View: Is Indian aviation looking at a summer of strain?

India’s airlines are optimistic about the summer ahead. With demand returning and yields holding strong the industry is poised for a climb out of the turbulent ride of the past two years. Strong domestic demand is set to continue and base case forecasts call for 135—140 million domestic passengers and another 30 million international passengers taking to the Indian skies in 2022. Most restrictions on flights have been lifted and schedule filings show aggressive capacity buildup for the summer months. Collectively, the six largest airlines have planned a domestic capacity deployment increase of 29 percent over the summer 2020 schedule.

Even so, that is only part of the picture. A summer of strength is concurrently also turning out to be a summer of strain. This as cash and credit continue to be constrained, inputs costs of fuel, exchange rates and financing continue to rise and talent wars may add to the overall cost base. And if that wasn’t challenge enough, two more airlines—a startup and a post-bankruptcy airline will enter the marketplace. For consumers it is a great time with fare wars, capacity wars and talent wars that are likely to ensue. For airlines—not so much.

The pandemic laid bare fault-lines with India’s airlines. Much like global counterparts, all Indian airlines parked planes, cut capacity and renegotiated contracts. All with a singular goal of conserving cash. But the period was especially challenging for weaker airlines defined as those with fragile balance sheets, no parent company backing and no alternate revenue streams. These airlines had to rely on any and all cuts to get alleviate the cash burn. This included employee costs by way of leaves without pay and compensation cuts. All airlines effected cuts in some measure but the speed with which these were resinded (if at all) were drastically different. As such a duopoly had already started to emerge—at least in the minds of the industry insiders. The sale of the national airline, Air India, to the Tata group further cemented the picture and as it stands the India market currently has two full-service carriers Air India and Vistara and four low-cost carriers: Indigo, SpiceJet, GoFirst and AirAsia India. Into this fray will enter a newly well capitalised startup (Akasa) and a seventh player—Jet 2.0 which is still trying to find a foothold post-bankruptcy. But when you compare marketshare it is Indigo and the Tata owned airlines that command more than 80 percent of the market. The rest are left competing at the fringes.

For India’s airlines, fundamental structural challenges continue. These are glossed over because of growth prospects as is the case once again. Leading the pack are the voluminous aircraft orders and the financing these orders. The sale-and-leaseback continues to be a core financing strategy for several airlines but is a double edged sword. This because, contractual clauses entail minimum delivery commitments and some of the weaker airlines are taking on aircraft to unlock the sale-and-leaseback cash-flow only to find themselves deploying unprofitable capacity. It is a situation that will not let up anytime soon.

As far as credit goes, the market is diverging between strong credit and weak credit. There is no middle. Parent company backing has helped but for players where this backing is weak or non-existent (usually evidenced by lack of equity infusions or the failure to engage) the default risks are high. Stand-alone balance sheets are far too weak to giver lenders any comfort. In fact, asset light balance sheets, once touted as management mantras, have now come to haunt with limited assets that can be collateralised or leveraged. Liens on this cash-flow are not viable because of the uncertainty of the cash-flow. Policy uncertainty and upcoming capacity wars only exacerbate the situation. This in turn is forcing all lenders to limit risk by insisting on collateral. Collateral that is found wanting.

India’s airlines also face the troika of fuel, FX and financing. Fuel, specifically Jet fuel, because it is taxed as a luxury and regulated as a commodity; FX because the rupee-dollar spread has gradually increased with no signs of settling; and financing because the cost of capital continues to be high. Into this mix talent costs have now become a new lever. Both for attracting and retaining talent. It is a situation that is bound to amplify.

Overall Indian aviation continues to be a paradox. Where opportunities abound and so do challenges. A market with immense potential but with fundamental challenges; a market with a growing traveller base but also rapidly improving road and rail infrastructure which will dent the demand in times to come; and a market where multiple airlines are flying in a sea of similarity—all claiming to be different. For now, the strongest player in the market financially also commands the highest capacity and market share but the price sensitivity is so high that in spite of a monopoly market share it does not translate into pricing power.

Even so, for folks looking for diversity—Indian aviation is as good as it gets. It is perhaps the only market that will witness capacity wars between one well capitalised startup, one post-bankruptcy revival, one privatised national airline and possibly a consolidation/ pivot of sorts. All fighting in an environment where fuel, financing, talent wars and FX continue to create havoc and policy actions are making for market distortions. And all fighting while the incumbent attempts to defend its monopoly market share in domestic markets and where foreign competitors eager to gain market access are likely to evaluate strategic stakes in current airlines.

The recently concluded financial year saw 6 airlines with 650 odd aircraft compete for 72.7 million passengers. All this while international skies were closed, fare floors were in place, capacity was restricted and credit was constrained. This year is likely to see a higher number of passengers but also two more airlines, a fleet count that will touch 700 and an environment where fundamental structural challenges continue.

With costs rising margin compression is a reality. But the hopes are pinned on strong demand and yields holding up. There is a lot of signal and a lot of noise and for now the jury is out and the debate is whether this will be a summer of strength or a summer of strain. All things considered, the latter seems more likely.