Airline restructuring and insolvencies are complex, multi-faceted and involve convoluted cross-border issues. India’s airline sector is more susceptible to distress, given its dependence on a wide range of macroeconomic factors such as fuel prices, lack of domestic leasing facilities, and geopolitical stress.

Every five years one airline in India is being grounded, the latest being Jet Airways, which had to suspend its operations in April 2019 due to a liquidity crisis. Covid-19 has worsened the stress in the business and to date, the industry as a whole has accumulated ₹1-1.3-lakh crore revenue loss over three years, according to Crisil.

Considering the operating expenses of which 35-42 per cent is fixed in nature, domestic carriers have been incurring a combined daily average loss of ₹75-90 crore. Many airline businesses in India were already facing existential stress due to multiple factors. On the regulatory side, the capping of price and excessive entry barriers such as fleet and equity requirements, route dispersal guidelines, regulated allocation of slots, make the market a collusive oligopoly.

Companies in the aviation sector have to constantly look at new strategies to maintain operating profit margins. ‘Operating profit to operating revenue’, which is one of the important performance metrics, stands negative for most Indian carriers. In such a dynamic scenario, there is a very high propensity for financial distress for these companies which eventually leads to financial bankruptcies.

‘De-stressing’ the sector

The KV Kamath committee (set up by the RBI to make recommendations on the one-time restructuring of loans hit by Covid) has selected 26 sectors, including aviation, that will require quick restructuring based on certain financial parameters such as Ebitda, current ratio, debt service coverage ratio, etc. The committee will follow a segmented approach of bucketing these into mild, moderate, and severe stress to decide on the intensity of restructuring.

In such a situation, most airlines are opting for operational excellence to sustain in the long run. This includes cost optimisation strategies such as fleet management, LCC models, channelising networks, etc. Hiving off of MRO and ground handling business to subsidiaries and renegotiating contracts is another common strategy being adopted by airlines to keep their operational expenses in range.

However, this means a lot of regulatory reforms and inadequate infrastructure facilities in India that makes the bottomline dependent on other external factors.

A financial turnaround in the aviation sector is more complex. Monetisation of assets often does not help airlines shed debt simply because of the construction of the covenants. For example, Air India failed to achieve the annual target of ₹500 crore for monetisation of the property due to deficiencies in conditions attached to the ownership. India lacks a domestic leasing market that makes financing options for airlines subject to macroeconomic developments. Since most Indian airlines face leverage-related issues and liquidity crunch, available avenues to reduce leverage include equity issuance and a dividend cut.

Exploring turnaround options

It is evident that there is a need for multiple restructuring and turnaround options that allow airlines to address the stress. The Insolvency and Bankruptcy Code, a sector agnostic law, is not the most best fit for restructuring the aviation sector. This is due to multiple reasons.

The moratorium provision under the IBC is detrimental for preserving the value of the asset. This industry is characterised by capital-intensive assets of which 81 per cent of the commercially operated aircraft are leased by foreign lessors that adds currency fluctuation appropriations in P&L statements of the operators.

Also, without an effective cross-border framework in place, the precariousness only increases the cost of financing for this sector.

As the Covid pandemic escalates to further strain the airline business, most operators will have to resort to financial restructuring in terms of their debt and other financial commitments. However, the Covid crisis is hopefully transient, and will not impact the long-term demand.

Warren Buffett referred to the aviation industry as a death trap for investors. A proclivity of this ecosystem is that firms will fail, making space for more efficient new entrants. This makes operational exclusivity a survival trick. Hence, it is extremely important to have an early-warning signalling mechanism to highlight distress in such a scenario.

Given that the demand is bound to come back, the revival strategy should not discount long-term benefits that the market may have from the companies, regardless of the current stress. Unilateral actions by creditors would only result in value destruction. The only way forward is collective and coordinated action ensuring the interest of all stakeholders.

The writers work with the Centre for Insolvency & Bankruptcy, Indian Institute of Corporate Affairs. Views are personal

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