Price caps for airlines complicated but minor issue, says CIMB Research

KUALA LUMPUR: CIMB Equities Research believes the move to impose price caps for airlines is likely to be a minor irritant to the carriers and unlikely to have any major commercial implications.

In its research note on Thursday, it said even if price caps are introduced, it believes that the impact on airlines will be limited as the price caps are likely to be set quite high. It maintained Neutral on the sector.

CIMB Research said the setting of price caps is a complicated affair:

1) it will need to be set route-by-route, taking into account flight distance;

2) the aviation regulator Malaysian Aviation Commission (Mavcom) will need to decide how to treat the different ways airlines price their tickets, i.e. bundled vs. unbundled fares;

3) Mavcom will need to work out how to factor in changes in airline costs into the price cap, i.e. the price of fuel, but also the US$ exchange rate which has a major impact on operating costs, and finally;

4) Mavcom needs to balance the public’s desire for reasonable fares with the ideal of free market forces, in the research house’s opinion.

CIMB Research believes that the price caps are likely to be set quite high, because 1) a low-price cap will hurt Malaysia Airlines (MAS) and Malindo more, as their airfares are typically higher than AirAsia's, and 2) it is not in the interests of Mavcom to drive MAS and Malindo out of business, since that would leave AirAsia as the de-facto monopoly which will have repercussions for the level of competition and consumer choice in the airline space.

To recap, in response to public complaints over the high price of domestic airfares during festive seasons, Mavcom initiated a study several months ago on how best to address the issue. Mavcom’s report will be presented to the Ministry of Transport (MOT) later this month.

Five issues to be looked into

Issue 1: How low will the price cap be?

The lower the price cap, the more airlines may be affected. Airlines typically apply “surge pricing” to festive periods, last minute bookings, and popular flights, e.g. Friday night flights from Singapore to KL.

Passengers who miss their flights and have to make on-the-spot bookings for the next available flight at the airport sales counter will probably be slaughtered on pricing.

Issue 2: How often do airlines breach the price cap?

If airlines do not breach the price cap often, then the impact on airlines' weighted average pricing will not be significant. 

Airlines will be prevented from applying “surge pricing” on just a handful of tickets, which will not have a material impact on the overall earnings of the airline. 

Again, it all boils down to the level at which the price cap is set.

Issue 3: Will MAS and Malindo object?

CIMB Research believes that the MOT and Mavcom will have to take into consideration the views of MAS and Malindo, which have continued to make losses in 2016, when jet fuel prices averaged only US$53/bbl.

 Jet fuel is currently trading at US$84/bbl, exacerbating the pressure on both MAS and Malindo which are likely to be suffering even bigger losses today. Neither would be in favour of a price cap that would be too low, as both would want to price higher to cross the breakeven threshold.

Issue 4: Will only base fares be capped?

Airlines typically charge base fares and add to that all kinds of other fees and ancillary income charges. 

AirAsia charges a “klia2 fee” of RM3/pax for all departures from klia2, and a minimum of RM24 processing fee for online bookings using credit cards. It also charges for baggage and food separately. Hence, AirAsia's base fares are very low.

Conversely, MAS and Malindo charge all-inclusive fares and do not segregate the base fare from the baggage and meal entitlements. 

In other words, if Mavcom were to cap base fares, the ceiling is likely to be set quite high to take into account the fact that MAS and Malindo charge all-inclusive fares, and the result of this is that AirAsia will have a very large headroom to play with its base fares.

Issue 5: Will fuel surcharges be included into the price cap?

This is an issue which is of great importance, given the upward trajectory of fuel prices right now. 

If MAVCOM sets a price cap on the overall ticket price, but exclude fuel surcharges, airlines will have some wriggle room to play around with their fuel surcharges to claw back what they were not allowed to charge elsewhere.

To be fair to airlines, Mavcom's price caps either have to be 1) quite high with a lot of headroom for airlines to adjust their fares higher due to higher fuel prices, or 2) the price caps will need to be dynamically adjusted for fluctuations in fuel prices.