aircraft movements (’000 times)

- 21 - Aviation Primer Winter 2012

Summary of major players’ strategies

More competition in Southeast Asia

We believe AC has a better operating environment and growth potential than its peers. However, limits on airport slots due to the insufficient availability of airspace will be a major obstacle to the industry expanding further in China. We expect the issue to be addressed over the long term given that flight delays are now common in the country, which has drawn the attention of the public and the government to the problem.

In terms of competition on international routes, we see it as being more intense in Southeast Asia than Northeast Asia (ie, Korea, Japan, Taiwan and Hong Kong). With an open-skies policy implemented in ASEAN and new LCCs being established, we expect Southeast Asian airlines to face the most competition by 2015. In Northeast Asia, capacity growth over the next decade is likely to be from existing players. Given that GDP growth in Northeast Asia is likely to be slower than in Southeast Asia for the near term, their capacity plans for the next three years are likely be less aggressive than those in Southeast Asia. In addition, the limited availability of airport slots at the major Northeast Asian airports, such as Tokyo, Hong Kong, Beijing and Shanghai, will slow the passenger-traffic growth of the airlines there.

Summary of competitive landscape in different countries Air China AirAsia Cathay Pacific Qantas Singapore Airlines ANA JAL Competitive edge Low pricing Very low pricing and low Premium brand Premium brand Premium brand Premium brand Premium brand cost Traffic rights Traditional bilateral Benefit from open skies Traditional bilateral Third- and fourth- Benefit from open skies Traditional bilateral but Traditional bilateral but agreement policy in ASEAN agreement in which CX freedom rights available policy in ASEAN not too open not too open still covers most of the domestic market open routes to competition Airport slots Very tight for major No major problem Tight No major problem Tight Tight in Tokyo Tight in Tokyo airports such as Beijing and Shanghai Source: Daiwa

- 22 - Aviation Primer Winter 2012

- 23 - Aviation Primer Winter 2012

Picking the right aircraft

Overview

There are several factors to consider when choosing one type of aircraft over another. The most important consideration is the maximum payload, which is the carrying capacity in terms of tonnage, and the flying range. These determine the passenger capacity and the destinations than can be flown to. In the following section, we compare the specifications of different aircraft types from various manufacturers, mainly Airbus, Boeing, Bombardier, and Embraer. Aircraft types can be broken down into regional jets, narrow-body, and wide-body aircraft, and further divided based on their typical passenger capacity.

Payload/range example Payload GE Engines 1,000kg 1,000lb

80 875,000lb (396,900kg) MTOW 150 70 800,000lb (362,880kg) MTOW 60 120 50

416 passengers 40 80 30

20 40 10

0 0 062 4 8 10 Range – 1,000nm

Source: Ascend, Boeing Note: B747-700 used as an example; MTOW: maximum takeoff weight

- 24 - Aviation Primer Winter 2012

Types of aircraft

A regional jet is an aircraft used mainly to transport passengers on short- and medium-haul routes (flying times of up to six hours). The original focus of regional jets was short-haul routes within the US and EU. The popularity of this type of aircraft was supported by the deregulation of the aviation market in the US in the 1970s. Regional jets are generally smaller than narrow-body aircraft, and vary in terms of their dimensions and capacity. They are used on some domestic routes in China and short-haul routes in Southeast Asia.

Narrow-body aircraft have a single aisle inside the cabin. They can fly longer distances than regional jets, and can carry a larger number of passengers. It is also common for narrow-body aircraft to carry small amounts of cargo in their holds, which regional jets may not always be able to do. They are capable of operating on longer journeys than regional jets, and are used on intra-Asia routes and domestically in China, or transcontinental services.

Wide-body aircraft have two passenger aisles. They are larger than narrow-body planes, used over longer distances and carry more passengers (which can make them more economical to operate on some short-haul routes with high levels of traffic). As they are larger, wide-body aircraft can carry a lot more cargo than narrow-body planes. They are often used as freighters as well.

Regional jet Narrow-body – A320 () Wide-body – A380 (economy class)

Source: Embraer Source: Airbus Source: Airbus

Summary of aircraft types and models Type of aircraft Seat range Aircraft model Regional jets 50-110 Bombardier CRJ-900/C-series, ARJ21, Embraer 145/190/195/Ejets, MRJ (Mitsubishi) Regional jets and 100-120 Airbus A318, Boeing B737-500/-600, Bombardier C-series narrow-body Regional jets & 125-160 Airbus A319/320, Boeing B737-300/-400, B737-7/ B737-8/ B737-600 -800/MD80/MD90, Bombardier CS-300, narrow-body COMAC C919 Narrow-body 180-220 , Boeing B737-900/B737-900ER/B737-9/B757-200 Wide-body 200-300 -200/A300-300/A350-800, Boeing B757-300/ B767-300/B767-300ER/B787-8/ B787-9 Wide-body 300-400 -300/A340-500/A340-600/A350-900/A350-1000, Boeing B777-200ER/B777-200LR/B777-300ER Wide-body 400 above Airbus A380, Boeing B747-8/B747-400 Source: Ascend, companies

- 25 - Aviation Primer Winter 2012

Performance analysis of selected aircraft

Performance Analysis of Selected Aircraft 10000

777-200LR

9000

A350-800 A350-1000 A380-800 787-8 A350-900 747-8I 8000 777-300ER 'Heavy' Widebody 777-200ER

7000 A330-200 Widebody

6000 767-300ER A330-300

5000 Range (nm) Range

4000 A319-100 757-200 737-700 737-800 737-900ER 737-600 3000 A318-100 A320-200 C919 A321-200 Narrowbody CS100 CS300 E190 2000 E195 E170 E175

CRJ700 CRJ1000 CRJ900 1000 Regional Jet

0 0 100 200 300 400 500 600 Seat (typical max)

Source: Ascend

Selected 2000-built aircraft market values trends Market Value (US$m) 120

100

80

60

40

20

0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Assumptions: generic specifications, single aircraft 'arms-length' transaction, 'Half-life' conditions and no lease attached A320-200 737-800 A330-300 767-300ER Source: Ascend

- 26 - Aviation Primer Winter 2012

Comparison of aircraft

Regional jets (50-110 seats)

The regional jet market concentrated on the 50-seater product initially (in the 1950s), but over the years the capacity of the aircraft has risen. Bombardier’s CRJ700, launched in 2001, was the most popular 70-seater launched that year. Competition increased in 2004 with the introduction of Embraer’s 70-seater, the E170, which had a much larger cabin size than the CRJ700 and was a good replacement for the 70-seater turboprops that were in use at the time, and represented an upgrade from the 50-seater jets. However, in the past decade, the regional jet market has been moving towards even larger sizes – 85-110 seats – such as the CRJ900/1000 and E175/E190.

The CRJ900, launched in 2003, was the first new generation type in the 85-seater market. Its major competitor was the E175, which had a larger cabin and more size variations (from 78-88 seats). We believe the E175 has become the benchmark type in its market sector based on order backlog and compared with the CRJ900. In the 100-seater segment, the CRJ1000 faces fierce competition from the E190 and E195. Meanwhile, Mitsubishi is developing the MR190, which should be available in the market in 2013 and be a new competitor.

An example of regional jet (50-110 seats) – Embraer E170

Economy class

Source: Embraer, Skytrax

- 27 - Aviation Primer Winter 2012

Regional jets – 50-110 seats Most popular √ √ √ √ √ Manufacturer Bombardier Bombardier Bombardier COMAC COMAC Embraer Embraer Embraer Embraer Embraer Mitsubishi Mitsubishi Country Canada Canada Canada China China Brazil Brazil Brazil Brazil Brazil Japan Japan Aircraft model CRJ700 (NG) CRJ900 (NG) CRJ1000 (NG) ARJ21-700 ARJ21-900 E145 E170 E175 E190 E195 MRJ70 MRJ90 Status In production In production In production In In Out of In production In production In production In production In In development development production development development Seat capacity Typical 70 Typical 88 Typical 98 Typical 78 Typical 78 Typical 50 Typical 70 Typical 78 Typical 94 Typical 106 Typical 70 Typical 82 MTOW (lb) 72,750 - 80,500 - 85,970 - 89,287 - 96,156 - 48,501~53,13 79,344 - 82,673 - 105,359 - 107,564 - 81,200 - 87,300 - 75,000 84,500 91,800 95,901 104,018 1 85,098 89,000 114,199 115,280 85,970 90,378 Payload (lb) 18,800-19,995 22,750-23,350 26,400 19,698 24,793 13,027 20,000-21,700 22,200-22,800 28,800 30,100 n.a n.a Range (nm) 1,218 - 1,504 1,048 - 1,515 971 - 1,622 1,200 - 2,000 1,200 - 1,800 1,550-2,000 1,800 - 2,100 1,800 - 2,100 1,800 - 2,400 1,400 - 2,200 860 - 1,510 920 - 1,360 (70 pax) (88 pax) (100 pax) Cargo capacity (cu 550 590 690 12.416 827 n.a n.a n.a n.a n.a n.a n.a ft) Fuel capacity (US 1,057 1,057 1,057 3,360 3,360 4,174 9,335 9,335 12,971 12,971 n.a n.a gal) High speed cruise 0.825 0.83 0.82 0.8 0.8 0.8 0.82 0.82 0.82 0.82 0.78 0.78 (Mach) Max altitude (ft) 41,000 41,000 41,000 39,000 39,000 37,000 41,000 41,000 41,000 41,000 39,000 39,000 Entry into service 2001 2003 2010 Late 2012 TBC 1996 2004 2005 2005 2006 TBC Late 2013 Number built 315 257 23 6 890 182 143 389 88 n.a n.a Order Backlog 9 11 33 132 n.a n.a 6 47 150 43 n.a 65 Fuel consumption 0.517 n.a n.a n.a n.a 0.620 n.a n.a 0.495 n.a n.a n.a per km (ton) Fuel consumption n.a n.a 0.007 n.a n.a n.a n.a 0.012 n.a n.a 0.005 n.a per km per seat Fuel consumption n.a n.a 1.505 n.a n.a n.a n.a 1.120 n.a n.a 2.114 n.a per hr (ton) Top three operators SkyWest Pinnacle , Henan n.a ExpressJet Shuttle Republic JetBlue Azul, n.a ANA, Trans (in-service, order, Airlines, Airlines, Mesa , Airlines, Airlines, America, Airlines, Airways, Lufthansa States stored) American Airlines, Garuda American Republic Compass Cityline, Holdings Eagle Airlines, Indonesia Airlines, Eagle Airlines, Airlines, Saudi Airlines, Flybe Airlines, Air ExpressJet Shandong Chautauqua Arabian Canada Airlines Airlines Airlines Airlines Source: Ascend, companies

Regional jets and narrow-body jets (110-125 seats)

Nowadays, operators of 100-120-seat narrow-body aircraft have started to focus more on alternatives, such as the Embraer E190/195 and Bombardier C-series regional jets. For example, Bombardier’s new CS100 (due to start commercial operation in 2013) has a seat capacity of 110-125, and is comparable to the A318-100, B737-500, and B737-600. However, we believe the most common aircraft types for commercial airlines’ short-haul routes are 125- 190 seaters, due to the better payload and thus passenger capacity.

- 28 - Aviation Primer Winter 2012

An example of narrow body (110–125 seats) – Airbus A318

Exit & Emergency Exit

Wings location Moveable curtain divider

Lavatory

Seats for unaccompanied minors travelling in UM

Cradles for European destinations

Economy class

Source: Air France, Skytrax

- 29 - Aviation Primer Winter 2012

Regional jets and narrow-body aircraft details – 110-125 seats Most popular √ Manufacturer Airbus Boeing Boeing Bombardier Country France, Germany, , UK US US Canada Aircraft model A318-100 737-500 737-600 CS100 Status In production Out of production In production In development Seat capacity Typical 107 108-122 Typical 110 110 -125 MTOW (lb) 149,900 115,500-133,500 145,500 121,100 - 128,200 Payload (lb) 30,780-34,090 31,960-32,700 n.a TBA Range (nm) 3,200 1,415-2,375 3,050 - 3,225* 2,200 - 2,950 Cargo capacity (cu ft) 749 546-822 756 820 Fuel capacity (US gal) 6400gal 5,311-6,295 6,875 n.a High speed cruise (Mach) 0.82 0.84 0.82 0.82 Max altitude (ft) 39,000 37,000 41,000 41,000 Entry into service 2003 1987 1998 Late 2013 Number built 77 389 69 n.a Order Backlog 2 n.a 0 61 Fuel consumption per km (ton) n.a 0.427 0.429 n.a Fuel consumption per km per seat n.a 0.004 0.004 n.a Fuel consumption per hr (ton) n.a 2.390 2.046 n.a Air France, , SAS, WestJet, Swiss, two unannounced Top three operators (in-service, order, stored) n.a LAN Airlines customers Source: Ascend, companies, various media

Regional jets and narrow-body aircraft (125-190 seats)

For aircraft with 125-190 seats or more, the market is mostly dominated by Airbus and Boeing (especially after McDonnell Douglas was acquired by Boeing in 1997). They produce the most common types of aircraft for short- haul routes in Asia. The most popular choices are the A320 (including A318/319) and the B737 series.

The A320 (launched in 1984) was the first new 150-seater to be introduced in over 20 years, and has since taken market share from the original B727s and MD-80s. In response, in 1991, Boeing initiated the development of its advanced 737 Next Generation family (NG series), with the B737-700 model competing head-to-head with the Airbus A319, and the B737-800 pitted against the A320. Since its launch in 1993, the B737-700 has achieved good traction with the LCCs over the A319, but both aircraft are now falling out of favour due to the high jet-fuel prices given that they are less fuel efficient than new types of aircraft. Bombardier is trying to take share in this market with its relatively more fuel-efficient CS100 and CS300. For larger sizes, the B737-800 has proven to be the most successful member of the Boeing family.

The Airbus A320neo, currently in development, should help Airbus regain the market share it lost in the 150-seater segment. In response, Boeing is developing its B737 Max, which is likely to be the replacement for the B737-700. So far, the A320neo and B737 Max have received orders of 1,278 and 451, respectively. The C919 aircraft from a new player from China, COMAC, is likely to enter the market at nearly the same time as the new Airbus and Boeing aircraft (2016). However, we believe its customers will mainly be Mainland Chinese airlines, and that it will find it hard to compete with the new A320neo and B737 Max series in terms of quality.

- 30 - Aviation Primer Winter 2012

An example of narrow-body aircraft (125-190 seats) – COMAC - C919 G: Galley Mixed class: 156 seats S: Storage L: Lavatory A: Attendant seat All economy: 168 seats W: Walking closet

Economy class

Source: COMAC, Xinhua

- 31 - Aviation Primer Winter 2012

Narrow-body aircraft details – 125-190 seats Most popular √ √ √ √ √ Manufacturer Airbus Airbus Airbus Airbus Boeing Boeing Boeing Boeing Boeing Boeing Boeing Boeing Bombardier Comac Country France, France, France, France, US US US US US US US US Canada China Germany, Germany, Germany, Germany, Spain, UK Spain, UK Spain, UK Spain, UK Aircraft model A319-100 A319neo A320-200 A320neo 737-300 737-400 737-700 737-800 737-7 737-8 MD-80 MD-90 CS300 C919 Status In production In In production In Out of Out of In In In In Out of Out of In In development development production production production production development development production production development development Seat capacity Typical 124 - 156 Typical 150 150 - 180 128-140 146-159 Typical 126 Typical 126 160 Typical Typical 110 120 - 145 168 - 190 124 162 130 MTOW (lb) 166,450 TBC 172,040 TBC 124,500- 138,500- 154,500 174,200 133,000 155,500 128,000- 156,000- 131,300 - 159,900 - 138,500 150,000 139,500 168,000 139,100 170,500 Payload (lb) n.a. n.a. 41,030 n.a. 32,900- 37,200- 41,420 n.a. n.a. n.a. 39,579- 38,200 45,200 36,260 39,480 43,451 Range (nm) 3,600 TBC 3,200 TBC 1,635-2,255 1,907-2,060 3,365 - 3,060 - TBC 1,990-3,060 1,565-2,504 2,085-2,172 2,200 - 2,950 2,200 - 3,000 3,440* 3,115* Cargo capacity 975 n.a. 1,321 n.a. 792-1,068 1,097-1,373 766 1555 n.a. n.a. 1,013-1,253 n.a. 1100 n.a. (cu ft) Fuel capacity (US 6400-7980 n.a. 6400-7980 n.a. 5,311-6,295 5,311-6,295 6,875 6,875 n.a. n.a. 5,779-6,970 n.a. n.a. n.a. gal) High-speed cruise 0.82 0.82 0.82 0.82 0.84 0.84 0.82 0.82 TBC TBC 0.8 n.a 0.82 0.785 (Mach) Max altitude (ft) 39,000 TBC 39,000 TBC 37,000 37,000 41,000 41,000 TBC TBC 35,000 35000 41,000 39,000 Entry into service 1990 2016 1988 2015 1981 1986 1997 1998 2017 2017 1980 1995 Late 2014 2016 Number built 1,331 n.a. 459 n.a. 1113 486 1,081 2522 n.a. n.a. 1,191 n.a. n.a. n.a. Order Backlog 152 35 1595 1167 n.a. n.a. 305 1530 451 451 n.a. n.a. 72 180 Fuel consumption 0.377 n.a. 0.322 n.a. 0.387 0.364 0.370 0.309 n.a. n.a n.a. 0.385 n.a. n.a. per km (ton) Fuel consumption 0.003 n.a. 0.002 n.a. 0.003 0.002 0.003 0.002 n.a. n.a. n.a. 0.004 n.a. n.a. per km per seat Fuel consumption 2.333 n.a. 2.499 n.a. 2.361 2.523 2.231 2.430 n.a. n.a. n.a. 2.865 n.a. n.a. per hr (ton) Top three EasyJet, US Frontier CEA, Jetblue AirAsia, n.a. n.a. Southwest Ryanair, , Lion Air, American Delta, Republic Sichuan operators (in- Airways, Airlines, Airways, ALAFCO, Airlines, American Southwest Southwest Airlines, , Airways, LCI, Airlines, service, order, United Avianca/Taca AirAsia IndiGo , GOL Airlines, Airlines, Delta, Japan Korean Air Hainan stored) Continental Group, Qatar Continental, Norwegian Norwegian Airlines Airlines, Airways WestJet CSA/CEA/AC Source: Ascend, companies, various media

Narrow-body aircraft (180-220 seats)

The original player in this category was Boeing with its B757-200, which was built from 1983, with the last delivery in 2005. The B757-200 was popular on US domestic, European and Chinese routes, but was gradually replaced by the A321 (except on relatively long-haul flights operated by US carriers). Production ceased in 2005. As the A321 is part of the A320 family (popular within the industry), it can share flight equipment and parts, and has become more popular than the B757.

For Boeing, the B737-900 was launched in 2001 and has had limited success in terms of regaining market share, as its seat capacity and range are smaller than those of the A321. As it has the same fuel capacity and maximum take-off weight (MTOW) as the B737-800, the range factor was sacrificed for more passenger capacity. In order to fill the gap in the 200+seat size market after production of the B757 ended in late 2003, and in a bid to develop a more competitive product against the A321, Boeing launched the B737-900ER in 2007, which has a longer range but slightly less capacity than the A321. The next round of competition is likely to occur from 2016-18, when Airbus’s A321neo and Boeing’s B737-9 (Max series) will be launched. For a longer range of close to 4,000 nautical miles (nm), Boeing is working on a replacement for the B757-200.

- 32 - Aviation Primer Winter 2012

An example of narrow-body aircraft (180-220 seats) – Boeing B737-900

Business class Economy class

Source: Korean Air, Skytrax

Narrow-body aircraft details – 180-220 seats Most popular √ √ √ √ Manufacturer Airbus Airbus Boeing Boeing Boeing Boeing Country France, Germany, Spain, UK France, Germany, Spain, UK US US US US Aircraft model A321-200 A321neo 737-900 737-900ER 737-9 757-200 Status In production In development Out of production In production In development Out of production Seat capacity Typical 185 185 - 220 Typical 177 Typical 174 Typical 180 Typical 200 MTOW (lb) 206,200 TBC 174,200 187,700 >187,700 220,000-255,000 Payload (lb) 47,100 n.a. n.a. n.a. n.a. 55,125-55,620 Range (nm) 3,000 TBC 2,745* 3,265 3,200 3,000-4,000 Cargo capacity (cu ft) 1,827 n.a. 1,835 1,852 n.a. 1,790 Fuel capacity (US gal) 6350-7930 n.a. 6,875 7,837 n.a. 11,276 High-speed cruise (Mach) 0.82 0.82 0.82 0.82 TBC 0.8 Max altitude (ft) 39,000 TBC 41,000 41,000 TBC 42,000 Entry into service 1997 2016 2001 2007 2017 1983 Number built 711 n.a. 52 118 n.a 994 Order Backlog 325 87 n.a. 328 451 n.a. Fuel consumption per km (ton) 0.306 n.a. 0.289 n.a. n.a. 0.328 Fuel consumption per km per seat 0.002 n.a. 0.002 n.a. n.a. 0.002 Fuel consumption per hr (ton) 2.726 n.a. 2.592 n.a. n.a. 3.227 Cebu Pacific, ILFC, Qatar , Korean Lion Air, Delta, United Lion Air, Southwest American Airlines, Delta, Top three operators (in-service, order, stored) US Airways, CSA, Lufthansa Airways Air, United Continental Continental Airlines, Norwegian BA Source: Ascend, companies, various media - 33 - Aviation Primer Winter 2012

Narrow-body and wide-body aircraft (200-300 seats)

The first generation of medium-range aircraft, such as the A300, A310, B767 and B757-300, have gradually been replaced by the A330 and then the B787 (the Dreamliner). The B787 is the first aircraft to use an all-composite fuselage. The B787 was designed as a replacement for the B767-300ER, and has more seats, a wider fuselage and a range comparable to the B777 (8,000nm). Its lower capacity enables airlines to explore new long-haul routes where demand would be thin initially.

To compete with Boeing’s new B787, Airbus has developed its A350 series, most of the models for which, eg, the A350-800, A350-900 and A350-1000, are larger than the B787. The A350-800, which is due to start flying in 2016, will be positioned between the B787-8 and B787-9, and should therefore replace the B767-300ER, and complement the A330-200. Similar to the B787, its capacity and range would enable the airlines to test new long- haul markets. In our view, both the A350 and B787 series will be the major players in the medium-to-long-haul markets going forward.

An example of wide-body aircraft (200-300 seats) – Airbus A330-300

Business class Economy class

Source: SIA, Skytrax

- 34 - Aviation Primer Winter 2012

Wide-body aircraft details – 200-300 seats Most popular √ √ √ √ √ Manufacturer Airbus Airbus Airbus Airbus Boeing Boeing Boeing Boeing Boeing Boeing Country France, Germany, France, Germany, France, Germany, France, Germany, US US US US US US Spain, UK Spain, UK Spain, UK Spain, UK Aircraft model A330-200 A330-300 A340-200 A350-800 757-300 767-200 767-200ER 767-300ER 787-8 787-9 Status In production In production Out of production In development Out of Out of production Out of production In In production In production production production Seat capacity Typical 253-293 Typical 295-335 Typical 263 Typical 276 Typical 243 Typical 181 Typical 181 Typical 218-269 210-250 250-290 MTOW (lb) Max 524,700 Max 518,300 568,800 571,000 240,000 282,000-315,000 278,000-285,000 412,000 502,500 553,000 Payload (lb) 80,200 96,400 97,000 TBA n.a 67,887-73,350 71,650-78,500 84,157 105,000 145,700 Range (nm) 7,250 5,850 7,200 8,500 2,345 2,350-4,000 5,650-6,600 5,990 7,600 - 8,200 8,000-8,500 Cargo capacity (cu ft) 4,800 5,700 3,540 4,452 1,670 3,070 3,070 4,030 4,826 5,452 Fuel capacity (US 36,750 25,760 37,150 34,100 11,466 12,140-16,700 20,450-24,140 24,140 33,528 33,384 gal) High speed cruise 0.86 0.86 0.86 0.89 0.8 0.86 0.86 0.86 0.89 0.89 (Mach) Max altitude (ft) 41,000 41,000 41,099 43,000 42,000 43,000 43,000 43,000 43,000 43,000 Entry into service 1998 1994 1993 2016 1998 1984 1984 1988 2011 2014 Number built 459 401 n.a n.a 55 128 121 563 11 n.a Order Backlog 106 165 n.a 118 n.a 0 0 21 508 335 Fuel consumption per 0.293 0.322 n.a n.a n.a 0.344 n.a n.a n.a n.a km (ton) Fuel consumption per 0.001 0.001 n.a n.a n.a 0.002 n.a n.a n.a n.a km per seat Fuel consumption per 5.176 4.992 n.a n.a n.a 4.252 n.a n.a n.a n.a hr (ton) Top three operators Air Caraibes, CX, SIA, Thai Lufthansa, , , ATA Airlines, ANA, United American Airlines, American Airlines, ANA, United , (in-service, order, Emirates, CEA SIA Aeroflot, US Northwest Airlines, Continental, Delta Continental Delta, LAN Continental, ILFC, Qantas stored) Airways Airlines, Air Air Canada Canada Source: Ascend, companies, various media

Wide-body aircraft (300-400 seats)

At the time of the introduction of the A340-200 and A340-300, both in 1993, the main competitor was the McDonnell Douglas MD-11. Airbus aimed for the A340-200 and A340-300 to replace the McDonnell Douglas DC- 10 and Lockheed L1011. However, as the MD-11 had problems with payload and range, most of those aircraft were converted to freight aircraft. It was the introduction of the B777-200ER in 1997 that created the main competition.

The B777-200ER can carry more passengers than the A340 over similar ranges (7,000-9,000nm). The four- engined A340 series (including the A340-300/500/600) has not been particularly welcomed by the airlines due to rising fuel prices since 2005; its competitor, the twin-engined B777 series (including the B777- 200ER/200LR/300ER) has been the preferred choice. For example, the B777-300ER gained the lion’s share of new business over 2005-10, which led to production of the A340-600 to cease in 2011. The B777-300ER has even replaced the B747-400 on some long-haul routes.

In response to the loss of market share, Airbus moved its focus to develop new twin-engined aircraft, the A350-900 and A350-1000, to compete with the B777-200ER and B777-300ER, respectively. However, the first deliveries will not be made until 2014 and 2017, respectively. Boeing, meanwhile, is likely to promote the 787-10X and 777-9X as the new competitors to Airbus’s new A350 series.

- 35 - Aviation Primer Winter 2012

An example of wide-body aircraft (300-400 seats) – Boeing - B777-300ER

Business class Economy class

Source: CX, Skytrax

Wide-body aircraft details – 300-400 seats Most popular √ √ √ √ Manufacturer Airbus Airbus Airbus Airbus Airbus Boeing Boeing Boeing Country France, Germany, Spain, UK France, Germany, France, Germany, France, Germany, France, Germany, US US US Spain, UK Spain, UK Spain, UK Spain, UK Aircraft model A340-300 A340-500 A340-600 A350-900 A350-1000 777-200ER 777-200LR 777-300ER Status Out of production Out of production Out of production In development In development In production In production In production Seat capacity Typical 295 Typical 313 Typical 260 Typical 315 Typical 350 Typical 301 Typical 301 Typical 365 MTOW (lb) 568,800 811,300 804,675 598,000 679,024 656,000 766,000 775,000 Payload (lb) 104,100 95,500 122,600 168,375 TBA 120,500 n.a n.a Range (nm) 6,500 8,650 7,500 8,100 8,400 7,725 9,380 7,930 Cargo capacity (cu ft) 5,700 5,384-5,435 7,280-7,331 5,682 6,996 5,720 5,720 7,640 Fuel capacity (US gal) 37,150 56,750 51,750 36,456 41,211 45,220 47,890 47,890 High-speed cruise 0.86 0.86 0.86 0.89 0.89 0.89 0.89 0.89 (Mach) Max altitude (ft) 41,099 41,000 41,000 43,000 43,000 43,000 43,000 43,000 Entry into service 1993 2002 2002 2014 2017 1997 2006 2004 Number built n.a. 129 n.a. n.a. 416 54 332 Order backlog n.a. n.a. n.a. 372 69 12 3 275 Fuel consumption per km 0.300 n.a. 0.374 n.a. n.a. n.a. 0.305 n.a. (ton) Fuel consumption per km 0.001 n.a. 0.001 n.a. n.a. n.a. 0.001 n.a. per seat Fuel consumption per hr 6.173 n.a. 8.187 n.a. n.a. n.a. 5.530 n.a. (ton) Top three operators (in- Lufthansa, Iberia, SIA Lufthansa, Iberia, Virgin Atlantic Emirates, Qatar Emirates, Qatar United Continental, Delta Air, Emirates, Emirates, CX, Air service, order, stored) Airways, CX Airways, Ethiad American Airlines, BA Qatar Airways France Airways Source: Ascend, companies, various media

- 36 - Aviation Primer Winter 2012

Wide-body aircraft (more than 400 seats)

The series, launched in 1969, was for many years the largest aircraft in terms of capacity. This record was not broken until 2007, when the A380 was introduced. The older versions of the passenger B747 Classic (100/200/300) were replaced by the B747-400, which in turn, have now been replaced by the B777-300ER and A380.

Currently, the A380-800, the first of which was delivered in 2007, is the world’s largest aircraft, with a typical seating capacity of 525 passengers (maximum seat capacity is 853). It has replaced the B747-400 on a number of trunk routes (considered the major routes for an airline, eg, SIA now uses the A380 on Singapore-New York- Frankfurt route, which previously was operated by B747s), primarily between hub cities in Asia, North America, and Europe. The drivers of the need for such a large aircraft were: the industry’s long-term traffic growth forecast of 5% a year, the need to start replacing the B747-400, because it was less fuel-efficient than newer planes, airport congestion at major hubs (such as London, Tokyo, Beijing, and Hong Kong), and lower fuel burn per seat cost (17% lower than the 747-400 and 6% lower than the 747-8, according to Airbus).

In response to the mega-sized A380, Boeing launched its fourth-generation Boeing 747 version, the B747-8I, which has a typical passenger capacity of 467. The first passenger aircraft was delivered on 1 May 2012. The size was designed to slot in between the B747-400 and A380-800. We expect the B747-8I to face keen competition from the A380, as the A380 has proved to be popular since its entry into service and provides more flexibility for premium cabins because there is more room. As at the end of April 2012, Boeing had received orders for 36 B747-8I aircraft, while Airbus had recieved 253 orders for its A380.

- 37 - Aviation Primer Winter 2012

An example of wide-body aircraft (more than 400 seats) – Airbus - A380

First class Business class Economy class

Source: SIA, Airbus, Skytrax

Wide-body aircraft details – more than 400 seats Most popular √ Manufacturer Airbus Boeing Boeing Country France, Germany, Spain, UK US US Aircraft model A380-800 747-400 747-8I Status In production Out of production, in service In development Seat capacity Typical 525 Typical 400 Typical 467 MTOW (lb) 1,235,000 800,000 987,000 Payload (lb) 197,000 138,858 169,100 Range (nm) 8,300 6,000 8,000 Cargo capacity (cu ft) 6,200 n.a 5,705 Fuel capacity (US gal) 84,600 53,765 60,755 High speed cruise (Mach) 0.89 n.a 0.92 Max altitude (ft) 43,000 n.a 43,000 Entry into service 2007 1988 2012 Number built 75 442 n.a Order backlog 178 n.a 36 Fuel consumption per km (ton) n.a 0.338 n.a Fuel consumption per km per seat n.a 0.003 n.a Fuel consumption per hr (ton) n.a 9.535 n.a Top three operators (in-service, order, stored) Emirates, QAN, SIA BA , CX, Korean Air, Lufthansa Lufthansa, Korean Air, Source: Ascend, companies, various media

- 38 - Aviation Primer Winter 2012

Operating old or new aircraft

Overview

The decision to buy a new aircraft as opposed to a second-hand one depends on several factors, including financing, purchase discount on the price of a new aircraft compared with the second-hand price, and other company- or country-specific issues. Most of the time, the aircraft value and lease rates move in line with economic growth. Although the current lease rate is at a low level, most Asian airlines are continuing to buy new aircraft, due to the better economic-growth outlook and their stronger balance sheets compared with US and EU peers.

Selected aircraft market lease rates (aircraft built in 2000) Market Lease Rate (US$m per month) 0.8

0.6

0.4

0.2

0.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Assumptions: generic specifications, 5 year lease term to a reasonably good credit airline A320-200 737-800 A330-300 767-300ER Source: Ascend

New aircraft – B787 Second-hand aircraft – B707

Source: Boeing Source: Global aircraft org (website)

- 39 - Aviation Primer Winter 2012

Financing

The availability of financing is the most fundamental question faced by airline managements when deciding to purchase an aircraft. Such a decision depends on the interest-rate cycle and also the cash available from the individual airline. From the following chart it can be seen that airlines with strong cash positions, such as SIA and Southwest, tend to pay cash up front rather than through finance leases.

Net debt-to-equity ratios vs. fleet ratios of airlines (2011) Southwest United 2011 CX SIA AC CSA CEA Qantas ANA JAL Airlines Continental Delta Net debt-to-equity ratio (x) 0.40 net cash 1.60 1.67 2.89 0.49 2.00 1.12 0.08 2.75 n.a Fleet ratio (%) Self-owned 37 61 47 47 65 64 73 73 71 51 74 Finance lease 31 3 21 18 n.a. n.a. n.a n.a 1 n.a. 14 Operating lease 31 36 32 35 35 36 27 27 28 49 12 Source: Bloomberg, companies, Daiwa

Purchasing new aircraft at a discount vs. second-hand

Airlines often negotiate a much lower price for new aircraft than the tag price. But this depends on the size of the order and reputation of the airline’s brand. Also, some customers that purchase aircraft when they are launched, such as Singapore Airlines with the A380 and ANA with the B787, are likely to receive a better deal than other customers. Large airlines have a higher tendency to buy new aircraft as they are often able to get a favourable discount from manufacturers because they buy in bulk. The following chart shows the discount that can be offered is huge compared with the listed price.

Newly set-up airlines often opt to lease aircraft or purchase second-hand planes due to a lack of capital, their inability to obtain a good discount, and also as the delivery schedule may not meet their demands. Many incumbent airlines are buying new aircraft as the new models are often more fuel-efficient than old, second-hand aircraft.

Discount on listed prices of some aircraft US$m Listed price 2012 Market price Discount A319 81 30 (63%) A320 88 40 (55%) A330-200 209 84 (60%) B737-800 84 41 (51%) B737-900ER 90 45 (49%) B777-300ER 398 149 (50%) Source: Airbus, Boeing, Ascend

Other company- and country-specific issues

Some airlines prefer to maintain their fleets at a certain age. This enables the airline to provide state-of-the-art inflight entertainment and also make use of the most fuel-efficient aircraft. For example, Singapore Airlines starts to seek buyers of its aircraft when they reach five years or above. Such a practice is commonplace among those airlines with strong balance sheets (or availability of funding) and good maintenance records. From the following chart, it can be seen that due to SIA’s policy on aircraft sales and its strong balance sheet, it has a relatively young fleet.

Average age and net debt-to-equity ratio of airlines 2011 CX SIA AC CSA CEA Qantas AirAsia ANA JAL Average age 10.70 6.25 7.03 6.20 < 78.1~8.8 3.3 n.a 9.0 Net debt-equity ratio (x) 0.40 net cash 1.60 1.67 2.89 0.49 1.41 2.00 1.12 Source: Companies

- 40 - Aviation Primer Winter 2012

Also, the competitive environment and an airline’s brand affect the choice of aircraft. For example, in the US, airlines can compete with older aircraft as most of the US airlines do not have strong balance sheets to replace their fleet with newer aircraft. However, in Asia, it is difficult for the airlines to compete if their fleets include old aircraft. Even LCCs such as AirAsia are buying new aircraft currently.

For some countries, aircraft purchases are becoming part of the political activity between developing countries and Western nations. For example, the diplomatic visits by Chinese leaders to the EU and US often include a discussion about a sizeable framework agreement for an aircraft purchase from Airbus and Boeing, respectively.

Does size really matter?

Many airlines have been attracted to mega aircraft by the fact that the average seat cost per passenger would be reduced using mega-sized aircraft, such as the Airbus A380 or Boeing 747. Also, airline managements tend to expand their fleets due to possible economies of scale. In the following, we will discuss the actual benefits and risks of doing so.

Size of aircraft

In our view, apart from the constraints in terms of flying range, the use of wide-body or narrow-body aircraft differs depending on the markets they serve. Wide-body aircraft are best deployed on routes with high traffic levels, especially those popular with business travellers, as these aircraft have better inflight facilities than narrow-body jets and can accommodate more premium-class passengers, who are more lucrative than economy-class passengers. Therefore, many airlines try to deploy wide-body aircraft on key trunk routes to attract more high-yield premium-class passengers. Narrow-body jets are best deployed on routes where frequency of operation is a key factor. Airlines that dominate the best airport slots can take a higher market share, but often this requires the use of smaller aircraft. Also, narrow-body aircraft are often used to launch new destinations, as traffic may not be high during the first few years after the launch.

For mega-sized jets (such as the A380 and B747), we believe they are best deployed at airports where traffic is busy (especially where there is an abundance of business travellers) and slots are tight. The flying distance between airports must be long enough to enjoy the better fuel efficiency of the mega-sized aircraft such as the A380. In our view, there are only a few routes globally that best suit large aircraft, eg, from Asia (Hong Kong, Tokyo, Singapore, Shanghai, Beijing) to the US (such as New York) and UK (London).

Another benefit of operating mega aircraft like the Airbus A380 or Boeing 747 is that if flights are full, the average seat cost per passenger is reduced. However, the downside of owning large aircraft is the lower flexibility in terms of capacity reduction or capacity redeployment during economic downturns. Average seat costs rise significantly if flights are not full. If the route is serviced by two smaller aircraft, an airline may choose to lower utilisation, parking, or redeploy one of the aircraft elsewhere.

- 41 - Aviation Primer Winter 2012

Mega aircraft order book (as at 31 July 2012) (No. of aircrafts) 100

80

60

40

20

0 SIA CSA Qatar Asiana Arik Air Qantas Emirates Lufthansa Air France Lufthansa Korean AirKorean Korean AirKorean Thai Airways Virgin Atlantic Virgin British Airways British Etihad Airways Skymark Malaysia Airlines Airlines Hong Kong Hong Airlines A380 B747-8

Source: Airbus, Boeing

Comparison of cost per ASK (2011) (US$) 0.22

0.18

0.14

0.10

0.06

0.02 AC CSA CEA CX SIA QAN AirAsia Tiger ANA Skymark Korean Asiana Thai MAS CAL EVA Garuda Cebu Air NZ Air Airways Airways Pacific

Source: Bloomberg, Companies Note: Figures for SIA, Tiger, and ANA are based on Mar 2012 year-end

Using large aircraft often leads to fewer frequencies and therefore reduced connectivity for transit passengers. Therefore, a crucial decision for network carriers is whether they opt for higher frequencies but higher operating costs, or sacrifice some transit passengers in exchange for a lower cost per seat.

As LCCs have a high-frequency, short-haul business model, their fleets mostly comprise short-haul aircraft, such as the A320 or B737 series. For FSCs in Asia, the choice depends on the network and revenue contribution from different regions. The FSCs with high long-haul exposure, such as SIA and QAN, are more aggressive in buying mega aircraft than other FSCs in the region, such as Thai Airways and Malaysia Airlines. This is mainly because mega aircraft provide greater advantages on long-haul routes.

Carriers such as ANA and CX focus on relatively small long-haul aircraft such as the B787 and B777-300ER, respectively, because they are well located in North Asia, allowing them to fly shorter distances to major cities in the US and Europe as compared with their peers in Southeast Asia.

- 42 - Aviation Primer Winter 2012

Fleet size

In our opinion, globally, airlines with larger fleets do not necessarily have better operating margins than those operating smaller fleets. Elevated operating margins are often achieved through good cost management, and having a competitive edge in niche markets, like the LCCs and/or premium traffic. Most of the economies of scale are achieved during the airline’s initial build-up stage. The cost of holding spare parts, crew training and maintenance are areas where economies of scale can be achieved in the early build-up stage.

The following table shows the operating-profit margin of an airline does not improve even with a large fleet size. For example, the operating-profit margin of US Airways, with a fleet size of 340, is lower than that of CX, which has a fleet size of only 175 aircraft. Meanwhile, the margins of CX and SIA have not improved even though they have expanded their respective fleets. This may due to high competition in the region, high jet-fuel price, and high staff costs over the past 20 years. Therefore, we see the economies of scale achieved from having a large fleet size as being insignificant.

Operating margins vs. fleet size Southwest United US 2011 CX SIA AC CSA CEA Qantas ANA JAL AirAsia Airlines Continental Delta Airways Ryanair Operating-profit margin 4 2 9 4 4 3 6.9 17 19 4 5 6 3 16 Fleet size 175 100 432 444 377 283 226 215 103 698 701 775 340 294 Source: Companies

Operating margin vs. fleet size – CX Operating margin vs. fleet size – SIA

(unit) (%) (unit) (%) 180 25 120 18

150 14 15 90 120 10 90 5 60 6 60 30 (5) 2 30

0 (15) 0 (2) 1991 1992 1993 1994 1995 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 1991 1992 1993 1994 1995 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Fleet size (LHS) OP margin (RHS) Fleet size (LHS) OP margin (RHS) Source: Company Source: Company

- 43 - Aviation Primer Winter 2012

Summary of major players’ strategies

Aircraft selection is becoming more focused

Over the past decade, AC has retired many of its old aircraft, such as the A319, A340, B757, B767 and B747 models, and the old B737 models. The company has accelerated its rate of replacing old models with new ones in recent years, leading it to record impairment losses in its 2010 and 2011 results. Regarding replacement activity, AC now focuses on a few aircraft types, such as the A320 and B737 for short-haul routes, the A330 for medium- haul routes and the B777 for long-haul routes. We believe AC, like most other airlines, is likely to continue to use models from both Airbus and Boeing in the future. This would help Air China to save costs, as the fewer types of aircraft an airline has, the fewer types of equipment and spare parts it needs.

For premium airlines, our research shows that they have more balanced fleets, comprising Airbus and Boeing models (thereby ensuring good relationships with both manufacturers), and that they focus on buying the most efficient models available. This enables them to achieve higher efficiency (especially in terms of fuel) in their operations, which is important for premium airlines flying long-haul routes. For example, CX recently replaced its old B747-400s with more fuel-efficient B777-300ERs. This is similar to FSCs such as ANA and JAL, which both will be using more fuel-efficient B787s in place of their old B767s.

LCCs usually focus exclusively on a single model. In AirAsia’s case, this is the A320 aircraft type: it does not need medium- or long-haul aircraft as it serves only short-haul routes in Asia. As an LCC, it is important for AirAsia to keep its aircraft portfolio as streamlined as possible. Having a single aircraft model in its fleet allows it to do this, reducing maintenance costs (fewer different types of spare parts), and making the rotation of aircraft easier (as they have the same passenger capacity and configuration). In addition, it enjoys greater bargaining power from buying a large number of a single type of aircraft.

- 44 - Aviation Primer Winter 2012

Fleet profiles and upcoming delivery schedules of airlines Air China Cathay Pacific Group Singapore Airlines AirAsia Qantas ANA JAL 2011 2012 2013 2011 2012 2013 2011/12 2012/13 2011 2012 2013 2011 2012 2013* 2011 2012 2013 2011 2012 2013 Reported Delivery Delivery Reported Delivery Delivery Reported Delivery Reported Delivery Delivery Reported Delivery Delivery Reported Delivery Delivery Reported Delivery Delivery fleet size schedule schedule fleet size schedule schedule fleet size schedule fleet size schedule schedule fleet size schedule schedule fleet size schedule schedule fleet size schedule schedule Airbus

A300 A310 A319 43 6 A320 106 11 2 14 97 20 13 56 9 80 25 A321 6 6 A320/A321 22 17 A330 6 7 48 6 4 19 1 27 2 1 A340 34 13 5 A380 16 3 10 2 2

Sub-total 183 28 24 78 8 4 60 4 97 20 13 99 13 83 25 0 0

Boeing

717 11 2 737 190 18 26 65 12 11 51 59 2 747 9 21 1 26 8 757 10 767 5 25 59 49 777 14 6 6 41 5 8 59 49 6 6 46 787 15 6 14 7 2 7 4

Sub-total 228 24 32 62 5 8 60 0 0 0 0 127 14 26 173 20 13 156 9 4

Cargo A300-600F 2 8 737-300SF 4 747-8F 4 4 2 747-400F 10 2 23 13 757-200F 767-300 1 7 777F MD-11F

Sub-total 12 2 0 35 4 2 13 0 0 0 0 5 0 0 7 0 0

Other

ATR-72 Business jet 9 2 CRJ-200 9 EMB-145 EMB-145LR EMB-170 10 1 EMB-190 Hawker 800 MD-90 13 Tupolev Tu-204 DHC-8-Q100 4 DHC-8-Q300 1 DHC-8-Q400 11 SAAB340 11 Others 52 8 8 21 3 2

Sub-total 9 2 0 52 8 8 21 3 2 59 1 0

Total fleet size 432 56 56 175 17 14 133 4 97 20 13 283 35 117 226 23 15 215 10 4 Source: Company Note: *Data for QAN shown in the 2013 column is for its FY13-18 financial years

Aircraft purchasing activity remains high in Asia

The global economic slowdown in 2008-09 led to only a temporary softening in aircraft purchasing activity globally/in Asia over that period. Many airlines, especially Asian ones, continue to buy aircraft to replace their aged aircraft or increase capacity for future business growth. For example, China plans to increase its fleet size at a CAGR of 11% over 2011-15 (only slightly below the CAGR of 13% over 2006-10). LCCs such as AirAsia continue to expand their fleets to cover different markets including Thailand, Indonesia, the Philippines and Japan. This may be due to pent-up demand for the low-cost model in Asia.

- 45 - Aviation Primer Winter 2012

Traditional premium carriers, especially those with strong balance sheets like SIA, appear to be expanding their fleets steadily each year. Due to its strong balance sheet and clear corporate strategy, SIA usually buys its aircraft with its own cash and resells them in the market after five years. This business model enables SIA to maintain a young fleet and high fuel efficiency, but it requires a good brand name, efficient aircraft maintenance and a strong balance sheet (attributes which SIA has) to implement this model. CX also has a significant number of aircraft on order, but all of them are for medium- to long-haul routes. Many of the orders, mainly for the A350, are to replace aircraft to improve fuel efficiency. This is similar to ANA’s strategy regarding the B787, with the company targeting greater fuel efficiency on its medium- to long-haul routes.

Compared with the developed nations in North America and Europe, aircraft per population ratios are significantly lower in Asia. With the more robust traffic-growth outlook and stronger balance sheets of the Asian airlines, we expect aircraft orders over the next 2-3 years to come mostly from airlines in the region.

Current order book vs. fleet size (aggregate data for global airlines)

(no. of aircraft) (% ) 30,000 45

25,000 36

20,000 27 15,000 18 10,000

9 5,000

0 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

In service (LHS) Orderbook (LHS) Order book to fleet ratio (RHS)

Source: ASO Fleets, Ascend Note: airline-operated, Western-built jets only

ASK growth of airlines since 2006 (YoY % ) 44

36

28

20

12

4

(4)

(12) 2006 2007 2008 2009 2010 2011

AC AirAsia CX SIA QAN Global

Source: IATA, Companies

- 46 - Aviation Primer Winter 2012

Summary of airlines’ aircraft AC AirAsia CX Qantas SIA ANA JAL Regional jets Business jet No No No No No Yes Short-haul aircraft A320/A321/B737 A320 A320/A321 (Dragonair) B737 A319/A320 (SilkAir) B737/A320/DHC-8 B737/MD-90/DHC-8 Medium-haul A330 A330 (AirAsiaX) A330 A330 A330 B767 B767/B787 aircraft Long-haul aircraft B777 A350 (AirAsiaX) B777 B787/A380 A350/A380/B777/B787 B747/B777 B777 Ownership (%) 47 87 37 64 61 73 73 Current fleet size 432 73 167 149 100 226 215 On order 103 270 83 174 60 63 39 Source: Airbus, Boeing, Companies, Daiwa

Aircraft per capita worldwide (2011)

Source: Ascend

- 47 - Aviation Primer Winter 2012

- 48 - Aviation Primer Winter 2012

- 49 - Aviation Primer Winter 2012

Buying vs. leasing

Overview

Aircraft are by far the largest capital cost that an airline has to meet. Typically, an airline can expect to pay US$40- 50m for a single-aisle (narrow-body) aircraft, about US$100m for a medium-sized twin-aisle (wide-body) aircraft and over US$150m for a large twin-aisle aircraft.

Because of the high amounts involved, financing appropriately the aircraft in an airline’s fleet is crucial in order to maximise the airline’s return on capital. Most airlines cannot afford to pay cash for their aircraft and will need to source finance in some form in order to purchase aircraft. Start-up airlines have even less capital to deploy than established airlines and need to lease most of their aircraft in order to start operating. The next chart shows how the number of leased aircraft has risen over the past 30 years to account for more than 35% of the world’s aircraft fleet today.

Number of aircraft leased globally by airlines vs. those owned 25,000 40%

35% 20,000 30%

25% 15,000

20%

10,000 15%

10% 5,000 5%

0 0% 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Operating Lease Owned % on lease Source: Ascend

Leasing vs. self-financing of fleets

Leasing companies provide many important services to an airline.

Airlines can transfer the asset risk to the lessor Aircraft are depreciating assets and, while their future value is relatively predictable, it will vary in line with the economic cycle and the profitability cycle of the airline industry. The volatility of this value movement varies for different aircraft. Leasing companies can evaluate and take on this asset risk.

Airlines have greater flexibility to manage their fleets When airlines get into financial difficulty, this is usually during periods of low passenger demand. Airlines struggle to deal with this overcapacity by selling aircraft because the process is generally slow and aircraft values are depressed in an industry downturn. Having a portion of their fleet on operating leases gives airlines the ability to manage their capacity by not renewing leases.

Leasing companies offer 100% financing and a lower cost of capital than banks For start-up airlines, the option to finance their aircraft through leases without the need to pay equity for the aircraft is crucial for these airlines to get through their first years of operation. Also, in industry downturns airlines need to conserve cash and financing aircraft via the sale-and-leaseback method offers a way of doing this.

- 50 - Aviation Primer Winter 2012

Leasing companies offer additional capacity Airlines will look to leasing companies for additional aircraft at a time when their new aircraft on order are insufficient to meet their business growth.

Deciding whether to buy or lease the aircraft is determined by the airline’s need for the leasing benefits described above over owning the aircraft. In addition, airlines generally look to diversify their sources of finance so almost all airlines will take some aircraft on operating leases.

Airlines will have more success selling modern, mainstream assets to leasing companies. While leasing companies are willing to take on the asset risk, they have a clear preference for mainstream aircraft with the most up-to-date technology. Leased fleets comprise mainly in-production narrow-body aircraft. This aircraft category makes up 52% of aircraft on operating leases but 39% of the global fleet at present (according to Ascend). The chart below shows the proportion of the global fleet currently under lease by aircraft class and production status.

In-production narrow-body aircraft are the most widely-used aircraft worldwide, and offer a leasing company the widest range of options for re-leasing and sale, and are also among the least volatile aircraft in terms of value. They are also significantly less costly than wide-body aircraft to prepare for re-lease because they are more standardised and the interior configuration is simpler. Airlines will be more likely to find a leasing company to buy their aircraft if they are in-production narrow-body aircraft.

Since 2008, leasing companies have been increasingly willing to take on asset risk on in-production regional jets, especially the Embraer E-jet family and on wide-body jets, especially the Airbus A330 family and the Boeing 777- 300ER. The E-jets have shown similar value-retention characteristics to narrow-body aircraft. Wide-body aircraft have become more popular with leasing companies because of their importance in Asia. Airlines in the Asia-Pacific region generally use wide-body aircraft for ‘short-haul’ flights of up to five hours and there is relative under-capacity in this market. This has meant that wide-body aircraft have shown low volatility in their values through the global- financial-crisis period from 2008-09.

- 51 - Aviation Primer Winter 2012

Financing options

Overview

Airlines have sought diversified financing for their fleets for many years, and this has become increasingly important since the global financial crisis of 2008-09. In this section we discuss the commonly used finance structures for an airline that wishes to own its aircraft. We do not discuss unsecured borrowing by airlines or other short-term financing methods but focus instead on how airlines can finance aircraft deliveries.

Pre-delivery payment (PDP) loans

Airlines need to make PDPs to an aircraft manufacturer in stages during the two years prior to an aircraft delivery. These PDPs typically amount to up to 35% of the aircraft cost and can cause a significant drain on the airline’s capital. A small number of banks will provide loans for PDPs and will often treat these as unsecured loans.

Mortgage finance

This is the simplest form of aircraft finance. A bank will provide a term loan to the airline to buy the aircraft. The bank will typically advance 70-75% of the aircraft’s value and the loan will usually be for a 10- or 12-year term for a new aircraft and a shorter term for an older one. As aircraft are valued in US dollars, the loan will in almost all cases be a US dollar loan. Airlines with good credit ratings can usually borrow in their own currency but this is an exception. These loans can be paid back via fixed or floating interest rates and are fairly flexible, usually allowing for pre-payments during the term of the loan.

Export credit agency- (ECA) backed loan

In an ECA-backed loan, a bank will lend money to an airline but with a guarantee from the export credit agency of the country or countries of the aircraft manufacturer. For Boeing, this is the US Export-Import Bank (Ex-Im Bank). For Airbus, this is a combination of the Export Credits Guarantee Department (ECGD, in the UK), Euler Hermes (Germany) and Coface (France).

The airline pays the ECA for the guarantee and pays interest on the loan from the bank. Because the bank looks at the sovereign risk of the ECA country, this interest rate will be lower than the interest rate that the bank would charge the airline for a loan with no guarantee. The amount of the fee and the advance rate will depend on the airline’s credit rating with the ECA – this is governed by a set of rules called the Aircraft Sector Understanding. The terms of an ECA-backed loan are not particularly flexible. Airlines will generally choose these loans because of the fairly low overall cost or if they cannot access finance from other sources.

Tax lease

Some airlines can lease their aircraft on an operating lease or finance lease that offers tax benefits to the leasing company. These types of lease are attractive to airlines because they offer a lower cost of funds and often offer 100% financing up front with a purchase option during the lease, thereby giving the airline a present value (PV) benefit (where the PV of the payments under the lease including the purchase option is lower than the purchase price of the aircraft at the beginning of the lease). The most common tax lease structures are the Japanese Operating Lease with a Call Option (JOLCO) and the Spanish Operating Lease (SOL). Tax leases are usually quite inflexible and do not allow prepayment without a large premium. Airlines will choose these types of lease because of their low cost. - 52 - Aviation Primer Winter 2012

Secured bond issue

Secured bonds are currently only used by airlines in the US, which issue what are called Enhanced Equipment Trust Certificates (EETC). Most major airlines in the US have a standalone credit rating of around B currently, and so would struggle to issue any corporate bonds. An EETC offers the airlines the ability to issue bonds by offering security over the aircraft plus other enhancements.

Rating agencies will rate these bonds based on the timely payment of interest and the ultimate payment of principal. Therefore, by including a liquidity facility that pays up to 18 months of interest and by borrowing on a conservative loan-to-value ratio, the airline can get a BB+ or an investment grade rating for its bonds. Since 2008, airlines have also had to allow the security pool to be cross-collateralised.

This has been a very successful source of finance for airlines in the US and works because of the educated investor market there and the US bankruptcy code, which offers certainty to bondholders in the event of an airline bankruptcy. Like other bond issues, airlines will need to pay a premium to prepay an EETC bond. The advantage of the structure to an airline is that the airline can finance a large portfolio of both new and old aircraft at an attractive overall cost.

- 53 - Aviation Primer Winter 2012

Impact of financial crises on aviation finance

Overview

The 2008-09 global financial crisis has made the aircraft finance market considerably less certain. The main reasons for this are:

• Aircraft finance was hitherto dominated by European commercial banks, almost all of which have scaled back all lending since 2008. • Aircraft finance is a US dollar business and the cost of providing finance in US dollars has greatly increased. • Aircraft finance is a global, product-led business. This does not suit many banks’ post-crisis business models, where banks prefer to be relationship-led and to focus on local regions rather than acting globally. • The crisis has been accompanied by a period of heavy losses at the airlines, and banks’ appetite to lend to airlines will always diminish in these times. In 2009 there were fears of a ‘funding gap’, where aircraft manufacturers would not be able to deliver all of the aircraft they had on order because the airlines would not have the money to buy them. This did not happen for new aircraft because the export credit agencies increased their activity in the market to ensure that new aircraft on order would be financed and delivered.

The availability of ECA-backed financing and the large increase in the cost of financing for commercial debt effectively made ECA-backed financing the first choice for many airlines, despite its relatively inflexible terms. This led to the renegotiation of the ASU to increase guarantee fees and make other terms less attractive to airlines and return ECA-backed financing to being the last resort rather than the first choice.

The market stabilised somewhat in 2010 and banks became more certain about the amounts that they could lend to airlines. New leasing companies also entered the market and offered a valuable new source of capital. Through 2011, however, the market worsened as the Eurozone crisis took hold and many of the remaining European banks in the market either exited or scaled back their operations.

The outlook for 2012 is uncertain because of the continuing issues with European banks. This situation is exacerbated by the increase in deliveries by the aircraft manufacturers – based on the airlines’ current delivery schedules, we expect deliveries to rise by 40% from 2011 to 2015, making the challenge of financing the aircraft even more difficult.

- 54 - Aviation Primer Winter 2012

Trends in aviation finance and leasing

Overview

The aircraft finance market is now characterised by a number of significant trends:

• New aircraft are being financed by commercial banks but airlines of low credit quality find it extremely difficult to obtain financing. • These airlines will continue to use ECA-backed finance and sale-and-leaseback deals with leasing. • Many banks prefer to lend money to leasing companies for lower-quality airlines because they have a motivated leasing company between them and the airline to manage the aircraft if something goes wrong. • Airlines and leasing companies have very few sources of finance for aircraft over five years of age. That such aircraft are considered old is a concern in the market. In March 2012, Ascend conducted a survey of over 600 aviation finance professionals at airlines, banks and leasing companies to gauge their levels of confidence in sourcing finance. The survey showed an unprecedented level of uncertainty about financing aircraft. It found that 73% of aviation professionals are seeking financing outside their current relationships with banks and established lenders. Prior to 2008, this level of difficulty in aircraft financing was unthinkable. The survey found a serious lack of confidence among financiers looking to borrow in US dollars, with 43% of respondents saying they were not very, or not at all, confident in its availability. This again is a level of uncertainty previously unseen in the aviation industry. Before 2008, this question would not even have been asked, such was the level of confidence in US dollar availability back then.

On the subject of government guarantees, the majority of survey respondents believed that borrowers will choose to go to the commercial bank market for finance over using ECA-supported finance. In seeking creative financing alternatives, respondents said they would turn to Asian financial institutions and capital markets; other capital markets; hedge funds; private debt facilities; and regional and local banks. In fact, 50% of respondents said they would seek finance on the capital markets – again indicating a huge shift in lending patterns.

This high percentage shows that airlines and leasing companies are preparing for big changes to their sources of finance. Before 2008, they were well served by European banks and only leasing companies and US airlines tapped the capital markets with any regularity. Now, all airlines and leasing companies should be thinking about it.

- 55 - Aviation Primer Winter 2012

Summary of major players’ strategies

Asian players should easily obtain financing

On average, the Asian airlines enjoy lower interest rates on their fleet financing than US airlines due to the better traffic and earnings growth in Asia. Moreover, financing is more readily available in Asia than in Western countries. The table below shows that airlines in Asia typically receive better interest rates than their counterparts in other markets, while Asian airlines with strong balance sheets, such as SIA, do better still. Other airlines that have strong government backing, such as AC, are likely to continue to obtain strong financial support from local banks. New airlines that have world-class brands, such as AirAsia, should also secure favourable financing terms. Still, airlines at which traffic growth is relatively slow and government support lacking, such as ANA, typically bear higher operating lease expenses, since their cash positions may not be strong enough to support planned aircraft purchases, while they are unable to obtain good terms on financing leases owing to their high gearing and prospects for slow traffic growth. For JAL, as it has just resurfaced from its debt restructuring, its bank loans should be relatively small in the near term.

In general, credit policies in Asia are looser than in the US and the EU. As such, Asian airlines are enjoying lower borrowing costs than their US and EU counterparts. This has encouraged more Asian airlines to buy brand-new aircraft rather than lease second-hand ones over the past decade.

Interest-cost comparison of airlines (2011) Air France- United Delta Southwest AC AirAsia CX SIA QAN MAS Thai KLM IAG Ryanair Continental Airways Airlines Interest costs as a percentage of operating costs (%) 1.78 0.01 1.84 0.51 2.11 0.98 2.91 1.87 1.39 2.95 2.69 2.72 1.30 Effective interest rate (%) 1.86 4.81 4.36 3.64 5.31 4.30 3.87 4.35 4.73 2.99 6.27 5.91 5.74 Source: Companies

Leverage of airlines (2011) AC AirAsia CX QAN SIA ANA JAL Net debt-to-equity ratio (x) 1.6 1.4 0.4 0.5 Net cash 2.0 1.1 Bank borrowings as a proportion of total debt (%) 76 82 54 74 83 73 28 Financing leases as a proportion of total debt (%) 24 18 46 8 17 3 72 Operating leases as a proportion of total operating expenses (%) 5 2 3 4 4 16 3 Source: Companies, Daiwa

- 56 - Aviation Primer Winter 2012

- 57 - Aviation Primer Winter 2012

Fare structure

Segmentation is key

An airline aims to structure its pricing so as to sell all the seats for an optimal fare – often referred to as revenue management. Airlines globally have long been focusing on how to offer the most suitable fares to meet demand and at the same time to generate a profit. As shown in the following chart, which uses SIA as an example, the breakeven load factor is inversely related to yield movements. Airlines try to segregate the demand by setting different criteria when offering discount fares.

The fare structure breaks down into two major categories. The first comprises the different fare types, which mostly follow the standard set by the International Air Transport Association (IATA). These include the segregation of First, business and economy class fares, as well as some preferential fares such as those for children, infants, etc. The second major category is the detailed and complex conditions attached to each individual fare within each fare type. Common restrictions include a minimum/maximum length of stay, deadlines for ticket issuance and departure, and whether the ticket can be rerouted, etc. Promotional fares are offered mostly for short-haul flights in economy class.

SIA: maximising yield reduces the breakeven load factor of an airline (S¢/pkm) (%) 13 100

12 90

11 80 10

70 9

8 60 1Q02 2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11

Passenger yield (LHS) Pax breakeven LF (RHS)

Source: SIA

Comparison of current fares for premium class and economy class Premium class (US$) To New York To London To Beijing To Shanghai To Tokyo SIA (from Singapore) 6,719-11,497 5,671-9,322 2,564-4,195 2,253-3,845 2,641-5,127 CX (from Hong Kong) 11,817-24,735 8,358-24,735 1,315-1,669 933 - 1,182 2,680-3,319 AC (from Beijing) 7,520 6,515 n.a 676 1,627 CSA (from Guangzhou) 8,697 4,551- 7,807 1,095 - 1,362 592 - 823 1,466 CEA (from Shanghai) 9,272-11,227 5,972 600 - 783 n.a 1,301- 2,285 QAN (from Sydney) 8,137 11,526-13,953 5,921-11,136 5,913-11,142 7,059-13,083 Economy class (US$) To New York To London To Beijing To Shanghai To Tokyo SIA (from Singapore) 1,826 1,359 583 513 637 CX (from Hong Kong) 1,753 972 717 525 972 AC (from Beijing) 3,559 2,032 n.a 157 534 CSA (from Guangzhou) 1,908 743 355 212 662 CEA (from Shanghai) 2,566 985 159 n.a 449 QAN (from Sydney) 1,616 1,877 1,214 1,131 1,076 Source: Companies

- 58 - Aviation Primer Winter 2012

Low marginal costs lead to aggressive pricing

As the airlines’ products, ie, aircraft seats, are limited in terms of capacity and time span (they must be sold before the flight departs), the timing and scale of promotional activity are crucial. The industry is characterised by short-run marginal costs of close to zero, ie, the marginal cost of carrying an extra passenger including an additional meal and a little extra fuel burnt as a result of the extra weight carried is negligible. Therefore, airlines tend to sell as much capacity as possible even at low prices, due to the low marginal costs incurred. However, there is a general concern among airlines that considerable promotional activity may lead to downward pressure on future fares, as passengers have come to expect large discounts. Therefore, many premium airlines, such as CX and SIA, are trying their best to maintain or increase passenger yields.

CX and SIA: passenger yields since 1997 (HK¢) (S¢) 70 13

65 12

60 11 55 10 50

9 45

40 8 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Cathay Pacific (LHS) Singapore Airlines (RHS)

Source: Bloomberg,Companies

The LCCs generally have a relatively simple fare structure compared with that of the FSCs. The LCCs usually offer one or only a few types of fare (mostly economy) on a particular flight. They also allow one-way fares, while traditional FSCs seldom offer one-way tickets at a discount. The fare restrictions are mostly uniform on all tickets, such as no refund if not used, specific to a certain flight, etc.

Comparison of current fares between FSCs and LCCs CX United Continental SIA HK Airlines Cebu Jetstar Tiger Singapore to 296 313 296 400 492 260 196 Hong Kong (US$) Conditions Ticket includes Ticket includes Ticket includes Cancellation/ Flight can be Extra payment for Extra payment for baggage baggage fee, meal baggage fee baggage fee, meal refund fee applies rebooked/transferred baggage (US$23 for 20kg) subject to applicable (US$15 for 20kg) fees and penalties Cancellation/refund No special meal Cancellation/ Extra pay for baggage No meal included No meal included fee applies offered refund fee applies (US$23 for 20kg) Cancellation/refund Fares are non-refundable Fares are non-refundable fee applies Limited changes are Flight can be changed up to four permitted, charges apply hours before departure; the booking can be changed but this does not apply to certain selected promotional fares Not allocated any particular seat Source: Companies

- 59 - Aviation Primer Winter 2012

Cabin configuration

What works best?

While there is high segmentation of passenger air fares, cabin configurations are generally not so flexible due to the high capex involved. Currently, most of the traditional airlines use the 3-class cabin system (first, business and economy) for their wide-body aircraft and the two-class system (business and economy) for their narrow-body aircraft. LCCs mostly start with a single-class economy-only configuration, while some may add business or first- class cabins for their long-haul products. Cabin configurations also depend on the flight distance and passengers’ reasons for travelling.

On short-haul routes, there is generally no need for a first-class cabin, and so a two-class configuration may be a better choice for those routes, especially as narrow-body aircraft are used for most short-haul routes. The FSCs may not go for the single-class configuration even on leisure-travel oriented routes, due mainly to the need to rotate their aircraft in case any of disruptions on other routes (eg, due to engineering works).

For long-haul flights, where premium inflight facilities can make a big difference to passengers’ comfort, most of the airlines still use their three-class configuration. However, we have seen that First-class cabins have become under- utilised and therefore more airlines are opting to dispense with first-class cabins. This may due to improvements in business-class cabin facilities and changes in corporate travel policies. Nowadays, business-class facilities are generally very comfortable (most have flat beds) and meet most business travellers’ needs.

Business class – current style Business class – old style

Source: CX Source: Airline.net

Recently, some airlines (such as ANA, EVA, and CX) have started promoting a four-class cabin configuration by adding a premium economy class. We believe this is due partly to there being a wide range of fares available for economy class seats. Therefore, some airlines would like to differentiate between the service they offer high-yield passengers (ie, those paying the normal full fare) and that for low-yield passengers (ie, group or leisure travellers). By offering some additional services or better facilities, airlines aim to generate incremental revenue in this niche market. We believe the premium economy class is likely to work best on medium-to-long-haul routes, where passengers tend to be more willing to pay a premium for service and inflight facilities. However, we also see a possible risk that bringing in extra revenue for the airlines, some passengers might downgrade from business class to premium economy class during periods of economic weakness.

- 60 - Aviation Primer Winter 2012

CX: premium and standard economy class configurations Economy Premium economy Economy Premium economy Premium economy Premium economy Premium economy No. of seats A330-300 A330-300 B777-300ER B777-300ER-3 B777-300ER-4 B747-400 B747-400 First 0 0 6 0 6 9 9 Business 44 39 53 40 53 46 46 Premium economy 0 28 0 32 34 0 26 Economy 267 175 238 268 182 324 278 Total 311 242 297 340 275 379 359

Economy Premium economy Economy Premium economy Premium economy Premium economy Premium economy % of total seats A330-300 A330-300 B777-300ER B777-300ER-3 B777-300ER-4 B747-400 B747-400 First 0 0 2 0 2 2 3 Business 14 16 18 12 19 12 13 Premium economy 0 12 0 9 12 0 7 Economy 86 72 80 79 66 85 77 Total 100 100 100 100 100 100 100 Source: CX

Premium economy class Standard economy class

Source: CX Source: CX

- 61 - Aviation Primer Winter 2012

Direct sales vs. agency sales

The Internet changes the rules of the game

In the past, airlines often relied on travel agents to sell tickets, mainly because agents could consolidate all the price information from the airlines and hotels and offer customers attractive travel packages. This was a labour- intensive process requiring many sales and ticketing offices, and hence airlines found it difficult to penetrate the agency-sales market in the past.

The advent of the Internet has transformed the ticket-sale process over the past decade. Through the airlines’ websites and online travel agencies, customers can easily compare fares, schedules, seat availability and tour packages among the different airlines. This has increased customers’ bargaining power and brought about three positive effects. First, the Internet enables the airlines to bypass traditional travel agents and sell directly to customers. Second, the information obtained from Internet sales enables the airlines to understand their customers’ profiles and how effective particular promotional fares are, thereby enabling the airlines to provide more tailor-made services. Third, the airlines can easily find out what their competitors are offering in the market, which enables them to react promptly to fare discounts by competitors.

% of online air-ticket sales globally (%) 45

36

27

18

9

0 US UK Japan Germany France Spain China Italy India Singapore

2009 2010 2011 2012

Source: PhoCusWright Note: 2010 figures are estimates, 2011-12 figures are forecasts

Due to such radical change in industry practice, the role of the travel agent has diminished in many western countries, where the airlines tend to offer better discounts on their own websites (most often in their home country where they have greater brand recognition and customer loyalty). As such, the commissions paid by airlines to travel agents have been on a declining trend over the past decade. In many western countries, ‘zero commissions’ are now proposed, whereby the airlines offer a fare (net of commission) to the travel agents and the travel agents decide how much commission or service charge to charge the customers. This has increased the transparency on the commissions charged by travel agents and has led to profit-margin compression for many travel agents due to competition.

- 62 - Aviation Primer Winter 2012

Changes in commission rates globally Airline Commission (%) Effective date Airline Commission (%) Effective date China* Europe AC 3%+ Jul-10Aer Lingus 1% 2003 Air Canada 3% Jul-10 Aeroflot Russian Airlines 0% 2004 Air France-KLM Group 0% Apr-10 Air Canada 0% Jan-10 ANA 3% Jul-10Air France 0% 2005 CEA 3%+ Jul-10Alitalia 1% 2004 CSA 3%+ Jul-10Austrian Airlines 0% Feb-10 Lufthansa 1% Aug-10British Airways 0% 2005 Swiss International Airlines 1% Aug-10 Airlines 0% Apr-10 0% 2003 India* Iberia 0% 2007 Air Canada 0% Nov-08 KLM 0% 2003 Air France - KLM 0% Nov-08 LOT Polish Airlines 1% 2004 0% Nov-08 Lufthansa 0% 2004 British Airways 0% Nov-08 Qatar Airways 0% late 2007 Continental Airlines 0% Nov-08 0% 2003 Delta Air Lines 0% Nov-08 SNBrussels Airlines 0% 2005 Japan Airlines 0% Nov-08 Tarom Airlines 1% 2006 Lufthansa 0% Nov-08 Northwest Airlines 0% Nov-08 US Qatar Airways 0% Nov-08 Delta Air Lines 0% 2002 SIA 0% Nov-08Hawaiian Airlines 0% Jul-10 Silk Air 0% Nov-08 US Airways 0% Jan-10 Malaysia Malaysia Airlines 0% Aug-08 Singapore SIA 0% Jun-00 Source: , companies, various media Note:* for foreign airlines flying to China and India

Global distribution systems: also affected by the Internet

The airlines’ reduced reliance on travel agents for ticket sales leads to lower operating margins for the Global Distribution System (GDS) companies. These companies have electronic systems that link the airlines with travel agents. Airlines relied heavily on the GDS during the 1980-90s, when the GDS market was dominated by a few providers, namely Amadeus, Sabre and Galileo. The dominance and high profit margins of the GDS business were eroded following the deregulation of the air-travel industry in the US and the EU after 2000. Currently, Asian airlines rely heavily on the GDS companies, as their online sales platforms are still immature. However, given the trend in the US and the EU, where many airlines are bypassing travel agents, we believe the GDS companies’ profitability will come under pressure in the future as Asian airlines, too, start to bypass the travel agents and sell their products directly online.

GDS providers and global market shares (2011) GDS Major market Share of world market Amadeus Europe (excluding the UK) 38% Travelport (combines Galileo and Worldspan) North America, the UK, Australia and New Zealand 30% Sabre North America 27% Abacus Southeast Asia Combined five providers: around 5% Infini Japan Axess Japan Topas Korea TravelSky Technology PRC Source: Travelport, Amadeus, Daiwa estimates

- 63 - Aviation Primer Winter 2012

Growth stages of a GDS company Revenue

US

Mature to slightly declining stage (2004 Travelsky Mature stage (1990- 2004) – network reaches onwards) –GDS most of the world’s deregulation, more competition leads to Growth stage (1970-90s) prosperous regions. The declining margins, more – fast expansion in which increasing use of the M&A in the industry. Pioneer GDS see market share Internet for reservations stage (1960-70s) rising . and ticketing encourages – airlines create GDS airlines to begin divesting and trav el agents start to use GDS. GDS. Pioneer Growth Mature Declining

Source: Daiwa

- 64 - Aviation Primer Winter 2012

Clients of worldwide GDS companies GDS provider Airline Airlines GDS provider Airlines Airlines ameliaRES InteliSys Aviation Systems Other 20 LCC & airlines Mercator Emirates InterSky Abacus ANA Malaysia Airlines Air Algérie JetLite CX Philippine Airlines Air Malawi China Airlines Air Pacific Malaysia Airlines Dragonair SABRE Air Merpati Nusantara Airlines EVA Airways SilkAir People's Viennaline Garuda Indonesia SIA Philippine Airlines AccelAero Mihin Lanka TransMaldivian Airlines CTK – CiTylinK Sky Work Airlines Over 2 airlines and low-cost carriers Amadeus LAN Airlines Danube Wings LAN Argentina Emirates LAN Zest Airways Air LAN Perú Navitaire Jet4you Air Caraïbes Aer Arann Jetstar Airways LOT Polish Airlines AirAsia Air France-KLM Lufthansa AirAsia X Jetstar Malév Hungarian Airlines Air Greenland LIAT Air Pacific Lion Air AirTran Airways Mandala Airlines airBaltic Niki Monarch Airlines OpenSkies Nas Air Austrian Airlines PLUNA Nok Air QAN Porter Airlines Blue1 Qatar Airways Ryanair British Airways Rossiya Skywest Airlines British Midland International bmibaby Royal Brunei Airlines CanJet SpiceJet CX Cebu Pacific Strategic Airlines Cimber Sterling Safi Airways Cobham Aviation Services Australia Tiger Airways Corsairfly SAS Eastar Jet Transavia.com SATA Air Açores Firefly TUIfly SATA International Dragonair Saudi Arabian Airlines Gol Transportes Aéreos Thomas Cook Airlines EgyptAir Scandinavian Airlines IndiGo Wizz Air Virgin Blue Estonian Air Etihad Airways TACA Airlines PARS/SHARES by EDS Air Nigeria Hawaii Island Air Finnair TAM Airlines Swiss International Air Lines Hex'Air TAM Mercosur Continental Airlines United Continental Iberia TAP US Airways Toumaï Air Tchad Flybe Virgin Atlantic Airways Jat Airways Tunisair Patheo Finnair Jin Air KLM LACSA Widerøe Lufthansa - > Moved to Amadeus XL Airways France Sabre Aeroflot Axess Japan Airlines Aerolíneas Argentinas Internet Booking Engine Qatar Airways Sri Lankan Airlines Air Jamaica Jet Airways KIU AeroGal Lloyd Aéreo Boliviano JetBlue Airways Aeropostal Alas de Venezuela MAYAir Air Nui Air Cuenca Peruvian Airlines Alaska Airlines Kingfisher Airlines Avolar Regional Paraguaya Avior Airlines kulula.com CATA Línea Aérea SAEREO Midwest Airlines EasyFly Sol América PenAir Guinea Líneas Aéreas Sol Líneas Aéreas Central Mountain Air TRIP Linhas Aéreas Interair Southern Winds Airlines Comair (South Africa) Vietnam Airlines LADE Star Perú Cyprus Airways Virgin America LAER Tiara Air Era Alaska Virgin Australia LASER Airlines Transportes Aéreos Cielos Andinos LC Busre Venezolana WestJet Línea Aérea Amaszonas VIP Ecuador TravelSky AC Hong Kong Airlines Hong Kong Express Airways CEA CSA Shanghai Airlines Hainan Airlines Source: Companies, various media

- 65 - Aviation Primer Winter 2012

Summary of major players’ strategies

High segmentation

Airlines still face the issue of how to maximise the revenue from every available seat. LCCs such as AirAsia have low fares, while premium carriers such as CX and SIA charge a premium for business class and even premium economy compared with economy class. Those airlines operating in a market with strong demand growth, such as AC and Jet Airways, may enjoy some pricing advantage due to less competition. However, others, such as QAN, JAL and ANA, may continue to lose market share.

AirAsia: fare promotion

Source: Company

Direct sales through loyalty programmes

Most Asian airlines rely on the services provided by GDSs, as the contribution from Internet sales remains limited. One exception is AirAsia, which relies solely on Internet sales. However, given the high GDS fees and commission expenses airlines have to pay, they are keen to expand direct sales to their customers. At ANA, for example, commission expenses were equivalent to 6% of its revenue in 2011, which we consider to be significant given the airlines net-profit margin was only 2% for 2011. In recent years, JAL, ANA, CX, SIA, and AC have been promoting special fares and tour packages on their websites to attract more individual travellers. In addition, they send special promotions through their frequent-flyer programmes (FFP).

However, as direct sales for many airlines are still not the sole distribution channel (they account for only 30% of revenue for AC and 50% for CX), we believe the airlines’ reliance on GDSs will continue for the next five years, as it will take time for customer behaviour to change and the airlines to develop the IT infrastructure for such a change. The growing number of online travel agents should help speed up this process.

- 66 - Aviation Primer Winter 2012

Frequent-flyer programmes

FFPs aim to encourage travellers, especially those who travel frequently, to use an airline as much as possible. The concept originated in the US in 1979. A customer can accumulate FFP miles or points when flying with the airline, and these can be redeemed for free tickets or other services, such as a cabin-class upgrades.

In addition, the FFPs allow the airlines to collect useful information about these high-spending customers, eg, travel patterns, and enable their marketing efforts to be more targeted.

An example of the benefits offered in a FFP – CX’s Marco Polo Benefits Green Silver Gold Diamond Reservation Flight reservations via dedicated 24-hr Club Service Line √ √ √ √ Advance Seat Reservation √ √ √ Priority waitlisting √ √ (High) √ (Top) Guaranteed Economy Class seat √* √** Guaranteed Premium Economy Class seat (on CX flights only) √** Guaranteed Business Class seat (on Cathay Pacific flights only) √** Extra-legroom Seats √ √ √ Extra-legroom Seats redemption √ √ √ √ Check-in First Class counters - √ Business Class counters √ √ √ Designated Club counters √ √ √ √ Baggage privileges Additional checked baggage allowance 10 kg 15 kg or 1 pc 20 kg or 1 pc Extra baggage redemption √ √ √ √ Priority baggage handling √ √ √ (First Priority) Special cabin baggage allowance 10 kg 10 kg 15 kg Lounge access Cathay Pacific First Class lounges √ Cathay Pacific Business Class lounges √ √ √ Dragonair lounge √ √ √ Arrival lounges √ √ Guests 1 2 Lounge access redemption √ √ √ √ Additional benefits (applicable to all tiers) Personalised baggage name tags √ √ √ √ Priority boarding √ √ √ √ Dedicated Club Service Desk at Hong Kong International Airport √ √ √ √ Dedicated Club Service Centre (24-hr worldwide toll-free service line) √ √ √ √ The Club digital magazine √ √ √ √ Exclusive promotions and offers √ √ √ √ Source: CX Note: * 72 hours prior to departure ** 24 hour prior to departure

- 67 - Aviation Primer Winter 2012

Airline loyalty programmes AC CEA

QAN CX

Source: Companies

Direct sales vs. GDS AC AirAsia CX QAN SIA ANA JAL Use of GDS Yes No Yes Yes Yes Yes Yes Direct sales as a % of total sales 30 85 50 67/30* n.a n.a n.a Commission expenses as a % of revenue (2011) 3.1 n.a 0.8 n.a 2.2 5.8 1.9 Source: Company, Daiwa Note:*QAN: 67% was from domestic bookings, about.30% was from international bookings

- 68 - Aviation Primer Winter 2012

- 69 - Aviation Primer Winter 2012

Industry divergence

LCCs vs. premium airlines vs. niche players

We believe the future winners in the industry will be either premium-class airlines (such as CX and SIA), LCCs (such as AirAsia) or those with an advantage in a niche market (such as AC and Jet Airways). We expect those in between to continue to struggle to make a profit, although they may not necessarily go bankrupt as many of them receive government support.

We expect the recent rise in the number of LCCs being established to continue for a while, as many airlines consider the current penetration rate of LCCs to be low in most Asian countries. However, we believe the situation will be similar to that from 2004-06, with not all of them succeeding. Ultimately, we believe those in Southeast Asia, where we see greater unsatisfied demand due to low income levels and less regulated aviation markets, have higher chances of succeeding. Leaders such as AirAsia will enjoy first-mover advantage, in our view.

In recent years, increasing numbers of FSCs, including ANA and SIA, have established a LCC branch (eg, Peach and Tiger Airways) in a bid to capture the low-end travel market. As it stands, however, the consolidated FSC+LCC model does not seem to have delivered a better profit margin when compared with operating either a FSC or a LCC. For example, CX and AirAsia had net-profit margins of 6% and 12% respectively, while for SIA, ANA and QAN the equivalent figure was only 2% for 2011. Some airlines pursuing the FSC+LCC model, such as Thai Airways and Malaysian Airlines, are even loss-making (see page 71).

Development timeline of LCCs in Asia

(No. of new set-up) Indonesia AirAsia 8

Air Next 7

Air India Express 6

Spring Airlines VietJet Air 5 Thai AirAsia AirAsia Japan 4 Orient Thai Tiger Airlines StarFlyer Airways Nok Air Mihin Lanka Thai Smile 3 Zest Cebu Solaseed Kingfisher Jetstar Jetstar Oasis JetLite Airways Pacific AirAsia Air Red Asia Airways Airlines Firefly Scoot 2 Jetstar Jet Shaheen Airphil JAL Batavia AirAsia Spirt of Air AirAsia Jetstar Pacific Airways Air Express Skymark Express Lion Air Citilink Air Airblue SpiceJet GoAir Indi Go X Manila Mekong Philippines Peach HK 1

0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 (Year) Source: Companies, various media

- 70 - Aviation Primer Winter 2012

LCCs: share of total seat capacity (domestic) LCCs: share of total seat capacity (international) (YoY %) (YoY %) 80 50

40 60 30 40 20 20 10

0 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Nov-12 Nov-12 Japan Malaysia Philippines Japan Malaysia Philippines India Indonesia China* India Indonesia China* Source: CAPA Source: CAPA Note:*China data includes Hong Kong and Macau Note:* China data includes Hong Kong and Macau

Business class Economy class

Source: SIA Source: SIA

Comparison: FSCs and LCCs Thai Malaysia Company AC CX SIA QAN ANA JAL Airways Airlines AirAsia Skymark Category FSC FSC FSC + LCC FSC + LCC FSC + LCC FSC FSC + LCC FSC + LCC LCC LCC Net-profit margin (%) 6.7 5.6 2.3 2.1 2.0 15.5 (5.3) (18.5) 12.4 9.6 Source: Bloomberg, Companies Note: Data based on 2011 reports

- 71 - Aviation Primer Winter 2012

Open skies

ASEAN to spark liberalisation in the region

The member countries of ASEAN are due to implement open skies by 2015. This includes multiple designations (more than one airline permitted to operate on one route), and the liberalisation of fifth- and possibly seventh- freedom rights with ASEAN countries. So far, only five countries (Singapore, Malaysia, Myanmar, Thailand, and Vietnam) have third- to fifth-freedom rights with each other, while three countries (Brunei, and Cambodia) only allow these to their capital cities. However, we believe that most ASEAN countries will be able to meet the schedule of full liberalisation by 2015.

Following the trend of open skies in ASEAN, we believe there will be increased liberalisation of traffic rights in Asia in the near future, with the liberalisation of third- and fourth-freedom rights the first steps down this path. Politics, as is the case with Mainland China and Taiwan, may help speed up the process as well.

In strong economies, such as China, India, and Japan, we expect objections to the liberalisation of fifth-freedom rights and above from the major players, mainly due to them being worried about increased competition, while there is little incentive to explore the markets of smaller Asian countries. The liberalisation of traffic rights between countries is often related to the relative economic strength of the economies, with stronger nations more reluctant to open their market to competition, while countries with weaker economies hope to attract traffic from stronger nations to boost the profitability of their airlines.

We believe the North Asian countries will monitor closely the impact of ASEAN’s open-skies policy on their incumbent carriers. Over the past five years, competition has increased in the ASEAN region. We believe it will intensify as ASEAN airlines had placed large aircraft orders in preparation for open skies in ASEAN.

ASEAN: phases for implementing open skies Phase 1: 2005 – 2007 Double designation, move to substantial ASEAN ownership; unlimited 3rd and 4th freedom within ASEAN; and opening of secondary gateways Phase 2: 2008 - 2010 Multiple designation; restricted 5th freedom beyond rights; completion of opening up of gateways, remove restrictions on fares Phase 3: 2011 - 2012 Principal place of business for ownership; 5th freedom within ASEAN; possible 7th freedom within ASEAN, charter liberalization Source: ADB Institute

SIA vs. traffic growth Malaysia Airlines and AirAsia Airlines vs. Kuala Lumpur International Airport traffic growth (YoY) % (YoY) % 25 40

30 15 20

5 10

0 (5) (10)

(15) (20) 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 SIA Singapore airport MAS Malaysia airport AirAsia Source: Airport International Council, companies Source: Airport International Council, companies

- 72 - Aviation Primer Winter 2012

Thai Airways vs. Suvarnabhumi Airport traffic growth (YoY) % 40

30

20

10

0

(10)

(20) 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Thai Air Suvarnabhumi Airport

Source: Airport International Council, companies

Asian airlines: aircraft orders

(No. of aircrafts) 400

350

300

250

200

150

100

50

0 AC CX SIA JAL CAL EVA ANA CEA CSA MAS QAN Cebu Qatar Asiana LionAir Etihad AirAsia Garuda Garuda Emirates Korean Air Korean Widebody Narrowbody Source: Airbus, Boeing

- 73 - Aviation Primer Winter 2012

Emission Trading Scheme

EU ETS to push forward the development

This year, the EU started implementing its aviation ETS (see section below for details), with the first payments due to be made in 2013. Airlines from many countries, including the US, China, Russia, India, and even IATA – have complained about the scheme. The major objection is the calculation of the charges, which are based on where the aircraft originated from (even if it was outside the EU) rather than from where it entered EU airspace.

Airlines from emerging countries have been the most resistant to the scheme, with those from China and India not submitting the required carbon emission data by the deadline of June 2012. The Civil Aviation Administration of China (CAAC) prohibits any PRC airline from joining the EU’s ETS. Meanwhile, India has said it will retaliate if the EU bans any Indian airlines from entering the EU. The political tension, therefore, surrounding the issue, is high. However, as we believe the EU and other countries do not want to ruin their political relationships because of the ETS, we expect them to seek a solution in the near term.

A possible solution is that each country develops its own ETS (maybe just a framework and a schedule) and asks for exemption from the EU scheme. However, there is a risk that the countries over which an aircraft flies will also want a ‘piece of the pie’ by raising overflying charges, using carbon emissions as an excuse. Over the long term, once all countries have established their own ETS, we believe each country will only be responsible for those flights departing from their airports, which would be easier administratively. The International Civil Aviation Organization (ICAO) is seeking a solution for airlines globally currently, but we believe it may not be able to meet the deadline of March 2013.

EU ETS: news flow on opposition to the scheme Date Detail Jun-12 Chinese airlines will snub a mid-June 2012 deadline for submitting carbon-emissions data to the EU Mar-12 India proposes asking Indian airlines not to share emissions data with the EU or not to buy any carbon credits Feb-12 29 nations join Russia in signing a declaration against the EU's ETS carbon tax. The declaration was signed at an international conference in by Armenia, Argentina, Belarus, Brazil, Cameroon, Chile, China, , , India, Japan, South Korea, Mexico, Nigeria, Paraguay, the Russian Federation, Saudi Arabia, Seychelles, Singapore, South Africa, Thailand, Uganda, and the US Oct-11 US House of Representatives rejects ETS and passes bipartisan legislation that prohibits the implementation of a new carbon-trading regime for aircraft flying from the US to the EU Mar-11 China Air Transport Association says ETS violates international law and is ‘not reasonable’ Source: BBC, Xinhua, various media

What is the EU’s ETS

The EU ETS was the first largest international scheme for the trading of greenhouse gas emission allowances, such as CO2. It was launched in 2005 and is based on a ‘cap and trade’ principle. According to the European Commission, this means there is a limit on the amount of greenhouse gases allowed by a particular business. Annually, each company receives free emission allowances. If the companies’ emissions are higher than their allowance, they need to buy the additional amount in the market. If their emissions are less, they can keep the residual allowances for future use by themselves or sell them to another company that has exceeded its allowance. The number of allowances is reduced over time. By 2020, emissions will be 21% lower than 2005, according to European Commission. The aviation sector aims to lower its emissions by 50% by 2050 compared with 2005 (see the following chart).

According to the European Commission, airlines are due to join the scheme in 2012. The allowance set for airlines this year is 0.6797 of emissions per thousand tonne kilometres. For 2013-20, the benchmark is 0.6422 allowance of emissions per thousand tonne kilometres metres. The total quantity of allowance for each airline is calculated by using this benchmark rate and multiplying the tonne-kilometres flown during 2010.

- 74 - Aviation Primer Winter 2012

Timeline for cutting carbon emissions by the airline industry

Known technology, operations Improve fleet fuel efficiency by 1.5% per 1 and infrastructure measures year from now until 2020 Bio-fuels and additional Cap net emissions from 2020 through 2 new-generation technology carbon neutral growth Economic measures By 2050, net aviation carbon emissions 3 Net emissions trajectory will be half of what they were in 2005 ‘No action’ emissions

Source: Airbus, Daiwa

- 75 - Aviation Primer Winter 2012

In search of greater fuel efficiency and alternative energy

Increasing need for improved fuel efficiency

The jet-fuel price has risen sharply over the past decade, increasing by 438%, from US$22.6/bbl at the end of 2001 to US$121.5/bbl at the end of 2011. For most airlines, fuel costs as a percentage of total operating expenses have increased from about 20-25% in 2001 to 35-40% recently.

Jet-fuel price since 2001 Fuel efficiency vs. capacity growth

(US$/bbl) (%) (% ) 200 160 900 120 160 700 80 120 500 40 80 300 0

40 (40) 100

0 (80) (100) -10 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 -01 -05 r-06 y g p p Jul-04 Jul-11 Oct-09 Oct-02 A Jun-07 Jan-08 Jan-01 Mar-09 Mar-02 Feb-05 Feb-12 Dec-03 Nov-06 Aug-08 Dec-10 Au Se Ma May-03 Fuel efficiency Capacity growth Jet fuel price Jet fuel price (LHS) YoY (RHS) Source: Bloomberg Source: CAAC

Growth of cost per ASK Fuel cost to operating expenses (YoY % ) (% ) 35 45

20 40 5

35 (10)

(25) 30

(40) 2007 2008 2009 2010 2011 25 Cost per ASK Cost per ASK (ex . fuel) Cost per ASK (fuel) 2007 2008 2009 2010 2011 Source: Companies Source: Companies Note: Average no. of six Asian airlines: AC, CSA, CEA, CX, SIA, QAN Note: Average no. of six Asian airlines: AC, CSA, CEA, CX, SIA, QAN

To mitigate the impact, many airlines are using oil derivatives to hedge against the volatility in the jet-fuel price. However, the huge loss made by the industry in 2008 and the high cost premium on oil derivatives have discouraged the managements of many airlines from entering into new contracts since 2008. Most airlines reduced their hedging ratios in 2011 compared with 2008.

Fuel-hedging comparison hedge loss AC CSA CEA CX SIA ANA JAL 2008 ($m) 1,137 n.a 900 984 249 n.a n.a Hedge % - 2008 50% 0 - 20% 0 - 30% 38% 30 - 60% 50% n.a Hedge % - 2011 0 0 0 20% 20% 40% n.a Source: Companies, HKEX

- 76 - Aviation Primer Winter 2012

Apart from hedging oil derivatives, the improving fuel efficiency of aircraft, due to increases in seat capacity, the use of lighter materials and more efficient fuel burning by engines, will help airlines use less fuel per kilometre of travel. Indeed, fuel efficiency is arguably the biggest selling point of the B787 Dreamliner, for which ANA is a launch customer. According to Boeing, the B787 consumes 20% less fuel than similar-sized aircraft. We believe this is a big factor in ANA’s purchasing decision, since the airline needs more fuel-efficient aircraft to replace its B767s.

In addition, the introduction of aviation biofuel (see below) in the future should help the industry to be less reliant on traditional kerosene as jet fuel. However, IATA expects biofuel to account for only 6% of the total global consumption of aviation fuel by 2020, making it only a long-term solution for the industry.

China: jet-fuel consumption (Tonnes m) (Tonnes per km) 18 1

15 0.8

12 0.6 9 0.4 6

0.2 3

0 0 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Fuel consumption Fuel consumption per km

Source: CAAC

Aviation biofuel development

Aviation biofuel was first approved for commercial use in July 2011. Before then, there were a number of test flights by airlines, starting from 2008. For example, in October 2011, AC operated a flight using jatropha oil that flew for two hours above Beijing, and in January 2012, Etihad Airways operated a biofuel flight from Abu Dhabi to Seattle using a combination of jet fuel and vegetable cooking oil. So far the aviation biofuel used in the test flights is mostly made from algae, jastropha, and camelina. Other common sources of biofuel include salicornia, wood waste, and yeast.

- 77 - Aviation Primer Winter 2012

The need for co-operation

Battle among the airline alliances

Airlines today are co-operating more than ever before. In the early 1990s, they started to cooperate through codeshare agreements (see pages 79-80), which we consider to be a loose type of co-operation given the low commitment among the companies to cross-sell each others’ seats.

This co-operation evolved in the early 2000s into the big three alliances: , SkyTeam, and . Alliances offer members the opportunity to reduce their operating costs through joint purchases of fuel and flight equipment, and the sharing of ground and engineering services at common airports, such as airport lounges. Meanwhile, members can expand their networks through codesharing, which can reduce the risks of expanding and the time and effort needed to launch flights on a route. By codesharing, airlines can also operate in some restricted markets (eg, domestic markets). Nowadays, most of the major airlines belong to one of the three major alliances.

In our view, future competition in the aviation industry will no longer simply be on an airline-to-airline basis, rather it will be at the alliance-to-alliance level. Alliances need to maintain a competitive network to attract passengers. We believe Star Alliance is currently the strongest, with most of its members based in different countries and therefore providing travellers with a much more comprehensive network.

Co-operation between airlines with different business models

In addition to the alliances, we are seeing a trend of more joint ventures (JV) being set up by airlines. A joint venture is a closer form of co-operation than codesharing and membership of an alliance. It involves the sharing of revenue and costs (there are no sharing of costs in codesharing). Recent examples include CEA and Jetstar Asia forming a JV to set up an LCC in Hong Kong, Jetstar Hong Kong, AirAsia and ANA establishing a JV for AirAsia Japan, and AC and CX forming a cargo JV in Shanghai. We have seen a growing trend for mature airlines (such as CX in the above case) form JVs with fast-growing airlines (such as AC) in order to benefit from new business opportunities. Also, some FSCs (such as CEA and ANA in the above case) have established JVs with LCCs (such as AirAsia and Jetstar Airways) to explore opportunities in the low-end market.

Some airlines are even becoming major shareholders in other airlines. For example, AC and CX own strategic stakes in each other. Meanwhile, some recent examples of M&A include CEA acquiring Shanghai Airlines in 2009, AC acquiring in 2010, and AirAsia’s proposed acquisition of Batavia Air in Indonesia in July 2012. We believe there have been more cases of M&A in recent years due to it being difficult for airlines to make a profit and many small players being in financial trouble. However, as some countries restrict ownership levels of domestic airlines by foreign airlines (often set at no more than 50%). Therefore, for the foreseeable future, M&A is likely to be restricted among domestic players.

- 78 - Aviation Primer Winter 2012

Airline alliances (2011)

Star Alliance members SkyTeam members oneworld members Countries 190 173 149 Destinations 1,293 958 800 Passengers (m people) 649 506 325 Revenue (US$bn) 161 n.a. 106 Members Adria Airways Aeroflot Airberlin Aegean Airlines AeroMexico American Airlines Air Canada British Airways AC Air France CX Air New Zealand Alitalia Dragonair (affiliate of CX) ANA China Airlines Finnair CEA Iberia Austrian Airlines CSA Japan Airlines Blue1 Czech Airlines LAN Brussels Airlines Delta QAN Croatia Airlines Kenya Airways Royal Jordanian EgyptAir KLM Ethiopian Airlines Korean Air LOT Polish Airlines Saudi Airlines Lufthansa Tarom Scandinavian Airlines Vietnam Airlines SIA Middle East Airlines* Silkair (affiliate of SIA) South African Airways Swiss International Air Lines TAP Portugal TAM Airlines Thai Airways United Continental US Airways Source: Star Alliance, SkyTeam, and oneworld Note: *Joined the alliance at 28 June 2012

What is a codeshare agreement?

A codeshare agreement is an arrangement between airlines to share their operating aircraft. The seat sold by one airline (airline A) can be operated by another airline (airline B). The flight number of the flight may be different depending on whether you buy the ticket from airline A or B. The airline that operates the flight (airline B, for example) is called the ‘operating carrier’. The airline that sells the seats on the flight but does not operate it is known as the ‘marketing carrier’. For example, in the following chart, AC codeshares with CX on a flight from Hong Kong to Beijing. Assuming CX is the operating carrier, it would sell the flight using its airline code, CX, and the flight number might be CX391. However, for the same flight, AC (as the marketing carrier) would be selling the seats under its own airline code, CA, flight number CA6603. Codeshare flight numbers for the marketing carrier often have four digits: for the operating carrier, three digits are used).

- 79 - Aviation Primer Winter 2012

Examples of codesharing

Source: Hong Kong International Airport

Advantages of codesharing

By entering into a codeshare agreement with another airline on a route on which both operate, an airline can increase the number of flights available to offer to its customers. Meanwhile, if the codeshare agreement is between airlines on a route on which they do not both operate, the marketing carrier is able to offer a new destination without operating to it. This may also help to provide access to routes on which there are traffic-right restrictions. For example, by codesharing with American Airlines on domestic flights in the US, CX is able to sell directly flights within the US, which are normally not available to overseas airlines. It also allows the airlines to provide an expanded route network to their customers. Meanwhile, the codeshare partners flying on a route on which both operate tend to have less incentive to increase capacity aggressively as they have higher flight frequencies from codesharing.

- 80 - Aviation Primer Winter 2012

Increased network coverage from codesharing: CX/AA

Cathay Pacific Services

Dragonair Services

Joint operating services or codeshare services

Source: CX , Daiwa

Pricing

Codeshare partners agree a settlement price for each codeshare seat sold. Prices vary depending on the flight times (arrival and departure) and the time of year. Normally, it is more expensive for flights that are considered to have good departure times and those during peak seasons (eg, on public holidays). The operating carrier will usually try not to set a price lower than the normal market fare. Otherwise, its partner (the marketing carrier) can sell seats at a cheaper price and earn a greater profit. However, if the price is set too high, there is less incentive for the marketing carrier to sell at the settlement price as the price may not be competitive compared with other airlines. As a result, it can take a long time before a consensus is reached between the two parties.

Overall, we believe that many codeshare agreements tend to set prices within a high range in order to protect the interests of the operating carrier. Therefore, the incentive for a marketing carrier to promote and sell seats on a codeshare flight is normally low, making the effectiveness of codesharing limited, in our view.

- 81 - Aviation Primer Winter 2012

Shortage of pilots

The situation favours the existing players

According to Aviation Media, quoting the International Civil Aviation Organization (ICAO), the global demand for pilots should reach 980,000 by 2030. This implies a need to recruit 52,500 pilots every year between now and then. However, the current number of new joiners was 44,534 per year in 2011, which means a shortfall of 8,146 pilots every year.

The biggest problem area globally is Asia Pacific, for which the ICAO has estimated a shortage of 9,048 pilots a year. If we combine this with the situation in the Middle East, the total shortage is 10,646 pilots a year in Asia. This is particularly significant in Northeast Asian countries such as China, and is likely to lead to high staff costs for new entrants as they are likely to use higher wages to attract experienced pilots from existing airlines. However, according to our market research, the opposite situation is occurring in ASEAN. For example, in Malaysia, there is an oversupply of pilots, as many cadets have not been able to find jobs. Many places such as Hong Kong and China impose restrictions on importing pilots from other countries, which is causing an imbalance in the supply and demand of pilots to persist.

Many existing airlines probably have their own pilot-training schools to recruit and train new pilots. For example, AirAsia has set up a pilot-training school, the Asia Aviation Academy, to do this. Also, the Big-3 PRC airlines have their own training schools in China. CX has flight simulators at its Hong Kong headquarters. Thus, the pilot-training costs for new entrants are likely to be higher than for existing players.

ƒ Shortage of pilots worldwide (a year from 2012-30)

Europe (7,597)

North America 17,206 Middle East (1,598)

Asia Pacific (9,048)

Africa Latin America (2,804) (4,305)

Enough pilots

Shortage of pilots

Source: ICAO, Daiwa

- 82 - Aviation Primer Winter 2012

- 83 - Aviation Primer Winter 2012

Revenue management

A good IT system is crucial

This is the most important aspect in maximising the revenue generated from every seat. Due to the abundance of historical data, most airlines have sophisticated inventory control and revenue-management systems to analyse the impact of ad-hoc promotional fares. Investing in such systems is important as it can provide a competitive advantage to the airline. We believe a well-developed revenue-management system helps an airline perform better analysis of market demand, and facilitates its decision-making process.

Although we do not know how each system works, we can see how well it performs by how the yield moves the relative to the passenger load factor. These systems enable airlines to reduce the yield during bad times and raise the yield significantly during good times.

IT system makes a difference: using CX as an example 30 82

20

10 78

0

(10) 74

(20)

(30) 70 2003 2004 2005 2006 2007 2008 2009 2010 2011

Net profit (US$bn) (LHS) IATA passenger yield (YoY %) (LHS) CX passenger yield (YoY %) (LHS) Passenger load factor (%) (RHS)

Source: IATA, CX

- 84 - Aviation Primer Winter 2012

Fleet structure

Simplified is best

Most airlines with a high operating margin have simplified fleet structures. They identify 1-2 aircraft types each for their short-haul fleet and long-haul fleet. Airlines with too many aircraft types face high maintenance and crewing costs, due to the need to store additional spare parts and train crew on different types of aircraft.

One of their cost advantages of LCCs comes from the simplified fleet structure, from which they can derive considerable economies of scale in maintenance and crew training.

Comparison of operating margin and fleet 2011 AC CSA CEA CX SIA AirAsia QAN ANA JAL Southwest Airlines United Continental Delta Airways US Airways Operating margin 9 4 4 4 2 19 3 7 17 4 5 6 3 Current fleet size (including freighters) 432 444 377 175 133 97 283 226 215 698 1,256 775 340 Short haul (%) 81 91 85 23 15 100 72 60 79 100 75 79 92 Long haul (%) 19 8 14 77 85 0 28 40 21 0 25 21 8 Source: Companies

Summary of aircraft type Southwest United Delta US AC CSA CEA CX SIA AirAsia QAN ANA JAL Airlines Continental Airways Airways Regional jets Business Yes Yes No No No No No Yes No Yes Yes Yes jet Short-haul aircraft A320/A321 A320/A321 A320/A321 A320/A330 A319/A320 A320 B737 B737/A320/ B737/MD- B737 A319/A320 A319/A320 A319/A320/A321 /B737 /B737 /B737 (Dragonair) (SilkAir) DHC-8 90/DHC-8 /B737 Medium-haul aircraft A330 A330 A330 A330 A330 A330 A330 B767 B767/B787 B737 B737 A330 A330 (AirAsiaX) Long-haul aircraft B777 A380/B747 A340 B777 A350/A380/ A350 B787/A380 B747/B777 B777 No B747/B777 B777/B787 A350 /B777 B777/B787 (AirAsiaX) Current fleet size 432 444 377 175 133 97 283 226 215 698 1,256 775 340 (including freighters) On order 167 256 282 67 65 306 65 63 39 342 270 127 261 Source: Airbus, Boeing, Companies, Daiwa

- 85 - Aviation Primer Winter 2012

Expansion strategy

The industry tends to over-expand

We believe most airlines are tempted to own a large fleet. This can be due to political considerations, or due to the airline chasing revenue growth to satisfy shareholders or owners. In bad economic times, aircraft financing is relatively tight, and so many airlines (especially those with weak balance sheets) may not have enough cash to expand rapidly even though aircraft prices are at low levels. The airlines usually have to wait until financing becomes more readily available, which may be at a time when the industry is reaching the peak of its cycle. Therefore, aggressive orders for aircraft by airlines may signal the peak of the industry cycle.

Order book to profit and traffic cycle (US$bn) (% ) 20 45

10 35

0 25

(10) 15

(20) 5

(30) (5) 2003 2004 2005 2006 2007 2008 2009 2010 2011

Net profit (LHS) RPK YoY (LHS) Orderbook to fleet ratio (RHS)

Source: IATA, Ascend

Most airlines in Asia are tempted to expand rapidly, as most are located in countries with a fast-growing economy. However, those with more prudent expansion strategies tend to have higher profit. We believe airlines with tight capacity find it relatively easy to raise their yields to improve profitability. It is rare for an airline to have to sacrifice profit due to a lack of capacity, but it is common to see one sacrifice profit due to overcapacity.

Some airlines, especially those in countries with high levels of GDP growth, tend to be more aggressive in terms of capacity expansion, partly due to the financial support they receive from the government. As shown in the following charts, net profit tends to be weak for them (such as CSA and CEA) compared with those pursuing a more prudent capacity-expansion strategy (such as CX and SIA). We believe this is partly due to aggressive capacity expansion leading to pressure on yield and a rise in costs.

- 86 - Aviation Primer Winter 2012

The link between net profit and capacity management – CX and SIA ($bn) (% ) 20 30

20 10 10

0 0

(10) (10)

(20) (20) (30)

(30) (40) 2003 2004 2005 2006 2007 2008 2009 2010 2011 Global net profit (LHS) CX net profit (LHS) SIA net profit (LHS) Global ASK growth (RHS) CX ASK (RHS) SIA ASK (RHS)

Source: Companies, IATA Note: For CX and SIA, net profit is in local currency; for global net profit the unit is US$. For ease of reference, we use a multiple of 5x for SIA’s net profit.

The link between net profit and capacity management – CSA and CEA ($bn) (%) 60 50

30 20

0 (10)

(30) (40) 2003 2004 2005 2006 2007 2008 2009 2010 2011 Global net profit (LHS) CSA net profit (LHS) CEA net profit (LHS) Global ASK growth (RHS) CSA ASK (RHS) CEA ASK (RHS)

Source: Companies, IATA Note: For CSA and CEA, net profit is in local currency; for global net profit the unit is US$.

- 87 - Aviation Primer Winter 2012

Positioning

Focus is the key to success

As mentioned in chapter 6, we believe that for a player to be successful in the future they must be either a premium carrier, an LCC, or operate in a niche markets. Among the Asian airlines, this trend is already happening, with the profit leaders, such as CX and SIA, focusing on being premium-class airlines, AirAsia being a successful LCC, and AC supported by the large Mainland China outbound market. Many other Asian airlines are finding it hard to positioning themselves and so their profit margins may start to deteriorate.

In practice, however, many airlines are unable to position themselves successfully. For example, a premium carrier has to invest heavily to ensure it has state-of-the-art facilities. Airlines may not be able to commit the high capex necessary if they have a weak balance sheet. Meanwhile, LCCs have to control costs carefully and avoid offering services to passengers that provide no return. There are cases where LCCs have started to offer new services that start to erode their margins.

Airlines: operating-profit margin Airlines: net-profit margin (% ) (% ) 35 45 35 25 25 15 15 5 5

(5) (5)

(15) (15) 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

CX SIA MAS Thai AirAsia CX SIA MAS Thai AirAsia Source: Bloomberg, Companies Source: Bloomberg, Companies

More ‘bimodal’ airlines emerging

There are numerous cases of airlines losing focus on how they should operate, and moving into markets or segments that are new to them. For example, many FSCs have established an LCC subsidiary after seeing this model develop in the US, Europe, and Asia. Examples include ANA, which established its Peach LCC and plans another LCC with AirAsia (AirAsia Japan), and SIA, which has two LCCs (Tiger Airways and Scoot). However, most FSC plus LCC models are unsuccessful, and have not produced the synergies that were expected to help the FSC turn around its business. Many of the LCC subsidiaries are struggling more than their FSC parent company. Indeed, there are only a few successful examples – one is QAN and Jetstar – where the LCC subsidiary is more profitable than the FSC parent.

The major problem we see is that airline managements consider setting up an LCC as a way to survive when the FSC model is not working for them. In addition, many of them believe they will be able to attract high-income travellers with the FSC and low-income travellers with the LCC. They also believe this model will provide economies of scale. However, as historical data shows, the synergy effect is limited. This may be due to timing: the decision by the FSC to set up the LCC subsidiary was taken at the end of the bull cycle in the industry. We value highly management that focuses on what it does best.

- 88 - Aviation Primer Winter 2012

FSCs with LCC subsidiaries Korean Asiana Thai Malaysia Garuda FSC CEA SIA QAN ANA JAL Air Airlines Airways Airlines Indonesia Iberia Lufthansa Subsidiary/ Jetstar HK Tiger Jetstar Asia Peach Jet Star Jin Air Air Busan Nok Air Firefly Citilink Iberia Germanwings Associate (LCC) Airways Aviation, Japan Express Air Next Scoot AirAsia Thai Smile SunExpress Japan Source: Companies

Net-profit margin: FSCs vs. LCCs Company AC CX SIA QAN ANA JAL Thai Airways Malaysia Airlines AirAsia Skymark Southwest Airways Category FSC FSC FSC + LCC FSC + LCC FSC + LCC FSC + LCC FSC + LCC FSC + LCC LCC LCC LCC Net-profit margin (with LCC) (%) 6.7 5.6 2.3 2.1 2.0 15.5 (5.3) (18.5) 12.4 9.6 1.1 Net-profit margin (w/out LCC) (%) 6.7 5.6 8.7 3.0 2.0 15.5 9.3 (1.0) 12.4 9.6 1.1 Source: Companies

- 89 - Aviation Primer Winter 2012

- 90 - Aviation Primer Winter 2012

- 91 - Aviation Primer Winter 2012

How to score an upgrade

This is a common question and, alas, there is no definitive answer. There are, however, factors that can increase the likelihood of landing an upgrade on a busy flight.

1) Chances are higher during peak leisure-travel seasons. Obviously, to stand any chance of getting into a premium cabin, there needs to a seat available in it – and economy class needs to be overbooked. As many tickets allow passengers to change the date of their travel, airlines tend to overbook a flight in order to maximise revenue, and assume that a certain number will not show up for the flight. In the event that all the booked passengers show up, the airline may have to upgrade passengers or, in the worst case, offer them guaranteed seat on the next flight and provide compensation as well as a meal and perhaps hotel accommodation.

Flights are often overbooked in peak leisure-travel seasons, and so this is when it is most likely that economy class will be full and you can receive an upgrade. But it should also be remembered that premium-class cabins on long-haul routes see a high number of business travellers and so are often full. Therefore, it is relatively hard to obtain an upgrade on long-haul routes such as Hong Kong-New York and Singapore-London.

You may stand a better chance of an upgrade to these destinations during the summer

Source: Bali.net Source: Phuket.net

2) Go by yourself. Airlines tend not to upgrade passengers who are flying with other people (especially those with small children). This is due mainly to the additional hassle involved in arranging seats together. In addition, other premium-class passengers might complain if the children are being noisy or running around the cabin. In order to avoid such problems, airline staff are more likely to upgrade single travellers who are seen as being more flexible.

This group probably isn’t going to land an upgrade

Source: Stock photo

- 92 - Aviation Primer Winter 2012

3) Dress appropriately. There are times when airline staff will consider your appearance when deciding whether or not to give you an upgrade. There is greater flexibility on leisure-travel routes, but overall smart casual is likely to give you a better chance. The reason is similar to why some high-end restaurants impose a dress code: brand image.

Dress is an important consideration on some routes

Source: Stock photo

4) Arrive at the check-in counter early. It takes time to arrange an upgrade, so do not arrive just before the check-in counter is due to close (or the boarding gate if you check in online). Usually, airline staff choose who they are going to upgrade before passengers start to arrive at the check-in counter. Some staff may just upgrade the last passenger(s) who check in. However, this is contrary to most airlines’ working procedures. If you are travelling on a well-managed airline, arriving early is the best policy.

Someone like this passenger probably has better chance

Source: SIA

- 93 - Aviation Primer Winter 2012

- 94 - Aviation Primer Winter 2012

- 95 - Aviation Primer Winter 2012

Glossary of industry terms Air-traffic rights The right that allows an airline to operate on a particular route or to a region. An agreement between two or more airlines to share their operating aircraft. The seats sold by one airline on a flight are actually on an aircraft operated by Codeshare agreement another airline.

European Union Emission Trading This is the largest international scheme for the trading of greenhouse gases (including CO2). It provides a certain level of free emission allowances to airlines, Scheme but they need to buy credits from the market when they exceed their allowance. A loyalty programme that allows members to accumulate miles or points when they travel with an airline, and use them to redeem free tickets or other services Frequent-flyer programme such as travel-class upgrades. The airlines use these to instil a sense of loyalty in travellers. An airline that provides a wide range of pre-flight and inflight services (included in the ticket price), including check-in baggage allowance, inflight meals, and an Full-service carrier inflight entertainment system. It often has multiple classes of travel, eg, first, business, and economy classes. A reservation system that travel agents use when booking air tickets, hotels, the hire of a car, or other travel-related services. It is linked directly to the internal Global distribution system (GDS) system of the airline, hotel, or related company. Long-haul A flight with a flying time of more than six hours. An airline that provides only the flight, and charged for every additional service, eg, check-in baggage, inflight meals, and priority boarding. It often provides a Low-cost carrier single class of service, meaning all economy-class seats. Marketing carrier The airline that sells the tickets on a codeshare flight but does not operate it. This is the maximum weight an aircraft can carry during take-off. It is unique to each type of aircraft and is often used as the benchmark for the landing/take-off Maximum take-off weight charges by an airport. Medium-haul A flight with a flying time of more than three hours but less than six hours. A single-aisle aircraft that can fly a longer distance than a regional jet. It often can carry a larger number of passengers than a regional jet and also a small Narrow-body aircraft amount of cargo in the hold. An agreement between countries that allows airlines to expand international passenger and cargo flights without restrictions in terms of capacity (including flight Open skies frequencies and aircraft type) Operating carrier The airline that operates the aircraft on a codeshare flight. Payload This is the maximum carrying capacity (passengers and cargo) of an aircraft. Premium carrier An airline that focuses on attracting high-end passengers (flying in first class and business class). Premium class First class and business class Regional jet A single-aisle aircraft that is used mainly on short- to medium-haul routes. Short-haul A flight with a flying time of less than three hours Wide-body aircraft A twin-aisle aircraft that is larger than a narrow-body aircraft and can carry more passengers over longer distances. Can be used as a freighter as well. Source: Daiwa

- 96 - Aviation Primer Winter 2012

Aviation: major listed players by segment Airline Name Bloomberg Description code China Air China Ltd-H 753 HK As at the end of 2011, AC was the largest commercial airline in China in terms of market capitalisation, operating 432 aircraft. China National Aviation Holding Company holds a 51% stake in AC. China Southern Airlines Co-H 1055 HK As at the end of 2011, CSA was the largest commercial airline in China in terms of fleet size, operating 444 aircraft. China Holding holds a 53% stake in China Southern Airlines. China Eastern Airlines Co-H 670 HK As at the end of 2011, CEA was the largest Shanghai-based airline in China, with 377 aircraft. China Eastern Air Holding Company holds a 50% stake in the company. Hainan Airlines Co-A 600221 CH Hainan Airlines the fourth-largest China airline, and is controlled by the HNA Group. It flies to more than 90 cities in total. The airline operates both scheduled and charter services. Asia Air New Zealand Ltd AIR NZ The national carrier of New Zealand, Air New Zealand is based in Auckland. It is member of Star Alliance. All Nippon Airways Co Ltd 9202 JP Founded in 1952, Tokyo-based ANA is a major Japanese airline with hubs in Tokyo, Kansai, and Osaka airports. In addition to its operations, ANA controls several subsidiary passenger carriers, including its , Air Nippon, charter carrier , and LCC Air Next. Asiana Airlines 020560 KS Asiana Airlines is the second-largest airline in South Korea and an increasingly important player in the East Asia region. It is majority-owned by one of South Korea's largest conglomerates, the Kumho Asiana Group. Asiana is a member of Star Alliance. Cathay Pacific Airways 293 HK CX is an international airline based in Hong Kong. As at 31 December 2011, and together with Dragonair and , the company operated 175 aircraft. China Airlines Ltd 2610 TT China Airlines is the of Taiwan. Its majority shareholder is China Aviation Development Foundation; wholly-owned subsidiary by the Taiwan Government. China Airlines Cargo is the airline's freight division. China Airlines is considering joining the Sky Team alliance. EVA Airways Corp 2618 TT EVA Airways Corp. provides passenger and cargo air-transportation services. It operates both scheduled and non-scheduled flights. As at the end of 2011, it operated 59 aircraft. Garuda Indonesia GIAA IJ Garuda Indonesia is the national airline of Indonesia. In June 2010, it resumed services to Europe (initially via Dubai) after an extended EU-imposed ban. Garuda Indonesia has undergone a thorough restructuring that it called The Quantum Leap, which involved a significant shift in the airline's strategic direction, its network, brand and fleet. The airline was listed in 2011. Japan Airlines 9201 JP Founded in 1951, it became Japan’s national flag carrier in 1953. Its main hubs are Tokyo Narita International Airport, , Nagoya Chubu Centrair International Airport and Osaka Kansai Internal Airport. The carrier served 33 destinations in 18 countries excluding Japan as at 31 March 2012. On 19 September 2012, Japan Airlines was relisted on the Tokyo Stock Exchange. Korean Air Lines Co Ltd 003490 KS Established in 1962, Korean Air is the largest airline in Korea, and the country’s flag carrier. Korean Air Cargo is the third-largest in the world and it together with Korean Air wholly owns a low-cost airline subsidiary, Jin Air. Korean Air is a founding member of the SkyTeam alliance. Malaysian Airlines System Bhd MAS MK Malaysia Airlines is the flag carrier of Malaysia. It has a strong presence in East and Southeast Asia, and on the ‘’ between Australia and the UK. In June 2011 it announced its intention to join the oneworld alliance in late 2012. MASkargo is the cargo division of Malaysia Airlines and operates scheduled and charter air cargo services. Qantas Airways Ltd QAN AU Qantas Airways is operated as part of the publicly listed Qantas Group. It is the national airline of Australia. As at June 2011, the group operated 283 aircraft. Qantas is a founding member of the oneworld alliance. Singapore Airlines Ltd SIA SP Singapore Airlines is an international airline based in Singapore. As at the end of March 2012, together with SilkAir and SIA Cargo, the group operated 133 aircraft. Temasek Holding Pte. has a 55% stake in Singapore Airlines. Thai Airways International THAI TB Based at ’s Suvarnabhumi Airport with secondary hubs in Phuket and Chiang Mai, Thai Airways is the national airline of Thailand and is majority-owned by the Thai Ministry of Finance. Thai Airways is a founding member of Star Alliance. LCCs AirAsia Bhd AIRA MK AirAsia is an LCC based at Kuala Lumpur International Airport, Malaysia. The carrier, which was formed out of Tune Air in 2002, is led by CEO and pioneered cross-border joint ventures in Asia, establishing Thail and Indonesian units with bases in Bangkok and Jakarta, respectively. AirAsia's extensive domestic and regional network includes services within Malaysia and to China, Southeast Asia and the subcontinent. Cebu Air Inc CEB PM Cebu Pacific is one of the largest LCCs in Asia. It is wholly-owned by the Gokongwei family-controlled JG Summit Holdings. Using a fleet that includes Airbus A319/320 and ATR72-500 aircraft, Cebu Pacific’s network consists of domestic and international services within Asia. Ltd TGR SP Tiger Airways is an LCC based in Singapore. It is owned by Tiger Airways Holdings, a consortium that includes Singapore Airlines, Indigo Partners Singapore, and Tony Ryan’s RyanAsia Ltd. Virgin Australia VAH AU Virgin Australia is Australia’s second-largest airline and one of the few airlines to have made a full transformation from LCC to FSC. Virgin Australia started operations in 2000 as Virgin Blue, and is wholly owned by Virgin Group.

Airports China Beijing Capital Intl Airport -H 694 HK Beijing Capital International Airport (BCIA) is engaged mainly in aeronautical and non-aeronautical businesses at Beijing Airport. As at the end of 2011, aircraft movements and passenger throughput at Beijing Airport were 533,257 and 79m, respectively. The Capital Airport Holding Company has a 56.6% stake in BCIA. Guangzhou Baiyun International -A 600004 CH Guangzhou Baiyun International Airport serves the city of Guangzhou. The airport is located in the Pearl River Delta, competing with Hong Kong, Macau, Shenzhen and Zhuhai airports. Providing domestic, regional and international passenger and cargo services for over 30 airlines, the airport is a hub for airlines including China Southern Airlines and FedEx Express. Hainan Meilan Intl Airport-H 357 HK Hainan Meilan International Airport is located in and is the gateway to Hainan Island. Providing domestic and international passenger and cargo services for over 15 airlines, the airport is a key base for Hainan Airlines and China Southern Airlines. Shanghai International Airport-A 600009 CH Shanghai International Airport Co Ltd, together with its subsidiaries, provides airport services in Pudong International Airport in Shanghai, China. The company offers ground- handling services to domestic and foreign airlines and passengers, and manages and leases aviation operation space, commercial space, and offices inside the airport. It also operates a domestic trade and advertising business and supplies air fuel. Shenzhen Airport Co-A 000089 CH Shenzhen Bao’an International Airport is the gateway to Shenzhen and a key airport in the powerhouse Guangdong Province of Southern China. Close to Hong Kong in the Pearl River Delta and hosting domestic, regional and international passenger and cargo services for over 15 airlines, the airport is a hub for Shenzhen Airlines, while China Southern Airlines also has a major presence at the airport. International Airport-A 600897 CH Xiamen International Airport Co Ltd is principally engaged in the provision of ground services for domestic and international flights and passengers. The company is also involved in commercial property leasing and concession services, cargo station and cargo services, as well as ground support services. As at the end of 2011, it handled about 16m passengers and about 260,600 tonnes of cargo and mail. Asia Airports Of Thailand Pcl AOT TB Airports of Thailand (AOT), originally a state enterprise, was corporatised in 2002 and a subsequent partial listing (30% institutional and retail investors) took place in 2004. The state retains 70% through the Ministry of Finance. (AOT) operates the two Bangkok airports and four others (Chiang Mai, Chiang Rai, Hat Yai, and Phuket). Auckland Intl Airport Ltd AIA NZ Auckland Airport, operated by Auckland International Airport Ltd, is the largest airport in New Zealand. Providing domestic, regional and international passenger and cargo services for over 20 airlines, Auckland Airport is the main hub of Air New Zealand. Japan Airport Terminal Co 9706 JP Japan Airport Terminal Co. Ltd is a Tokyo-based corporation engaged in the construction and management of passenger terminal facilities at Tokyo's Haneda International Airport. The company is listed on the Tokyo Stock Exchange and the main investors include Macquarie Bank, JAL, ANA, Mizuho Corporate Bank, Mitsubishi Tokyo UFJ Bank, and Morgan Stanley. Malaysia Airports Hldgs Bhd MAHB MK Malaysia Airports Holdings (MAHB) manages and operates 39 airports in Malaysia:five international, 16 domestic, and 18 short take-off and landing ports. It was the first airport company to be listed in Asia. MAHB co-operates extensively with India's GMR Group, a company that invests in ariports, energy, highways and urban infrastructure, and holds an 11% stake in Hyderabad International Airport Ltd, a 10% stake in Delhi International Airport Ltd through Malaysia Airports (Mauritius) Pvt Ltd, a 20% stake in Sabiha Gocken Airport, Istanbul with GMR and Limak, as well as the 25-year contract to construct, operate, modernise and expand Male International Airport in the through the GMR- MAHB consortium. MAHB also holds a 40% stake in CAMS, which operates the Phnom Penh-Pochentong Airport in Cambodia. Corporation Ltd SYD AU Sydney (Kingsford Smith) Airport is the only major airport serving Sydney, and is a primary hub for Qantas. In 2011, Sydney Airport handled 36m passengers and 280,910 aircraft movements. The airport is managed by Sydney Airport Corporation Limited and the current CEO is Kerrie Mather. Flights from Sydney link with all states and territories of Australia. Currently, 47 domestic destinations are served directly from Sydney.

- 97 - Aviation Primer Winter 2012

Aviation: major listed players by segment Korea Airport Services Col Ltd 005430 KS Korea Airport Service Co Ltd provides aircraft ground-handling, aircraft fuelling and refuelling, air-cargo handling, cargo/baggage loading/unloading, and aircraft-maintenance services to domestic and international airlines in South Korea. The company is also engaged in producing mineral water under the Hanjin jejupurewater trademark; and tomatoes and green peppers, paprika, cherry tomatoes, lettuce, and other vegetables. In addition, it operates Jeju Folk Village Museum, provides laundry and forklift-rental services, is engaged in mining limestone, and raises beef, cattle and chicken. The company sells vegetables online. Korea Airport Service Co Ltd was founded in 1968 and is based in Seoul, South Korea. Aviation IT China Travelsky Technology Ltd-H 696 HK TravelSky Technology is the dominant service provider of aviation IT in China. For 2011, the total number of bookings processed by the company was 319m. The China TravelSky Holding Company has a 29.3% stake in the company. Aviation manufacturing China AVIC Aero-Engine Controls-A 000738 CH AVIC Aero-Engine Controls designs and manufactures a variety of motorcycles, engines, and related parts. The company also provides aircraft parts and repair services. AVIC Heavy Machinery Co Lt-A 600765 CH AVIC Heavy Machinery develops, manufactures, and markets hydraulic pumps and motors, Rzeppa constant-velocity joints, and other related products. AVIC International Holding Ltd. 232 HK AVIC International Holding manufactures and markets aircraft. The company produces fighters, trainers, bombers, helicopters, transporters, general aviation aircraft associated airborne equipment, and spare parts. AVIC Sanxin Co Ltd-A 002163 CH AVIC Sanxin designs and builds glass, aviation materials, and (PV) manufactures and installs curtain walls. Avichina Industry & Tech-H* 2357 HK AviChina Industry & Technology Company Ltd (AVC) is mainly engaged in the development, manufacture, sales and upgrading of aviation equipment and related products. The major shareholder of the company's H shares is Aviation Industry Corporation of China, with a 56.7% stake. China Aviation Optical -A 002179 CH China Aviation Optical develops and manufactures electric connectors, optical device and cable components. China AVIC Avionics Equip-A 600372 CH China AVIC Avionics manufactures and markets a series of cars, vans, and related parts, and also provides after-sales and consulting services. China Dongfanghong Spacesat-A 600118 CH China Spacesat Co Ltd is principally engaged in the research, manufacture, and application of satellites in China. Its satellites are primarily used for satellite communication, satellite navigation and ground integrated appliance systems. The company is based in Beijing. It operates as a subsidiary of China Aerospace Science and Technology Corporation. Citic Offshore Helicopter-A 000099 CH CITIC Offshore Helicopter Co Ltd provides general aviation transportation services and aviation maintenance services. The company was incorporated in 1999 and is headquartered in Shenzhen. Hafei Aviation Industry Co-A 600038 CH Hafei Aviation Industry designs, develops, manufactures, and sells helicopters, airplane parts, and aviation-related products, and also manufactures auto parts. Aviation Precision-A 002013 CH Hubei Aviation Precision manufactures and markets precision punching products, including angle modulation devices for auto seats, sliding rails, seat-lifting devices, and other related products. Hongdu Aviation-A 600316 CH Jiangxi Hongdu Aviation designs, manufactures, and markets training planes, planes for agricultural and forestry use, other aviation products and spare parts, and also processes consumer products and provides aviation services. Sichuan Chengfa Aero-Science & 600391 CH Sichuan Chengfa Aero-Science produces and markets a variety of parts for the manufacturers of aircraft engines and combustion turbines. The company’s products include Technology Co. Ltd. cartridge receivers, blades, ring-shape parts, and metal plates. Sichuan Chengfei Integration 002190 CH Sichuan Chengfei Integration Technology Co Ltd researches, designs, and manufactures car moulds, aircraft moulds, and frames. Technology Co. Ltd Sichuan Haite High-Tech Co-A 002023 CH Sichuan HAITE High-tech Co Ltd, through its subsidiaries, is engaged in the research, development, manufacture, repair, and inspection of aircraft appliances, mechanical accessories, and small engines. The company was founded in 1992 and is based in Chengdu. Tianma Microelectronics-A 000050 CH Tianma Microelectronics manufactures and markets liquid crystal displays and liquid crystal display modules. Wisesoft Co Ltd -A 002253 CH Wisesoft is a software and heavy-equipment provider. The company's major products include air traffic management (ATM) products, including ATM real-time strategic command systems and ATM simulation training systems, and surface intelligent traffic-management products, including traffic management application systems for vehicle automatic recognition. Xi'An Aero-Engine Plc -A 600893 CH Xi'an Aero-engine PLC is principally engaged in the manufacture and distribution of aero engines. The company provides aero products, including low-pressure compressor rotors, turbine nozzle boxes, low-pressure turbine shaft blocks, turboelectric power units and turbo-starters, among others. Export products include high-pressure turbine forward shafts, turbine disks, cartridge receivers, turbine blades, set collars, blades, loop-forming parts and guide vanes, as well as non-aero products. Xi'An Aircraft Intl Corp-A 000768 CH Xi'an Aircraft Intl' manufactures large and mid-sized aircraft components and aluminium materials. The company primarily contracts and produces vertical stable board, horizontal stable board, front inspection doors for Boeing 737s, and components for Boeing 747s and ATR-42s, and produces decorating materials and automobile parts. Asia Korea Aerospace Industries 047810 KS Korea Aerospace Industries was established by Samsung Aerospace, Daewoo Heavy Industries (aerospace division), and Hyundai Space and Aircraft Company. The company develops and manufactures fixed-wing aircraft, helicopter aircraft, and satellites. Singapore Tech Engineering STE SP Singapore Technologies Engineering, an investment holding company, provides engineering and related services worldwide. It operates in four segments: aerospace, electronics, land systems, and marine. The aerospace segment provides a range of maintenance and engineering services comprising airframe, engine, and component maintenance, repair, and overhaul services, engineering design and technical services, and aviation materials and management services, including total aviation support. Singapore Technologies Engineering is a subsidiary of Temasek Holdings (Private) Ltd.

Ground services Asia SATS Limited SATS SP SATS provides integrated ground-handling and in-flight catering services at Singapore Changi Airport. The company also provides aviation security, airlines laundry, and airport cargo delivery management services

Maintenance services Asia AGP Corporation 9377 JP AGP Corporation is primarily engaged in the power business and the maintenance and management of buildings and facilities. The company operates in three business segments: power segment, maintenance segment, associated business segment. The maintenance segment is engaged in the maintenance and management of buildings and facilities such as airplane hangars, airplane meal plants, cargo terminals and hotels, as well as the maintenance of airport-related special facilities such as jet way and carry-on luggage transportation facilities. Hong Kong Aircraft Engineering 44 HK Hong Kong Aircraft Engineering maintains and overhauls commercial aircraft. It performs comprehensive checks, refurbishments and reconfigurations of airframes and engines. SIA Engineering Co Ltd SIE SP SIA Engineering provides aviation engineering services worldwide. The company provides airframe maintenance and component overhaul services, line maintenance, and technical ground-handling services. Through its subsidiaries, it is also engaged in the manufacture of aircraft cabin equipment, refurbishment of aircraft galleys, and the provision of technical and non-technical handling services, the repair, and overhaul of hydro-mechanical aircraft equipment, and airframe-maintenance services. On January 18, 2010, SIA Engineering signed a definitive agreement to participate in Pratt & Whitney's PurePower PW1000G engine Risk-Revenue Sharing Program. Source: Bloomberg, Companies

- 98 - Aviation Primer Winter 2012

Common industry metrics Metric Unit Definition Passenger RPK (revenue passenger kilometres) Passenger km Number of passengers carried x distance flown ASK (available seat kilometres) Seat km Available capacity (number of seats) x distance flown PLF (passenger load factor) % RPK (revenue passenger kilometres)/ASK (available seat kilometres) Yield per RPK (revenue passenger kilometres) Currency Passenger revenue/RPK (revenue passenger kilometres) Cost per ASK (available seat kilometres) Currency Operating cost/ASK (available seat kilometres) Freight RFTK (revenue freight tonne kilometres) tonne km Cargo tonnage carried x distance flown AFTK (available freight tonne kilometres) tonne km Available capacity (cargo space) x distance flown CLF (cargo load factor) % RFTK (revenue freight tonne kilometres) / AFTK (available freight tonne kilometres) Yield per RFTK (revenue freight tonne Currency Cargo revenue/RFTK (revenue freight tonne kilometres) kilometres) Cost per AFTK (available freight tonne Currency Operating cost/AFTK (available freight tonne kilometres) kilometres) Overall RTK (revenue tonne kilometres) tonne km Number of passengers carried (including baggage) is converted into weight (90-95kg) to become PTK (passenger tonne kilometres) and is added to RFTK (revenue freight tonne kilometres) ATK (available tonne kilometres) tonne km Passenger capacity is converted into weight (90-95kg) to become ASTK (available seat tonne kilometres) and is added to AFTK (available freight tonne kilometres) Total load factor % RTK (revenue tonne kilometres)/ATK (available seat kilometres) Yield per RTK (revenue tonne kilometre) Currency Passenger and cargo revenue/RTK (revenue tonne kilometres) – generally excludes other revenue Cost per ATK (available seat kilometre) Currency Operating cost/ATK (available tonne kilometres) Source: Daiwa

- 99 - Aviation Primer Winter 2012

- 100 - Aviation Primer Winter 2012

- 101 - Aviation Primer Winter 2012

- 102 - Aviation Primer Winter 2012

Daiwa’s Asia Pacific Research Directory

HONG KONG SOUTH KOREA Nagahisa MIYABE (852) 2848 4971 [email protected] Chang H LEE (82) 2 787 9177 [email protected] Regional Research Head Head of Korea Research; Strategy; Banking/Finance John HETHERINGTON (852) 2773 8787 [email protected] Sung Yop CHUNG (82) 2 787 9157 [email protected] Regional Head of Product Management Pan-Asia Co-head/Regional Head of Automobiles and Components; Automobiles; Pranab Kumar SARMAH (852) 2848 4441 [email protected] Shipbuilding; Steel Regional Head of Research Promotion Anderson CHA (82) 2 787 9185 [email protected] Mingchun SUN (852) 2773 8751 [email protected] Banking/Finance Head of China Research; Chief Economist (Regional) Mike OH (82) 2 787 9179 [email protected] Dave DAI (852) 2848 4068 [email protected] Capital Goods (Construction and Machinery) Deputy Head of Hong Kong and China Research; Pan-Asia/Regional Head of Clean Sang Hee PARK (82) 2 787 9165 [email protected] Energy and Utilities; Utilities; Power Equipment; Renewables (Hong Kong, China) Consumer/Retail Kevin LAI (852) 2848 4926 [email protected] Jae H LEE (82) 2 787 9173 [email protected] Deputy Head of Regional Economics; Macro Economics (Regional) IT/Electronics (Tech Hardware and Memory Chips) Chi SUN (852) 2848 4427 [email protected] Thomas Y KWON (82) 2 787 9181 [email protected] Macro Economics (China) Pan-Asia Head of Internet & Telecommunications; Software (Korea) – Internet/On-line Game Jonas KAN (852) 2848 4439 [email protected] Shannen PARK (82) 2 787 9184 [email protected] Head of Hong Kong Research; Head of Hong Kong and China Property; Regional Custom Products Group Property Coordinator; Property Developers (Hong Kong) Jeff CHUNG (852) 2773 8783 [email protected] TAIWAN Automobiles and Components (China) Mark CHANG (886) 2 8758 6245 [email protected] Grace WU (852) 2532 4383 [email protected] Head of Research; Regional Head of Small/Medium Cap; Small/Medium Cap (Regional) Head of Greater China FIG; Banking (Hong Kong, China) Birdy LU (886) 2 8758 6248 [email protected] Jerry YANG (852) 2773 8842 [email protected] IT/Technology Hardware (Handsets and Components) Banking/Diversified Financials (Taiwan) Christine WANG (886) 2 8758 6249 [email protected] Leon QI (852) 2532 4381 [email protected] IT/Technology Hardware (PC Hardware) Banking (Hong Kong, China) Chris LIN (886) 2 8758 6251 [email protected] Joseph HO (852) 2848 4443 [email protected] IT/Technology Hardware (Panels) Head of Industrials and Machineries (Hong Kong, China); Capital Goods –Electronics Equipments and Machinery (Hong Kong, China) Bing ZHOU (852) 2773 8782 [email protected] INDIA Consumer/Retail (Hong Kong, China) Punit SRIVASTAVA (91) 22 6622 1013 [email protected] Hongxia ZHU (852) 2848 4460 [email protected] Head of Research; Strategy; Banking/Finance Consumer, Pharmaceuticals and Healthcare (China) Navin MATTA (91) 22 6622 8411 [email protected] Eric CHEN (852) 2773 8702 [email protected] Automobiles and Components Pan-Asia/Regional Head of IT/Electronics; Semiconductor/IC Design (Regional) Saurabh MEHTA (91) 22 6622 1009 [email protected] Felix LAM (852) 2532 4341 [email protected] Capital Goods; Utilities Head of Materials (Hong Kong, China); Cement and Building Materials (China, Mihir SHAH (91) 22 6622 1020 [email protected] Taiwan); Property (China) FMCG/Consumer John CHOI (852) 2773 8730 [email protected] Deepak PODDAR (91) 22 6622 1016 [email protected] Head of Multi-Industries (Hong Kong, China); Small/Mid Cap (Regional); Materials Internet (China) Nirmal RAGHAVAN (91) 22 6622 1018 [email protected] Kelvin LAU (852) 2848 4467 [email protected] Oil and Gas; Utilities Head of Transportation (Hong Kong, China); Hong Kong and China Research

Coordinator; Transportation (Regional) SINGAPORE Jibo MA (852) 2848 4489 [email protected] Head of Custom Products Group; Custom Products Group Adrian LOH (65) 6499 6548 [email protected] Head of Singapore Research, Regional Head of Oil and Gas; Oil and Gas (ASEAN and Thomas HO (852) 2773 8716 [email protected] China); Capital Goods (Singapore) Custom Products Group Srikanth VADLAMANI (65) 6499 6570 [email protected]

Banking (ASEAN) PHILIPPINES David LUM (65) 6329 2102 [email protected] Rommel RODRIGO (63) 2 813 7344 [email protected] Property and REITs ext 302 Ramakrishna MARUVADA (65) 6499 6543 [email protected] Head of Philippines Research; Strategy; Capital Goods; Materials Head of ASEAN & India Telecommunications; Telecommunications (ASEAN & India) Danielo PICACHE (63) 2 813 7344 [email protected]

ext 293

Property; Banking; Transportation – Port

- 103 - Aviation Primer Winter 2012

Daiwa’s Offices Office / Branch / Affiliate Address Tel Fax DAIWA SECURITIES GROUP INC HEAD OFFICE Gran Tokyo North Tower, 1-9-1, Marunouchi, Chiyoda-ku, Tokyo, 100-6753 (81) 3 5555 3111 (81) 3 5555 0661 Daiwa Securities Trust Company One Evertrust Plaza, Jersey City, NJ 07302, U.S.A. (1) 201 333 7300 (1) 201 333 7726 Daiwa Securities Trust and Banking (Europe) PLC (Head Office) 5 King William Street, London EC4N 7JB, (44) 207 320 8000 (44) 207 410 0129 Daiwa Europe Trustees (Ireland) Ltd Level 3, Block 5, Harcourt Centre, Harcourt Road, Dublin 2, Ireland (353) 1 603 9900 (353) 1 478 3469

Daiwa Capital Markets America Inc Financial Square, 32 Old Slip, New York, NY10005, U.S.A. (1) 212 612 7000 (1) 212 612 7100 Daiwa Capital Markets America Inc. San Francisco Branch 555 California Street, Suite 3360, San Francisco, CA 94104, U.S.A. (1) 415 955 8100 (1) 415 956 1935 Daiwa Capital Markets Europe Limited 5 King William Street, London EC4N 7AX, United Kingdom (44) 20 7597 8000 (44) 20 7597 8600 Daiwa Capital Markets Europe Limited, Frankfurt Branch Trianon Building, Mainzer Landstrasse 16, 60325 Frankfurt am Main, (49) 69 717 080 (49) 69 723 340 Federal Republic of Germany Daiwa Capital Markets Europe Limited, Representative Office 36, rue de , 75008 Paris, France (33) 1 56 262 200 (33) 1 47 550 808 Daiwa Capital Markets Europe Limited, London, Geneva Branch 50 rue du Rhône, P.O.Box 3198, 1211 Geneva 3, (41) 22 818 7400 (41) 22 818 7441 Daiwa Capital Markets Europe Limited, Midland Plaza 7th Floor, 10 Arbat Street, Moscow 119002, (7) 495 641 3416 (7) 495 775 6238 Moscow Representative Office Russian Federation Daiwa Capital Markets Europe Limited, Bahrain Branch 7th Floor, The Tower, Bahrain Commercial Complex, P.O. Box 30069, (973) 17 534 452 (973) 17 535 113 Manama, Bahrain Daiwa Capital Markets Hong Kong Limited Level 28, One Pacific Place, 88 Queensway, Hong Kong (852) 2525 0121 (852) 2845 1621 Daiwa Capital Markets Singapore Limited 6 Shenton Way #26-08, DBS Building Tower Two, Singapore 068809, (65) 6220 3666 (65) 6223 6198 Republic of Singapore Daiwa Capital Markets Australia Limited Level 34, Rialto North Tower, 525 Collins Street, Melbourne, (61) 3 9916 1300 (61) 3 9916 1330 Victoria 3000, Australia DBP-Daiwa Capital Markets Philippines, Inc 18th Floor, Citibank Tower, 8741 Paseo de Roxas, Salcedo Village, (632) 813 7344 (632) 848 0105 Makati City, Republic of the Philippines Daiwa-Cathay Capital Markets Co Ltd 14/F, 200, Keelung Road, Sec 1, Taipei, Taiwan, R.O.C. (886) 2 2723 9698 (886) 2 2345 3638 Daiwa Securities Capital Markets Korea Co., Ltd. One IFC, 10 Gukjegeumyung-Ro, Yeouido-dong, Yeongdeungpo-gu, (82) 2 787 9100 (82) 2 787 9191 Seoul, 150-876, Korea Daiwa Securities Capital Markets Co Ltd, Room 3503/3504, SK Tower, (86) 10 6500 6688 (86) 10 6500 3594 Beijing Representative Office No.6 Jia Jianguomen Wai Avenue, Chaoyang District, Beijing 100022, People’s Republic of China Daiwa SSC Securities Co Ltd 45/F, Hang Seng Tower, 1000 Lujiazui Ring Road, (86) 21 3858 2000 (86) 21 3858 2111 Pudong, Shanghai 200120, People’s Republic of China Daiwa Securities Capital Markets Co. Ltd, 18th Floor, M Thai Tower, All Seasons Place, 87 Wireless Road, (66) 2 252 5650 (66) 2 252 5665 Bangkok Representative Office Lumpini, Pathumwan, Bangkok 10330, Thailand Daiwa Capital Markets India Private Ltd 10th Floor, 3 North Avenue, Maker Maxity, Bandra Kurla Complex, (91) 22 6622 1000 (91) 22 6622 1019 Bandra East, Mumbai – 400051, India Daiwa Securities Capital Markets Co. Ltd, Suite 405, Pacific Palace Building, 83B, Ly Thuong Kiet Street, (84) 4 3946 0460 (84) 4 3946 0461 Representative Office Hoan Kiem Dist. Hanoi, Vietnam

DAIWA INSTITUTE OF RESEARCH LTD HEAD OFFICE 15-6, Fuyuki, Koto-ku, Tokyo, 135-8460, Japan (81) 3 5620 5100 (81) 3 5620 5603 MARUNOUCHI OFFICE Gran Tokyo North Tower, 1-9-1, Marunouchi, Chiyoda-ku, Tokyo, 100-6756 (81) 3 5555 7011 (81) 3 5202 2021

New York Research Center 11th Floor, Financial Square, 32 Old Slip, NY, NY 10005-3504, U.S.A. (1) 212 612 6100 (1) 212 612 8417 London Research Centre 3/F, 5 King William Street, London, EC4N 7AX, United Kingdom (44) 207 597 8000 (44) 207 597 8550

- 104 - Aviation Primer Winter 2012

Disclaimer This publication is produced by Daiwa Securities Group Inc. and/or its non-U.S. affiliates, and distributed by Daiwa Securities Group Inc. and/or its non-U.S. affiliates, except to the extent expressly provided herein. This publication and the contents hereof are intended for information purposes only, and may be subject to change without further notice. Any use, disclosure, distribution, dissemination, copying, printing or reliance on this publication for any other purpose without our prior consent or approval is strictly prohibited. Neither Daiwa Securities Group Inc. nor any of its respective parent, holding, subsidiaries or affiliates, nor any of its respective directors, officers, servants and employees, represent nor warrant the accuracy or completeness of the information contained herein or as to the existence of other facts which might be significant, and will not accept any responsibility or liability whatsoever for any use of or reliance upon this publication or any of the contents hereof. Neither this publication, nor any content hereof, constitute, or are to be construed as, an offer or solicitation of an offer to buy or sell any of the securities or investments mentioned herein in any country or jurisdiction nor, unless expressly provided, any recommendation or investment opinion or advice. Any view, recommendation, opinion or advice expressed in this publication may not necessarily reflect those of Daiwa Securities Capital Markets Co. Ltd., and/or its affiliates nor any of its respective directors, officers, servants and employees except where the publication states otherwise. This research report is not to be relied upon by any person in making any investment decision or otherwise advising with respect to, or dealing in, the securities mentioned, as it does not take into account the specific investment objectives, financial situation and particular needs of any person. Daiwa Securities Group Inc., its subsidiaries or affiliates, or its or their respective directors, officers and employees from time to time have trades as principals, or have positions in, or have other interests in the securities of the company under research including derivatives in respect of such securities or may have also performed investment banking and other services for the issuer of such securities. The following are additional disclosures. Japan Daiwa Securities Co. Ltd. and Daiwa Securities Group Inc. Daiwa Securities Co. Ltd. is a subsidiary of Daiwa Securities Group Inc. Investment Banking Relationship Within the preceding 12 months, The subsidiaries and/or affiliates of Daiwa Securities Group Inc. * has lead-managed public offerings and/or secondary offerings (excluding straight bonds) of the securities of the following companies: Rexlot Holdings Limited (555 HK); China Outfitters Holdings Limited (1146 HK); Beijing Jingneng Clean Energy Co. Limited (579 HK); Infraware Inc. (041020 KS); Jiangnan Group Limited (1366 HK); Huadian Fuxin Energy Corporation Limited (816 HK). *Subsidiaries of Daiwa Securities Group Inc. for the purposes of this section shall mean any one or more of: Daiwa Capital Markets Hong Kong Limited, Daiwa Capital Markets Singapore Limited, Daiwa Capital Markets Australia Limited, Daiwa Capital Markets India Private Limited, Daiwa-Cathay Capital Markets Co., Ltd., Daiwa Securities Capital Markets Korea Co., Ltd. Hong Kong This research is distributed in Hong Kong by Daiwa Capital Markets Hong Kong Limited (“DHK”) which is regulated by the Hong Kong Securities and Futures Commission. Recipients of this research in Hong Kong may contact DHK in respect of any matter arising from or in connection with this research. Ownership of Securities For “Ownership of Securities” information, please visit BlueMatrix disclosure Link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. Investment Banking Relationship For “Investment Banking Relationship”, please visit BlueMatrix disclosure Link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. Relevant Relationship (DHK) DHK may from time to time have an individual employed by or associated with it serves as an officer of any of the companies under its research coverage. DHK market making DHK may from time to time make a market in securities covered by this research. Singapore This research is distributed in Singapore by Daiwa Capital Markets Singapore Limited and it may only be distributed in Singapore to accredited investors, expert investors and institutional investors as defined in the Financial Advisers Regulations and the Securities and Futures Act (Chapter 289), as amended from time to time. By virtue of distribution to these category of investors, Daiwa Capital Markets Singapore Limited and its representatives are not required to comply with Section 36 of the Financial Advisers Act (Chapter 110) (Section 36 relates to disclosure of Daiwa Capital Markets Singapore Limited’s interest and/or its representative’s interest in securities). Recipients of this research in Singapore may contact Daiwa Capital Markets Singapore Limited in respect of any matter arising from or in connection with the research. Australia This research is distributed in Australia by Daiwa Capital Markets Stockbroking Limited and it may only be distributed in Australia to wholesale investors within the meaning of the Corporations Act. Recipients of this research in Australia may contact Daiwa Capital Markets Stockbroking Limited in respect of any matter arising from or in connection with the research. Ownership of Securities For “Ownership of Securities” information, please visit BlueMatrix disclosure Link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. India This research is distributed by Daiwa Capital Markets India Private Limited (DAIWA) which is an intermediary registered with Securities & Exchange Board of India. This report is not to be considered as an offer or solicitation for any dealings in securities. While the information in this report has been compiled by DAIWA in good faith from sources believed to be reliable, no representation or warranty, express of implied, is made or given as to its accuracy, completeness or correctness. DAIWA its officers, employees, representatives and agents accept no liability whatsoever for any loss or damage whether direct, indirect, consequential or otherwise howsoever arising (whether in negligence or otherwise) out of or in connection with or from any use of or reliance on the contents of and/or omissions from this document. Consequently DAIWA expressly disclaims any and all liability for, or based on or relating to any such information contained in or errors in or omissions in this report. Accordingly, you are recommended to seek your own legal, tax or other advice and should rely solely on your own judgment, review and analysis, in evaluating the information in this document. The data contained in this document is subject to change without any prior notice DAIWA reserves its right to modify this report as maybe required from time to time. DAIWA is committed to providing independent recommendations to its Clients and would be happy to provide any information in response to any query from its Clients. This report is strictly confidential and is being furnished to you solely for your information. The information contained in this document should not be reproduced (in whole or in part) or redistributed in any form to any other person. We and our group companies, affiliates, officers, directors and employees may from time to time, have long or short positions, in and buy sell the securities thereof, of company(ies) mentioned herein or be engaged in any other transactions involving such securities and earn brokerage or other compensation or act as advisor or have the potential conflict of interest with respect to any recommendation and related information or opinion. DAIWA prohibits its analyst and their family members from maintaining a financial interest in the securities or derivatives of any companies that the analyst cover. This report is not intended or directed for distribution to, or use by any person, citizen or entity which is resident or located in any state or country or jurisdiction where such publication, distribution or use would be contrary to any statutory legislation, or regulation which would require DAIWA and its affiliates/ group companies to any registration or licensing requirements. The views expressed in the report accurately reflect the analyst’s personal views about the securities and issuers that are subject of the Report, and that no part of the analyst’s compensation was, is or will be directly or indirectly, related to the recommendations or views expressed in the Report. This report does not recommend to US recipients the use of Daiwa Capital Markets India Private Limited or any of its non – US affiliates to effect trades in any securities and is not supplied with any understanding that US recipients will direct commission business to Daiwa Capital Markets India Private Limited. Taiwan This research is distributed in Taiwan by Daiwa-Cathay Capital Markets Co., Ltd and it may only be distributed in Taiwan to institutional investors or specific investors who have signed recommendation contracts with Daiwa-Cathay Capital Markets Co., Ltd in accordance with the Operational Regulations Governing Securities Firms Recommending Trades in Securities to Customers. Recipients of this research in Taiwan may contact Daiwa-Cathay Capital Markets Co., Ltd in respect of any matter arising from or in connection with the research. Philippines This research is distributed in the Philippines by DBP-Daiwa Capital Markets Philippines, Inc. which is regulated by the Philippines Securities and Exchange Commission and the Philippines Stock Exchange, Inc. Recipients of this research in the Philippines may contact DBP-Daiwa Capital Markets Philippines, Inc. in respect of any matter arising from or in connection with the research. DBP-Daiwa Capital Markets Philippines, Inc. recommends that investors independently assess, with a professional advisor, the specific financial risks as well as the legal, regulatory, tax, accounting, and other consequences of a proposed transaction. DBP-Daiwa Capital Markets Philippines, Inc. may have positions or may be materially interested in the securities in any of the markets mentioned in the publication or may have performed other services for the issuers of such securities. For relevant securities and trading rules please visit SEC and PSE Link at http://www.sec.gov.ph/irr/AmendedIRRfinalversion.pdf and http://www.pse.com.ph/ respectively. United Kingdom This research report is produced by Daiwa Securities Capital Markets Co., Ltd and/or its affiliates and is distributed by Daiwa Capital Markets Europe Limited in the European Union, Iceland, Liechtenstein, Norway and Switzerland. Daiwa Capital Markets Europe Limited is authorised and regulated by The Financial Services Authority (“FSA”) and is a member of the London Stock Exchange, Chi-X, Eurex and NYSE Liffe. Daiwa Capital Markets Europe Limited and its affiliates may, from time to time, to the extent permitted by law, participate or invest in other financing transactions with the issuers of the securities referred to herein (the “Securities”), perform services for or solicit business from such issuers, and/or have a position or effect transactions in the Securities or options thereof and/or may have acted as an underwriter during the past twelve months for the issuer of such securities. In addition, employees of Daiwa Capital Markets Europe Limited and its affiliates may have positions and effect transactions in such securities or options and may serve as Directors of such issuers. Daiwa Capital Markets Europe Limited may, to the extent permitted by applicable UK law and other applicable law or regulation, effect transactions in the Securities before this material is published to recipients.

- 105 - Aviation Primer Winter 2012

This publication is intended for investors who are not Retail Clients in the United Kingdom within the meaning of the Rules of the FSA and should not therefore be distributed to such Retail Clients in the United Kingdom. Should you enter into investment business with Daiwa Capital Markets Europe’s affiliates outside the United Kingdom, we are obliged to advise that the protection afforded by the United Kingdom regulatory system may not apply; in particular, the benefits of the Financial Services Compensation Scheme may not be available. Daiwa Capital Markets Europe Limited has in place organisational arrangements for the prevention and avoidance of conflicts of interest. Our conflict management policy is available at http://www.uk.daiwacm.com/about-us/corporate-governance-and-regulatory. Regulatory disclosures of investment banking relationships are available at https://daiwa3.bluematrix.com/sellside/Disclosures.action. Germany This document has been approved by Daiwa Capital Markets Europe Limited and is distributed in Germany by Daiwa Capital Markets Europe Limited, Niederlassung Frankfurt which is regulated by BaFin (Bundesanstalt fuer Finanzdienstleistungsaufsicht) for the conduct of business in Germany. Bahrain This research material is issued/compiled by Daiwa Capital Markets Europe Limited, Bahrain Branch, regulated by The Central Bank of Bahrain and holds Investment Business Firm – Category 2 license and having its official place of business at the Bahrain World Trade Centre, South Tower, 7th floor, P.O. Box 30069, Manama, Kingdom of Bahrain. Tel No. +973 17534452 Fax No. +973 535113 This material is provided as a reference for making investment decisions and is not intended to be a solicitation for investment. Investment decisions should be made at your own discretion and risk. Accordingly, no representation or warranty, express or implied, is made as to and no reliance should be placed on the fairness, accuracy, completeness or correctness of the information and opinions contained in this document, Content herein is based on information available at the time the research material was prepared and may be amended or otherwise changed in the future without notice. All information is intended for the private use of the person to whom it is provided without any liability whatsoever on the part of Daiwa Capital Markets Europe Limited, Bahrain Branch, any associated company or the employees thereof. If you are in doubt about the suitability of the product or the research material itself, please consult your own financial adviser. Daiwa Capital Markets Europe Limited, Bahrain Branch retains all rights related to the content of this material, which may not be redistributed or otherwise transmitted without prior consent. This report is distributed in the U.S. by Daiwa Capital Markets America Inc. (DCMA). It may not be accurate or complete and should not be relied upon as such. It reflects the preparer’s views at the time of its preparation, but may not reflect events occurring after its preparation; nor does it reflect DCMA’s views at any time. Neither DCMA nor the preparer has any obligation to update this report or to continue to prepare research on this subject. This report is not an offer to sell or the solicitation of any offer to buy securities. Unless this report says otherwise, any recommendation it makes is risky and appropriate only for sophisticated speculative investors able to incur significant losses. Readers should consult their financial advisors to determine whether any such recommendation is consistent with their own investment objectives, financial situation and needs. This report does not recommend to U.S. recipients the use of any of DCMA’s non-U.S. affiliates to effect trades in any security and is not supplied with any understanding that U.S. recipients of this report will direct commission business to such non-U.S. entities. Unless applicable law permits otherwise, non-U.S. customers wishing to effect a transaction in any securities referenced in this material should contact a Daiwa entity in their local jurisdiction. Most countries throughout the world have their own laws regulating the types of securities and other investment products which may be offered to their residents, as well as a process for doing so. As a result, the securities discussed in this report may not be eligible for sales in some jurisdictions. Customers wishing to obtain further information about this report should contact DCMA: Daiwa Capital Markets America Inc., Financial Square, 32 Old Slip, New York, New York 10005 (telephone 212-612-7000).

Ownership of Securities For “Ownership of Securities” information please visit BlueMatrix disclosure Link at https://daiwa3.bluematrix.com/sellside/Disclosures.action.

Investment Banking Relationships For “Investment Banking Relationships” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action.

DCMA Market Making For “DCMA Market Making” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action.

Research Analyst Conflicts For updates on “Research Analyst Conflicts” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The principal research analysts who prepared this report have no financial interest in securities of the issuers covered in the report, are not (nor are any members of their household) an officer, director or advisory board member of the issuer(s) covered in the report, and are not aware of any material relevant conflict of interest involving the analyst or DCMA, and did not receive any compensation from the issuer during the past 12 months except as noted: no exceptions.

Research Analyst Certification For updates on “Research Analyst Certification” and “Rating System” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The views about any and all of the subject securities and issuers expressed in this Research Report accurately reflect the personal views of the research analyst(s) primarily responsible for this report (or the views of the firm producing the report if no individual analysts[s] is named on the report); and no part of the compensation of such analyst(s) (or no part of the compensation of the firm if no individual analyst[s)] is named on the report) was, is, or will be directly or indirectly related to the specific recommendations or views contained in this Research Report. The following explains the rating system in the report as compared to relevant local indices, based on the beliefs of the author of the report. "1": the security could outperform the local index by more than 15% over the next six months. "2": the security is expected to outperform the local index by 5-15% over the next six months. "3": the security is expected to perform within 5% of the local index (better or worse) over the next six months. "4": the security is expected to underperform the local index by 5-15% over the next six months. "5": the security could underperform the local index by more than 15% over the next six months. Additional information may be available upon request. Japan - additional notification items pursuant to Article 37 of the Financial Instruments and Exchange Law (This Notification is only applicable where report is distributed by Daiwa Securities Co. Ltd.)

If you decide to enter into a business arrangement with us based on the information described in materials presented along with this document, we ask you to pay close attention to the following items. • In addition to the purchase price of a financial instrument, we will collect a trading commission* for each transaction as agreed beforehand with you. Since commissions may be included in the purchase price or may not be charged for certain transactions, we recommend that you confirm the commission for each transaction. • In some cases, we may also charge a maximum of ¥ 2 million (including tax) per year as a standing proxy fee for our deposit of your securities, if you are a non-resident of Japan. • For derivative and margin transactions etc., we may require collateral or margin requirements in accordance with an agreement made beforehand with you. Ordinarily in such cases, the amount of the transaction will be in excess of the required collateral or margin requirements. • There is a risk that you will incur losses on your transactions due to changes in the market price of financial instruments based on fluctuations in interest rates, exchange rates, stock prices, real estate prices, commodity prices, and others. In addition, depending on the content of the transaction, the loss could exceed the amount of the collateral or margin requirements. • There may be a difference between bid price etc. and ask price etc. of OTC derivatives handled by us. • Before engaging in any trading, please thoroughly confirm accounting and tax treatments regarding your trading in financial instruments with such experts as certified public accountants. *The amount of the trading commission cannot be stated here in advance because it will be determined between our company and you based on current market conditions and the content of each transaction etc.

When making an actual transaction, please be sure to carefully read the materials presented to you prior to the execution of agreement, and to take responsibility for your own decisions regarding the signing of the agreement with us.

Corporate Name: Daiwa Securities Co. Ltd. Financial instruments firm: chief of Kanto Local Finance Bureau (Kin-sho) No.108 Memberships: Japan Securities Dealers Association, The Financial Futures Association of Japan Japan Investment Advisers Association Type II Financial Instruments Firms Association