India's airlines still face significant headwinds

The number of domestic air travellers has been rapidly increasing. Most recent figures show that domestic travel is inching towards 70 percent of pre-Covid levels. Packed airport terminals and rising occupancy on flights are proof of the same. Add to this the recent 72 aircraft order by the startup airline Akasa, the successful sale of the national airline Air India to the Tata group, a settlement between Boeing and SpiceJet, the possible revival of Jet Airways, buzz about additional aircraft orders by incumbents and another startup waiting in the wings. Together these are adding up to much enthusiasm. Yet, behind the narrative also lies the fact that yields are being held up by government-mandated price-floors, international flying continues to be depressed, airlines are carrying excess fleet and fixed costs, currency fluctuations continue, fuel prices have doubled in the past year and airport charges continue to rise unabated. Overall, Indian aviation is not quite out of the woods yet. There are still significant headwinds ahead.

As of this writing, the government-mandated price-floors continue. Effectively flyers are denied access to discounted fares within a 15-day window as a minimum price band has been set. When removed it is assumed that airlines will rush to discount. Given liquidity profiles, this means that one or two airlines will inevitably fly dangerously close to closure, keeping the price-floors in place is just not a long-term solution. Faulty fundamentals that should have been addressed remain untouched.

Even prior to the pandemic, airlines were flying without fundamentals in place. And this was glossed over only because of the promise of significant growth for many years to come. The pandemic laid bare these fault-lines and this was bandaged by a customer-funded bailout. In that, a minimum price band was set during a time where there was reduced capacity on rail and challenges with road travel. Flyers had no option but to pay the higher fares. And they did. Interestingly with the number of travellers rising in spite of the price floors, this only means that once these floors are removed the segment that is not travelling due to being priced out of the market will also return. Now with domestic flyers rising, what has returned is the growth albeit from a lower base. But behind the growth is the fact that the structure of demand has also changed. And this change may not bode very well – especially because business demand translates to higher yields and does not show the same seasonality patterns as leisure demand. And regardless of the narrative business travel revival is still a while away. Impacts on cash flow are all but certain.

For India's airlines, costs have been rising. Fuel is now at twice the levels from a year ago, currency fluctuations continue, and due to risk premium adjustments financing at an industry level is more expensive. Couple this with brittle balance sheets and a banking sector that is averse to aviation and credit is just not to be found. Especially for airlines that do not have other collateral or guarantees to put up. For India's airlines to navigate this challenge requires more than just traffic volumes. It also requires structural changes and a shift in the quality of revenue. In the interim, equity seems to be the only option.

GoAir (now GoFirst) is proceeding with an IPO hoping to raise more funds majority of which are towards paying creditors; Tata-owned Vistara and AirAsia have tempered growth plans and Vistara has seen significant equity infusions and both are likely to require additional capital infusions in addition to the injections that will be required by Air India. Meanwhile, SpiceJet is leveraging its cargo division and has settled with Boeing; and Jet Airways continues to work on a revival plan. Indigo while well-positioned continues to see eroded margins and is sitting on excess fleet due to restrictions on international flying and depressed demand. For the airline industry to pull through the constrained cost and credit scenario, a range of actions is needed. And for now, they are found wanting.

The Indian airline market structure has evolved to a point where one airline with a monopoly market-share in excess of 50 percent while the others play in various segments. Interestingly, this market share is not translating into pricing power. Assuming a consolidation within the Tata-owned airlines, the market will have two strong players while others will play at the periphery. And a race to discount cannot be ruled out.

Indeed, discounting is almost certain – which is both a justification for and against the price-floors. Irrational pricing by competitors is best left to management to decide; the government cannot play referee in this especially with an agenda of inclusive growth. As international skies open up, India's airlines will be faced to compete with foreign competitors – which will also compete ferociously on price.

There is also the issue of a supply-demand mismatch. As it stands India's airlines are collectively sitting on 650-odd aircraft, of which the majority are on lease. Some airlines have resorted to a sale-and-leaseback model to augment cash flow. This points to the fact that operational cash-flows are not quite where they need to be. And the constrained credit environment is not helping either. Sizeable orders and idle fleet with continued restriction on international flying also means that airlines will rush to build volumes where they cannot capture margins.

Overall, while the domestic air-travel market is no doubt showing a rebound in volumes, this cannot be conflated with clear skies ahead. For airlines, eventual success is measured at the margins. And as of now the margins for the industry don’t quite cover the cost of capital and will not for a while. For India’s airlines, there still are significant headwinds ahead.