Airline Industry: A Hard Landing After A Dream Run

There was a time when the airline industry was looked upon as a sunrise industry in the Indian context. New players, innovative selling ideas and burgeoning affluence among consumers led one to believe that those who invested in these ventures were in for some hefty gains. The reality has turned out to be in stark contrast and rather painful. Prasanna Bidkar tells you what went wrong with the Indian aviation story and what you should be doing with your aviation stocks in the current scenario.

As a child, your dreams take wing and soar unbridled. As life turns out most of the times, it is likely that you end up doing something completely different than what you dreamt of. Those of us who have grown up in the liberalised Indian economy would certainly recall the charm that some sectors have long held, particularly as vocations of choice. One such sector that was at the top of everybody’s mind (until a couple of years ago) was aviation.

Of course, the limitations associated with this choice were tremendous. You couldn’t become a pilot just like that. Huge amounts were spent on training. Even jobs lower down the line like those of ground staff or in-flight attendant carried a huge premium. This only heightened the attraction that the sector held for youngsters.

The year 2003, when the Indian aviation sector was liberalised, brought about a sea change and fanned aspirations further. Young girls dreamt of flying the world with the mantle of air hostess on their shoulders, and young men wished to steer the course of shiny crafts as pilots. The sentiment was so euphoric that training institutes began flourishing, with some of them running multiple batches even in relatively smaller towns.

All went according to expectations, and the aviation industry witnessed strong growth from 2004 onwards. The growth story of this sector was supported well by India’s stellar GDP growth and a growing middle class, where the demographic shift was clearly in its favour. The passenger numbers handled at Indian airports exceeded six crore in 2011 (from just about a few lakh in 2003), making it one of the 10 largest and fastest growing markets globally.

From just few players like Indian Airlines (the state carrier), Jet Airways and Deccan Aviation (hailed as India’s first low-cost airline), many new players like Kingfisher Airlines, GoAir, SpiceJet and IndiGo entered the playing field. Every big business house wanted to have its share of the pie by launching its own airline. The fleet size increased to more than 381 in FY08 from just around 138 in 2003. The great Indian aviation dream prospered, and began reflecting in the strong growth in air passenger traffic, which in turn, translated into fat bank balances for companies operating in this sector.[PAGE BREAK]

The First Hints Of A Nosedive

While everyone one was transfixed by the growth in the sector and by the passenger growth, something was brewing in the background. Though passenger traffic was witnessing a growth, the increased number of players (especially low-cost ones) saw competition heating up, which lead to price wars among the operators. Companies began expanding by using unprofitable, and in some cases, even unviable routes in order to grab a larger market share. The result was that the margins, which were already as thin as boarding passes, shrank further.

Private airlines began bleeding heavily. Indian Airlines was the happier of the lot as it gained from the government’s largesse in the form of subsidies. The worst came in 2008, when the global economy was shaken up by the financial meltdown. In FY09, the combined losses of Indian aviation companies (including Indian Airlines) touched Rs 10000 crore.

The Indian aviation industry just hasn’t been able to turn around and move ahead from then on. The problems have only exacerbated, and companies have found it increasingly difficult to tide over them. Why did this happen? Where are we headed? Will the Indian aviation sector be able to fly high again? Here is what emerged from some probing on this.

Early Consolidation – A Faux Pas

As is typically seen in every industry, the aviation industry too witnessed some consolidation early on. Jet Airways bought the ailing Sahara Airlines and Kingfisher Airlines took over Captain Gopinath’s dream, Deccan Aviation. While consolidation per se isn’t bad for any industry, the problem with these deals was that both were done at reasonably high valuations. In April 2007, Jet paid Sahara a whopping USD 350 million (Rs 14500 crore), while Kingfisher Airline paid USD 135 million for just a 26 per cent stake in Deccan in October 2007. So much for acquiring loss making concerns!

These deals came in almost at the peak of the exuberance that was surrounding the sector. What happened thereafter and its aftermath is something that we are all still coming to terms with.[PAGE BREAK]

Even after consolidation, though, the problems did not subside. Many players went on to add new and unviable routes. In fact, Kingfisher even tried to make a grab at the international market through Deccan Aviation (minimum five years of domestic flying was compulsory for starting to fly on international routes). As a result, fleet additions kept happening and new orders were flowing so freely that aircraft manufacturers trained all their attention on the Indian aviation market.

Eventually, the already cash-strapped airline companies were left grappling with debt levels that strained their balance sheets far too much. Passenger traffic declined following the economic turmoil that hit the world in 2008. Data provided by IATA shows that in 2008, global airline companies suffered losses to the tune of USD 26.10 billion. Those companies that were operating on international routes were also affected.

On the home front, the financial stability of most of the Indian players got impacted. To put the numbers in perspective, at the end of FY09, the debt levels of Kingfisher Airlines stood at 5665.60 crore, those of Jet Airways at Rs 16323.53 crore and SpiceJet’s debt was at Rs 489 crore. As on March 31, 2012, Kingfisher had Rs 8030 crore in debt, Jet Airways’ was at Rs 10867 crore and SpiceJet’s debt swelled to Rs 855 crore.

As a natural consequence of all this mayhem, investors had a bad time with their holdings. Reality is always harsher than you think, and when it comes to losing money, it is even more painful. Since December 2007, Kingfisher Airlines has lost almost 95 per cent of its market capitalisation. Jet Airways’ market capitalisation too has declined by almost 55 per cent since then. Rather, Jet Airways is one on those companies that has not created any value even for investors who bought shares through its IPO. The story of SpiceJet is no different. For those who have held aviation stocks in their portfolio, these numbers would only be adding insult to injury.

Mounting Losses Of Indian Carriers

A logical question here would be as to whether there are no companies that have made profits at all? Well, there are a few like IndiGo and Paramount that are indeed making good profits. The reason why they have been able to hold their ground firmly so far is that they haven’t expanded unnecessarily into unviable routes and have stuck only to the profitable ones. However, some these are not listed entities, and hence, the details of their financial performance are not available in the public domain.

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Improving Situation? Not Yet

While the story so far reflects what happened in the past, a lot has transpired in the airline industry over the past few months and the current situation isn’t any better. Far from it, the scenario has only deteriorated, with companies like Kingfisher Airlines delaying payments for fuel suppliers as well as the Airports Authority of India (AAI) and also defaulting on lease rental payments. According to news reports, a few of them have also evoked bank guarantees provided by Kingfisher Airlines. The employees are facing the worst of the woes. They haven’t been paid for a long while, and there is no sign of them being paid any time soon.

The non-availability of credit from fuel suppliers and the AAI resulted in the cancellation of flights on many non-viable routes for Kingfisher. It is probably the worst affected carrier, with its license being cancelled by the Directorate General of Civil Aviation (DGCA) since October 2012 following strikes by employees and the airline disregarding the minimum safety norms. The sudden sharp drop in passenger seat availability that the license cancellation caused only fuelled further chaos in the industry, with airfares skyrocketing and ultimately impacting passenger growth.

Data shows that the domestic air passenger traffic has declined marginally for 2012. For the period January-November 2012, there were 5.34 crore air passengers. This was a decline of 2.94 per cent from 5.50 crore passengers during the same period of 2011. Another reason behind lower passenger growth is that flight cancellation has become more of a norm rather than an exception, adding to the woes of passengers. Cancelled flights can be a nightmare. You could end up paying double the fare for the same destination if you cannot call off your travel following a flight cancellation.

Amid all this uncertainty, SpiceJet has surprised the investor fraternity by better reporting better financial performance for the quarter ended December 2012. Here, it posted a topline of Rs 1602.7 crore and net profit of Rs 102 crore as against Rs 1172.83 crore and a loss of Rs 39.26 crore in the December 2011 quarter. The moot question is, does this indicate a betterment in the industry?

Before coming to any conclusion, there are a few factors that we need to understand. First, the sudden jump in profitability has been on account of higher passenger yield achieved (up 29 per cent to Rs 4412 as compared to Rs 3421 in December 2011) and lower fuel expenses as a percentage of sales. However, the primary reason behind the increased passenger yield is the cancellation of Kingfisher’s licenses, which led to a higher market share gained by other companies and increased fares. Even the change in accounting policy for foreign exchange rates has helped the company at the bottomline level.

Further, in a press release, SpiceJet’s management has mentioned that, “Notwithstanding this improvement, which certainly augurs well for civil aviation sector in the country, the fact remains that the Indian airline industry continues to bear the brunt of extremely high incidence of taxation. A weighted average tax rate of 24 per cent on Aviation Turbine Fuel prices across various stations in India is among the highest in the world, and constitutes the biggest hurdle for domestic carriers in their quest for long term profitable growth”.[PAGE BREAK]

What Lies Ahead?

The first source of succour for any troubled industry is the government. In case of aviation too, the government had done its two bits. In a recent move, it has allowed a 49 per cent FDI in aviation. However, not much has happened after that. It seems that not many foreign companies are interested in buying out the troubled Indian aviation players.

The situation is not any different for global aviation players, who are not in any better shape than the Indian companies. To give you a perspective, only eight of the 250-odd aviation companies globally are profitable, raking in around USD 500 million in operating profits. There are just three of them who earn in excess of a billion dollars in operating profits. In fact, over the past few years, the EBITDA margins for aviation companies have declined and so have the profits. (See Charts: EBITDA Margins Of Global Airlines, Net Profit Of Global Airlines).

It is well known that the industry has been in losses ever since it was invented by the Wright brothers. With thinner net margins that are only shrinking by the day, no one would like to needlessly burn their fingers in highly regulated skies like those in India.

In recent times, a carrier from UAE, Etihad, has shown a keen interest in going against the tide. The Abu Dhabi-based airline had initially evinced interest in both Jet as well as Kingfisher, but there is no clarification on whether they will really invest in either of them as yet. The talks with Kingfisher fell through after it failed to impress both Etihad and the DGCA with its financial turnaround plan. According to sources, Etihad may buy a 24 per cent stake in Jet Airways for about Rs 1800 crore, but again, there is not enough clarity on this part. In another development, rumours are surfacing about Qatar Airways wanting to buy a stake in SpiceJet. However, Qatar Airways itself has denied any interest in buying a stake in the company.

Analysts suggest that Kingfisher would require at least Rs 3000-5000 crore to re-start its operations. Anything less than that will not be of any use. Though the company’s management has stated that it is restarting with a minimum of 7 ATRs in February 2013, there is no confirmation on this part. Will this bring back any cheer to investors who are currently stuck with this dud stock in their portfolio? We don’t think so. As far as Jet Airways is concerned, you could expect some clarity over the next 10-20 days. Having said that, the valuation at which the deal goes through will certainly be a matter of great concern. Until then, staying away from stocks in the aviation sector seems to be the only prudent investment strategy.