Unlocking the potential

It’s no secret most of India’s ambitious airlines, including stateowned Air India (AI), have endured years of miserable performance struggling to cope with crippling local fuel costs, high taxes and airport charges, constant bouts of vicious fare-cutting and a regulatory regime that has stymied their efforts to achieve fiscal stability. The dramatic collapse of Kingfisher Airlines last year was sufficient proof of that.

There is plenty of evidence to suggest that if AI hadn’t been government-owned and subsidised, it would have followed suit. Before merging in 2007, the two stateowned carriers, international Air India and domestic Indian Airlines, posted profits. Since then, the new AI has been drowning inred ink with accumulated losses of $3. 2 billion and debts t hat have climbed to nearly $7 billion.

Its lifeline: a bailout package announced last year involving a $4. 7 billion equity infusion phased through to 2020… providing it meets certain milestones.

Air India isn’t walking the tightrope alone. In late September, auditors of budget operator SpiceJet raised concerns about its ability to stay aloft because operating losses have completely eroded its net worth. That followed a similar warning about Jet Airways concerning its financial stability. Jet, majority-owned by industry veteran Naresh Goyal, was recently hit with a default notice from one of its lessors, USbased International Lease Finance Corp (ILFC), for non-payment of rentals on six 737s. Jet says it is negotiating with the lessor and the account will be settled.

Overall, the Indian aviation landscape is grim, failing miserably to produce the potential bonanza everyone believes is there.

According to CAPA (Centre for Asia Pacific Aviation), the industry lost an estimated US$1. 65 billion on $9. 5 billion in revenues last financial year ending March 31, although that was down from $2. 28 billion the year before mainly thanks to the departure of Kingfisher capacity. It is estimated it lost another $450 million in the first quarter (ended June 30) of the current year. Total airline debt is around $13. 3 billion and rising.

There are six scheduled domestic airlines – Air India, Jet Airways, Jet Lite, SpiceJet, IndiGo and GoAir – and only one – no-frills IndiGo – reports consistent profitability, though even that has been questioned because the airline isn’t listed and doesn’t issue full financial details. It remains the market leader with nearly 30 per cent of domestic traffic. Jet and JetLite hold about 23 per cent, SpiceJet 19. 5 per cent, Air India 18. 9 per cent and GoAir 8. 9 per cent.

In its latest year IndiGo claimed a more than six-fold increase in profit to $126. 5 million, its fifth consecutive profitable year. In contrast, its closest low-fare rival SpiceJet reported a loss of $97. 4 million, while Jet Airways and its low-fare service JetKonnect together made a loss of $125. 3 million.

Air India was by far the worst performer, though it narrowed its losses in 2012-13 to $774 million from a record deficit of $1. 2 billion a year earlier. Chairman and managing director Rohit Nandan plans to reduce losses to $640 million this year but his target of profitability by 2019/20 still looks a long way off.

Since India opened its domestic skies in 2005, AI’s near-monopoly dominance of the market has been eroding. Today, privately-owned carriers account for more than 80 per cent of domestic departures and 70 per cent of t he country’s

The Indian aviation landscape is grim, failing miserably to produce the potential bonanza everyone believes is there.

fleet. Some 65 per cent of passengers fly on budget airlines.

Given the enormity of the task, just how well is Air India doing in its turnaround efforts? Fleet and network adjustments, pricing, schedules and revenue management improvements, coupled with aggressive costcutting and marketing are having an impact. The carrier has reported a consistent growth trend over the past year and actually generated a cash surplus of $72. 6 million in the April-June period. For the first time since the merger, AI was EBIDTA (earnings before interest, taxes, depreciation and amortisation) positive in 2012-13 despite a twomonth long pilot strike and the grounding of its Dreamliner fleet.

So far, says Nandan, critical targets are being achieved.

“We are meeting and surpassing the parameters we were supposed to meet under the turnaround plan,” he told Australian Aviation in Sydney during a ceremony marking the first 787 arrival from New Delhi.

Nandan, who took charge of the troubled airline in August 2011, is certainly making some progress.

Losses are shrinking but the road ahead remains pitted with potential landmines, not least a wave of new challenges that could seriously threaten the marginal improvements already achieved.

First, there is the blossoming Jet Airways-Etihad Airways partnership and planned massive capacity increases by Gulf carriers into India. To make matters worse, the surprise October announcement from Singapore Airlines and local group Tata they are launching a new full-service carrier in India brings a deep-pocketed player into the market and serious competition for existing incumbents, particularly AI. A new budget operator, AirAsia India, in which Tata also has a 30 per cent stake, plans to fly later this year, though it still has to gain its air operators certificate.

Not helping is the plunge in the value of the rupee to record lows against the US dollar, critical regulatory issues that still have to be resolved, and damagingly high taxes imposed on jet fuel by most of the country’s state governments.

Fuel accounts for some 40 per cent of airline costs and analysts estimate this erodes the operating margin of Indian airlines by around 12-18 percentage points. Domestic carriers are also subjected to higher taxes on aircraft leases, aircraft charges and maintenance costs. AI’s fuel budget this year will be $1. 4 billion, 45 per cent of its costs. Some $94. 7 million of that is for sales and other taxes to state governments.

Nandan has decided AI needed to drop out of the price wars arena.

“After I came, I decided no more low fares. There is no point in focusing on your marketshare at the cost of profitability,” he says. He has also put a stop to what he calls “reckless borrowing” and has taken steps to improve staff morale, which had plunged in the years following the merger.

Like most Indian carriers AI has also been trying to renegotiate the terms of its aircraft leasing arrangements. What it pays in US dollars has soared as a result of the plunge in value of the rupee, down 20 per cent. Nandan said about 50‑60 per cent of the carrier’s business brings income in dollars and this does hedge against bills that aren’t rupee-denominated, but “as far as the escalation of the dollar is concerned, it’s going to impact all of us… but the increase in the value of the dollar doesn’t affect Air India as much as it might affect other airlines. ” He says AI needs to have a long-term road map for health and growth. “This should include various strategies including havingprivate sector investments sometime in the future”.

What improvements have been achieved are hardly a signal for celebration. In the year to March only 14 of its 201 services managed to meet the cost of operating them, though that was an improvement on the single route that made money a year earlier.

As Kapil Kaul, South Asia chief executive of CAPA put it bluntly: “AI remains structurally challenged and critically vulnerable to the external and internal environments.

A genuine and sustainable turnaround is not feasible and realistic under government ownership and management. ” But privatisation isn’t on the agenda despite the government’s breakthrough policy change last year that for the first time allows foreign carriers to take up to 49 per cent share in India’s airlines. Apart from the operational challenges, AI continues to be a slave to government interference. Any major decisions have to make their tortuous way through an endless array of approvals from various government ministries and committees. It makes genuine commercial practices difficult. In addition, the Indian airline market is in a strange state of flux.

It has long been touted as one of the region’s two major growth markets, along with China, with enormous potential. Yet traffic has been declining and most analysts agree the country is underserved by air services.

The demise of Kingfisher took seats out of the market and enabled rivals to increase load factors, raise fares and reduce their losses. Yet the capacity-demand equation is unbalanced. In March, for instance, demand rose 8. 8 per cent while capacity increased only 5. 1 per cent. In July demand increase 6. 6 per cent while capacity lifted only 1. 6 per cent.

The arrival of AirAsia, initially with only three aircraft but plans to increase to nearly 40, and the Singapore Airlines joint venture (unlikely to launch until next year) may eventually redress some of this shortfall but it will also likely spark intense pricing competition that will adversely impact yields.

On the plus side, AI is pressing ahead with its turnaround plan and expects some major gains in lowering costs. It is in the process of replacing ageing aircraft – more than a dozen are over 20 years old – with newer jets such as the 787. It will have 14 Dreamliners by years’ end, with another 13 to come. The 787’s arrival, with its 25 per cent better fuel efficiency, make the carrier’s long-haul flying far more economic.

AI flies to 33 cities overseas and after launching to Sydney and Melbourne plans to add Birmingham, Milan, Rome and Moscow this fiscal year.

Nandan is also slashing staff costs.

Salaries for its 24,000 employees were trimmed seven per cent to $524. 4 million last year and 7,000 employees are expected to retire over the next five years, enabling further reductions.

Ground handling and engineering services have also been hived off, bringing a further $157. 8 million annual cut in costs. Overall, the number of employees per aircraft has plunged from about 220 – nearly double its local rivals – to about

The country’s carriers will need 1,450 new planes over the next 20 years.

100. AI is also planning to sell or lease out underutilised assets such as land and buildings and has appointed global consultant DTZ to raise money from its real estate assets with a target of getting $789 million from leasing and selling off these assets over the next 10 years.

India remains a high-risk aviation market.

Whether all of this will ultimately be enough hinges on several factors, including the potential for industrial unrest.

It has a history of strikes by employees, including pilots. It must also meet the emerging challenges from the Jet-Etihad joint onslaught, the arrival of SIA’s new joint venture full service carrier and budget AirAsia India.

Jet may be losing money but the tie-up with Etihad should enable it to rationalise operations, including such things as pilot training, joint purchasing and marketing.

Working together, the partners will be able to offer Indian travellers a wide domestic and international network through Abu Dhabi to Europe and North America.

A new air services agreement between India and the United Arab Emirates finalised recently allows Etihad to significantly increase its capacity into India. For example, it has already announced that from November 1 it will triple the number of seats it now offers on the prime Abu Dhabi to Mumbai and New Delhi routes.

AI’s Nandan doesn’t think it is a real threat. He says the higher allocation of seats under bilateral treaties is part and parcel of the travel industry.

“We will not be affected by the Jet-Etihad combine because our business model is different.

We offer travellers point-to-point direct travel. One need not break the journey. This will be our unique selling point with increased deployment of Dreamliner planes. ” In other words, he is banking on travellers preferring nonstop services, particularly into Europe, against one-stop routing through Abu Dhabi. Industry observers are not so sure, pointing out the wider network of Jet-Etihad will be a big draw, particularly for lucrative frequent flyers.

Coupled with this is the arrival of SIA. Under Indian law a local airline can’t fly internationally until it has operated for five years and has 20 aircraft. At present the newIndia remains a high-risk aviation market. carrier will be limited to domestic flying. However, there have already been discussions about changing these rules and it is possible they could be eased. Just five days after it announced the launch of the new carrier, SIA and its offshoot Silk Air disclosed plans to increase services between India and Singapore to 107 times a week from 98 across 11 Indian cities.

While SIA insists this has nothing to do with its joint venture move, it underscores how important India is seen in terms of network growth. The SIA-Tata operation (yet to be branded) linking with SIA mainline will be a major player domestically and internationally.

This is particularly significant given that since last year Air India has not even been the largest carrier of international passengers from India. That is Emirates, which now carries around 13 per cent of India’s international travellers, compared with AI’s 12 per cent (this includes AI’s budget arm Air India Express).

Another major challenge will be rising airport charges. Carriers have already seen some horrendous increases, such as the 346 per cent rise in charges at Delhi airport approved by the Airports Economic Regulatory Authority of India in May last year. Now, the government is looking at privatising six major public sector airports currently operated by the Airports Authority of India (AAI): Lucknow, Ahmedabad, Jaipur, Chennai, Kolkata and Guwahati airports.

The International Air Transport Association (IATA) has expressed grave concerns about this, saying “any unnecessary private shareholding” may increase thefocus on “profit-maximisation” and lead to higher user costs.

“The privatisation of these six AAI airports will only serve to fuel a further round of increases in the airport cost environment, adding to costs for passengers and the airlines,” added IATA.

Aircraft leasing and financing is also an issue. Global leasing companies hiked their rental rates by up to seven per cent for Indian carriers after they faced difficulties repossessing planes following defaults by Kingfisher. Indeed, AI has been trying to lease 19 Airbus A320s but hasn’t received an adequate response to its call for tenders. It has had to repeatedly extend the bid date and is currently reworking the tender again to try and attract takers.

Is there a clue to success in IndiGo’s apparently trend-breaking profitability? Many local analysts agree the budget carrier is well managed and IndiGo president Aditya Ghosh says a combination of capacity deployment and yield management has driven profitability.

The carrier took a different road to its rivals last year, increasing capacity by 39 per cent while overall industry capacity shrunk by four per cent. It now has 70 aircraft and that will rise to 75 this year, with some 100 A320s on order. While traffic in India fell five per cent in 2012-13, IndiGo passengers rose 27 per cent.

As CAPA’s Kaul put it: “IndiGo continues to outperform on every single benchmark. Customer ratings are high, service delivery is consistent with quality maintained, operating and financial measurements are best in the industry.

“Overall, IndiGo continues to focus on their business plan with strategic clarity and has demonstrated high execution ability – 70 aircraft in seven years and yet profitable for the last five-six years is remarkable. ” Even given the lack of real financial detail about what precisely contributed to profitability (such as the possibility of exceptional one-off items) as a result of its unlisted position, there is no doubt IndiGo is performing far better than its rivals. Its focus on capacity expansion, yield management and cost control should probably be markers for other Indian airlines.

No-one doubts the potential of Indian aviation.

Airbus and Boeing are bullish on aircraft sales, estimating the country’s carriers will need 1,450 new planes worth $175 billion over the next 20 years. A study by India’s planning commission points out that in terms of air travel penetration, India today, at just 0. 04 air-trips per capita annually, lags far behind developed countries, such as the US and Australia, with two air-trips per capita a year. China’s domestic air traffic is five times the size of India’s despite having a population that is just 10 per cent more.

The trick for Air India and other players will be turning that promise into a profitable reality. Right now, the truth is that India remains a high-risk aviation market that still requires some decisive government policy decisions to ease the heavy cost burden on airlines in terms of taxes and charges and their freedom to operate commercially at home and abroad.