The churn in Indian aviation

The travails of the Indian aviation sector, in general, and Kingfisher Airlines, in particular, have been in the spotlight over the past fortnight. It is a paradoxical situation.

On the one hand, India is among the countries with the fastest growing passenger traffic (in the mid to high teens). On the other, high costs (primarily that of aviation turbine fuel) and the inability to raise fares even to break-even levels has meant that all the listed players have been posting big losses over the past three quarters.

Compounding the woes for players such as NACIL, Jet Airways and Kingfisher Airlines is huge debt and massive accumulated losses. Amidst talks of an imminent shakeout, it is noteworthy that Indian aviation is not unfamiliar to churn.

The first round of consolidation happened in the mid-1990s when airlines such as Damania Airways, East-West Airlines and ModiLuft which had opened shop after the ‘open skies' policy of 1991 either shut down or sold out, due to lack of management bandwidth or financial constraints. It was an era of high fares which made air travel a luxury restricted to business executives and moneyed individuals. This scenario continued till the early part of the last decade.

LCC churn

However, the low cost carrier (LCC) model introduced by Air Deccan in 2004 proved a game changer. By offering seats at rock bottom fares unheard of before, it democratised air travel in the country and catalysed rapid growth in passenger traffic. The full service carriers — Indian Airlines, Jet Airways and Sahara Airlines — who till then were operating in an oligopolistic market with high fares and plum profits found themselves at the receiving end and saw market share erode.

The advent of the LCC also set into motion some key structural changes in the sector. Perceiving a burgeoning opportunity in Indian aviation, three more LCCs (SpiceJet, GoAir and IndiGo) and a couple of full service carriers — Kingfisher Airlines and Paramount Airways opened shop during 2006 and 2007.

However, with as many as 10 carriers operating, the market soon became too crowded for comfort, and several players started feeling the heat. What followed were some high-profile mergers and acquisitions in 2007-08. Jet Airways took over Sahara Airlines (renamed JetLite) after false starts and a continuing spat; Air India and Indian Airlines merged to form NACIL — a move which has generated more pain than synergies; Kingfisher Airlines took over the original low cost warrior Air Deccan (renamed Kingfisher Red) which had high leverage and found the going unsustainable.

Finally, the growing market share of LCCs and the economic slowdown in 2008 and 2009 meant that the pure full service model was given a go-by. Full service carriers embraced the low fare model in good measure to ride out the downturn.

While Air India had its low cost arm, Air India Express, Jet and Kingfisher shifted a majority of their seats to the low fare category. Meanwhile, Paramount Airlines which was showing promise in South India was grounded in 2010 with some of its planes seized on reports of non-payment of lease dues. As things stand, the aviation market in India comprises three LCCs — SpiceJet, IndiGo and GoAir — and three full service carriers — NACIL, Jet Airways and Kingfisher Airlines —which also offer low fare seats.

Amid this comes Kingfisher's plans to do away with its low fare offering (Kingfisher Red) and focus only on the high yield segment of the market. The company claims that reconfiguration of planes towards this exercise led to the recent flight cancellation imbroglio.

Uninspiring Financials

Not only did LCCs chip away at market share, they also dented the financials of full service carriers by lowering yields across the board. This, even as they themselves suffered start-up pangs. Full service carriers were also badly impacted by the high debt they had taken to expand fleet capacities and at the time of acquisition of other airlines.

Data from aviation regulator, Directorate General of Civil Aviation (DGCA) shows that prior to the advent of LCCs, Jet Airways and Indian Airlines had been posting healthy operating profits in most years.

However, amidst the LCC churn, the financials of most airlines inspired little confidence. The last time Indian Airlines (now NACIL) posted operating profits was in 2006. Among private airlines, only Jet Airways managed to make an operating profit in 2006, while Paramount alone made minor operating profits in 2007.

The situation was no better in 2008 and 2009 with slowdown induced demand contraction and fleet oversupply conditions causing most players to report operating losses. Paramount and IndiGo were the only exceptions posting minor profits in 2009.

The picture however improved in 2010 with the revival in the economy, curtailed seats and relatively benign crude oil prices. Except Kingfisher, all private airlines posted operating profits, though at the net level, only the low cost carriers managed to remain in the green.

Again, it was debt which dragged down the full service carriers. The situation was similar in 2011 when buoyant demand conditions and reasonable crude oil prices for most part of the year led to a good operating performance by many airlines.

Yet, only the LCCs have managed to post profits at the net level. In essence, for most of its history, a chunk of the Indian aviation sector has been in the red.

2012 sadly is turning out to be a nightmare for the sector. Oil prices have shot up sharply beyond $100 a barrel levels. However, though demand is growing at a healthy clip, airlines are not able to hike prices to the extent needed, thanks to alleged predatory pricing by NACIL in a bid to recoup its lost market share.

If things continue as they are, this fiscal may be a washout for most airlines, including LCCs, even at the operating level. However, given their low levels of leverage (at least till now), LCCs seem better positioned to tackle the current turbulence. They, in fact, seem to be optimistic about the prospects of the sector and have placed large fleet orders.

Cost control helping LCCs

Besides having low leverage, LCCs true to their moniker exercise tight control over cost. DGCA data for 2010 (latest available) shows the cost per revenue passenger kilometre (a key metric of cost measurement in airlines) was as low as Rs 2.9 for IndiGo, Rs 3.16 for SpiceJet and Rs 3.8 for GoAir.

Comparable numbers for Kingfisher (Rs 5.59), NACIL (Rs 5.7), Jet Airways (Rs 4.5) and JetLite (Rs 4.2) were much higher.

Among the factors which help LCCs keep costs low is the limited type of aircraft in their fleet. This reduces maintenance cost. Also, the average age of their fleet is quite low which aids in curtailing costs.

Besides, LCCs sweat their aircraft better by reducing turnaround time and making optimum use of aircraft space.

Full service carriers' woes

All of India's full service carriers are laden with heavy debt — in excess of Rs 47,000 crore for NACIL, more than Rs 14,000 crore in the case of Jet Airways and around Rs 7,500 crore for Kingfisher. The high interest burden on these loans prevents the airlines from reporting profits even when times are good.

Adding to NACIL's pain is the botched merger between Air India and Indian Airlines which is reflected in continued human resources integration issues.

The way ahead

The aviation sector is a crucial cog in the country's infrastructure wheel. To ease its troubles, the government could consider reducing the high taxes on aviation turbine fuel. Also, allowing investment by foreign airlines in the aviation sector (reportedly being considered by the government now) would be welcome.

It is also critical for the sector players to revert to rational fares, as soon as possible. In this regard, continued shielding of NACIL by the government needs to be stopped. Also, there is little case for bailout of private airlines.

While the government should do its bit in terms of the policy framework, the sector should then be left to function on the principle of ‘survival of the fittest'. Another round of churn may be just what the doctor ordered for India's aviation sector.

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