India’s airlines lost USD1.65 billion in FY2013. CAPA India Aviation Outlook 2013/14: Part 4

Indian airlines lost an estimated USD1.65 billion on revenue of USD 9.5 billion in FY2013. 40% of the annual loss was generated in the last quarter

CAPA estimates that India's airlines posted a combined loss of USD1.65 billion in FY2013 (USD1.15 billion if Kingfisher is excluded), down from approximately USD2.28 billion the previous year. More than 40% of the loss was incurred in the last quarter alone, squandering the improved performance posted during the first nine months of the year.

Kingfisher's exit from the Indian aviation sector was one of the most significant developments for the market in FY2013. It highlighted the fragility of the sector when an airline that was the largest in the country less than two years earlier and with an excellent reputation amongst passengers, could fall from grace so swiftly.

But with it came a silver lining for the remaining carriers. As a result of the removal of Kingfisher's seats, combined with modest capacity induction by other carriers, the demand/supply dynamics in the market started to favour airlines for the first time since 2004. This was reflected positively in the average fares which increased by 15-20% year-on-year.

India's airlines were showing signs of a steady recovery in financial performance during the first three quarters of FY2013; however the fourth quarter spoilt the party. Aggressive discounting during the traditionally weak period between January and March resulted in losses of USD700 million during this quarter alone (close to USD500 million if Kingfisher is excluded).

The cost environment remained hostile throughout the year with the weakness of the Indian rupee and continued high oil prices being the key challenges. Even though Brent Crude levels softened towards the end of the year, the depreciation of the rupee meant that carriers did not see any benefit from this.

Over the 12 months to 31-Mar-2013, with carriers moving to fill the space vacated by Kingfisher, all airlines except Jet Konnect saw an increase in their domestic market share over the previous year, but none more so than IndiGo which saw a 7ppt improvement.

Indian domestic airline market share: FY2013 vs FY2012

Source: CAPA - Centre for Aviation, DGCA

However, despite the moderation in capacity in the market, the steep increase in domestic fares curtailed demand and meant that almost all carriers reported a slight decrease in average passenger load factors during the year.

The sole exception to this was Air India which achieved a creditable 5ppt improvement to 69%, although it remained the lowest of all the carriers that are currently operating. However, its load factors in economy class were much higher (as is the case for Jet Airways) with the average being depressed by the relatively poor performance of business class on domestic routes.

IndiGo was once again the stand-out performer achieving sustained load factors of above 80% throughout the year.

Average passenger load factors on domestic routes: FY2013 vs FY2012

Source: CAPA - Centre for Aviation, DGCA

Emirates emerges as India's leading international airline in FY2013

On the international front an important development was the fact that in FY2013 for the first time a foreign carrier, Emirates, claimed the highest market share for traffic to/from India. Air India, historically the market leader on international routes was impacted by the grounding of its 787s for most of the last quarter.

While India's second largest international carrier, Jet Airways, saw only a marginal increase in traffic as it consolidated its network and dropped services to points such as New York JFK, Milan, Johannesburg and Kuala Lumpur.

Airline market share on international routes to/from India: FY2013

Source: CAPA - Centre for Aviation, DGCA

Industry lost USD1.65 billion (est.) on revenue of USD9.5 billion - IndiGo was exceptional with USD100-110 million profit on revenue of USD1.5-1.6 billion

India's airlines lost USD1.65 billion on total revenue of approximately USD9.5 billion. Despite the magnitude of the loss there were year-on-year improvements almost across the board.

Reported and estimated Indian carrier revenue and net income: FY2012 and FY2013

	FY2012 Revenue	FY2012 Net Income	FY2013 Revenue	FY2013 Net Income
Air India	USD2.6 bn	(USD1.4 bn)	USD3.0 bn	(USD950 mn)
GoAir	USD278 mn	(USD24 mn)	USD375-400 mn	(USD14-16 mn)
IndiGo	USD1.0 bn	USD23 mn	USD1.5-1.6 bn	USD100-110 mn
Jet Airways	USD2.7 bn	(USD226 mn)	USD3.0bn	(USD87 mn)
Jet Konnect	USD340 mn	(USD33 mn)	USD387 mn	(USD53 mn)
Kingfisher	USD1.0 bn	(USD423 mn)	USD91 mn	(USD500-520+ mn)
SpiceJet	USD720 mn	(USD109 mn)	USD1.0 bn)	(USD34 mn)

Source: CAPA - Centre for Aviation, CAPA Research and company filings.
Note: Data for unlisted carriers Air India, GoAir and IndiGo are CAPA estimates. Final results for these carriers may vary due to one-off accounting adjustments.

FY2013 losses may impact investor valuations but CAPA expects two further transactions in FY2014

These continued losses and the further erosion of net worth may widen the gap between promoter and investor expectations when it comes to valuations. Combined with the prospect of new entrants into the market, this might impact capital raising plans for incumbent carriers.

Nevertheless we believe there is sufficient confidence in the long term fundamentals of the market to maintain investor interest and we expect a further two Indian carriers to complete transactions with strategic or financial partners in FY2014.

Q4 re-wrote the results for all airlines, especially Jet and SpiceJet

The sector generated losses of approximately USD700 million in the last quarter (close to USD500 million excluding Kingfisher). Jet Airways, which had reported a marginal profit of USD2 million over the first nine months, ended the year with a USD87 million loss due to one-off costs and increased maintenance expenses. While SpiceJet's loss of under USD1 million for the first three quarters finished up as a US34 million full year loss due to maintenance costs being more than USD30 million higher than last year, coupled with a significant increase in interest expense.

IndiGo was earlier on track to achieve a higher full year profit but it too was impacted by lower than expected yields in Q4. Air India's losses were intensified as a result of the weak fares environment and the grounding of its 787 fleet during a crucial period.

Industry debt increased 8-9% in FY2013 to USD14.5 billion

India's airlines have an estimated combined debt of approximately USD14.5 billion (with additional vendor-related liabilities of around USD2 billion), compared with an average cash position of just USD500-550 million. Air India holds just over 60% of that debt, with full service carriers combined accounting for close to 90%, although the Jet Airways Group reduced its debt position from USD2.62 billion to USD2.25 billion during FY2013.

A key contributor to the overall debt has been the industry's accumulated losses since 2007 which were approaching USD9.5 billion as at 31Mar-2013. This has resulted in continued erosion of the net worth of India's carriers which are estimated as follows:

• Air India (FY2012): (USD3 billion)
• GoAir (FY2012): (USD107 million)
• IndiGo (FY2012): USD69 million
• Jet Airways: (USD62 million)
• Jet Konnect: (USD311 million)
• SpiceJet: (USD41 million)

Source: CAPA Research and company filings.
Note: Data for unlisted carriers Air India, GoAir and IndiGo are CAPA estimates.

International accounts for 80% of Air India's losses, while the Jet Airways Group is hurting on domestic where it lost USD210 million in FY2013

Air India faces key structural viability issues on its international routes due to poor alignment between its fleet structure and route network, and weak commercial capability, particularly in offshore markets. As a result international operations account for 80% of its losses. The resumption of 787 services will help to improve the situation but huge losses are expected to continue.

Jet Airways and Jet Konnect combined reported losses of approximately USD210 million on domestic routes in FY2013, whereas the international business was profitable to the tune of approximately USD70 million.

The carrier has struggled on the domestic front as a result of its confused strategy with at one stage three separate brands operating without a clear market proposition for each. With the recent consolidation down to two brands and the greater strategic clarity afforded by the partnership with Etihad, a more focused approach can be expected.

That said, both Jet Airways and Air India remain vulnerable on domestic routes, especially as they continue to operate with a full service cost structure in a market that has shifted predominantly to low cost. Until both of these full service carriers have developed a competitive domestic cost structure the sector will remain unviable as it is otherwise impossible for them to sustain fares close to the levels charged by LCCs. They have been unable to extract a premium for the full service product and the fare difference between full service and low-cost carriers is negligible.

Domestic Outlook FY2014: Passenger numbers expected to cross 60 million once again in FY2014

Domestic traffic is expected to expand by 4-6% in FY2014, with most of the growth to occur in the second half of the year. Starting from Q3 the traditional festival and holiday traffic is expected to be supplemented by increased passenger movements driven by state elections in November, and then by general elections some time prior to May-2014. AirAsia's possible entry in the second half of this financial year could also provide some further growth although the airline will still be relatively small even by the end of the forecast period.

These factors could push growth above 6% subject to market conditions from 3Q onwards. We expect that by the end of FY2014 domestic traffic will have matched or slightly exceeded the previous high water mark of just over 60 million annual domestic passengers reported in FY2012.

International outlook FY2014: Buoyant traffic could grow at 10-12%, twice the pace of domestic

International traffic growth is expected to be more buoyant than domestic and could grow by 10-12% as Indian carriers expand and as more bilateral entitlements are expected to be granted to foreign carriers. As is the case for domestic traffic, the second half of the year is expected to account for the majority of the growth. Capacity expansion during the year ahead is likely to be around 10%, largely driven by LCCs.

Jet is already profitable on international operations and is expected to further strengthen its performance in the coming year as a result of its increasing cooperation with Etihad. IndiGo and SpiceJet are both nearing break-even on overseas routes. However Air India continues to incur huge losses on international services. The 787s will help but the structural issues run deep and this will impact the carrier's overall turnaround prospects.

Profitability outlook FY2014: Private airlines expected to report USD250-300+ million profits, but Air India is projected to lose USD750-800 million

CAPA estimates India's private airlines could post combined profits of USD250-300 million or more in FY2014 with a projected breakdown as follows, based on CAPA Research estimates:

• GoAir: USD8-10 million profit;
• IndiGo: USD100-120 million profit;
• Jet Airways: USD125+ million profit;
• SpiceJet: USD25-30 million profit.

Jet's return to profitability is largely being driven by a significant reduction in interest costs as a result of a USD600 million reduction in high interest rupee debt and access to lower interest rates through offshore financing options that have become available in light of the Etihad investment. In addition the carrier is expected to see an increase in net earnings from further strengthening of its international operations although the real benefits will be seen from FY2015. SpiceJet and GoAir's profitability is subject to them being able to control their losses during the weaker second and fourth quarters which have let them down in the past.

In the case of SpiceJet, now that it is a relatively large airline these swings between strong and weak quarters can have a major impact on financials.

However, the overall industry result is expected to remain in the red, dragged down by a projected USD750-800 million loss at Air India.

These projections have been developed on the expectation:

• that oil prices will remain stubbornly high with average Brent Crude rates for the year assumed to be USD100-110/barrel;
• the rupee is not expected to provide any cushion with rates projected to remain in the range of INR54-55 to the US dollar;
• and that pricing discipline will be maintained - if we were to experience an extended period of discounting similar to that seen in 4QFY2013, profitability would deteriorate well below the projected levels.

Key challenges will remain, but there are some positive developments on the horizon

The viability of domestic operations will continue to face several fundamental challenges. Fare levels are expected to be softer than in FY2013 and there is no significant easing around the corner in terms of costs.

Fuel, the largest input cost, is expected to remain high. This is leading airlines to consider direct import of aviation turbine fuel which is exempt from sales taxation. Permission to do so was granted last year but due to the associated logistical and infrastructure challenges no carrier has yet taken advantage of the option. The matter was also held up due to inter-ministerial issues.

SpiceJet is expected to commence importing some of its requirements from Q2, although given that this is a complex and untested undertaking it is difficult to assess how successful it will be. It is likely to start on a small scale and then grow subject to whether genuine savings are realised. This will take some time to assess so we do not expect that direct import of fuel will have a material impact on profitability in FY2014 and we have not included it in our projections.

However, if successful it could be an important trigger towards creating a more sustainable long term cost base for domestic operations. Ideally it would result in a direct reduction in sales taxation allowing carriers to benefit from lower prices through the front door rather than having to develop a bypass solution.

If Jet Airways proceeds down the direct import path it may be able to leverage its relationship with Etihad to secure favourable commercial terms and reduce the advance cash commitments required by fuel suppliers in Abu Dhabi. One of the stumbling blocks to date has been that carriers do not have available cash balances to be able to place the bulk orders that are required for wholesale import purposes.

Ancillaries expected to be grasped with greater vigour as regulator gives green light

The recent green light given by the regulator for unbundling of fares (although technically there was no formal restriction earlier) should see airlines pursue ancillary opportunities more aggressively. CAPA estimates there is the potential for carriers to generate an additional USD500 million per annum through this channel to be developed over the next two years.

Only a fraction of this ancillary revenue will be tapped in the coming year as it will take some time to implement new initiatives, however more significant benefits can be expected to accrue from FY2015 onwards. Low hanging fruit such as charging for premium seats and priority check-in could generate an additional USD10-12 million relatively quickly in the current financial year.

Small but important steps towards achieving a viable operating environment

The successful direct import of fuel or a possible reduction in taxation, combined with increasing ancillary revenue will help to bridge the cost-revenue gap.

The introduction of GAGAN, India's satellite-based navigation system in 2014, together with the flexible use of airspace between civil and military purposes which has recently been approved, are two further initiatives that will be very important in reducing airline operating costs. The more direct flight routings they enable allow for reduced fuel consumption.

And from 2016 onwards as these developments become more established and the market sees the introduction of re-engined A320neos and 737 MAX aircraft, we can expect to see a meaningful change in the landscape.

See related reports:

• Indian aviation in 2013/14 Part 1: Jet Airways expected to place 737 MAX and A320neo order
• Indian aviation in 2013/14 Part 2: Immense change ahead - but a policy vacuum persists
• Indian aviation in 2013/14 Part 3: Global operators bid for Chennai and Kolkata airport management

CAPA India Aviation Outlook Report 2013/14

This analysis is an extract from the keenly anticipated 2013/14 edition of the annual CAPA India Aviation Outlook Report to be released in May 2013.

The coming year 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 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.