Will cost-cutting help turn around MAS?

By Chan Quan Min

Malaysia Airlines head honcho Ahmad Jauhari Yahya is relying on aggressive cost-cutting in his latest move to turn around the ailing flag carrier. KiniBiz weighs in on Jauhari’s ambitious goal to trim 10% off the airline’s cost base.

Jauhari, now two months into his third year as managing director and group CEO of Malaysia Airlines, in interviews last week said the airline must go further in reducing costs in order to break even by year-end.

The target is 10%, formidable given that historically, costs have been downward sticky for the cumbersome legacy carrier.

Jauhari’s cost cutting zeal coincides with the national carrier having reported last week disappointing third-quarter financial results. Passenger yield, an indicator of average ticket prices, has fallen 13% this year alone.

To make up for the decline in yields or revenue per paying passenger per kilometre, Jauhari must reduce costs by a comparable amount, if not more, to return profitability to Malaysia Airlines.

Unfortunately, Jauhari stopped short of elaborating on his plans to trim costs. He did, however, give a vague indication of which business areas he might focus his efforts on.

“We are going to review all our procurements. I don’t want to pick a single one, it will be right across the board. Every single major procurement will be looked at, such as engineering services and IT,” Jauhari was quoted as saying in last week’s edition of Focus Malaysia.

“We have a long-term contract with Brahim’s Airline Catering (Sdn Bhd), which used to be LSG Sky Chefs,” he mentioned.

Possible review of controversial catering contract

Malaysia Airlines is serving out an exclusive 25-year contract with 30% owned caterer, Brahim’s Airline Catering Sdn Bhd (formerly LSG Sky Chef – Brahim’s Sdn Bhd) signed in 2003.

The terms of the contract, while not publicly available, has been reported to be unfairly skewed towards the caterer, which has Ibrahim Ahmad Badawi, the brother of a former prime minister as its executive chairman and indirect shareholder.

For the 2012 financial year, Malaysia Airlines made payments totalling RM234.8 million to Brahim’s Airline Catering in return for the supply of meals and beverages.

Some quarters have alleged the meals supplied by the caterer are grossly overpriced, by as much as RM60 for a serving of nasi lemak as claimed by an MP in parliament in 2006.

But the real number could be closer to an average of RM20 per meal, according to a conversation between the caterer’s senior management and a Hong Leong Investment Bank (HLIB) research analyst, subsequently relayed to KiniBiz.

Despite the 25-year term of the contract, there is reportedly some room to renegotiate meal pricing. According to HLIB Research, the contract has allowances to accommodate meal-pricing changes based on variables such as labour cost.

Meal pricing is dependent upon the particular menu item and is known to change as often as a year on average, said HLIB Research.

While reducing costs related to catering is a possibility, the net impact to operating expenses is expected to be miniscule at best.

As a share of operating expenses, payments to Brahim’s Airline Catering Sdn Bhd make up only 1.9% of total expenses this year to date.

Given the small share of catering costs, Jauhari will need to make drastic changes to come close to reaching his 10% target.

Staff downsizing can make an impact

Fuel costs are proportionally the largest cost component of operating expenses for Malaysia Airlines. However, the price of jet fuel is subject to international market movements and cannot be predicted.

The elephant in the room is staff costs, which in the 2012 financial year contributed to 18% of operating expenses. Mohshin Aziz of Maybank IB Research picked out staff costs as “low hanging fruit” ripe for downsizing.

“MAS must be prepared to let go of redundant staff and aim for higher labour productivity,” he said. Revenue per employee for the national carrier ranks low compared to its regional competitors. For the 2012 financial year, revenue per employee was half that of Singapore Airlines and Cathay Pacific.

Mohshin cited Malaysia Airlines’ poor labour productivity as reason enough for the airline to ask more from its staff. Management should be prepared to give the golden handshake, he said.

But retrenching staff is easier said than done. Malaysia Airlines is notorious for the strength of its labour unions.

While reducing staff costs could make a real impact in Jauhari’s cost cutting efforts, it is not likely to feature in his turnaround plan.

To date, Jauhari has made no mention of tackling high staff costs, preferring instead to reduce unit costs by expanding flight operations.

Spreading out costs over expanded operations

The bulk of the decrease in unit costs or CASK (cost per available seat-kilometre) can be traced back to the airline maintaining fixed costs constant while increasing flight operations or in other words, adding ASKs (available seat-kilometres), said Mohshin.

Over the past year, Malaysia Airlines has added close to 40% in additional capacity to its network while using the same number of aircraft.

This has had the effect of spreading out fixed costs over a larger denominator, in effect reducing CASK.

It is likely that Malaysia Airline will continue to count on growth to reduce unit costs. Jauhari himself has indicated that he will continue to improve aircraft utilisation by mounting additional flights to regional destinations.

Inevitably, Jauhari’s fervour for cost cutting begs the question: How important is keeping costs down to airline profitability?

Unfortunately, not much. Among regional peers, Malaysia Airlines could be considered somewhere in between high-cost and low-cost.

A survey titled ‘Asian airline cost rankings’ by the Centre for Aviation found Malaysia Airlines to have comparable CASK to Thai Airways and Singapore Airlines.

Budget Airlines such as the AirAsia group, Cebu Pacific and Tiger Airways have lower CASK than Malaysia Airlines while East Asian airlines such as Japan Airlines, All Nippon Airways and Korean Air have far higher cost structures.

Most if not all airlines listed in the Asian airline cost survey are currently turning a profit, regardless of the airline’s cost structure.

Given the data, the national airline might want to heed the calls of analysts and perhaps look more closely at the other side of the equation; yield.

“The transformation plan has to look deeper,” Mohshin said, lamenting the lacklustre progress so far.