Sinking
City: 
Indian aviation must brace itself for a hard landing amid the turbulence of cyclical market disruption. ’Coz quick-fixes aren’t working any more

These are troubles times for the airline business in India. And it is sparing no one. Indian aviation's poster boy IndiGo left investors in a tizzy as it reported a steep 97 per cent fall in profits in April-June quarter. Close on the heels, the other BSE-listed peers SpiceJet and Jet Airways too logged losses with the latter shocking industry watchers with its Rs 1,326 crore hole in its April-June financial statement. The poor show by the three carriers has sent distress signal for the sector, early signs of crisis seen last in 2012 when Vijay Mallya-led Kingfisher Airlines went bust.

With rising fuel price, weakening rupee and cut-throat rivalry for market share, the financial health of most carriers are likely to worsen in the absence of tough measures. Given that the operating environment is now altogether different from earlier years when there were limited players in the market and competitive pressure was much lower, the airlines would need to act fast on options available for reversing the trend.

In the light of current headwinds, investors have started downgrading airline stocks while sector consultancies are revising the outlook downward. In its revised outlook for the Indian aviation sector, global advisory Centre for Asia Pacific Aviation (CAPA) has said that the combined loss of the sector could be in the range of $1.65 billion to $1.90 billion in FY19 if oil hovers at $75-$80 a barrel and the exchange rate stays in the region of Rs 70-Rs 72 a dollar.

Noting that air traffic growth continues unabated, CAPA said that financial outlook has deteriorated dramatically since January. “At that time (since January) CAPA India forecast a consolidated industry loss of $430 million to $460 million, subject to oil remaining below $70 a barrel and the US dollar exchange rate at Rs 65 to Rs 67,” it said.

CAPA said that the full-year result of three low-cost carriers — IndiGo, GoAir and SpiceJet — is likely to range between break-even and modest profitability but the possibility of a full-year loss cannot be ruled out. Full service carriers (FSCs) are critically placed and could lose $1.75 billion to $2 billion in the current fiscal year largely because of their uncompetitive cost base on domestic operations and a lack of profitability on international routes, it said.

In the pre-boom phase in the mid-90s, there were only three key players namely, Air Sahara, Jet Airways and Indian Airlines, now Air India following the merger of the two state-owned carriers. Invariably, each of them back then followed one another in raising ticket prices to pass on the increased input cost and remain profitable. But the scene changed completely after the launch of low-cost airline Air Deccan that frequently stimulated the market with their promotional fare of Rs 1, Rs 100 and Rs 500.

In the last few years, the country has seen the success of the low-cost airline model. At the same time, the sector has also witnessed unsustainable low-fares that have taken a heavy toll on the airlines. It pushed Air Deccan to the verge of collapse before liquor baron Vijay Mallya bought it and reverse-merged his Kingfisher Airlines. The move later turned out to be a misadventure for Mallya who had put a lot of blood and sweat, and a lot of signature flash and extravagance, in building his airline business.

Not only did the airline became bankrupt, the heavy debt taken to pull it through the crisis severely affected Mallya’s other business since he had given personal guarantee for part of it. As the noose tightened over Mallya to repay the loan with the law closing in on him, he left India and now lives in London. While he seemingly continues to be haunted by the Kingfisher ghost, some of the Indian authorities have declared him an absconder. The Indian government is trying to have Mallya extradited so that he could be brought back to face the law.

Shakeout

It has been almost six years since Kingfisher failed in 2012 and it seems another shakeout in the airline sector is in the offing. As the problems remain the same and vulnerability of some carriers continues, there are bound to be casualties. It is only a matter of time and degrees. Some airlines in the past have been lucky and have survived but this may not be the case with others.

“I don’t think any airline will close but they will have to raise fresh money. They will have to beg, borrow and steal for survival,” a top industry executive who did not wish to be named, said.

ClubOne Air CEO and former India head of Qatar Airways Rajan Mehra agreed, saying that the present situation is as bad as it was in 2012 or 2004-05. He noted that the problem faced by airlines is partly because of high fuel prices and a weak rupee in addition to individual airlines having their own inefficiencies.

“The fact that none of the airlines have cancelled aircraft order is proof that things are not that bad. I think the outlook is still very bright. This is a temporary glitch that has happened and it is different for different airlines. For example, in case of IndiGo it is because of issues with faults in their Neo engines. For Jet Airways, it is unexplained financial reasons. Of course, fuel and forex are important factors,” said Mehra.

When there were few airlines, they all had almost the same cost structure. Therefore, if there was a downturn or a fuel price rise or any other cost going up, they would raise fares almost simultaneously. There was no Competition Commission of India (CCI) back then. So, when the market leader announced an increase in ticket prices, others followed. For instance, if being market leader Indian Airlines raised ticket prices others followed them closely. Today, there is no airline which can say that it can dictate ticket prices which others will follow. The cost structure of each airline is different. Therefore, while lower ticket price does not matter much for one airline for others it matters a lot.

However, since airline tickets have become a commodity everybody has to keep the same price. Unfortunately, the airline which has the lowest cost structure does not increase prices forcing the high-cost airlines to sell tickets at lower price and make losses. There are two major high-cost airlines, Jet Airways and Air India. For Air India, the government is behind it to bail it out of trouble in times of need but Jet Airways, a private airline with large operations, has to fend for itself.

In these situations, larger the fleet higher is the loss. So, there are chances that airlines with not very large operations like SpiceJet and GoAir will sail through the turbulence but big carriers like IndiGo, Jet Airways and Air India may find the flight path difficult.

Aviation is a cyclical business and after few years there is reversal of the trend for reasons including economic slowdown, political instability, fuel prices and local governmental issues.

Among private airlines, Jet Airways and the now defunct Kingfisher Airlines suffered the most in 2012. There were basically two reasons for that. Firstly, their business model was flawed and second, their size. At that time other airlines like IndiGo, GoAir and SpiceJet were smaller in size. Even the biggest carrier, now IndiGo, did not have more than 50 aircraft in its fleet. So, they could survive the bad times much better than their bigger peers. Experts do not rule out a better chance of survival for GoAir and Air Asia if the adverse operating conditions stretch longer.

Currently, low-cost airlines are not raising ticket prices in proportion to the increase in fuel prices and the weakening of the rupee. For roughly two hours of flight, tickets are being sold for about Rs 3,000. Full-service carrier Jet Airways has already come under huge pressure and its CEO Vinay Dube was candid in flagging the issue during the earnings conference call last week.

“Airlines have been unable to pass on this increased cost to consumers by increasing fares. The lag between the increase in fuel costs and fares must get corrected over time. The industry cannot sustain such low fares in the long run,”“ Dube said.

Global crude prices has jumped nearly 150 per cent from their lowest levels two-and-a-half years ago. Further, the rupee has also depreciated significantly in the last one year and the downward trend continues. Together, the two key cost components have hit the airline sector hard.

Because of more competition and inventory available now, airlines do not command much pricing power. There is a very thin line in business models of airlines. Both full service and LCCs or low cost carriers have the same pricing structure but in terms of cost there is wide difference. This is the reason FSCs or full service carriers suffer more than LCCs when fuel price and other input cost goes up. In times of crisis, smaller airlines therefore succeed in bleeding less and manage to stay afloat.

“It seems, at least at this point of time, that airlines have chosen growth over profitability. They are expanding network and deploying capacity without keeping profit in mind. This has caused pain among airlines,” said an airline executive.

Capacity induction

Going by the flight occupancy of various airlines it seems there is enough demand for existing capacity but experts point out that the real picture would come only when ticket prices cover cost and profits. They argue that at lower ticket prices even more capacity would be required.

The official data shows most airlines had a passenger load factor (PLF) or flight occupancy of nearly 80 per cent with no-frill carriers SpiceJet recording 93.8 per cent PLF in July in spite of the period being lean season. According to the expansion plan shared with the government, Indian Airlines is likely to induct more than 900 aircraft in the coming years, with the largest private carrier IndiGo alone expected to add 448 planes.  Jet Airways has placed a firm order of 225 B737-MAX aircraft with American manufacturer Boeing. In the current fiscal alone, the airline will be inducting 11 new B737-MAX aircraft. The largest carrier by fleet and market share, IndiGo, has been inducting new planes almost every fortnight. Launched in 2005, IndiGo currently has a fleet size of over 170 aircraft and operates more than 1,200 flights.

Another fast growing budget carrier, SpiceJet, had last year announced a deal to purchase 205 airplanes from Boeing for a massive $22 billion. It continues to expand its network and fleet. The airline has also been aggressive in launching new flights under the government’s flagship regional connectivity scheme (RCS) that subsidies part of the seats to make air travel affordable for common man. New airlines Air Asia India and Vistara, the Tata group joint ventures with Air Asia Berhad and Singapore Airlines respectively, too have catched up fast. Both of them now have sizeable fleet of almost 20 each and growing.

“The airlines do not have control over external factors like fuel prices and forex. At a time when headwinds are strong, they should go for meaningful expansion and cut cost,” said the airline executive quoted above.

But airlines are in no mood to slow down. They have been increasing flights and frequency on both domestic and international networks. IndiGo would be adding Kuwait and Abu Dhabi to its network starting this winter schedule. In a first by an LCC, the Gurugram-based carrier would also launch low fare flights to London, one of the key routes to and from India.

“A low-cost carrier, coming into the picture, will make it much easier for Indians to fulfil their London dream. We are expecting an approximate difference of 20 per cent from current average flight fares for this route,” said Aloke Bajpai, CEO & Co-founder of IxiGo, a leading travel marketplace.

All major players on the India-UK sector are full-service carriers like Air India, Jet Airways and British Airways.

Riding high on air travel demand, Wadia group-promoted budget carrier GoAir plans to launch international flights this October with maiden operations to popular tourist hotspot Phuket. The inaugural flight will operate to Phuket from New Delhi and Mumbai. The airline will also launch flights to Male in Maldives from Mumbai and Delhi on October 14. The Mumbai-based carrier will be the sixth domestic carrier to have international operations. Singapore Airlines and Tata group joint venture Vistara is also expected to start flying on foreign routes from this year.

Proposing to launch its international operations from the ongoing summer flying season, Vistara plans to operate flights to popular foreign tourist destinations of Bangkok, Phuket, Colombo and Male. The airline has sought government approval to operate seven flights a week or 1,148 seats to each city.

From the winter schedule that starts from October and ends in March, Vistara plans to operate daily flights to the Gulf, Bangladesh and Singapore. Entry of Tata-Singapore Airlines joint venture to international market is set to offer consumer more flying choices at competitive ticket prices.

One of the fast growing airlines in the domestic market, Vistara recently agreed to place firm orders with Airbus for 13 aircraft from the A320neo family and with Boeing for six 787-9 Dreamliner. Together, the deals are valued at $ 3.1 billion, based on published list prices.

Choices for flyers

While affordable fares have helped domestic airlines clock double-digit growth for 48-50 months in a row, the demand on international routes also remain strong. According to latest data from the Directorate General of Civil Aviation (DGCA), the scheduled international passenger traffic for the first quarter (January-March) of 2018 stands at 15.8 million while the international passenger traffic for the corresponding period in the year 2017 stood at 14.2 million — a growth of 11.3 per cent.

“The top 10 international carriers accounted for almost 60 per cent of the international passenger traffic during the first quarter of the year 2018. Jet Airways carried the highest number of international passengers followed by Air India and Emirates airlines. All the 5 Indian carriers, that is Air India, Air India Express, IndiGo, Jet Airways and SpiceJet operating on international routes, find place in the top 10 list,” the DGCA said in its analysis of international traffic.

As GoAir and Vistara enter the international market, the share of traffic on foreign routes for Indian carriers is set to rise further. The combined share of Indian carriers in the total international traffic during April-March of 2018 stood at 39.5 per cent with the remaining held by foreign carriers. In the same quarter last year, the local carriers had a combined share of 38.5 per cent.

As the flooding of capacity in the domestic market has given consumers more fare choices, the additional flights by Vistara, GoAir and IndiGo are expected to stimulate traffic growth on foreign sectors resulting in lowering of fare level. Besides, they would also offer more new destinations for flying.

At present, there are 91 scheduled international carriers- 5 domestic and 86 foreign carriers operating to and from India. They together connect India with 59 foreign countries with flights on 344 routes. Almost all the domestic carriers have been announcing flash sales with tickets available for as low as Rs 999 on domestic network. The largest carrier IndiGo put as many as 10 lakh seats on offer across its network forcing others to follow.

Jet Airways, which has maintained that current fares are not in line with increase in input costs, followed IndiGo and announced global sale of tickets. It offered up to 30 per cent discount on economy and business class. In a statement it said that over 2.5 million seats would be available for booking during the six-day global sale. As competition on foreign routes hots up with the entry of new carriers, fire sale is expected to be more frequent. While flash sale is a gimmick to stimulate demand, airlines also come with it when they face cash flow issues. In 2015, SpiceJet had launched flash sales almost every week to generate cash flow as it struggled to meet daily operational expenses.

More often than not, airlines reduce fares to chase customers in a situation when available capacity far exceeds demand. Given the massive capacity expansion on the cards, the domestic fare sale is likely to extend to international market as well. There is already stiff competition on India-Gulf routes. Once highly lucrative, the sector has turned regular and less profitable.

Severe capacity crunch at most of India's major airports have rung alarm bells among airlines. With double-digit growth in traffic, smaller airports in off-metro areas are virtually choked. The two major airports in Delhi and Mumbai are hardly in the position to provide slots to airlines during peak hours and choices are limited during off-peak hours. Out of 10 major airports, eight are nearly saturated. The remaining 50-odd airports have constraints like limited terminal space, insufficient window for commercial flights and absence of night landing facilities.

Among various suggestions to tackle the capacity issue, the airline industry has suggested extension of watch-hour at defence airports and mount security and immigration personnel at smaller airports. Sydney-based CAPA estimates that most of the 30 large AAI airports would saturate within 10 years. Further, India could face a capacity crisis without construction of 50 new airports over the next decade.

In view of the exponential growth, aircraft manufacturers like Boeing and Airbus have revised their projections upward but have at the same time warned of gradually choking airport infrastructure in the country.

“In terms of all airlines wanting to operate during peak hour, the capacity is definitely likely to be constrained. In India, the air traffic has been growing double-digit for the last 48-50 months. So, there has definitely been an unprecedented growth in traffic. The government has been upgrading airports for UDAN in tier-II and III cities.

AAI has been expanding its airports in various cities. Besides, new airports are coming up. The Navi Mumbai airport has been awarded. Further, bidding for Bhogapuram and Jewar in NCR is on the cards,” said Deloitte India partner Peeyush Naidu. The issue of appropriate infrastructure creation and upgrade is important and needs to be addressed urgently to sustain growth, he said.

“This would need strengthening of public institutions and their capacity to facilitate predictable and transparent policy formulation, project implementation and regulation. New projects would need due preparation in terms of strong business case preparation, flexible models for varying needs and requirements, government agencies being able to coordinate land acquisition/ connecting infrastructure in a time bound manner, and time-bound decision making and approval processes. We will then be able to attract credible private players including international ones to invest their time and resources in these projects,” Naidu added.

While the government has charted out a plan to build new airports, they are years away from becoming operational. The airline industry may not afford any delay as fuel burn as a result of congestion at airports could leave holes in their books. In an interview to FC, Vistara CEO Leslie Thng recently said that almost all metro cities need two airports to handle the growing demand for air travel, and smaller cities need significant improvement of existing airports. “This is, perhaps, the biggest issue that hinders the growth of the Indian aviation ecosystem today, for it limits possibilities for airlines and eventually all related businesses and at the end, inconveniences consumers as well,” he had said.

Nodal role

The civil aviation ministry has pitched for inclusion of aviation turbine fuel (ATF) in GST. Once included in GST, tax incidence on jetfuel would significantly come down besides allowing airlines to claim input tax credit (ITC). Sector experts claim that ATF price would come down if it is kept in the 18 per cent GST bracket and no other surcharge is levied. The lower fuel cost would mean ticket prices going down for air-travellers.

As fuel accounts for nearly 35-40 per cent of an airline’s operating cost, its inclusion into GST would bring significant gain for the sector. While it will improve the profitability of airlines it will give major boost to government's ambitious plan to enable every common man to fly by providing air travel at affordable price. The retail price of ATF currently carries high profit margins of oil companies, an excise duty of 8.24 per cent by the centre and sales tax levied by various states ranging from 4 per cent to 30 per cent. The average of state sales tax is about 22 per cent.

The ministry has also proposed to reduce GST on MRO activities from the current level of 18 per cent. Due to higher tax which makes aircraft maintenance expensive in the country, most airlines prefer to get it done in neighbouring aviation hubs such as Dubai, Singapore and Kuala Lumpur. The local MRO players argue that the labour cost advantage of $20 to $25 an hour which India enjoys get negated by high GST.

The ministry has requested finance ministry and RBI to bring back the earlier scheme that allowed air operators to raise funds through ECB route with a cap of $1 billion. It has also asked for widening the scope of such window to use ECB funds for local sourcing of aircraft, import of other capital goods.

Over the last few decades, government has taken several steps to expand air-connectivity in the country but the first serious attempt was made in early 90s when private players were allowed to start air taxi service and subsequently scheduled operations. The partial removal of entry barrier saw airlines like Air Sahara, Jet Airways, East-West, ModiLuft and Damania Airways entering the market. But the success of most of these airlines was short-lived and they closed one after the other for reasons ranging from rift with partner (in case of ModiLuft) to cash crunch and regulatory challenges. In the last 10 years, the domestic airline industry has gradually matured but yet to become formidable enough to withstand major shocks. One certainly hopes it will cruise through the minor turbulences.

nirbhaykumar@mydigitalfc.com

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Columnist: 
Nirbhay Kumar