Outlook For The Indian Aviation Market: On The Pathway To Profitability?

Transcript

Binit Somaia:Good afternoon, everyone. So just to provide some context, CAPA is a well-established and large aviation advisory and research practice in New Delhi that looks after the Indian and South Asian market. We've done, I think, in excess of 100 consulting projects in that market. So it's a market that we live and breathe, and if we can help any of you with your strategies in India, we'd be very happy to do so. But so if you were here last year when I gave an update on the Indian market, what I said was that after several years of mounting losses, crippling debt, a dysfunctional policy and regulatory framework, we were seeing a glimmer of hope that things might improve. So what's happened in those 12 months? Well, fuel prices. It's not unique to India. Fuel prices at Delhi Airport are down 35% year on year. That obviously has a very significant impact on airlines and even more so in India where the impact of taxes on fuel is equivalent to almost 50% of the base price of fuel. So the benefits of lower fuel is actually compounded in India because the tax is also reduced ad valorem. But another positive phenomenon in India is the strength of the economy. GDP growth of 7.5%. Amongst the BRICS, it's probably the only one that has a fairly positive short-term outlook, of an improving short-term outlook, although, to be honest, the sort of mood on the ground is perhaps less exuberant than you might expect for an economy growing at 7.5%, but nevertheless, it does provide the foundation for very robust demand, underlying demand, and you can see that in the traffic figures. Last year, domestic traffic was up 14%, First half of 2016, financial year 2016, up almost 20% for domestic. International, 9-8%, and that's actually been a feature of international traffic to and from India for the last decade. Growth very consistently in the, in the range of about 8 to 12%. At the moment, that's largely being driven by outbound growth rather than inbound. That's a function of the strength of the Indian economy, and despite the fact that in the last 12 months the government has taken a very positive initiative of rolling out electronic visas to 113 nationalities, which has removed one of the sort of significant impediments to travel to India. So, with costs down, traffic strong, capacity deployment quite disciplined, it's perhaps not surprising that financial performance of the industry has improved substantially. Although this is relative. We're still talking about losses here. As you can see, a lot of red ink, almost $12 billion lost over the last 9 years. That's a huge amount to lose. This is at an industry level. But as you can see, for this current financial year, which goes through to the 31st of March, 2016, We're seeing a substantial reduction in losses. We project with our modelling about $480 to $500 million loss. That's down from $1.2 billion in 2015 financial year. That's an industry-wide figure of losses. That actually masks quite a significant variation at an individual airline level. You can see here there's a sort of diversity of performance. You have IndiGo, which is the star performer, net profit last year of just over $200 million. That's a margin of 9.2%. GoAir was the only other profitable carrier, and at the other extreme, Air India, the national carrier, losing almost $900 million, so accounting for a substantial proportion of the losses in the industry. Thank you. Indigo, though, is really quite an outstanding story. It's just completed 10 years of operations. It now has a fleet of about 100 aircraft, 430 aircraft on order, and recently completed a successful IPO beginning of November or late October, valuing the carrier at just over $4 billion. So it proves that despite the challenges in the Indian market, it is possible to succeed. Looking to the end of this financial year, 2016, we see improvements pretty much across the board. IndiGo and GoAir, the 2 profitable carriers, expected to see increased profits. SpiceJet and Jet should turn around from a full-year loss to a full-year profit. Air India, even Air India is going to show some improvement as well. They might only lose $770 million this year. The only sort of deterioration in those figures is the others column. That covers 3 carriers with actually quite diverse business models. There's a regional carrier, Air Costa. There's LCC AirAsia India, and a full-service carrier, Vistara. Those 3 carriers, which all launched in the last 24 months, and which account for only about 4% of total domestic traffic, but who've probably found the going during their early stages a little bit more difficult than they anticipated, and we see their losses increasing slightly in 2016. But this improved financial performance, as I said, is largely due to external factors. It's fuel and it's the economy. Nothing structurally has really changed in Indian aviation over the last 12 months. If fuel goes back up, the losses will deteriorate. Nothing substantive has really changed on the ground. And as we said last year, we said that if Indian aviation is to achieve a genuine and transformational step change, the onus is on the government to pursue meaningful reform, because really you can trace back a lot of the challenges in Indian aviation to a highly dysfunctional policy and regulatory framework. So what's happened on that front? Well, if you'd asked this question about a month ago, we would have said pretty much nothing. Prime Minister Modi came in on a wave of euphoria, on a reformist agenda, and to be quite honest, in the first 15 to 18 months, as far as at least aviation is concerned, the results, the action was highly disappointing. Although I should say that there was one important development, and we shouldn't understate that, and that was that we observed, and when we worked quite closely with the ministry, we observed that there was a restoration of integrity and intent at the ministry, and there was a greater level of consultation between the ministry and the industry. And restoring that trust and that transparency is obviously a very important foundation for anything that goes forward from here. So we don't discount the importance of what has happened on that front. So that was a month ago, and then on the 30th of October, the government finally announced its long-awaited draft civil aviation policy. Now, no policy is going to be perfect, and given where we are today and where we need to be in terms of policy, I think it would be unrealistic to expect that we could make that step in one announcement. So we look at it from that perspective. And what has really changed, and it's an important change, is the fact that Our understanding is that the Prime Minister gave a directive to the ministry about 3 months ago when this policy was being formulated, and the directive was that the policy had to treat aviation not as a preserve of the elite, but it should be seen as a means of economic development, of facilitating tourism, and as a means of mass transportation. And what we see in the policy, we believe, signals a very positive intent. We see that there is a sort of intention to make doing business easier, to try and reduce costs, to liberalise, to open the market, to make aviation more accessible. That is there, but Having said that, we see a lot of challenges with the policy. There are certainly some things that appear to be a backward step, other areas that require further clarification. But it is important that there is this step change in thinking, a thinking that has prevailed for almost 70 years since independence, that aviation was for the rich. So looking at some of the specifics of the draft policy, and just to give you a timeframe, the policy is currently open for public response. That closes at the end of this month. The government is planning to finalize the policy by January and implement it from the 1st of April, the beginning of the new financial year. So the areas where we were disappointed, there was no mention of of what the government plans to do with the 2 state-owned entities in aviation, Air India and the Airports Authority of India. And as you saw earlier, the losses that Air India is incurring, really there's no need for the government to continue to own this airline and subsidise it to that extent, especially when there is a vibrant private sector that is willing to provide air transportation. Investment in infrastructure. There isn't a clear plan for for how airport capacity and airspace capacity is going to be developed. The unconstrained demand projections, and we'll see that later on, for India are potentially so strong, and yet the challenges of developing infrastructure are so great that we see that there is potentially a capacity crisis looming because of a failure to be able to develop airport capacity at the rate that is required. We can see the top 30 airports in India all being saturated and operating well above design capacity within the next 10 years. Airspace is another issue, and we were encouraged that initially the plan was to corporatize air navigation services, which would have given them access to more capital, more flexibility to invest in developing airspace. Unfortunately, this policy suggests that those plans have been shelved. Taxation reform. I mean, taxation is a serious challenge for aviation. As mentioned, fuel taxes can add up to 50% to the base price of fuel. No mention of anything being done on ATF tax, on withholding tax on leases, on service tax on airfares. The route dispersal guidelines, the RDG, which is the policy which requires Indian carriers to operate certain non-viable routes to remote parts of the country. Instead of diminishing this requirement, it's actually being expanded. And the 5/20 rule, a very discriminatory regulation which requires that Indian carriers must operate for at least 5 years on domestic services and have a fleet size of 20 aircraft before they can operate internationally. It's a restriction that doesn't apply to foreign carriers that operate to India, but it does apply to Indian carriers that go overseas. That decision was deferred until January, and really we see no reason to continue with this regulation. If the overall thrust of the policy is to liberalize, we see no reason to continue to be ambiguous on this particular regulation. A couple of areas where the signs are encouraging, but we'd really like to understand some more detail. Bilaterals. The policy makes a statement that India will work towards having an open skies agreement with all markets on a reciprocal basis by 2020. That's a— whether that happens or not, I don't know. That's up for discussion. But the fact that they're even saying it is quite a change in approach. They have in the interim, they've awarded open skies to all markets more than 5,000 kilometres away from India. That's somewhat meaningless because we know of no market more than 5,000 kilometres away that's actually looking for more bilaterals, but it's a nice statement. And it means that in the interim, the carriers from from the Gulf, from Turkey, from Southeast Asia, who are looking for quite significant expansion in access, I think they will probably have to make do with relatively modest expansion, at least until 2020. Regional services. Again, this was a very significant push in the policy. It's part of the government's objective of making aviation accessible to the smaller towns and cities. There are a lot of concessions that have been offered: airport charges waived, utilities waived, taxes, tax holidays on regional carriers. I mean, a whole raft of concessions that have been offered, and again, it indicates that they understand that costs are a challenge for the industry and they're trying to do something about it. But— and they're also trying to make it a means of mass transportation. So on the other side, they've said that if you want to take advantage of these concessions, fares need to be capped at the equivalent of around $40 for 1 hour of flying. Now, we're talking about regional services and not even— not necessarily even 50-, 70-seater aircraft. We could be talking sub-30-seater aircraft. These are small aircraft with high unit costs. Achieving a fare and capping a fare at $40 is probably a little unrealistic, and as a result, may deter investors. But the positives: airport-based providers, so ground handlers, MROs, catering companies, have been granted infrastructure status. Now, under the tax code of India, That means that you have access to cheaper debt, and it also provides quite significant corporate tax concessions for up to 10 years. This is a very significant development and one that is very welcome. MROs, apart from the infrastructure status, they have been granted almost their entire wish list that they had submitted. Duties gone, excise gone, service tax gone, All the issues that had been plaguing the industry that made it uncompetitive relative to offshore providers, almost all of those wish list items have been answered. Although, I was at a summit in Bangalore just a couple of weeks ago, and just after the announcement about this, and there was a panel on MROs, and you would have expected that there would be a great deal of euphoria, So their dream policy had just been announced, but interestingly enough, their concern was that this is great, but we don't have the skills to do it. And that is going to be an emerging issue for India going forward, is the availability of skilled resources. But again, you know, the government has taken the steps required in terms of addressing some of these issues. Clarity on a couple of issues that have been pending for 7 or 8 years and has made it very difficult for anyone to plan or to proceed or to invest because there was no certainty about the regulations. So domestic carriers will now be allowed to self-handle. Previously, it was— the policy stated that they would have to outsource. Economic regulation. All future PPP airports will have a 30% hybrid till. Until now, we've sort of switched from dual till to single till to hybrid till, 30%, 40%. It's now clear. That again provides a great deal of important certainty to the investor community. Helicopters. General aviation has generally been ignored in India, but helicopters have finally been recognised as a separate sector with its own regulations with regard to airspace, etc., which should again really unshackle the opportunities for using helicopters for medical evacuation, intercity or intracity shuttles. That's something the GA community has been waiting for for a very long time. And codesharing, again, just making life easier. Previously, codeshare agreements between Indian carriers and foreign carriers had to go through a very lengthy approval process through the ministry. Now it's automatic. So as you can see, there is a very clear intent, and, you know, many of these things still need to be improved and addressed, and we have 2 or 3 months to do that. And if we can implement a policy that is an enabling policy and regulatory framework, and we maintain this benign fuel environment, and India's short-term economic outlook, at least for the next 5 years, is for 7%, 8%, 9% GDP growth, we're very bullish about the prospects for growth. As you can see, over the next 10 years, on most traffic metrics, we expect to see a doubling or tripling of traffic. Some caveats, as mentioned, this is subject to continued liberalisation and reforms and improving the policy that is going to be implemented. Skills, that has the potential to be a serious roadblock to the sector. As of today, whilst we sit here, Air India has 19 aircraft sitting on the ground because of a shortage of pilots and cabin crew. I mean, the cost of that is immense. And as mentioned, the supply-side airport and airspace capacity is going to be another significant challenge for the industry. So, thank you for your time, and if you're interested in exploring any of those issues in more detail, do come to our CAPA India Aviation Summit, which will take place in early February, and we look forward to seeing you there. Thank you.

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