India Aviation Outlook: Traffic up, losses down but operating environment remains challenging

The greatest risk to recovery and profitability - other than an increase in fuel prices - is a failure to maintain pricing discipline. In 1Q2016 airlines have already been seen to visibly compromise yields in order to generate cash.

If India is to achieve a genuine, transformational step-change and claim its rightful place as one of the world's leading aviation markets, the onus in the coming year will be on the government to establish a clear vision and roadmap for the sector, supported by an enabling policy and regulatory framework.

This is a short extract from CAPA's comprehensive 300-page India Aviation Outlook Report FY2016, to be released on 31-Jul-2015. The Outlook includes CAPA's projections for traffic, capacity, yields and earnings and presents fleet induction plans, detailed operating and financial analysis and risk assessments of each Indian airline. The report also outlines domestic and international strategies, including expected developments on bilateral policy, codeshares and partnerships. Please contact Binit Somaia on bs@centreforaviation.com to order your copy.

The new government has been disappointing for the aviation industry, but institutional integrity has been restored

Since 2008 the Indian government has failed to set a clear vision and direction for the aviation industry. Aside from the decision to allow foreign airline investment in Indian carriers in 2012, there have been no game-changing initiatives designed to address the structural issues facing the industry.

The aviation sector was therefore eagerly looking forward to the prospect of transformational reforms following the election of a new government in May-2014 which came to power with a single-party parliamentary majority and a mandate for growth and change.

It was expected that the administration would quickly seek to address some of the key policy and fiscal distortions, strengthen institutions and kick-start stalled airport infrastructure projects.

But progress on fundamental issues over the last year has been very disappointing. This has been a year of inaction across multiple critical issues such as a new civil aviation policy; institutional strengthening; developing a strategic direction for Air India and the Airports Authority of India; reducing sales tax on fuel; removing the 5 year/20 aircraft rule for international services; airport infrastructure.

The critical role that aviation can play in ensuring economic competitiveness and generating employment by facilitating business, trade and tourism has not yet been recognised, despite the unprecedented emphasis which this administration places on tourism as a priority sector.

However, the one area in which there has been some positive development is the demonstrated commitment to restoring institutional integrity to the Ministry's engagement with the industry. This is an achievement that should not be underestimated.

Trust and integrity between the government and stakeholders is essential if transformational outcomes are to be achieved and if capital is to be attracted to the sector, and on this front there has been good progress. This at least provides a foundation for what will hopefully be a more active and decisive second year of the government. The administration appears to have the intent and the willingness to deliver on reforms but needs to translate this into action.

DGCA reforms and institutional strengthening are critical but do not appear to be a priority

India's aviation regulator, the Directorate General of Civil Aviation (DGCA) remains weak in terms of skills and resources. The task of reforming the DGCA to support the needs of a fast growing aviation sector has been neglected since 2004.

Internal targets for resourcing - which are far from being met - are based on requirements that were defined several years ago and have since been superseded by market growth. Indian carriers are adding 12-15 million passengers per annum, a number that is only expected to increase over time. If the sector is going to expand safely then the DGCA must start building for the future and not for the past.

An independent Civil Aviation Authority, professionally managed, funded by stakeholders and free from government interference is essential. But plans for its establishment have stalled. In the meantime civil servants rather than specialist professionals continue to be appointed to the position of Director-General, which does not serve the agency well given the technical scope of its purview.

A failure to implement reforms and under-preparedness of the DGCA could prove to be the biggest impediment and constraint to the safe and sustainable long term growth of the aviation industry in India.

India's domestic and international growth accelerated in FY2015

India's aviation market picked up speed in the 12 months ended 31-Mar-2015 with domestic traffic up 13.9% year-on-year and international traffic up 9.0%.

At the start of the year, CAPA had projected growth of 6-8% for domestic traffic and 10-12% for international, however this was based on an assumption of fuel prices at an average of USD110/barrel. The higher than expected growth in domestic traffic was due to airlines being able to reduce fares as a result of the steep decline in oil prices.

The price of aviation turbine fuel at Delhi Airport for domestic services was just over 30% less at the end of FY2015 relative to the beginning of the financial year.

Aviation Turbine Fuel Price per Kilolitre at Delhi Airport for Domestic Services FY2015

Source: CAPA, Indian Oil

IndiGo was the key driver of domestic traffic growth

IndiGo carried more than half of the incremental domestic passengers across the industry during FY2015. As a result its market share soared to 36.4% by the end of the financial year, widening the gap between itself and the second largest carrier, Jet Airways, which had a market share of 25.4%.

IndiGo's domestic market share will almost certainly cross 40% during FY2016 and could approach 45-50% within the next two years based on CAPA's proprietary capacity forecasting models. The carrier could expand more aggressively in the near term in order to further consolidate its leading position in the domestic market.

Jet Airways was the fastest expanding Indian carrier on international routes

Total international traffic to/from India grew at 9.0% in FY2015, however Indian carriers grew slightly faster at 10.2%. Jet's growth rate was around twice that at 20.6%, with the airline accounting for close to 75% of the incremental international traffic carried on Indian airlines.

Jet Airways is now clearly prioritising growth on international routes following its partnership with Etihad. Its capacity on domestic routes is expected to remain stable or possibly even contract marginally.

Foreign carriers, which handle around 65% of international traffic to/from India, grew their passenger numbers by around 8.6% but several airlines would have expanded faster if they were not constrained by bilaterals.

Losses declined by 30% to USD1.21-1.27 billion in FY2015, largely due to lower fuel prices; LCCs continue to outperform FSCs

India's airlines generated revenue of approximately USD11.1 billion in FY2015, with a combined net loss of around USD1.21-1.27 billion.

Indian Airline Estimated Profitability by Business Model in FY2015

Source: CAPA India

IndiGo posted its highest-ever profits in FY2015, while GoAir also achieved a close to record result

IndiGo saw strong growth in total revenue in FY2015 which crossed USD2.5 billion. Based on projected growth this should bring it to within striking distance of Jet Airways' topline by the end of FY2016. The carrier is estimated to have posted a record profit of USD150-175 million in FY2015 representing a net margin of 6-7%.

GoAir is the only other carrier that is understood to have been in the black with an estimated profit of USD14-15 million, close to its peak result posted in FY2013. This result was achieved on record revenue of USD450-475 million. The rest of the industry is estimated to have lost around a combined USD1.35 billion, of which USD900-920 million was accounted for by Air India.

Indian Airline Estimated Profitability by Carrier in FY2015

Source: CAPA India

New start-ups, which include an FSC (Vistara), an LCC (AirAsia India) and a regional carrier (Air Costa) all performed below expectations and remain challenged by market dynamics, competitive pressures and strategic issues.

Airport traffic grew at double-digits; private airports in south India were the strongest performers

The country's airports handled 190 million passengers in FY2015, more than three times higher than the 59 million passengers handled just ten years earlier. India's two largest airports, Delhi and Mumbai both grew at close to the national average of 12.5% year-on-year, but the three PPP airports in southern India, Bangalore, Cochin and Hyderabad, all saw growth of around 20%.

As a result, Bangalore overtook Chennai (which is operated by the state-owned Airports Authority of India) to become the largest airport in south India with just over 15 million passengers. Meanwhile Bangalore, Cochin (up 39.5%) and Hyderabad also outperformed the market in terms of cargo volumes with double digit growth, while air freight activity at Chennai was flat, up just 0.9% year-on-year.

CAPA forecasts 8-10% international and close to 15% domestic traffic growth in FY2016

With India's GDP forecast to grow at 7.5% in FY2016, CAPA expects double-digit traffic growth of around 8-10% for international and close to 15% for domestic. This would result in international traffic increasing to 54-55 million passengers and domestic traffic to around 80 million. Domestic traffic could rise higher if airlines engage in extended periods of aggressive pricing.

Domestic capacity expansion is likely to be less than 5% resulting in higher load factors

Domestic capacity growth will be relatively modest, with around 22 narrow body and 10-12 regional aircraft scheduled to be delivered. The coming year is expected to be see fewer aircraft inductions than any time over the next decade. And, after accounting for retirements and the possibility that some aircraft may not in fact be inducted as scheduled, the fleet size is expected to increase by just 12 narrow body and 10-12 regional aircraft.

Most of this growth is only expected to occur from Q3 onwards. As a result domestic seat capacity is likely to grow by less than 5% in FY2016 which should result in load factors increasing by 6-7 ppts.

Projected deliveries of aircraft on order from OEMs to Indian carriers 2015-2025

Source: CAPA Fleet Database

A couple of new airlines are preparing to launch but any meaningful capacity impact is unlikely until FY2017

Premier Airways, which hopes to launch by the last quarter of FY2016, is not included in this projection. The proposed start-up continues to make significant progress towards its launch from a Hyderabad base, and most of its core team is now in place. However, commencement of operations in 1Q2017 is more realistic.

Another planned start-up this year is Turbo Megha Airways, a new regional airline operating ATR-72 equipment. One aircraft has already been delivered in advance of its proposed launch in 2Q2016.

In addition, other serious projects understood to be in the pipeline include one major pan-India airline to be established as a JV with a foreign carrier, and a large regional airline.

Airline losses could reduce by a further 40% in FY2016

Assuming oil prices at USD60-70/barrel and an exchange rate of USD1=INR64-66, the industry's financial performance is expected to improve further in FY2016, with total industry losses declining to USD680-750 million. LCCs are expected to generate a combined profit of USD200-220 million, while FSCs could post losses of USD900-950 million.

But with balance sheets remaining weak in the case of several airlines, significant capitalisation to the value of an estimated USD1.2-1.5 billion will be required over the next 12 months. One or more airlines are expected to IPO during the next 18 months.

A failure to maintain pricing discipline is the key risk to improved financials

The challenging cash position of several airlines is driving some of them to compromise on yields despite the improving demand-supply conditions in the market. During the peak first quarter of FY2016 carriers have been seen to pursue volume ahead of yields which is ultimately negative for the industry overall.

Fuel prices remain a perennial risk. The current consensus is that oil is not likely to cross above USD70/barrel but as history has shown changes in fuel prices can be unexpected, sudden and significant. Further depreciation of the Rupee also remains a possibility, especially if the US Federal Reserve was to increase interest rates in the latter part of 2015.

Foreign carriers continue to knock on India's door seeking an additional 100,000+ weekly seat entitlements in the near term

International airlines, encouraged by the strong and steady growth in international traffic to/from India, are keen to expand their presence in the market, but airlines from several countries have exhausted, or are close to exhausting the bilateral seat entitlements currently available to them. Airlines from Dubai, Hong Kong, Malaysia, Qatar, Oman, Sharjah, Singapore, Thailand and Turkey combined are expected to push for an additional 100,000 weekly seats in the near term.

In addition to demands for additional seats the Ministry is also receiving multiple requests for codeshares, third party codeshares and joint venture arrangements. In the absence of a stated policy and lacking the expertise to understand evolving trends in global airline commercial arrangements, the Ministry is unsure how to respond.

For now these requests have been placed on hold and there is no clarity on when and how the process will move forward. This is impacting connectivity to India at a time when the government is trying to encourage inbound tourism, as evidenced by its decision in recent months to extend electronic visa facilities to almost 80 nationalities including most of the largest source markets.

The new administration has been keen to address the lack of transparency which has at times accompanied the award of bilaterals in the past. This is an approach which is to be welcomed. However, freezing the award of additional bilaterals is not the solution.

The future of Air India remains as unclear as ever

Air India's financial and operational performance have certainly improved significantly over the last couple of years, but the expected change of guard at the top has created uncertainty about the future direction of the airline. The current Chairman and Managing Director has officially completed his tenure and only remains in the post pending the appointment of a new head. No suitable candidates have been found for several months.

Air India has neither a viable domestic nor a long haul business model, and is the only carrier in the country without a long term fleet plan. Air India Express did however see a strong improvement last year. But with no clear strategy for Air India the prospect of annual losses stabilising at close to USD1 billion sadly appears to have become accepted as the normal state of play.

The funding required by the carrier is even greater than projected in its turnaround plan. For a government with so many other pressing economic and social priorities to address, subsidising an airline when there are so many capable private operators is a tragic waste of taxpayer funds.

But the more funds the government invests the harder it becomes to take the bold decisions that are necessary to extricate Air India from its difficult situation. Already USD3 billion has been invested under the turnaround plan to date, while the carrier's debt of over USD8 billion is more than twice its annual revenue.

Apart from the cash infusion, the other cost of state ownership is that it impacts policy decisions and prevents genuine market-based reforms in an effort to protect the national carrier.

Airports Authority of India faces a critical future and requires a completely new business plan

The Airports Authority of India generates revenue from managing 125 airports and providing air navigation services across India's airspace. It also earns a revenue share from the four metro PPP airports.

However, each of these revenue streams is under threat. The government has accepted a recommendation to hive off and corporatise the AAI's air navigation services division. If this was to proceed, it would remove an activity that accounts for more than 25% of its revenue and an even higher share of its profits.

Of the 125 airports managed by the AAI, only around 10% are profitable and even their performance is falling behind the overall market. Furthermore, the AAI's most profitable airports, Chennai and Kolkata, have been identified for privatisation.

Although the loss of these airports would be replaced by a share of revenue from the new operator, global interest in Indian airports is declining which could result in much lower revenue share bids than was the case in Delhi and Mumbai. And with the regulator pushing for 78% lower charges at Delhi, even the existing revenue share receipts could decline substantially.

As a result of these fundamental challenges to its revenue model, the AAI needs a strategic renewal and direction.

Airport investors are likely to face further frustrating delays to the award of PPP concessions

Navi Mumbai and Goa Mopa continue to miss published timelines for the tender process to award PPP concessions for these greenfield airports. Despite the fact that four consortia were shortlisted for the Navi Mumbai Airport project in Jan-2015, the agency managing the tender recently announced that the successful party will not be selected until Apr-2016.

The deadline for submission of Expressions of Interest for PPP concessions for four brownfield airports at Chennai, Kolkata, Ahmedabad and Jaipur has already been pushed back twice since the beginning of this year. This is turning into a replay of the constant delays which plagued the first attempt at privatising these airports in 2013, which eventually led to the process being shelved.

When the new government - which had promised to speed-up and streamline infrastructure development - resumed the process it was assumed that any issues that had delayed the projects earlier had been resolved, but that is clearly not the case.

As it is, investor interest in Kolkata and Jaipur airports is muted, and these repeated delays have resulted in a fatigue factor and a further loss of confidence amongst prospective bidders. The government must decide once and for all whether it wishes to proceed with awarding PPP concessions.

Meanwhile, the Airports Economic Regulatory Authority has proposed that Delhi Airport should reduce aeronautical charges by 78% from the upcoming tariff period. That is a very strong signal that will reset the expectations of investors in Indian airports going forward, and will have a strategic impact on the AAI and existing private airport operators. What is unusual about this situation is that it is the regulator that is setting the agenda on the till framework for airports, rather than the government. However, if implemented it will be strongly welcomed by airlines and passengers.

Air navigation services should be corporatised but challenges remain

Air navigation services in India have improved markedly under the AAI over the last couple of years as a result of investment in new technologies and implementation of more efficient systems and procedures.

However, corporatisation is likely to be the best model for creating an organisation with the structure and ability to raise capital to meet the growing demands that will be placed on air traffic management in the future.

The government has accepted the recommendation to corporatise, but there could be several barriers to its implementation. The impact on the AAI as a result of the loss of more than 25% of its revenue being key amongst them.

Nevertheless, a legal consultant has been appointed to propose amendments to the relevant Act, which may be tabled in the next session of parliament commencing Aug-2015. If the revisions are passed it is possible that a corporatised ANSP could be functioning before the end of FY2016. However, with the challenges that exist a further delay cannot be ruled out.

This is a short extract from CAPA's comprehensive 300-page India Aviation Outlook Report FY2016 which will be released on 31-Jul-2015. The Outlook includes CAPA's projections for traffic, capacity, yields and earnings and presents fleet induction plans, detailed operating and financial analysis and risk assessments of each Indian airline. The report also outlines domestic and international strategies, including expected developments on bilateral policy, codeshares and partneships. Please contact Binit Somaia on bs@centreforaviation.com to order your copy.