View | Airlines in India and the risks of large aircraft orders

In India, this strategy was first leveraged by Indigo which placed an order for a whopping 100 Airbus aircraft in 2005. This was followed by an additional orders in subsequent years and as of now Indigo sits on an order stream of 550-odd aircraft. Additional orders cannot be ruled out.

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These orders were and are largely financed by the sale-and-leaseback method which has become a cornerstone of Indigo’s overall strategy. While other airlines have attempted to ape this strategy but several take a myopic view. That is the order has to be seen in the context of the overall business and on other parameters they are found wanting. The volume of the order is only a part of the overall equation and the order risk has to be evaluated in terms of several items including the airlines balance sheet strength, network, management capability, order flexibility and engagement with suppliers.

While Indigo’s order strategy was a success and in some parts was copied by competitors,  there are also counter example wheres the order risk led to significant calls on capital and rapid deterioration of the balance sheet. There are examples including Air India, AirAsia Berhad and Etihad.

Orders carry with them inherent risks

Aircraft are the highest capital cost for any airline and aircraft orders by their very nature demand a long-term planning horizon. Planning includes the type of aircraft, the mix of aircraft, specification of aircraft and liquidity on the aircraft type. Risk mitigation includes looking at the time horizon, staying true to the mission and not giving in to an “overspec” of the aircraft. Competitive maintenance contracts, unit economics and assessing the total cost of ownership and operation are also critical. These are only a few items from a comprehensive list where no item can be overlooked. Because, over time they add up to exponential outcomes — whether positive or negative.

Aircraft orders also require the ability to finance the orders. There are multiple methods for this each with advantages and disadvantages. Collectively, India’s airlines have used a mix of financing mechanisms ranging from export credit to sale-and-leasebacks to outright purchases. In the last decade, India’s airlines have leaned towards the sale-and-leaseback method due to its cash-accretive nature. Yet, the sale-and-leaseback also is an expensive form of financing and in an environment where liquidity is lacking and interest rates are on the rise, this throws up new challenges. New methods of financing have to factor in macro-economic trends and market specific challenges notably the fluctuating rupee, contract enforcement costs and rising inflation.

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The inability to finance orders leads to a market impact as suppliers adjust the market risk premium driving up costs for all. And there are examples such as Jet Airways, Kingfisher and Air Costa that had large outstanding orders at the time of shutdown and led to such outcomes.

As India’s airlines position themselves for a post-pandemic reality the aircraft orders will continue. One additional order, in addition to the one by Air India cannot be ruled out. But orders also carry absorption risk and the inability to line up financing at favourable terms has consequential impact for the entire industry. While it is not an outcome that one envisions and certainly not with a group such as the Tatas nevertheless it has to be planned for.

Orders coupled with a liquidity crunch also lead to an outcome where some airlines engage in sale-and-leaseback transactions to book profits on the aircraft in the near term but find themselves with reduced asset utilization levels or the inability to profitably deploy these assets. Consequential market impacts are even more detrimental. Deployment is also limited by the fact that our airports have not been able to position as hubs and the aviation policy has given away critical bilateral rights to a point where foreign carriers can deploy capacity and take away from demand that otherwise would have travelled on India’s airlines. As such international deployment possibilities remain muted at best. A solution requires multiple stakeholders to align but by all indications that will not happen in the near or medium-term.

As of this writing, India’s airlines collectively are sitting on aircraft orders in excess of 950-odd aircraft. With an additional order by Air India, the market will have more than 1,200 airplanes on order making for a ratio where there will be approximately 1.7 aircraft on order for each aircraft flying. And many of the aircraft are larger variants which means additional capacity. Even factoring in double digit market growth, the absorption of such orders especially by airlines with weak balance sheets and inadequate credit quality remains in question.

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