Hitting An Air Pocket

IN JUST one quarter, the fortunes of the aviation sector have gone from best to worst. The second quarter earnings of India's largest carrier, IndiGo, have come has a shock. Low-cost carrier (LCC) IndiGo, which controls 48.2 per cent of the market, posted a net loss of Rs 1,062 crore in the July-to-September period, which is in sharp contrast to its record-high net profits of Rs 1,203 crore in the previous quarter. The LCC blamed the falling rupee for its losses.

The second quarter results of other carriers in all likelihood are going to be equally disappointing.

The chain of events that contributed to the (now what seems like a short-lived) revival of the sector is beginning to reverse: ATF (aviation turbine fuel) prices are rising, rupee is depreciating, and benefits from Jet Airways' grounding have stopped. As if these didn't pose a big enough challenge, there are new reasons that the beleaguered sector has to worry about: the slowdown in the economy and the aggressive capacity additions being planned by some airlines.

Take ATF prices. Domestic ATF prices have been moving up since early this year. Between January and October, the price of ATF sold by Indian Oil Corp (IOC) in Delhi rose over 9 per cent to reach Rs 63,295 per kilolitre. Though the prices are not yet as high as last year, the tense geopolitical situation due to deteriorating Turkey-US relations could affect crude oil prices in the near future.

"The changes in geopolitical scenario are not good for the economy. The first casualty has always been the aviation sector," says Mark Martin, CEO of Dubai-based Martin Consulting. ATF is 30-35 per cent of the overall cost of an airline.

The volatility in the rupee-dollar exchange rate is bad news too because it impacts crude oil prices (and thus ATF) in addition to increasing the cost of maintenance and spare parts. IndiGo, for instance, has reported a jump in maintenace costs in the September quarter to Rs 319 crore.

The airlines have been candid about the gains from Jet's grounding, which took place in April. IndiGo, for instance, reported positive impact on unit revenues and increase in cargo revenues in the June quarter.

Many of Jet's planes have changed hands - taken over on lease by Vistara and SpiceJet. So, while Jet's void is gradually being filled, the mess it had created will take time to be cleaned up. On the domestic side, Jet's slots are yet to be fully re-distributed. It will be a gradual process for the entire capacity to get absorbed. "By thumb rule, if Jet had 20 per cent of the total airline capacity, it will take at least 20 months to replenish it. Even if some capacity has come back, what matters more is the sectors where the capacity has been added. If you take a plane away from Mumbai in a specific slot and put it in Amritsar, it doesn't help," says Amit Sinha, Partner at Bain & Co.

Slowdown Blues

A bigger worry is the economic slump which is affecting both leisure and business travel. An average corporate traveller takes 150-200 flights a year. This has come down as the focus is to plan in advance and defer travel. For instance, a corporate traveller, who would otherwise go to Mumbai and Bengaluru separately in a particular week, is now clubbing these to reduce travel spends. This has affected the airlines' ability to increase yields (yield is the average fare per passenger per kilometre).

Airlines generally sell tickets at a lesser price to passengers booking in advance and maximise yields from passengers who book in the 0-15-day window. The demand slowdown has put pressure on fares even in the 0-15-day booking window.

"People are being wary about discretionary spending. There's caution in the minds of corporate and leisure travellers," says an aviation analyst.

In the September quarter earnings call, IndiGo's CEO Ronojoy Dutta said that there were signs of weakness in September. In October, which is typically a strong month for airline companies due to the festive season, Dutta said that two of its competitors announced flash sales which was unusual. "That shows weakness. Revenues in the festive season (in October) remain subdued. We are seeing decline in yields in metro-to-metro markets. In the last quarter, we reported unit revenue growth of 5.7 per cent but it's going to be flattish growth in the third quarter," Dutta said.

Short-term Outlook

Jet's grounding created a demand-supply imbalance and spiked the overall fares across sectors. But the fares remain high even after more than six months of grounding. In a price-sensitive market, this can lead to travellers further reducing travel-related spending. "Aviation is a highly elastic market. When the capacity goes down, the fares go up. Airlines are fast in increasing fares but bring them down slowly - balancing demand and supply trends," says Bain & Co's Sinha.

However, that's set to change. The capacity additions being planned by many airlines are going to put further pressure on fares, especially in the economy class. "Being a full-service carrier, Jet's capacity had more business seats as compared to LCCs. Since that kind of capacity will take a longer time (than economy capacity) to be added, business class fares are unlikely to come down even during times of general over-capacity," says a consultant.

IndiGo, for instance, plans to increase capacity by 25 per cent in 2019/20, which means that the airline will take its total fleet to about 260 planes. As per IndiGo's website, its current fleet is 245. In the June quarter, the airline had projected 30 per cent capacity addition in 2019/20 but the numbers were revised downwards on account of problems in the aircraft supply chain.

Its archrival SpiceJet has inducted 36 planes between March and October this year, and plans to induct aggressively over the course of this financial year. Vistara, too, has higher-than-normal capacity induction plans for 2019/20.

According to experts, such moves by various airlines would result in overcapacity - a problem that plagued the sector for the whole of 2018 and got resolved to an extent when Jet was grounded.

Overcapacity leads to lower fares, and airlines enter a vicious battle of profit-less growth. The aviation sector has historically been brutal for carriers that are not cost efficient. Every three-four years, an airline goes bust. It was Kingfisher Airlines in 2012, and this year, Jet succumbed. "The current demand is just enough for airlines to fill up their seats. Their capacity addition plans are unsustainable over a long period of time," says Devesh Agarwal, an aviation blogger.

Slow Recovery

The air passenger numbers over the past one year are weak. The nine-month passenger growth (January-to-September) stood at 3.01 per cent as compared to 20.94 per cent in the same period last year. This is the lowest growth in at least six years. Typically, the aviation sector grows at twice the rate of GDP growth which means that if economy grows at 6.1 per cent in 2019/20 (as projected by the International Monetary Fund), the aviation should grow at 12 per cent. But that seems unlikely at the moment.

For a possible rebound, a host of factors will have to come together. "For the situation to change, the economy needs to improve first. Passenger growth is going to stabilise at 2-5 per cent until the economy looks up," says Martin.

According to Sinha, it will take six months to a year for the aviation sector to recover. "It requires liquidity in the market, job creation, high-value transactions to pick up, and salary growth. If we are lucky, we might see some improvement in six months," he adds.

As a sector that has been hurtling from one downcycle to another, this period is perhaps the best for aviation companies. They might be in for a trouble later but they will continue to make the most of good times till they last.