View | All is not well with Indian aviation

India’s largest airline IndiGo reported its annual results last week. With a loss of Rs 6,161 crores for FY22, the numbers were humbling. Especially given that the airline in relation to its competitors has a much stronger cash position, a well-defined asset strategy and mitigation measures to de-risk revenue.

Other airlines — private and public — are likely to report similar numbers. The quantum of these results surprised many. It was hoped that 83 million flyers taking to the skies in FY22 — a growth of 58 percent over the previous year — would lead to some respite.

Yet, it is the input costs for the industry as a whole that have gown awry and the troika of fuel, financing and FX are making for the perfect storm. Cash flows for the sector continue to be propped up artificially by government-mandated fare levels, which concurrently impact the ability to manage yield. Market forces are not being allowed to take their own course. It is a situation that is unsustainable. And things are likely to get worse before they get better.

India’s airlines are operating under a peculiar mandate. Namely, fare caps. Or the mandate by the government on the minimum and maximum ticket prices airlines can charge. The government has been dictating fares since the domestic skies opened up in May 2020.

Industry experts indicate that this is towards aiding cash flow for weaker airlines and ensuring they are not bled dry by stronger ones. But the intent versus the impact of such a policy is questionable as it also prevents capacity rationalisation which could lead to overall sector stabilisation.

Interestingly, the fare cap for the most part is irrelevant except during peak travel periods when flights are sold out. And it is the fare floor that huts as it limits the airline from discounting seats, capturing cash flow and managing revenue. And with airlines putting in an increasing number of flights and occupancy factors not quite where they need to be discounting is a critical tool.

For instance, a Delhi-Mumbai airfare would price at least 40 percent lower were it not for the fare floor. But with a fare floor that is a fairly high fare floor, it effectively prices out a large segment of the market while interfering in the commercial decisions of airlines.

The key input costs, led by fuel, continue to rise for airlines. Jet fuel is at levels that are on average 70 percent higher than the previous year and if that was not challenging enough the rupee has weakened by about 5 percent compared to the previous year. Large capital costs for airlines namely for fleet financing and maintenance are dollar-denominated, thus, a weakening rupee has devastating impacts. Mitigation measures for both fuel prices and FX are few and far between.

While passing through these increases in fares is a logical step, at a certain point the consumer will simply not absorb the additional pricing, which then means an impact on existing margins.

Financing woes are also beginning to creep up given the inflation and interest rate scenario. Add to this the fact that almost all major airports will seek an increase in airport charges. Other line items show similar trends. Banks continue to be averse to the sector and without parent guarantees lending is severely restricted.

Consequently, airlines continue to fall back on mechanisms such as the sale-and-leaseback to generate cash, with the impact that additional capacity is entering the market without enough avenues for deployment. With costs at the current levels, the industry continues to fly but it is locked into an unstable approach. Without a course correction — a hard landing could very well be the outcome.

The sector will see two new entrants in the domestic skies namely Akasa Air and the revived Jet Airways, which will further impact capacity and costs. While capitalisation levels for both differ, it is a fair assumption that the entrants will plan for at least 12-18 months towards stabilisation.

To make a dent in the market, it is safe to assume that both will use the time-tested lever of price. This means price wars are inevitable. But this may also mean that routes that are just about breaking even may go into losses with the addition of capacity.

Further, for all airlines alike, new and old, cash cushions will be essential. But carrying excess cash is an item that has to be planned for. By way of access to credit facilities, by way of strong balance sheets and by way of continuously evaluating the margins. With costs rising disproportionally as compared to revenues, shoring up liquidity remains a distant dream. As of now the credit quality across airlines varies greatly and for some weaker airlines equity infusions — usually a resort of the first measure — have not happened.

Finally, if the domestic challenges were not challenging enough, international competitors are also gearing up. To deploy capacity where possible, offer new pricing and products, and leverage India’s growing demand. Competing with such airlines that have the benefit of a stronger currency and wider networks will be a task for even the most seasoned managers. Already the market has seen new players like Qantas start to fly direct. Other airlines such as WizzAir and FlyNas are bound to follow.

Airline valuations are fluctuating wildly. Mostly because of projections into the future and the uncertainty of such projections. To be sure the uncertainty comes from structural challenges which have just not been addressed. While it is true that passenger traffic has shown a rebound, it is also true that the market situation is one where all airlines except one don’t have any clear path to profitability. Cash flow is constrained and some airlines continue to delay payments, revisit contractual commitments and cancel and consolidate flights.

The current market structure of two full-service and four low-cost airlines is soon to change to one where there are two full-service, one hybrid service and five low-cost offerings.

Either way, if one slices and dices the numbers, the supply-demand dynamics don’t make for very healthy margins. The bleeding is set to continue for a bit. Losses will mount. All is not well with Indian aviation.