Flying through turbulent weather
Guest Column: Dhiraj Mathur, Partner, Leader National A&D Practice PwC

It is well established that the civil aviation industry has close correlation to the economy. Growth in GDP, per capita income and increasing tourism are the major drivers of air passenger growth. The Indian economy has performed well over the past four years, barring a brief interlude and passenger growth has reflected this positive trend. However, despite the growth in traffic and topline revenue, the Indian aviation industry has faced multiple challenges that have impacted not just its profitability but even cast a question mark on the viability of some of its key players.

India is among the fastest-growing aviation sectors and is expected to become the world’s largest domestic civil aviation market by 2030. Tier 1, 2 and 3 cities are expected to be connected by a network of air routes by the next decade driven by the government’s regional connectivity scheme (UDAN). Capacity expansion of existing airports and construction of new airports would facilitate increased air travel and connectivity to remote locations. This, in turn, would contribute to the enhancement of the local economy due to direct, indirect and induced effects. As more and more of the price sensitive Indian middle-class population gets to fly – and they can easily access the internet to get more transparency on air fares – price competition will continue.

To truly realise the growth potential of the industry, several issues need to be addressed.

Airport capacity has become a serious issue: while Mumbai, Bangalore, Hyderabad, Ahmedabad and Pune airports are operating beyond their capacity, Delhi, Kolkata, Chennai, Goa and Lucknow are expected to reach their full capacity soon. Several smaller airports including Rajkot, Nagpur, Patna, Leh, Dehradun, Bagdogra, Jammu, Port Blair, Imphal, Agartala, Guwahati, Jaipur and Coimbatore are also handling passengers far beyond their capacity.

Constraints

Capacity constraints create several bottlenecks including longer check-in time, clogging of gates, delayed flights and increased security risks. This also means that airlines have to incur higher costs due to longer hover time over airports, increased on ground time and delays in taking off. To support the unprecedented growth in air traffic, there has to be better forecasting and major capacity expansion at the airports.

Almost 40 per cent of the operating costs of airlines are on account of fuel. Crude oil price has increased by close to 50 per cent over the last year, leading to significant increase in aviation turbine fuel (ATF) costs. Air fuel is also subject to excise duties and state taxes of up to 30 per cent. Moreover, the three largest airlines in India have an average fleet age of over 6, 8 and 7 years respectively.

This deals a double whammy of operating through lower fuel economy and higher maintenance costs. The Indian Rupee has depreciated by more than 10 per cent against the dollar in the last one year. A consequence of this is that airlines have to incur higher leasing costs as all leases are in dollar denominations. This has added to the pressure on the margins of most of the airlines. The recent grounding of aircraft by some airlines due to technical issues in engines, further added pressure on their operations.

Rising fuel prices, depreciating rupee, capacity constraints in airports and competition have collectively taken a toll on the financials of all airlines. Barring one, all went into losses in the first quarter of FY19. A leading airline reported a more than 50 per cent increase in its fuel costs and over 10 per cent increase in aircraft lease rentals in the first quarter of FY19, as compared to the same quarter last year. It further incurred over Rs 350 crore in losses from a negative impact of foreign currency fluctuations. A couple of airlines with legacy high debt bled even more. A significant portion of the debt of a leading airline is in working capital, the money needed to fund its everyday operations. Furthermore, given its huge employee strength, the costs of employee remuneration and benefits is also huge for the state-owned airline. Although there was a recent attempt by the government to divest majority stake in the airline, it failed to attract any bids.

Business model

A final problem is that of the business model. An airline can operate sustainably either as a low cost carrier (LCC) or a full service carrier (FSC). Managing both in one company presents multiple challenges. To survive and grow in the Indian civil aviation market, an airline must have a well-designed long-term cost control and revenue enhancement strategy in place. It must strive for increasing their revenues through strategic initiatives around pricing, networking, inventory and sales.

Given the rising fuel costs, airlines should implement well-structured cost reduction programmes. Key areas include improving average fuel efficiency of the fleet by introducing the new generation fuel-efficient aircraft, restructuring through buy back and lease and better fuel-hedging to reduce the exposure to price volatility. Debt-ridden airlines should consider financial restructuring to raise capital and replacing high cost debt.

There is tremendous latent demand in the severely under-served Indian civil aviation market. Whilst the government has taken various initiatives towards realising the potential in the industry, it must reduce taxes on ATF and bring it under GST. A synergetic approach by airlines, airports and the policy makers would make India well positioned to achieve its vision of becoming the largest aviation market by 2030.

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