Outlook for Air India's turnaround clouded by HR issues

REVIEW of 2011/2012

Market share declines but fares boosted by Kingfisher downsizing

Air India's domestic market share declined from 17.1% in FY2011 to 16.5% in FY2012. International market share also fell, from 19.5% in FY2011 to 18.6% in FY2012. The passenger load factor on domestic routes, however, improved from 66.1% in FY2011 to 68.5% in FY2012. Domestic market share stood at 16.2% in May-2012 with an average load factor of 70.6%.

However, Air India experienced a strong 30-35% year-on-year improvement in revenue in the period from Jan-2012 to Apr-2012 as a result of the downsizing of Kingfisher Airlines and due to benefits generated from better integration of the route network. Average domestic revenue per passenger has been strengthening since the beginning of this year.

Air India average domestic fares: Jan-2012 to May-2012

Month	Average domestic fare
Jan-12	INR4900
Feb-12	INR4950
Mar-12	INR5250
Apr-12	INR5600
May-12	INR5400

Source: CAPA Research

The average fares in Apr/May-2012 were approximately INR1050-1100 (USD19-20) higher than the corresponding period last year, equivalent to 23-24%.

Network restructuring has positive impact but international route network heavily loss-making

Network restructuring to enhance connecting hub opportunities - especially at Delhi Terminal T3 - has resulted in an almost 10% increase in traffic. With the opening of the hub in Delhi and the launch of non-stop services to North America, plans to establish a hub in Europe were dropped. Parallel operations of Air India and the former Indian Airlines have also been eliminated resulting in improved efficiency. And several loss making routes have been suspended. A further 31 poorly-performing routes are under evaluation, some of which could also be terminated.

Meanwhile, an Indian Government committee established to review Air India's route network found the carrier lost INR14.92 billion (USD261 million) on its international route network in FY2011/12. 13 routes accounted for approximately 75% of the losses, including seven routes to North America and Europe.

In terms of fleet, older aircraft have been grounded, while the airline took delivery of some new Boeing 777s during the year. All 43 narrowbodies ordered in 2005 have been delivered, however, commencement of the deliveries of the 27 787s on order continued to be delayed and are now expected to join the fleet from Jun/Jul-2012.

Human resource issues remain following Air India-Indian Airlines merger

The integration of the overall organisation structures at the former Air India and Indian Airlines has now been completed although the merger remains defined by the fact that the most critical issue, namely that of the integration of human resources, has been ineptly handled and almost willfully ignored, with nobody within the airline senior management or at the level of the Government having taken responsibility. Issues related to pay, allowances and career progression remain unresolved, particularly with respect to pilots, and this continues to remain a source of industrial unrest going forward.

Coordination of activities in areas such as sales and marketing, information technology, passenger service systems, enterprise resource planning and property management is still in process. The introduction of a unified enterprise resource planning system is likely to be delayed beyond 2013.

India's Ministry of Civil Aviation on 21-Jun-2012 published the Justice Dharmadhikari Committee report on the human resources issues at Air India created as a result of the 2007 merger between the two airlines. Key recommendations on ways and means of harmonisation and rationalisation of the merged workforce include:

• Pay scales: Fixed pay scales should be as per Indian Department of Public Enterprises (DPE) guidelines from Apr-2007, when the carriers merged;
• Workforce levels: New approach to be taken to determine necessary manpower at various levels of Air India, reflecting operational requirements. Establish a fresh setup with revised hierarchy of positions for the merged entity;
• Seniority: Seniority to be granted to workers having longer period of service at either Air India or Indian Airlines, above a worker of the same grade with a shorter period of service;
• Pilots and engineers: Granted line seniority based on aircraft for which they are trained and licensed;
• Cabin crew: Common seniority, pay structure and career progression;
• Promotion and career progression: Establishment of departmental promotion committees to recommend and review promotions, formed of equal numbers of workers from Air India or Indian Airlines. All promotions to be vacancy-based on the basis of seniority with due regard to merit. No age bar put on promotions;
• Pay linked incentives (PLI): Currently paid "without appropriate linkage to operational and financial performance". Recommend use of DPE guidelines or abandonment of PLI, to be replaced with alternative schemes;
• Free Passage Policy: To be restricted to close blood relations who are dependent on employees;
• Voluntary Retirement Scheme (VRS): Formulation of a VRS, available to all employees with a sizable proportion of the benefits available in the form of an Employees Stock Option Plan. In view of "severe financial constraints" at the carrier, it may approach the Indian Government to support a viable VRS scheme, including a listing stock market. 7000 employees eligible for retirement in the next five years.

On 22-Jun-2012, the Ministry of Civil Aviation confirmed Air India had constituted a committee to implement the recommendations of the report. The Ministry will seek special dispensation from the recommendations to the incentives for certain class of employees including pilots, engineers and cabin crew, as such incentives fall beyond the guidelines of the Indian Department of Public Enterprises. The process of fixation of pay, level mapping and seniority is expected to be completed within 6-8 weeks. The carrier has reportedly estimated it would reduce wage costs by INR2.5 billion (USD43.7 million) in the first full year of implementation of the recommendations.

Massive losses of USD1.45bn in FY2012, USD5.45bn infusion through FY2021

The airline has suffered massive losses of approximately INR80 billion (USD1.45 billion) in FY2012. These losses could have been higher if it was not for the increase in revenue since Jan-2012 as a result of the difficulties faced by Kingfisher.

The carrier's financial restructuring plan was approved by the Cabinet in Apr-2012, which will see an infusion of approximately INR300 billion (USD5.45 billion) over the period through to FY2021. The key highlights of the plan are as follows:

• Upfront equity of INR67.5 billion (USD1.2 billion) is to be inducted (of which INR12 billion was already approved and released in the FY12 budget);
• Equity of INR45.5 billion (USD827 million) to be provided to support operating cash deficits through to FY2018, at which time the airline is projected to become profitable;
• Equity of INR189.3 billion (USD3.4 billion) will be infused, equivalent to the amount that had already been guaranteed as loans for aircraft acquisition;
• The Government of India will also offer a sovereign guarantee on non-convertible debentures to the amount of INR74 billion (USD1.3 billion), to be issued to financial institutions, banks, the Life Insurance Corporation of India and the Employees Provident Fund Organisation. Funds raised through this channel are to be used to repay high interest working capital loans. This refinancing will reduce the annual interest burden by INR10 billion (USD180 million). The infusion of equity as per the turnaround and financial restructuring plans is intended to improve the net worth of the company by reducing the debt/equity ratio and to improve operational performance to levels required by the lenders.

OUTLOOK FOR 2012/13

Induction of 787s imminent

The long awaited induction of the first three 787s is expected to take place in Jun/Jul-2012, once the Cabinet Committee on Economic Affairs approves the compensation plan that has been negotiated with Boeing for the late delivery of the aircraft. India's Civil Aviation Minister Ajit Singh, at the end of Jun-2012, said once the Committee approves the compensation agreement, the carrier will take delivery of three 787s within 20 days. Air India chairman and managing director Rohit Nandan said the next six months will be "crucial" for the carrier as it inducts its first 787s into its fleet, as the carrier's plans for international expansion hinge on the performance of the aircraft.

CAPA estimates that the compensation package will be in the region of USD250-300 million. A further four 787s are expected to be delivered by Jan-2013, followed by another seven in FY2014 taking the total number of the type to 14. Air India has a total order for 27 aircraft. The first two aircraft will be financed by a USD220 million bridge loan.

The first three aircraft will initially be deployed on domestic routes for a few weeks to enable multiple daily cycles, allowing pilots to familiarise themselves with the new aircraft and to facilitate observation of its performance. From Aug-2012 onwards, the carrier is expected to replace 777s with 787s on European routes such as London, Frankfurt and Paris. A new triangular route from Delhi to Melbourne and Sydney is also planned from Sep-2012. Following the induction of 787s, Air India will seek to sub-lease five larger 777s to other carriers.

The induction of seven 787s and three 777-300ERs during FY2013 is expected to be on a sale-and-leaseback basis. It is estimated that the airline could earn USD10-15 million per 787 aircraft through this channel as the price of the aircraft has appreciated since the order was placed due to the shortage of available delivery slots. Meanwhile, the carrier has confirmed it plans to lease out some of its older 777 aircraft once it starts to take delivery of new 787s.

Domestic LCC to be launched, Air India Express to continue to face expansion problems

Air India plans to launch an LCC in the domestic market by converting its fleet of 12-14 older A320s into single-class configuration. CAPA estimates that at least two aircraft have already been reconfigured. Meanwhile, Air India Express is expected to continue to face expansion problems due to a shortage of pilots.

To hive-off MRO and ground handling subsidiaries

Air India is planning to hive-off its MRO and ground handling subsidiaries as separate entities, into which third party investors may be invited. This is a critical element of the airline's turnaround plan. Approximately 15,000 employees are expected to be transferred into these subsidiaries, Air India Engineering Services Limited, and Air India Transport Services Limited. Details include:

• MRO: The proposal involves the separation of the MRO business of Air India Engineering Services Limited to "tap the potential of nearly USD1.5 billion MRO business in the Asia Pacific Region". Air India will provide the required equity for capital expenditure to the extent of INR3.75 billion (USD72.7 million) over a period of three years. This would be based on equity support received from the Indian Government as part of its financial restructuring plan. The company is projected to be profitable from financial year 2017/18. About 7000 employees of Air India will migrate to this new subsidiary company;
• Air India Transport Services Limited: Will be operationalised as a new subsidiary of Air India responsible for ground handling activities. The separation has been recommended in the turnaround plan of Air India and is supported by the Justice Dharmadhikari Committee. Air India will provide the required equity for capital expenditure to the extent of INR3.93 billion (USD76.2 million) over a span of 12 years. This would be based on equity support received from the Government as part of its FRP. The new subsidiary is projected to to be profitable from the current financial year.

Industrial unrest continues

CAPA expects that Air India will continue to face industrial action due to a failure to address human resources issues. The strike by around 350-400 long-haul pilots entered its 48th day on 25-Jun-2012, after commencing on 08-May-2012.

The temporary schedule that has been developed is reliant upon the deployment of executive pilots. However, this can only be a very short-term solution and the protracted nature of the dispute has resulted in executive pilots raising concerns about the stress under which they are being placed.

Air India has advertised for 100 new pilots (with positions available to both Indians and foreign nationals) to replace the 101 crew members that have been suspended since the industrial dispute commenced in early May-2012. The Government is adopting a tough stance and is threatening to suspend the remaining 300 long-haul pilots. CAPA welcomes the strong approach and the signal that it sends to other unions that the Government is running out of patience and will no longer tolerate inefficiency that stands in the way of the airline's turnaround. Meanwhile, Air India expects its international operations to fully return to normal by Nov-2012.

Air India's revenue loss from the "illegal" strike by pilots associated with the Indian Pilots' Guild reportedly reached INR5 billion (USD89.1 million) as of 20-Jun-2012, or approximately INR10 million per day (USD178,500). However, Air India chairman and MD, Rohit Nandan said the carrier is also achieving "some substantial savings" due to its reduced level of operations, but has not yet been able to quantify the amount.

CAPA advocates that Air India should be placed in special administration

A key concern is the fact that at this critical juncture the management at Air India could be set for change at the most senior levels, including the position of chairman and managing director. Up to 16 executive directors are due to retire over the next 12 months. The new team could be faced with a highly charged and complex situation. Similarly, the board has not been strengthened following a couple of high profile non‐executive departures last year, while there will be new appointments in a number of senior government roles as well. All of this further compounds the fact that there is nobody taking ownership of the turnaround of Air India, which in itself is unrealistic and unachievable without resolution of the personnel issues.

Meanwhile, Mr Singh this month said an Air India IPO is not possible before 2020 as the Securities and Exchange Board of India (SEBI) requires a three-year track record of consistent profit making. Mr Singh also said the IPO would not provide the Indian Government any returns on its investment in the carrier.

For the last two years CAPA has strongly advocated that Air India should be placed in special administration, similar to that adopted for Satyam, if any meaningful progress is to be achieved.