Portfolio

Airlines flying into headwinds

ANAND KALYANARAMAN | Updated on July 23, 2011

Low-cost carriers have been upping their share of the domestic pie at the expense of Air India.

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Galloping crude oil prices threaten to take the wind out of the recovery in the aviation sector.

Only the brave or the foolhardy would venture into the business of flying in the Indian skies. If this is the unflattering first impression one makes after running through the financials of most airlines in India, it would be understandable.

Consider this: National carrier Air India has not made a profit since the merger with Indian Airlines in 2007; it has a mind-boggling debt of Rs 47,000 crore, accumulated losses of Rs 20,300 crore, and is desperately dependent on government handouts for survival. Kingfisher Airlines has not made a profit since inception in 2005, has loans in excess of Rs 6,000 crore (after the recent loan restructuring), and accumulated losses of around Rs 5,300 crore. The net worth of both these airlines today has been badly eroded.

The other original full-service carrier, Jet Airways, made a loss on a consolidated basis in each of the last four years, has debt of around Rs 13,700 crore and accumulated losses of Rs 1,730 crore (as on March 2011). Clearly, not a pretty picture.

The skies, though, look somewhat clearer when it comes to the country's low-cost carriers. SpiceJet, the only listed pure play low-cost airline in the country has posted profits in the last two years (after losses for three years before), and has little debt on its books (at least for now).

The other two low-cost players — Indigo and GoAir — whose financials are not publicly available, are reported to be doing well. Not surprisingly, of late, it is players in this category which have been stealing the thunder, in the sky and also on the airwaves. They have been increasing their market shares and have been placing mega orders for aircraft in anticipation of future growth, mainly in smaller cities and towns of the country.

Crude Impact

Yet, even for the low-cost grouping, it may not be a smooth flight this year, courtesy that old bugbear of the aviation industry — galloping crude oil prices — which seriously threatens to take the wind out of the nascent recovery in the sector. After a disastrous 2008 and 2009 when zooming crude oil price, overcapacities and finally slowdown-induced demand destruction almost crippled the sector, airlines slowly picked up the strings in 2010.

An improving economy propelled strong growth in demand for air travel. Low-cost carriers, aided by healthier balance-sheets and offerings that catered to a predominantly price-conscious market in the country, benefitted the most. The full service carriers too showed signs of revival, helped by tweaks to their product-mix and debt restructuring initiatives.

The process of recovery and growth however received a rude jolt in the latter part of 2011 with crude oil again crossing the $100 a barrel mark. This resulted in losses for all the listed players in the March 2011 quarter — a spectre which may continue if crude oil remains at elevated levels (currently around $118 a barrel).

Fuel costs, which typically account for around 30-40 per cent of airline sales, shot up to as much as 50 per cent during the March 2011 quarter. Not surprisingly, the stocks of Jet Airways, Kingfisher Airlines and SpiceJet have been battered on the bourses over the past six to nine months.

While continued strong demand conditions (domestic passenger traffic grew by almost 18 per cent in the first half of the calendar) will ensure that top-line growth for the sector remains healthy, high cost pressure, especially on the fuel front, is likely to take a toll on the bottomlines. Those with huge debt to service will feel the pressure more. This will make it imperative for airlines to increase fares — easier said than done.

While airlines have started passing on cost hikes to some extent, a steep increase in yields may be possible only at the risk of negatively impacting load factors (currently hovering around 80 per percent for most players).

What may make this more difficult is that during the last three months, increase in domestic capacity has exceeded increase in demand. Another factor that could preclude fare hikes is the aggressive pricing strategy adopted by players such as Air India in a bid to recoup lost market share.

Upping the stakes

Over the past year, the low-cost carriers have been upping their share of the domestic pie at the expense of the full service carriers, primarily Air India, whose share has declined sharply from 17.3 per cent in July 2010 to 14.9 per cent currently.

During this period, the sharpest gain has been registered by Indigo, which has seen its share go up from 16.9 per cent to 19.6 per cent. SpiceJet and GoAir have also increased their share to 14 per cent (13.2 per cent) and 6.1 per cent (5.6 per cent) respectively.

As things stand, Jet Airways, along with JetLite, has the highest domestic market share at 25.5 per cent though this has come down from 26.6 per cent in July 2010. Kingfisher Airlines is at a distant second with a share of 19.8 per cent down marginally from 20 per cent a year ago.

With Indigo snapping close on the heels of Kingfisher, and SpiceJet planning to launch services to Tier-II and Tier-III cities this calendar, the market share dynamics could be set for further change, in favour of the low-cost carriers.

To tap new markets and expand market share, the low-cost carriers have gone on an aircraft shopping spree. SpiceJet has placed an order for 30 Boeing 737-800, and 30 Bombardier aircraft. GoAir has placed an order for 72 A320 neo aircraft, while Indigo's order for 180 aircraft of the same type was one of the largest in commercial aviation history.

While delivery of most of these aircraft is scheduled to be phased out over the next three to six years, it remains to be seen, whether the assumptions of strong growth implicit in these big-ticket buys will hold true. If these come unstuck, it could well be an encore of 2008 and 2009, when oversupply added significantly to the pain .

Shake-out?

Given the current sector dynamics is a shake-out or consolidation possible?

If international experience is anything to go by, this cannot be ruled out. Already, the clamour for shutting down Air India is getting louder, with many objecting over what is perceived as throwing good (tax-payer) money after bad. Quick completion of their fund-raising plans and moderation of debt levels is also vital in the case of Kingfisher Airlines and Jet Airways. For the moment, the low-cost players seem much better placed to tide the turbulence.

Published on July 23, 2011

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