Views: IndiGo earnings point to a better flight-path ahead for Indian airlines?

IndiGo reported its third quarter results on Friday. A profit of 129.8 crores was a pleasant surprise and was a much needed respite from the constant stream of negative news emanating from the aviation sector. The profit was largely driven by very strong revenue growth up by 84.3 percent from the same quarter last year and 64.3 percent from the prior quarter.

Yields held up mostly driven by the mandated price floors that continue as a part of government policy. The question doing the rounds is whether IndiGo’s performance reflects a better flight path ahead for the airline and for the aviation sector overall?

With revenues of 9480 crores – a number that would have reached 10,000 crores were it not for the onset of the pandemic – the key driver was the yield. At INR 4.41 the yield was amongst the highest that Indigo has seen and was aided by an occupancy factors of 79.7 percent. The yield was driven by price-floors, timely sales incentives and the fact that Indigo was cancelling far fewer flights than many competitors which translated into a “reliability premium.” This “reliability premium” is expected to continue for a while given the weaker cash position of some competitors which is forcing clubbing and cancellation of flights.

Interestingly, international operations continued to be muted given the restrictions on flights with the exception of those operated under bubble arrangements. This is a mixed bag and while it may help with route based revenues overall it has impacts on asset utilization which is sub-optimal at present and also the revenue mix.

On the costs side, there were several items of note. Firstly, fuel cost was up by 2.8X from the same period last year and 1.6X from the prior quarter. This was driven by a sharp increase in jet-fuel prices and also capacity growth. To arrest these costs the airline continues to move to a newer fleet and by the end of the year expects to retire all of the older Airbus 320 aircraft (the A320 CEOs). Other airlines may not have the same luxury.

Other than fuel, maintenance costs also rose rapidly. These too are tied to level of operations and a newer fleet will help arrest the rise of these costs as well. Airport fees and charges rose as well and will sharply rise going forward with majority of the metro airports looking at a hike in tariffs and no strong united front by the airlines to oppose such charges.

Perhaps an increase that caught folks off guard was the increase in employee costs. In addition to the increased manpower required for increased capacity, these costs also have other elements that are bound to increase. With the competitive intensity increasing especially given the new entrants like Akasa, the likely hiring by the Tata group and with international airlines also searching for talent, Indigo has to prepare to retain talent. The 65,000 stock options that were announced in January to be granted at a competitive strike price are proof of the same. Yet again, other airlines may not have the same luxury.

For the quarter, IndiGo continued to dominate the market in terms of highest capacity and lowest costs. Yet this dominance may start to see a few dents as the Tata’s consolidate operations with their majority owned airlines (Air India, Vistara and AirAsia India). Additionally, on the costs side, it is expected that Akasa may have costs that are competitive at the very least and thus the ability to compete on fares.

The price floors that have held up yields cannot also continue indefinitely and an impact to yields once these are removed is all but certain. On the financing side, while Indigo continues to have a strong balance sheet, concurrently banks continue to review exposure to the overall sector and lending is constrained. The industry is moving to a structure where the credit quality will be labelled black and white and the impact to weaker airlines will be fairly negative.

As of this writing, Jet Airways is looking to revive and Akasa is expecting its first aircraft by April. What this means is that as the industry heads into the first quarter of the new financial year – traditionally the strongest demand period - domestic skies will see eight airlines chasing demand. Demand that is rising but still below pre-COVID levels and with costs that in many areas have outstripped pre-COVID levels. New fleet orders are on the anvil and this will mean additional pressure on incumbents especially in the area of fleet, financing and talent.

Finally there is the pandemic that has altered demand patterns. While the sector is getting used to the repeated shocks, cash-flow once lost is lost forever. For sustainability at an industry level, forward bookings have to stabilize or the revenue mix altered. Success will entail taking a longer term view but weaknesses of balance sheet don’t allow that luxury for many.

Overall, while the ride ahead seems to be better, it is still too early to tell if the clouds have lifted.