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Indian carrier losses return in 2Q2012, high structural challenges remain

24-Oct-2012

1QFY2012/13 marked the best result in 18 months. In the three months ended 30-Jun-2012 all private Indian carriers, with the exception of Kingfisher, were profitable, albeit that in several cases this was as a result of sale-and-leaseback and other income.

1QFY2012/13 reflected two key trends faced by Indian carriers. On the one hand, improved matching of demand and supply (largely as a result of the contraction of capacity by Kingfisher), combined with greater pricing discipline resulted in a substantial increase in average yields which contributed significantly to the improved performance.

But this was offset by a hostile cost environment primarily related to high fuel prices and a weak currency. The particularly strong performance by Air India, which achieved the highest average fare and reported a small operating profit on domestic operations, reflected the changing market dynamics.

But 2QFY2012/13 highlights that underlying structural challenges remain

However, CAPA India estimates that 2QFY2012/13, traditionally a weak quarter, saw a return to significant losses across the board, with the airlines combined losing USD470-550 million (it should be noted that the results for IndiGo and Go Air are CAPA India estimates as these two carriers are not listed and do not publish their financials). However, it was also observed that airlines maintained pricing discipline and were prepared to sacrifice load factors rather than compromise yields, which were higher than the corresponding period last year.

CAPA India estimated losses by Indian carriers, three months ended 30-Sep-2012

  • Air India (USD280-320 million loss)
  • Go Air: (USD2.5-2.8 million loss)
  • IndiGo: (Breakeven-5.7 million loss)
  • Jet Airways: (USD45-60 million loss)
  • Kingfisher: (USD110-130 million loss)
  • SpiceJet: (USD25-28 million loss)

The airlines are hoping for a robust second half of the year. The month of October has not lived up to expectations, with most carriers breaking-even and some posting modest losses, however November and December look encouraging with strong yields and load factors.

Supply and demand are better aligned, but costs remain a major concern

Kingfisher has been steadily contracting over the last 12 months such that in Sep-2012, the last month before it suspended services, it had only a 3.2% share of the domestic market. As a result the sector has already largely adjusted to the reduction in capacity, however the current grounding of the airline could result in a seat cruch on key routes such as Delhi-Mumbai and Mumbai-Bangalore, particularly during the upcoming Diwali holiday season.

The decision by the DGCA to revoke Kingfisher’s licence on 20-Oct-2012 does not change much in practice except to formalise the grounding of the airline which had suspended all flights since 01-Oct-2012. In fact the airline is now no longer required to meet deadlines for responding to the DGCA on the status of its operations.

Costs are a major concern, however airlines are paying attention to this issue and are striving to compensate by maintaining price discipline.

Kingfisher’s grounding has already been factored into capacity and pricing, but implications for the sector will be widespread

Kingfisher Airlines has USD2.5 billion of liabilities of which USD1.1 billion is bank debt. Banks may be able to recover some of their loans depending on the quality of the collateral in place but this is likely to be a very long drawn-out process and risks are inevitable. However, banks with an exposure to Kingfisher have been increasing provisions over the last few quarters. The Indian aviation sector will see a further downgrade of its credit rating and airlines in particular are likely to be faced with an increasingly tight debt market.

The balance USD1.4 billion of liabilities to vendors and employees is largely irrecoverable except for some secured debt where airport operators and oil companies hold bank guarantees that could be invoked. It is the employees that are likely to face the greatest impact with seven months of unpaid salaries and a tight job market in the aviation sector.

Aircraft lessors, and the banks financing them, will also be affected. India is a signatory to the Cape Town Convention (subject to local regulations) which should in theory facilitate the repossession of aircraft. However, this is also proving to be a challenge as related government agencies have not allowed lessors access to aircraft due to their own outstanding dues with Kingfisher. India needs to abide by its international obligations and should not add to the already negative sentiment of global investors and suppliers.

Lessors have several months of unpaid aircraft rentals and will also incur costs related to restoring the aircraft to a condition to be able to re-market them. Large global banks have taken a serious view of the situation. This experience is likely to negatively impact future financing of Indian aircraft orders and increase lease charges due to a perceived higher risk rating.

Air India shows continued improvement but a real turnaround remains distant

Air India continued its upward trend in 2QFY2012/13 with overall daily losses reduced by 15-20% year-on-year as a result of improved pricing discipline and passenger loads. In 3QFY2012/13 and 4QFY2012/13, which include the peak inbound and outbound travel periods, international operations will contribute to lower losses. However, there are strategic concerns about the overall slow pace of the revival of the carrier. Air India needs to be more aggressive to take advantage of the current market dynamics.

The carrier has failed to be decisive in its plans to launch domestic low-cost operations which have been repeatedly delayed. In light of Kingfisher’s grounding and the space this opens up in the full service segment, Air India is likely to yet again postpone a decision on establishing a domestic LCC. However the airline is reconfiguring its A320 fleet to single-class configuration and 16 aircraft have so far been completed.

Jet Airways focusing on yields but domestic strategy continues to be uncertain

With Jet now presented with an opportunity to take a dominant position in the full service, corporate market, the airline’s strategic focus is on yields and margin but its domestic market strategy remains uncertain. Jet Airways has not fully managed to leverage the opportunities presented by the downsizing of Kingfisher over the last six months.

All single-class domestic aircraft are being reconfigured to two-class with the introduction of eight business class seats. This is expected to have a positive impact on yields. Business class occupancy has improved significantly to about 65% and is expected to stabilise at this level. The earlier focus on low-cost operations has been shelved as the airline re-assesses its strategic direction in light of the developments at Kingfisher. Capital raising will continue to be challenging and will remain a major structural hurdle to the carrier’s expansion.

SpiceJet facing short-term funding challenges but keeping an eye on the future, likely to order 30-40 B737MAX

The 2QFY2012/13 losses will increase SpiceJet’s challenges with respect to funding which will add pressure on the airline to improve its performance in the second half of the year. However, the airline is also taking a long-term perspective with respect to its fleet requirements. Advanced discussions are underway to order 30-40 B737MAX aircraft. Meanwhile, three of the 15 Q400s that were ordered are yet to be delivered pending financing which has been a challenge. However, management is increasingly focused on driving profitability and the next six months will be critical in this regard.

IndiGo remains the strongest performer

IndiGo remains the leading performer in the market, although based on CAPA India’s estimates the airline at best broke even and may have made a modest loss. However, service quality challenges have arisen at some of the larger airports, particularly during peak hours, and these have not been adequately addressed.

Go Air, small but steady

Go continued to be rewarded for operating a small fleet in a situation of tight demand and supply. The carrier’s modest 2QFY2012/13 loss suggests a stable trajectory. Overall the airline continues to be well-received by the travelling public.

Kingfisher’s capital requirements increased, revival would need to be decisive

Kingfisher’s recapitalisation requirements have increased with CAPA India estimate that more than USD1 billion will be required to fully-fund a turnaround business plan. The immediate requirements to actively re-launch the airline – as opposed to operating a skeleton fleet of five aircraft – have also increased from an earlier USD600 million to closer to USD700 million. CAPA India continues to believe that taking to the skies with a minimalist approach is likely to result in increased losses and would make any revival more challenging. Kingfisher’s greatest chance of success is likely to lie in a decisive and well-funded resumption of services but this is looking less likely.

Outlook for 3QFY2012 is promising

Based on CAPA Research’s analysis of current traffic and yield trends, CAPA India has developed the following outlook for 3QFY2012/13 financial performance, which will be largely driven by what looks to be a promising November and December. The private carriers combined could post a profit of USD120-140 million for the quarter, although including Air India will keep the sector in the red. It should be noted that forward-looking estimates are subject to many uncertain external factors and therefore may be wrong.

Estimated 3QFY2012 results, three months ending 31-Dec-2012

  • Air India USD189-226 million loss
  • Go Air: USD7.5-9.4 million profit
  • IndiGo: USD47-57 million profit
  • Jet Airways: USD38-47 million profit
  • SpiceJet: USD25-28 million profit

Our estimates are based on Brent crude at an average of around USD110/barrel and an exchange rate of INR52-54 to the USD, reflecting a continued high cost environment.

But despite the projected strength of the market in 3QFY2012/13, the hostile cost environment – some of which management has limited control over, such as the cost of fuel and the depreciation of the Rupee – continues to impact all carriers.

The CAPA India Aviation Summit to be held in Mumbai on 30/31 October 2012 will include a special focus on the airline performance and structural challenges in the sector. For more information visit www.capaindiasummit.com


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