Kingfisher Airlines going against the trend with plans to exit low cost business by Jan-2012
Kingfisher Airlines stated it would end its low-cost operations in four months to focus on premium operations, contrary to its rivals in India who are increasingly adding low-fare capacity in the price-sensitive market to cater to rising demand for air travel in the fast growing domestic market.
Kingfisher Airlines chairman Dr Vijay Mallya stated the move to “do away” with its low-cost subsidiary, which is taking place 52 months after the acquisition of Air Deccan, has been prompted by higher demand for premium seats and better margins and load factors on full-service operations, adding there are enough operators and capacity in the low-cost space. "Yes, we are doing away with Kingfisher Red, as we don't intend to compete in the low-cost segment. But all is not gloom and doom..."
..."We believe there are more than enough guests who prefer to travel the full-service Kingfisher Class. And that shows through in our own performance where load factors in Kingfisher Class are more than in Kingfisher Red," Dr Mallya confirmed.
Kingfisher Airlines going against the LCC trend
Kingfisher Airlines, which has struggled to operate a low-cost and premium brand under a single management structure, is certainly going against the trend in a market that is moving toward low cost. Half of the six major airlines are budget carriers, with SpiceJet, IndiGo and GoAir among the nation’s fastest growing carriers. The strategy is also diametrically opposite to that of Jet Airways. Jet Airways, the nation’s largest domestic airline grouping, in Aug-2011 stated it would increase its proportion of seats in the low-cost category.
Kingfisher Airlines' premium service strategy, which comes at a time of widespread losses in the Indian airline industry, also foreshadows a period of slower growth at Kingfisher Airlines, as the full-service market, while still growing, is expanding at a slower pace than the LCC operators. This could impact Kingfisher’s market share while simultaneously increasing the prominence of LCC rivals, who no doubt see an opportunity to fill the space left by the exit of Kingfisher Red capacity.
The strategy will also create a differential offering in the market for the carrier. The carrier hopes to improve the profitability with the move, with Dr Mallya noting that "the margins of Kingfisher class are higher than Kingfisher Red. That's because the yields are better”.
However, given the price sensitive nature of the domestic aviation market considerable risks do exist with the strategy. It also marks a significant strategic change, with around 70% of the existing business for Kingfisher Airlines coming from its low-cost division at present.
Kingfisher Airlines commenced service in 2005 as a full-service airline and two years later in 2007 acquired LCC Air Deccan, renaming it Kingfisher Red. The carrier has not made a profit since its launch in 2005, struggling to keep pace with fast-growing LCCs in the market. The challenges associated with the integration of Air Deccan hampered the path to profitability. The purchase of Deccan Aviation was aimed at providing Kingfisher Airlines access to international routes quickly but was in many ways incompatible. "Mallya is from Venus and I (Gopinath) am from Mars", G R Gopinath had said before the acquisition, noting the contrasting personalities running the two companies.
Cabin reconfiguration to add 10% more economy seats
As part of the restructure, Kingfisher Airlines is undertaking a cabin reconfiguration that will add a significant number of seats while simultaneously phasing out the Kingfisher Red no-frills product. The reconfiguration process which will be concluded over the next four months will see a reduction in the size of the First class cabins to make way for more economy class seats.
“This reconfiguration will increase capacity by 10% at minimal incremental cost. With Kingfisher’s domestic economy load factors running in the mid-80s, this additional capacity will result in significantly improved revenue. There are numerous other initiatives under way to make Kingfisher a more efficient airline,” Dr Mallya said. Kingfisher First load factors average around 50%.
Kingfisher Airlines, which operates around 370 daily services, currently offers three classes of service: Kingfisher First, Kingfisher Class Economy and Kingfisher Red No Frills Economy. The company operates a fleet of 67 aircraft, 40 of which are Airbus aircraft (A319/A320/A321 and A330s), while the remainder are ATRs, used on regional routes.
While the new focus will be on full service, the fleet reconfiguration of all the carrier’s Airbus aircraft will result in the number of economy seats across the Airbus fleet increasing by approximately 10%. The carrier’s Airbus aircraft will be reconfigured to a dual-class configuration with a reduced first class offering and an incremental addition of economy seats. The smaller ATRs will continue with a single configuration as a Kingfisher Class full-service product.
At present, Kingfisher Airlines has 10 two-class A320s configured with 20 first class and 114 economy seats and 13 A320s configured in an all-class configuration with 180 seats. The carrier also has two A321s configured with 20 first class and 158 economy seats, four A321s with 32 first and 119 economy seats and three all-economy A321s with 199 seats. The new configuration will see first class reduced to 8-12, which will be more closely matched to demand.
Jet Airways increasing low-fare capacity in reaction to industry trends
In contrast, Jet Airways in Aug-2011 stated it plans to increase local low-fare capacity to 80-85% of total domestic flights from 72% while also starting low-fare flights to short-haul destinations overseas. Jet Airways plans to increase domestic and short-haul international low-fare capacity in response to rising LCC competition in the Indian market. The move will entail a change in its current business model to be “in sync with market realities”.
Jet Airways chairman Naresh Goyal stated the company's management is undertaking an in-depth review of its business model. “With growth mostly coming from the low-fare segment market in domestic volumes, we are urgently addressing this issue and undertaking an in-depth review of the business model, including reviewing multiplicity of ‘brands’ being offered in the marketplace, and will soon be making changes to enable us to compete more effectively and retain our dominant position in the Indian market,” he said.
Around 72% of the airline's capacity, which includes its subsidiaries JetLite and Jet Konnect, is deployed in the low-cost category. CCO Sudheer Raghavan expects this to grow: "It is my gut feeling that 85-90% of the capacity will be in the low-cost medium in five years or before", he said, noting there will be a continued and “progressive transfer of capacity from full service to low fare”.
He added: "Jet Airways is not a dogmatic carrier. We will respond and change according to market conditions", which has seen the “real” and global “push” towards LCCs, where "low-cost aviation is a reality globally and we have to be ready to face any such demand." Mr Raghavan went on to conclude that “India is witnessing what Europe faced five years ago with the emergence of several low-fare carriers".
Describing the need to adapt, Mr Goyal called into question the relevancy and viability of the full-service model amid continuously falling yields. “The fares offered by the full-service carriers have dropped to match those offered by the new low-fare no-frills carriers. This has resulted in a high growth rate with a sharp drop in yields and escalation of the break-even seat factors,” Mr Goyal said.
Meanwhile, Air India also reportedly plans to launch a domestic LCC under the Alliance Air brand. The carrier's board has reportedly provided in-principle approval to transfer 14 A320s to the subsidiary as part of efforts to better compete with the nation's fast growing LCCs. Air India is the only carrier not to operate a domestic low-cost service.
LCC penetration more than doubled pax in five years to 46% of the market
Indian airlines handled 39.5 million passengers in the eight months to Aug-2011, a 19% year-on-year increase. Standalone LCCs held 45.5% of the domestic market in Aug-2011, up from 42.2% in Aug-2010. This figure does not include the low-cost subsidiaries of the full service carriers. LCC penetration has more than doubled over the past five years, with LCCs commanding 19.4% of the domestic market in Aug-2006.
India domestic market share by carrier: Aug-2011
Kingfisher reevaluating network
Dr Mallya also stated the carrier is looking at deferring its plan to acquire A380 equipment and will cut unprofitable routes. He also stated the carrier is being "careful in terms of our yield management": "We have not added any more planes. We are achieving the highest load factors in our history," Dr Mallya said.
On international routes, Dr Mallya said the airline was awaiting approval for several destinations to operate at night and improve aircraft utilisation. "Our focus is on ensuring that we drive profitability through domestic and international networks. Unless we are given additional rights to fly overseas by the Civil Aviation Ministry, we will not go for A380s."
International flights account for around 22% of Kingfisher's revenues.
Number of measures to push Kingfisher towards profitability
The Kingfisher Red announcement was one of a number of measures announced by the carrier on 28-Sep-2011 at its AGM, as part of efforts to push the indebted carrier to profitability.
Kingfisher Airlines noted that it had incurred substantial losses and its net worth has been eroded. Kingfisher has debts of INR60 billion (USD1.23 billion), accumulated losses of INR50 billion (USD1.02 billion) and has interest payments that exceed its market capitalisation. Its share price value has lost as much as 70% within the past 12 months and hit a 52-week low following the announcement.
Kingfisher Airlines share price: Sep-2010 to Sep-2011
However, the carrier expects to benefit from an “improvement in the economic sentiment, rationalisation measures adopted by the company, fleet recovery and the implementation of the debt recast package with the lenders and promoters including conversion of debt into share capital”.
Kingfisher plans to increase revenues through more efficient operations, while simultaneously controlling costs by shedding some realty assets (including its Mumbai corporate office), entering sale and leasebacks for some Airbus aircraft, and switching some high-cost rupee loans into low-cost foreign currency loans. There has also been speculation the carrier will permanently reduce its fleet of 66 aircraft (the same level as Jun-2010) to 35 aircraft. At present, over 14 aircraft are grounded, including ATR equipment.
Kingfisher Airlines is also working “aggressively” with a consortium of banks, which hold a 23% stake in the company, to further reduce interest costs and raise working capital. "As you would appreciate, in a volatile global economic environment and with oil prices as high as they have been, it is not an easy task," Dr Mallya said.
In Aug-2011, Kingfisher Airlines' board of directors approved plans to raise up to INR20 billion (USD433 million) through a rights issue, although no time frame was provided. The fund raising will provide the carrier with a new option to raise funds amid delays to its plans to sell around USD250 million of global depository receipts. Commenting on the delay, Dr Mallya stated: “Timing is everything. We'll obviously take all factors into consideration before we launch the rights issue. You must appreciate that pricing of the issue will also be a determining factor in how attractive it is. Sometimes, in a bad environment, a lower price becomes an attractive investment.”
Kingfisher Airlines chairman 'optimistic' about future; sees strong aviation demand
Dr Mallya, meanwhile, stated he is optimistic about the outlook for the carrier, seeking to address the "sensational" media reports about the carrier's financial state and future in the crowded Indian aviation market, stating: "All is not doom and gloom as people like to report".
Earlier this month, Kingfisher was forced to dismiss concerns about its ability to survive, stating its lenders have confirmed the company is viable and a “going concern”. The carrier added: "It is incorrect to say that Kingfisher Airlines' auditors have raised serious doubts about the survival of the airline. During the year, the Reserve Bank of India (RBI) had directed the banks to independently assess the viability of KFA and this was in fact carried out by the lenders with the assistance of SBI Capital Markets confirming that KFA is viable, i.e. as a going concern."
The comments were made after Kingfisher Airlines' audit firm BK Ramadhyani & Co stated the net worth of the airline has been "completely eroded", adding the carrier would require further cash infusions to meet its obligations. “The financial statements of the company have been prepared on a going concern basis notwithstanding the fact that its net worth is completely eroded", the auditor said in comments which form part of the carrier's annual report for 2010/11. The audit report also noted the company's accumulated losses at the end of the financial year were more than 50% of its net worth. “The company has incurred cash losses during the financial year and in the immediately preceding financial year,” it said. The auditor added that Kingfisher had defaulted and delayed on loan and interest payments, and had not regularly deposited dues to authorities. Meanwhile, State Bank of India MD A P Verma stated: “Whatever the auditor has said is not very new...it’s talking about infusion of fresh equity, and this is what the lenders had also stipulated [a] long time back. Unless the long-term funds come, unless they bring down the leverage, their problems will continue."
Dr Mallya was also critical of a recent report by Canadian research firm Veritas, which had said Kingfisher Airlines was on the verge of bankruptcy and its parent, UB Holdings, was also facing financial challenges. Dr Mallya said though the situation is challenging, UB Holdings has supported the airline through direct investment, advances from the holding company, guarantees from the holding company and also by securing third party funds to meet exigencies in Kingfisher.
He added the UB Group is committed to supporting the carrier and is working out ways of further cutting debt. “I have also personally stepped in to provide a third level of comfort to the lenders, who have been extremely supportive of Kingfisher,” he said.
Kingfisher unprofitable since launch
Dr Mallya added that Kingfisher "delivered a better financial performance than other listed Indian carriers". On domestic operations, Kingfisher reported an EBITDAR margin of 15.4% which compares favourably with the 6.4% and 7.2% reported by others, Dr Mallya said.
However, Kingfisher Airlines has never reported a profit since its launch. The carrier reported a widened net loss of INR2.64 billion (USD58.3 million) in 1QFY2012 (three months ended 30-Jun-2011) compared with a loss of INR1.87 billion (USD41.5 million) a year earlier, due to increased fuel costs, intense competition in the domestic market and a shift in the market towards low-fare travel. These factors have negatively impacted margins and offset increased revenues from higher demand levels, load factors and yields and a debt recast that has helped reduce interest costs.
UB Group CFO, Ravi Nedungadi, has previously stated that Kingfisher Airlines expects to post its first net profit this financial year (FY2011/12) due to growing passenger traffic and improved yields.
A lot at stake with new strategy
Kingfisher Airlines has stated it has no immediate interest in significantly expanding its international network, with its A380 orders now in doubt and only five A330s in service. The carrier will instead expand internationally through its oneworld alliance partners. Domestically, yields remain low and profitability remains a dream, with the cost of ATF coupled with a weakening rupee representing the “biggest challenge that the whole aviation industry in India is currently dealing with and we are no exception," according to Dr Mallya.
The decision to withdraw from the rapidly growing low cost segment, counter-intuitive in some ways, does differentiate Kingfisher Airlines in the market, positioning it at the premium end which has a comparatively smaller degree of competition. This 'high end' positioning is where Dr Vijay Mallya has always wanted the carrier to be. The Deccan acquisition was essentially a move to enable Kingfisher to overcome regulatory hurdles to gain access to international markets. However, this move will limit Kingfisher to a slower growing niche.
On the financial side, the failure to develop a low cost structure for its low fare subsidiary severely impacted the carrier's bottom-line and debt-levels. The airline had the same aircraft-to-employee ratio for its low-cost service as it has for the Kingfisher brand, despite fares and yields being lower, creating an unattractive cost-to-revenue ratio. Meanwhile, the lack of clear and structured planning to raise equity and reduce debt levels has also caused concern in investor circles, with the carrier's shares losing close to 9% over the past two days. The move, if it fails, could further strain the company’s already challenged financial position.