India's airlines could lose USD400-450 million in Q2 FY14 due to aggressive discounting

India's airline pricing regime in Q2 is an indication of the irrational competition which exists in the market and there are no signs of fares stabilising at least until Oct-13. Meanwhile the cost environment remains hostile with high fuel prices compounded by a weak Rupee. There exists an overall systemic weakness with low fares and high costs, and with industry risks at a peak there do not appear to be any clear initiatives underway, either by industry or government, to correct the deteriorating financial situation.

CAPA expects Q2 losses for the industry could reach USD400mn to USD450 million (excluding Kingfisher Airlines which as a listed company will have to release its results even though it is not operating). Air India accounts for the largest share of these losses but as its shortfall continues to be funded by the government the carrier will not be pressing the panic button, especially as its overall financial performance has improved over the last 12 months.

However the ability of India's private airlines to continue to absorb such huge losses is limited and may impact industry dynamics well into the future. With no clear signs of recovery sources of capital are drying up.

The continuing losses, high cost environment and structural instability of the sector are likely to drive away the very few foreign airlines that have shown interest in investing in Indian carriers as the value proposition is weakening. A foreign airline could generate value from a transaction if the deal was accompanied by significantly enhanced market access which suits its strategic interests. However, a sweeping revamp of a bilateral similar to the India-Abu Dhabi agreement, with a manifold increase in seat entitlements, more than 20 points of call in India, unrestricted equipment and permitted change of gauge, may be difficult to replicate.

Nevertheless, even though the conditions are not favourable and the number of interested parties is small in number, we expect that at least one more deal - most likely by a Middle East carrier - is still possible this year subject to the promoters being willing to agree to valuations that are significantly below their original expectations. Qatar Airways may be emerging as the next suitor.

Jet Airways' international division will be strengthened by partnership with Etihad, but loss-making domestic operations are a concern

• As CAPA had projected in its India Outlook Report FY14, the sale of a 24% stake to Etihad Airways is expected to receive the remaining regulatory approvals in the next few days, although legal challenges may still emerge. The carrier's focus will now shift to establishing a new corporate structure which will involve a complete revamp of the senior management and Board, including new independent directors. The contours of a new business plan will emerge in which Jet Airways will focus on becoming a key component of Etihad's global and long term ambitions which will include an integrated network from the Winter 2013/14 schedule.
• We expect that Jet Airways - which has already reportedly signed an order for 50 B737 MAX aircraft which has yet to be announced - will shortly confirm a further narrow body order, which is likely to be for up to 50 A320 neos. A wide body order for B777s for long haul operations is also expected. The total number of aircraft on order is expected to exceed 250 in due course to support the carrier's growth and replacement requirements through to 2025. Aircraft orders will be closely coordinated with Etihad and its other partner airlines which will provide greater negotiating strength. Interior configurations will also be aligned to enable the flexibility to transfer aircraft between carriers in Etihad's equity alliance.
• Jet's domestic business is struggling and the fact that the carrier's full-year domestic losses in FY13 have extended into the first quarter of FY14 - a peak travel period - suggests that there are underlying structural challenges. In the last five quarters Jet Airways/JetLite have lost in excess of USD250 million on domestic operations. The carrier cannot deliver sustained overall profitability unless the domestic business is turned around.

Jet Airways Group Quarterly Results on Domestic Routes Q1FY13 to Q1FY14

Source: CAPA, Jet Airways Quarterly Reports

• However, the fare discounting in which Jet is engaging in Q2 indicates that the airline is comfortable incurring such losses and may be prepared to pursue strategic pricing designed to exert greater financial pressure on its domestic competitors, some of whom are already vulnerable.

SpiceJet's disappointing results could dim investor interest; possible switch in aircraft manufacturers could introduce operational challeges

• The LCC's modest profitability in Q1 was not encouraging and the structural fault lines in the business are becoming visible. Given the current weakness in the market, SpiceJet may be headed for a record Q2 loss. The next few months will be critical for the long-term future of SpiceJet as the carrier needs to focus on minimising red ink in Q2 and recovering some of these losses in Q3, which seems challenging at present. Seeking investment from a strategic or financial investor is high on the carrier's agenda.
• Following the recent departure of its CEO, SpiceJet has the opportunity to induct an entire new senior management team with a mandate to restore internal and external confidence in the carrier.
• SpiceJet is currently developing a fleet plan for beyond 2017. CAPA expects that SpiceJet, which currently has an all-Boeing narrow body fleet is likely to finalise an order in Aug/Sep-13 for close to 50 A320s and A320 neos - subject to resolving a few critical issues. It may at the same time announce plans to eventually transition to an all-Airbus narrow body fleet. Switching manufacturers would be a major strategic decision and one which would introduce significant operational challenges that will place great pressure on management capabilities in the short-term. As a result of the move to Airbus narrow bodies we do not rule out the possibility of SpiceJet transitioning to ATRs in the medium term for its regional fleet, which currently consists of 15 Q400s.
• In light of the financial challenges faced by SpiceJet, investment by a foreign airline is not expected soon and it appears inevitable that the promoter will need to provide significant additional funding.

IndiGo, India's most profitable carrier, also likely to post losses in Q2

• India's largest domestic carrier is understood to have enjoyed a highly profitable Q1, but is estimated to be heading for a loss in Q2 due to the weak commercial environment.

Indian Domestic Market Share by Airline May-13

Source: CAPA, DGCA

• To date IndiGo has inducted the vast majority of its fleet through sale-and-leaseback transactions. However going forward we expect that the carrier will purchase an increasing proportion of its aircraft. IndiGo is reportedly seeking financing for close to 25 of 180 A320/320 neos ordered in 2011 and may need to increase its equity base in order to support this. The carrier has apparently sought permission from the Reserve Bank of India to raise USD760 million through external commercial borrowings. We expect IndiGo to be in the market for capital in FY15 with an IPO being a possibility.

GoAir awaits regulatory change to be able to launch international services

• In common with the two larger LCCs, GoAir is also estimated to have reported a profit in Q1FY14, albeit modest. However it too is expected to post a loss in Q2.
• The airline is expected to launch international services in late Q3FY14 subject to the abolition of the regulation which requires Indian carriers to have a minimum fleet size of 20 aircraft and five years of domestic operations before being permitted to commence overseas routes. GoAir launched more than seven years ago but has a fleet size of just 16 aircraft. As a result of an expected easing of the threshold restrictions by Sep-13, the carrier is expected to qualify to launch international operations.
• Although GoAir has been in preliminary discussions with some foreign airlines about a potential investment, we expect that any such transaction is likely to take some time as it will be dependent on certain critical decisions to be taken by the government. GoAir's relatively small size could in some ways make it more attractive to a foreign airline because it will be easier to re-align its business model and operations to suit the strategic investor.

Air India pins hopes on 787 Dreamliner to turnaround its international operations

• The state-owned carrier achieved a cash surplus of approximately USD75 million in Q1 but like other carriers is expected to report a large loss in the second quarter.
• International operations continue to drag down Air India. The induction of the Boeing 787 provides a window of opportunity to turnaround international performance as a result of the aircraft's superior operating economics. However the intermittent teething problems that have risen with the Dreamliner have been damaging for the airline and have cast some uncertainty over an aircraft that has otherwise performed well.
• Nevertheless the airline is opening new routes with the aircraft, having launched direct Delhi-Birmingham service on 1-Aug-13, to be followed by a triangular Delhi-Sydney-Melbourne and v.v. service from 29-Aug-13 and later to Rome and Milan.

Air India Boeing 787 International Routes

Route	Status
Delhi - London	Daily
Delhi - Paris	Daily
Delhi - Frankfurt	Daily
Amritsar - Delhi - Birmingham	4x weekly launched 1-Aug-13
Delhi - Sydney - Melbourne - Delhi v.v.	Daily launching 29-Aug-13
Delhi - Rome / Delhi - Milan	Planned launch in Oct-13

Source: CAPA, Air India, Innovata

• Air India is also understood to have resumed attempts to be inducted into the Star Alliance after having reportedly failed to meet minimum standards for membership in 2011.
  

Air Costa set to launch as India's newest airline

The first start-up scheduled carrier in India in almost seven years is expected to commence operations in the next one to two months. Air Costa plans to operate regional routes from Vijayawada using Embraer E190 jets.

Policy & Regulation: International market access should be further liberalised in the next couple of months

India is expected to sign liberalised bilateral agreements in the next 2-3 months with a number of key markets in the Gulf, such as Dubai, Qatar and Sharjah. The projected increase in entitlements may be less than the foreign carriers would like - unless driven by strategic reason - but are expected to be significant nevertheless. Indian carriers will be asked to submit their seat requirements on these Gulf routes over the next 3-5 years. With the LCCs in particular, perhaps soon to be joined by GoAir, expected to increase their operations to the Gulf, this may allow the government to justify the increased market access provided to Middle East carriers.

The international aviation market from India has been fundamentally changed as a result of the Jet-Etihad deal and further transactions and other strategic development involving Gulf carriers and associated market access will shift the axis completely.

We expect that the Indian government will shortly also approve an amendment to certain bilateral air services agreements e.g. with Dubai and Germany, to permit A380 operations. Currently a number of bilaterals specify the Boeing 747 as the largest permitted aircraft type. As a result we may see Emirates and Lufthansa A380s operating on Indian routes from the Winter 2013/14 schedule.

Government agencies are likely to see a change in leadership

A number of changes are expected in the leadership of key government agencies in the next 2-3 months which could result in a new Civil Aviation Secretary (due to the retirement of the incumbent), Director-General of Civil Aviation and possibly a new Chairman and Managing Director at Air India. There could also be a change of guard at other aviation-related public sector units.

Airports: AAI to invite private operators to bid for management contracts for up to 15 airports, starting with Chennai and Kolkata

The Airports Authority of India plans to invite bids for operations and management contracts at up to 15 of its profitable airports. Chennai and Kolkata, the 3rd and 5th largest airports in India respectively, will be the first two airports off the block, to be followed shortly by Ahmedabad, Guwahati, Jaipur and Lucknow and then a further nine airports.

Expressions of Interest in Chennai and Kolkata are expected to be invited in the next couple of days with Requests for Proposals to be submitted by the end of Sep-13 and concessions awarded by the end of this financial year.

Total Annual Passenger Traffic at Indian Metro Airports FY13

Source: CAPA, Airports Authority of India

Tenders for PPP greenfield airports at Navi Mumbai and Goa Mopa to be issued by Dec-13

• The tender process for the construction of a second airport at Mopa in Goa is expected to commence by the end of Aug-13.
• Meanwhile pending issues, particularly related to land acquisition, that have held up the progress of Navi Mumbai Airport are expected to be cleared by the end of Q3FY14 paving the way for a second airport to serve the Mumbai metropolitan region. The Central and State governments have identified Navi Mumbai Airport as one of three priority infrastructure projects to be launched by the end of this year.

Government plans to fast-track development of 50 low cost airports to enhance regional connectivity

• The Government of India had recently announced plans to fast-track the development of 50 greenfield low cost airports to encourage regional connectivity. In the first phase concessions are expected to be awarded for 12-15 airports primarily in the states of Andhra Pradesh, Karnataka, Rajasthan and Uttar Pradesh. Further direction on these plans is expected shortly.

India's largest private airport operators look to raise capital as current expansion projects approach completion

• The current Mumbai Airport is expected to open the new Terminal 2 for international operations by the end of Q3FY14 (domestic services will move into the same terminal approximately 12 months later to facilitate integrated operations). Initial impressions about the quality of T2 have been very positive and the terminal is expected to be a landmark in a city that has an acute infrastructure deficit.
• Mumbai International Airport Limited (MIAL) has recently received approval to commercialise 10% of its land bank. The first phase will see the monetisation of approximately 2 million square feet of land which is expected to generate USD175 million. This could act as a trigger for further fund raising as MIAL has been in the market for some time.
• Meanwhile Bangalore Airport is also scheduled to open the extension of Terminal 1 by the end of Q3FY14 (operational trials are expected to commence from Sep/Oct-13) providing some relief at the congested airport which has recently been operating at above its design capacity.
• GMR Airports, which operates Delhi and Hyderabad airports, is likely to proceed with an IPO in Q3FY14 subject to market conditions.

India's first greenfield non-metro airport in more than a decade is expected to open next year

• Aprivate commercial airport is currently under construction at Durgapur in West Bengal. Changi Airports International is a 26% equity holder in the project. The greenfield airport is not expected to be operational until FY15. The announcement last week by West Bengal that it will provide a 3-year waiver at Durgapur on the 30% state sales tax on fuel is a very positive initiative by the state government. However, even with this concession the airport is likely to face challenges in attracting airline services given current market conditions.

Corporatisation of air navigation services likely to be delayed due to internal resistance with the AAI

• Plans to hive-off and corporatise the air navigation services division of the AAI are unlikely to proceed soon as there is internal resistance to the initiative from divisions other than air navigation services, partly due to concerns about the loss of revenue that would result.
  

Ancillary Sectors: Indian MROs continue to be challenged by difficult environment and strong competition from overseas

India continues to represent a challenging environment for 3rd party MROs, with high taxation, expensive infrastructure, a shortage of skills and strong competition from neighbouring markets such as Sri Lanka and the UAE. We expect consolidation in the sector in FY14 with one or two acquisitions likely and the possible announcement by the end of this financial year of a new joint venture.

Ground handling: Supreme Court to rule on new policy on 3-Sep-13 - which could trigger new JVs

The ground handling policy which the Indian government first wanted to introduce in 2007, and which would restrict carriers from self-handling, was legally challenged by the airlines arguing that they would face higher costs and a loss of control over critical customer service functions.

The matter has been in dispute for several years however the Supreme Court has announced that it will hand down a final decision on 3-Sep-13. Following the ruling we expect one or two joint ventures to be formed between Indian LCCs and ground handling firm. We also expect consolidation in the sector in FY14 on both the passenger and cargo sides of the business.

Distribution: Likely changes in ownership of key Online Travel Agencies are expected to create a new dynamic in travel distribution

Among India's three largest online travel agencies (OTAs) we expect one to see a new promoter and management team take over, while a second is likely to see the induction of a large new investor, creating a new dynamic in the sector.

The realities of the Indian market may also impact the joint venture between AirAsia and Expedia whose territory includes India. Under the partnership Expedia is the sole OTA which has access to AirAsia inventory. However, OTAs play a major role in domestic travel distribution in India and Expedia has a relatively small share of the market.

For AirAsia India to succeed it will likely have to seek an exemption from its exclusivity agreement with Expedia and offer inventory through the three large Indian OTAs, MakeMyTrip, Yatra and Cleartrip.

CAPA India

The coming year to Mar-2014 will be a defining period for the long-term prospects of the Indian aviation market. In this complex environment, having access to up-to-date research and insights into the direction of the market is critical for any business with exposure to Indian aviation. For more information about CAPA India's research reports - including the recently released 320 page CAPA India Aviation Outlook Report FY14 - click here or contact Binit Somaia on bs@centreforaviation.com

CAPA has a strong and established track record in accurately identifying key trends and developments in the Indian market. We operate India's leading dedicated aviation advisory and research practice offering unrivalled analysis and data across the value chain. Visit www.capaindia.com