India’s airlines settle into sustainable growth

Over the past two decades, the Indian civil aviation market has experienced both stagnation and unprecedented growth.

1st Jul 2010

Over the past two decades, the Indian civil aviation market has experienced both stagnation and unprecedented growth.

Yet, even with the country’s expanding middle and the massive boom in air travel demand at the beginning of the century, fewer than 2 percent of Indians travel by air each year. This figure just underlines how much growth potential remains in the market.

Between 2003 and 2006, India’s aviation industry changed beyond recognition: the adoption of a new open skies policy for domestic routes opened the floodgates for the arrival of a wave of new start-up carriers. Some of these adopted the low-cost business model that had succeeded so well in Europe and the United States, and was just beginning to take hold in Asia.

Airlines like Air Deccan, Go Air, IndiGo and SpiceJet made air travel realistic and affordable to people who could never previously afford it. At that time, India’s national carriers – Air India and Indian Airlines – went ahead with a long-expected fleet modernisation and expansion plan, ordering 111 new aircraft.

Liberalisation took hold in the international air transport sector too, with some private carriers starting to operate overseas services, while foreign airlines were allowed greater access to the Indian market and international routes began to fly into and out of some secondary airports.

All of this led to double-digit expansion in domestic and international traffic as pent-up demand turned into actual ticket sales.

Too much, too soon

However, with traffic growth nudging an incredible 40 percent, people began to see that the boom was unsustainable. By 2007, yields were under pressure as overcapacity took hold, while costs were being pushed ever higher by factors such as inadequate airport infrastructure and a lack of trained pilots and engineers.
By this time, capacity was rising twice as fast as demand, with aircraft being delivered at a rate of six to 6.5 per month, while actual growth in demand only justified about three a month Meanwhile, airlines found themselves struggling to compete with other forms of transport as airports became ever more congested and surface access to the facilities remained woefully inadequate.

At the same time, loss-leader ticket pricing was increasingly widespread – and Air Deccan in particular was responsible for setting fares well below cost as it fought to retain its market share.

As oil prices soared to an unprecedented high of close to US$150 a barrel in 2008, hurting airlines the world over, Indian taxes made the local situation even worse – adding as much as 60 percent to airline fuel costs. Carriers were forced to increase their fares at precisely the time that the national economy slowed. Naturally, travel demand fell, leading to a 10-12 percent drop in traffic.

But now, a more positive environment is starting to emerge, the Centre for Asia Pacific Aviation says in its report ‘Indian Aviation: A Review of 2009 and Outlook for 2010’. Even though the country’s economic growth slowed during the worldwide recession, from 9 percent in 2007-2008 to 6.1 percent in 2008-2009, CAPA points out that this is not a bad result under the circumstances.

The Indian economy is now recovering faster than expected and will probably return to 8 percent annual growth in the period 2011 to 2014, according to World Bank predictions.

Traffic, too, is starting to grow once again. After 12 straight months of year-on-year declines, the figure returned to positive territory in July last year and has stayed positive since then, although yields remain low.

“The operating environment is improving, with airports and airspace gradually being upgraded and ground access being developed, which will not only enhance the passenger experience, but should allow airlines to achieve faster turnarounds and higher aircraft utilisation,” CAPA says.

Sector transformation

India’s airline industry has completely transformed since 2003, when there were just four airlines in the country – Air India, Indian Airlines, Air Sahara and Jet Airways – all of which were operating on full-service business models. At that time, private carriers were also restricted to operating only domestic services.

Today, there are basically seven airlines with 11 different brands: Air India and Indian Express; Jet Airways, with JetKonnect and JetLite; Kigfisher Airlines and Kingfisher Red; IndiGo; SpiceJet; Go Air and Paramount Airways. The three largest airline groups – Air India, Jet and Kingfisher – now hold about 67 percent of the country’s domestic air travel market.

According to the CAPA report, Indian airlines accumulated about 260 billion rupees (US$5.62 billion) of losses in the four years ended March 2010. The three largest airline groups – Air India, Jet and Kingfisher – accounted for almost 230 billion rupees of that total. CAPA estimates that the current financial year will see a further loss for the sector of the order of 65-70 billion rupees.

“The most significant recent strategic development in the Indian domestic market is that it is rapidly turning low-cost,” the report says. “An operating model which did not exist in the Indian market until six years ago could account for almost 70 percent of domestic capacity within the next two to three quarters.”

This is largely thanks to moves by Kingfisher and Jet to reconfigure most of their domestic aircraft for all-economy, no-frills services. Air India also plans to follow suit.
“There has been a clear recognition that there is a limited market for full-service travel, particularly business class, beyond the key metro routes,” CAPA says. “Full service may in future be restricted to just a handful of services, or may even disappear entirely. It is driven by a decisive change in the demographic profile of the Indian domestic traveller. Whereas five years ago, approximately 80 percent of air travel in India was for business, today that figure is less than half.”

The shift to low-cost operations should allow the big three carriers to develop a more competitive cost structure. This will be much needed as Jet Airways and Kingfisher have both been facing a cash crunch and have been trying to raise capital.

According to CAPA, the three biggest Indian airline groups have combined debt of about US$10 billion. They will need to raise about US$10-12 billion over the next two to three years to fund aircraft deliveries.

Restructuring needs

“There is a clear recognition at all levels that Air India is in need of desperate restructuring and much is in fact underway in this regard,” CAPA says. “The restructuring plan is in the process of being implemented and nine committees have been established to execute this process.”

But the restructuring will be a challenging exercise. Over the next two to three years, Air India is set to accumulate additional debt of 310 billion rupees – 160 billion for working capital and 150 billion for fleet acquisitions. About a third of the total will be raised this year, with the rest over the following year or two.

As a result, the airline will have to pay about 90 billion rupees in interest over the next three years – a tall order in today’s low-yield environment.

The carrier plans to cut its annual loss from 50 billion rupees to 13-18 billion over the next 12-18 months, through a 20 billion rupee increase in revenue and cost cutting. The carrier will be helped by a strengthening of the market in the fiscal third quarter and continued global economic recovery.

“Air India will continue to have cash deficits for the next 5‐7 years which could cumulatively amount to US$4‐5 billion,” CAPA says. Air India was to receive an infusion of 20 billion rupees from the government early this year, with a further 20 billion coming in the next financial year and 10 billion rupees more after that. The funding is conditional on the carrier meeting certain restructuring milestones.

“However, the latter will be difficult to achieve, especially in the category of labour, where union resistance has already been encountered. In order to generate momentum, the carrier needs to achieve a few quick wins, and one area in which there has been a marked improvement is on-time performance,” the report says.

Precarious situation

On-board and ground services, too, have improved, but the situation remains precarious. Massive restructuring is needed to meet the carrier’s financial targets, since its current operating margins of -20 percent are far below industry benchmarks – even in the current environment.

Plans for the suspension of unprofitable routes will probably lead to the release of about a quarter of the fleet, leaving Air India focused mostly on domestic and regional routes. The carrier is to defer the delivery of five Airbus A320s and six Boeing 777-300ERs, returning as many as 48 leased aircraft.

Six Boeing 747s are to be sold to the government, while 19 other aircraft – including 11 A320s – are to be auctioned on the open market. “However, in the current environment, receipts are likely to be depressed,” CAPA says.

For its fleet, the carrier still lacks a suitable aircraft for medium-haul flights to Singapore, Hong Kong or even Europe. “Operating Boeing 777s on such routes could be extremely challenging to make viable, especially due to the fact that Air India has suffered from having weak commercial capabilities,” the CAPA report says.

Air India may need to have another look at strategic fleet planning for the period after 2011. Up to 30 percent of the carrier’s capacity is being put under the low-cost Air India Express brand, which will also take on some Gulf routes.

Air India and Indian are also still behind schedule on achieving operations under a single carrier code, which is a pre-requisite to joining the Star Alliance.

“The continuing delays to [Air India’s] accession to the global alliance mean that it is possible that Jet Airways may be considered for Star Alliance membership,” CAPA says.

CAPA says it believes the Air India restructuring programme should consider “all ownership options, which include continuing under government control as at present, privatisation or even closure”. Whichever option is pursued, it should only be done after careful planning and review, with the support of all stakeholders, the consultancy says.

Rival Jet Airways saw a strong recovery in both its domestic and international operations during the fiscal third quarter, ended 31 December 2009. The carrier is now starting to see some stabilisation of its international operations, which were initially ramped up faster than was justified by sales and without appropriate marketing and distribution support.

The carrier’s international operations now account for about 62 percent of revenue and its load factor in the third quarter of the last business year was over 80 percent.

“We expect the international operations to be consistently profitable during the 2010/11 financial year,” CAPA says.

In the short- to medium-term, the airline will further expand its regional international routes around South Asia and the Gulf, using surplus Boeing 737s from its domestic fleet. However, the carrier is also evaluating new destinations in the US such as Chicago and Los Angeles.

Jet Airways’ next phase of long-haul expansion is expected to begin from the summer 2011 schedule, although it could potentially be brought forward to winter 2010/11 if traffic recovers faster than expected.

Domestic routes

Domestically, about 65 percent of Jet’s capacity comes under the no-frills Jet Konnect brand, which results in an improved cost structure and higher loads.

CAPA believes that Jet Airways “may exit the full service model on most domestic and regional international routes in 2010/11 ... leaving Jet Airways and its full-service model on longer international routes and a handful of key metro domestic city pairs”, while the rest of the network is operated by Jet Konnect.

“This strategy will allow it to compete more effectively against the standalone LCCs such as IndiGo and SpiceJet,” the consultancy says.

Although the airline has withdrawn some aircraft from its domestic fleet for deployment on regional international routes, domestic capacity has been maintained by increasing seat-density with the adoption of more all-economy services.

Jet Airways and JetLite have a combined 47 aircraft on order, comprising: five A330s, three 777s, ten 787s and 29 single-aisle 737s, with options for a further ten 737s and ten 787s. Some delivery deferrals have been negotiated with the manufacturers.

“Jet Airways currently has US$3.5 billion in debt and desperately needs to de‐leverage its balance sheet and reduce the interest-servicing obligations,” CAPA says. “It has received conditional approval to raise US$400 million through Qualified Institutional Placements (QIPs), for which it is expected to achieve a price of 350‐400 rupees per share.”

Kingfisher Airlines has seen improvement in its operational performance over the past two to three quarters and was poised to break even in the third quarter of the last business year.

“Right-sizing capacity in line with demand has had a beneficial impact, however the interest burden on its debt continues to be a major challenge,” CAPA says in its report. “The fact that a number of aircraft are grounded, especially its A340 fleet, is a further financial commitment.”

The consultancy stresses the importance of the airline restructuring its cost base to “a more manageable level”, since yields remain under pressure.

“The increasing transfer of aircraft to the low-cost Kingfisher Red brand is helping, but there may be a need to go a step further and transform domestic entirely to a single-class configuration. Further right-sizing of the capacity deployment in the domestic market is also possible,” CAPA says.

While Kingfisher has always harboured strong international ambitions, the carrier is more likely to concentrate on the regional international market using the single-aisle Airbus A320/A321 fleet rather than further expansion of A330 long-haul services.

“Kingfisher Airlines may need to reconsider its fleet composition, particularly for its long-haul operations to North America. The A340‐500 which it ordered is unlikely to be competitive and this may lead it to consider the B777 as an alternative,” CAPA says.

Asian Aviation at a glance