View: India's airlines and the credit conundrum

The Indian aviation story finds itself facing crossroads. With the recent sale of the national airline Air India to the Tata group, the market structure now has two ownership profiles (Indigo and Tata group) that control over 80 percent of the market. Into the mix comes a well-capitalized startup namely Akasa. The rest of the players which also counts Jet Airways that is attempting to revive itself are looking at avenues to access credit.

And by all indications, credit flows to airlines are constrained. At an industry level, cash positions are weak, collateral is a pre-requisite, and without corporate guarantees, the credit is just not flowing. It is a situation that poses challenges for weaker airlines.

The airline business is notorious for high fixed costs, limited variable costs and razor-thin margins. For India’s airlines, fundamental structural challenges have only added to these costs. Take for instance voluminous fleet counts, the financing of the fleet and future orders. As it stands India’s airlines are collectively sitting on six hundred and fifty-odd aircraft, of which the majority are on lease. This means there is a monthly cash-outflow associated with these aircraft.

Given the structure of demand and pricing of that demand, the avenues to deploy these aircraft in profitable flight are few and far between and given brittle balance sheets and a banking sector that is totally averse to aviation. To make matters more complex, the market leader Indigo sits with a monopoly market share in excess of 55 percent. It is also the airline best positioned to weather the storm and one that is assessed to be most creditworthy mostly driven by a past focus on the balance sheet and a focus on engaging with suppliers throughout the pandemic.

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The Tata-owned airlines namely Air India, Air Asia India and Vistara are also found to be creditworthy driven largely parent company backing and equity infusions. Accordingly, suppliers are most willing to engage with these airlines; for the rest it is a mixed bag. As far as credit profiles go, the market is diverging with strong credit profiles and weak profiles. There is no middle.

Asset light balance sheets, once touted as management mantras, have now come to haunt with limited assets that can be collateralized or leveraged. For airlines that rely on the sale-and-leaseback mechanism the constrained credit is a double edged sword. Because they are taking on aircraft to realize the sale-and-leaseback gains but the deployment possibilities are limited. Yet again, a situation that is untenable.

While domestic travel has indeed picked up and demand is expected to cross pre-covid levels by the end of the year, the start-stop-start nature of the demand which in turn is driven by the pandemic has been damaging. Cash-flow over the trailing twelve months has been tepid and erratic at best and as far as lending is concerned liens on this cash-flow are not viable because of the uncertainty of the cash-flow. Which in turn is forcing all lenders to limit risk by insisting on collateral.

As far as airline cash-flows go, the yields are being held up by government mandated price-floors. Effectively the citizens are funding a bailout of sorts for airlines because were there price-floors to be removed, it is all but certain that fares would go down. With continued restrictions on international flying, airlines are limited in terms of the capacity that can be added which has consequent impacts on cash-flow. Yet again, once the restrictions are lifted, consumers are all but certain to benefit from lower fares.

For the time being, the price-floors and international restrictions continue. Arguably because at an industry level, the cash situation shows no signs of letting up and without these measure one or more airlines could be looking at a situation of shutdown.

If the macro-environment was not challenging enough, the lending environment has only added to challenges. Banks are extremely cautious in lending to weaker airlines in the sector given the razor thin margins and the credit risk profile.

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As folks celebrate the rising domestic passenger counts, when viewed through an investment lens the painting is very different. While it is true that demand is soaring, but pricing is propped up by government mandated price floors. When these are lifted, airlines with weaker cash positions will find it hard to compete. Pricing and capacity returns to levels that help cover the cost of capital at the very least are not quite on the radar; international traffic is not forecast to return to stable levels prior to 2024; and cash and credit both stands constrained. And all of this assumes that the third-wave does not hit and case havoc once again.

For lenders looking for comfort, there is little on the horizon. Especially for weaker airlines that have an asset light balance sheet, lack of equity infusions and no alternate revenue streams. In such a situation if the lenders lend anyway, it is presumably in the hopes that the earlier loans don’t go bad. And the past precedents in this regard have not worked out too well. Until the market gets a strong signal from weak airlines regarding skin in the game, the credit situation is not likely to ease.

As far as India’s airlines are concerned a credit conundrum continues.