VIEW: Top risks for India’s airlines in 2021

Airlines have always had to juggle yields with occupancy. In an ideal scenario, both are high but over the last few years yields have been sacrificed for volumes. Currently, the Indian government has mandated price floors and price caps—thus artificially ensuring a minimum level of yield. Add to that reduced capacity on railways. Occupancy has been a struggle for airlines and now in the 62 percent—65 percent range—are far too low. This cannot continue endlessly and it is forecast that once the price floors are taken away, airlines will resort to deep discounting. Largely for cash-flow and also to compete. This will drive down the yields while stimulating volumes—or so it is hoped. Overall again a negative outcome.

If that wasn’t bad enough, the demand for the near future is weak. This is in contrast to what is reported as the reporting fails to account for the base effect. On fundamentals, demand is closely tied to economic growth and as a rule of thumb in growth markets demand grows at the factor of 1.4X – 1.7X GDP. But with India’s GDP growth in slowdown mode, aviation growth will continue to languish.

It also doesn’t help that airlines are sitting on firm fleet orders which they will find challenging to induct. Deferrals and even cancellations cannot be ruled out.

In good times and bad, airline success can be traced to how well the troika of fuel, FX and financing is managed. Fuel is forecast to be stable for the remainder of the year through to April. After historic lows in the middle of the year, ATF prices have gradually increased and are up by 25 percent. On a YOY basis, these are still within a reasonable range, however, but they could trend either way. The volatility depends on geopolitical aspects, economic recovery and demand. And as of now, the jury is out on that.

On the foreign exchange front, the dollar is likely to strengthen further causing much pain to India’s airlines. This because lease payments, maintenance payments and financing is in dollar terms while revenues are in rupee terms. The currency differential will lead to greater pressures on cash outflow. This pressure is likely to continue.

On the financing side, there is a rush to quality and banks, lessors and financiers are demanding corporate guarantees or first charge on assets. With the exception of two airlines, the remaining are left to find solutions to mitigate this risk. The financing mechanism of sale-and-leasebacks which gained traction for certain Indian carriers may now haunt as without adequate balance sheet strength financiers may not engage. Further, the sale and leaseback is dependent on fleet growth and for some airlines, this is just not a sustainable proposition.

Airlines depend on passenger demand as a core component of cash-flow. Airlines collect money for tickets upfront and service is rendered at a later date. That is, an airline sells tickets in advance and collects cash. The actual flight may be several days or weeks later and only then will the airline realise a profit or a loss. With demand declining, other measures have to be resorted to. These usually include higher borrowing, leveraging assets and fare-sales.

Given the state of the Indian banking sector and overall negative sentiment towards lending to airlines, lending is extremely constrained. Furthermore, since the airlines pushed for asset-light balance sheets, leveraging assets is not a possibility. Indeed some balance sheets are so week that the net realizable value of assets is a tenth of what is reported. In this scenario, most airlines will be pushed towards fare-sales and this is likely to be the case.

In looking at the major players in the market, IndiGo has a big war-chest of cash and will continue to leverage it and its market dominance to put pressure on competitors. Vistara may have additional calls on capital especially as 2021; it could scale up the longer distance international operations.

2021 may be the year we finally see the sale of Air India. While most analysis is focused on who will be the buyer and how the airline will be sold, almost no-one has attacked the question of what if the airline does not get sold.

In such a scenario, if Air India continues and if lending to the airline is stopped it too will resort to fare-sales. If lending is continued via banks or government against sovereign guarantees, it also has a contradictory effect. Specifically, the lenders engage in a practice of lending to the company in the hopes they will get better and thereby repay the capital to the bank. However, in doing this, banks are extending credit to an airline at a cost of borrowing that may be lower than that extended to the stronger airlines. The lending which is ideally to be used towards recapitalisation will end up being used for continuing operations and not growth. Consequently, industry pricing power, capacity utilisation and borrowing rates will be further impacted.

A sale of Air India seems to be the only option but it seems the question of what happens if no successful bid emerges is not being explored. And whether or not the government will pull the plug in case of no sale is debatable.

2021 will see the return of the Boeing 737 MAX to the Indian skies, but a slow ramp-up beginning is expected. With the FAA certification, the aircraft has already been approved by other regulators as well. Industry estimates indicate that India at most will receive four or five units towards the second half of the year. That too is contingent in a lot of things going right. The jury is still out on how the passengers accept this aircraft once it returns. Jet Airways may resurrect its flight on an all 737-Max proposition.

Then there is the question of the pricing on the aircraft is another factor that can drive decisions. With airlines like RyanAir and Alaska Airlines betting big on the 737 Max, it is likely that they have been able to renegotiate very competitive terms. This itself can have significant repercussions. Concurrently, liquidity on the asset remains to be seen. It remains to be seen if India’s airlines can build a solid negotiating position.

Boeing (and also Airbus) may have to find new sources of financing for airlines in India. This is driven by weak balance sheets (with one exception) and no equity forthcoming. Against this backdrop, lending continues to be constrained while competitive intensity is expected to increase. Impacts on cost of capital and pricing power are likely to be negative.

Sisyphus, is a figure of Greek mythology who was condemned to repeat the task of pushing a boulder up a mountain—repeatedly. Each time he reached the mountaintop, the boulder would roll down again. And this cycle continued—endlessly.

In the case of India’s airlines, which were in a downward spiral and engaged in irrational discounting while inducting capacity that exceeded demand, a similar outcome followed. The one impact corona had on aviation was to limit the capacity wars. But the industry will likely revert to old tactics. On the domestic front committed orders by Indigo, GoAir and SpiceJet will ensure that capacity continues to grow. Further induction from Vistara, AirAsia India and Air India (with possible new ownership) will exacerbate this situation. The failure of Jet Airways which was to provide some respite to unabated capacity growth didn’t quite materialise as all of that domestic capacity returned to the market within five months. A revived Jet Airways only means more capacity.

On the international front, from Emirates to Vietjet everyone is after the huge Indian travel base. Airlines in the Middle East have always dominated the capacity of up to 70 percent in some cases. But as the Middle East itself faces challenges including declining oil prices, declining demand, the rise of the low-cost airlines and premium demand dissipating via more direct point to point flights, the strategy is to capture a greater portion of the demand that is willing to pay any premium. While airlines like Emirates and Qatar have traditionally done well with the business traveller, it is quite telling that these very have now unbundled fares even in business class and are introducing a premium economy product. Pricing is expected to be very aggressive—across geographies, across cabins and across airlines. And keeping aside regulatory barriers, the impact on India’s airlines and their international ambitions will be negative.

As airlines fly into 2021, it may very well be the case that the airlines revert to their old ways: of mindless discounting, of weak balance sheets and of a race to the bottom. Airline failures cannot be ruled out.