IndiGo's Revival Bid

On March 25, 2020, all 259 aircraft of India's largest airline by market share, IndiGo, were grounded as the government suspended commercial flights - domestic and international -indefinitely due to rising Covid cases. While Indian aviation has seen numerous ups and downs, the March-May 2020 period was the worst-ever.

As the market leader and the country's largest low-cost carrier (LCC), the scale of damage for IndiGo was bigger than the rest. While revenues stopped coming, fixed costs started eating into profits, and in turn, cash reserves. In April, agencies such as CAPA India predicted a loss of $1.5 billion for IndiGo and SpiceJet over the next six months. The impact was so brutal that some brokerages stopped tracking the sector, and IndiGo in particular. "We believe the impact on aviation sector will be severe and the ability to forecast financial consequence is difficult today, given the evolving nature of the situation. We are dropping the stock (IndiGo) from our coverage in the short-to-medium term," Geojit Financial Services said in a note issued in May.

Not surprisingly, during the nine months between April and December 2020, IndiGo reported net losses of Rs 4,659 crore (against a net profit of Rs 698 crore a year ago), while revenues shrank 67.5 per cent year-on-year.

Yet, CEO Ronojoy Dutta remains confident. In the March 2020-quarter earnings call, he told a bunch of harried investors that IndiGo wants to emerge from this crisis stronger than ever. "In that context we are paying particular attention to our product, our costs, our brand and our employee culture," Dutta had said.

In February 2021, the airline registered a 54.2 per cent market share in an 11-player market - up from 48 per cent in February 2020. Costs are going down, and revenues are rising quarter after quarter. But even though it is making a strong comeback from its low, it needs to tackle challenges such as subdued international travel demand, permanent loss of some business traffic, rising crude prices, and high cost to make the revival sustainable.

What Next?

Going by monthly data from the Directorate General of Civil Aviation (DGCA), it seems the worst is over for the aviation sector. There is gradual improvement in all parameters - number of flights, number of passengers flying, and as a result, number of passengers per flight. In May, when scheduled airline services resumed, domestic airlines flew 8,554 passengers across 109 flights in a month. In January, this has shot up substantially to 7.6 million passengers across 2,190 flights. Yet, it is still about a third lower than the 3,080 average daily departures in January 2020.

IndiGo expects to reach pre-Covid levels by 2021-end. "We have different trajectories for domestic and international. In domestic, the only thing holding us back is government restrictions. As soon as they go to 100 per cent, we will be 100 per cent. International is difficult because every country has its own rules. Hopefully, the vaccine should make a change. But right now, everyone has got quarantine restrictions, and there are pre-testing (conditions)in some countries. That's holding international back. I would hope that by end of 2021, we should be back - all international and domestic - to pre-Covid levels, and higher. 2022 will become a year of growth again," says Dutta.

Since May, domestic carriers are operating under capacity restrictions, which have been slowly eased from 33 per cent (pre-Covid) to 45 per cent in June, 60 per cent in September, 70 per cent in November, and 80 per cent in December.

In January, IndiGo was doing around 1,100 departures a day. Its domestic and international capacity deployment was 70 per cent and 28 per cent, respectively, of pre-Covid levels. At its peak, IndiGo was doing 1,750 departures a day, which it aims to achieve again by 2021-end.

Industry experts believe once air traffic comes back fully, IndiGo will benefit the most. In an October report, investment banking firm BOB Capital Markets said IndiGo will outperform the entire sector during FY20 to FY23 with 11 per cent growth in passenger traffic share, against 7 per cent for the sector. Its market share is also likely to be 58 per cent in FY21 and 56 per cent in FY22 and FY23, significantly higher than 48 per cent in FY20.

"We believe IndiGo is in a sweet spot for growth over the next two years given a benign dollar-rupee exchange rate, the vulnerability of its peers (in terms of negative networth and massive cash burn), and a strong balance sheet. Nevertheless, the sharp jump in crude prices is expected to severely erode profitability in the near-to-mid-term," said another BOB Capital Markets report published in January.

But as the recovery happens, experts predict a bloodbath. That's because once fare caps are lifted, airlines will in all likelihood bring down ticket prices to fill up planes. "As soon as capacity restrictions are lifted, everybody would want to pack their domestic flights because international flights are not coming back soon. To do that, they would offer deep discounts. I believe two Tata airlines (AirAsia India and Vistara), and IndiGo can offer such discounts because they are either funded well or have strong liquidity," says Vinamra Longani, head of operations at Sarin & Co, a law firm specialising in aviation.

There's additional concern in Jet Airways making a comeback as the winning bidder Kalrock Capital-Murari Jalan consortium is planning to resume services shortly. The expected sale of Air India and its LCC subsidiary Air India Express will further intensify competition, and take away some market share from IndiGo.

Dutta, however, is not worried. "There's no correlation between market share and profitability. It's not that having more market share gives any pricing leverage. It's not been proven anywhere in the world. Our goal is not market share but to connect India," he says.

Dealing With The Pandemic

When Covid struck, IndiGo was at the peak of its game. It was sitting on free cash reserves of Rs 8,928 crore, significantly higher than its peers. But, Covid-19 acted as a dampener. Still, it was in the best situation to overcome a large-scale event like the pandemic. "We didn't fly for two months. We have lost a lot of money, and we have been losing money. Fortunately, we had a healthy balance sheet, and were able to sustain those losses. We started off with Rs 40 crore of cash burn a day. It's coming down gradually," says Dutta.

"It didn't fly for two months, and that had a major impact on financials. The airline is still losing money but macros have improved," says an aviation analyst with a leading brokerage.

Also, right from March 2020, IndiGo took many initiatives to reduce expenses. Cost reduction was needed for two reasons. One, the airline could not do much on revenues since the government put a capacity limit on each airline along with fare caps. Then, although demand is picking up gradually, it will still take a few quarters before it reaches pre-Covid levels, especially internationally. In short, the airline was badly squeezed between high fixed costs (about 30 per cent of its overall costs) and low traffic.

IndiGo tinkered with costs in the form of paycuts, furloughs, layoffs, renegotiating contracts with suppliers and drop in maintenance costs. That helped reduce cash burn to Rs 15 crore per day in the December quarter. Payroll costs alone have been curtailed by some 30 per cent, and will remain in the current range for the foreseeable future.

"We really focus on unit costs. It's a question of total costs divided by how many seats flown. Because we are not flying enough seats, our unit costs are still elevated. But they are coming down sharply. If we get to pre-Covid level capacity, our unit cost will be down significantly. We have to wait for that to happen," says Dutta.

The low-cost structure has been IndiGo's core strength from the beginning. Take the case of ATF (aviation turbine fuel). The airline is replacing older version A320ceos with A320neos and A321neo, leading to about 15 per cent fuel savings. IndiGo plans to get rid of all A320ceos by 2023 by returning 30-40 aircraft per year. The management also reviews fuel-savings programme every quarter based on initiatives taken by the flight operations department. The department's main job is to look for ways to save fuel. Small changes like how the aircraft climbs/descends or taxis with single-engine in use save a lot of fuel.

"Within the fleet, IndiGo seems to be using more A320neos than A320ceos. A320neos are not just fuel efficient, they don't need to make shop visits for checks as much as A320ceos," says Longani of Sarin & Co. In the year to December, IndiGo reduced its fleet size by 30 planes.

"Despite flying 40.8 per cent lower capacity, our CASK (cost per available seat-kilometre) during the December quarter remained flat at Rs 3.68 on a year-over-year basis. This was largely due to lower fuel prices combined by our cost reduction efforts, higher utilisation of our A320neo fleet and positive movement in the value of the rupee. Sequentially, CASK has reduced by almost 20 per cent," says Jiten Chopra, CFO at IndiGo. CASK is an industry metric to measure an airline's unit cost.

Besides cost measures, the airline embarked on an asset monetisation plan and converted some of its owned aircraft into sale-and-leaseback structure that generated liquidity. The airline owns about 29 planes (combination of ATR and A320s), and had ramped up the purchase of aircraft through free cash from 2017 onwards. During the peak of the pandemic, the airline sold some of these planes - to generate liquidity - and took them back on lease.

"We would like to own some of our airplanes. In good times, that's a good strategy. In bad times, when liquidity is important, we need to do sale and leaseback. As our cash flow improves, we will look at owning a few airplanes. The extreme example is Irish LCC, Ryanair, which owns all its planes. We have no goals of getting there. But we would like to own a small percentage of the fleet," says Dutta.

Not just old ones, every aircraft delivery that IndiGo takes creates liquidity for the airline. That's because it orders aircraft in bulk - 100 in 2005, 180 in 2011, 250 in 2015 and 300 in 2019 - which gives it a favourable pricing with manufacturers such as Airbus. So when these new planes are sold to lessors, IndiGo earns a decent amount.

"The average number of domestic passengers per flight improved from 98 in September to 112 in December, depicting rising consumer confidence... We believe IndiGo continues to remain better placed than peers and is likely to emerge stronger from the current crisis given strong balance sheet, industry leading cost structure (to improve further after replacing older A320ceos with A320neo family) and strong management team," brokerage Prabhudas Lilladher said in its January report.

IndiGo's management believes they are just scratching the surface, and when it comes to growth, the sky is the limit. "In the long term, we think there's going to be big growth in air traffic. There are a couple of things that are driving this (growth). Air travel in India is lowest in terms of penetration across the world. Only 5 per cent of Indians travel by air. But India is a big country. We should at least get to the level of Indonesia and Thailand in terms of penetration, yields, and frequency of flights. Every forecast we see, there's a big growth coming in middle-class income levels. As that happen, 5 per cent should go to 10 per cent or 15 per cent. One can imagine the volumes in that," says Dutta.

Blessing In Disguise

The pandemic also caused an unintended gain for domestic carriers. Take IndiGo's example. The airline used to move 100,000 tonnes of cargo on a monthly basis domestically. It used the plane belly to ferry this cargo. But when passenger flights were shut, cargo still had to move. Suddenly, there was demand for cargo freighters, and that's when IndiGo converted 10 planes into freighters with dedicated cargo operations.

"Cargo charters emerged as a big opportunity for the industry. When other transportation systems were down (railways, ground support), the easiest way to ship goods is through air cargo. The airline industry turned some planes for cargo operations. Our team has done a fabulous job to make sure our cargo tonnage is at an all-time high," says Sanjay Kumar, Chief Strategy and Revenue Officer at IndiGo. The airline is now exploring options to induct dedicated freighters, and a decision is expected soon.

The other discovery is private charters. It started in May when a family in Bhopal asked IndiGo to arrange for a Bhopal to Delhi flight for four members. IndiGo ferried the aircraft from Delhi to Bhopal and back, and started exploring this as a new business stream.

"We did both domestic and international charters. Students stuck in Tblisi or Moscow, wanted to fly back to India. We saw huge requirement in CIS countries, Middle East, and parts of Europe. Suddenly, we had this new market because commercial flights were not available," says Kumar.

This is expected to become a regular revenue stream going forward. The airline, for instance, has tied up with hotels, and has introduced products around wedding charters. "We can do destination weddings. We have done charters to Male, Goa, Trivandrum, Udaipur, and Jodhpur for this purpose. These people are seeking safe travel for families, and they can afford it. As long as people don't find foreign destinations opening up, domestic destination weddings charter will remain a strong business," adds Kumar.

The pandemic has led to a shift in travel patterns favouring domestic airlines. Despite a geographically and strategically sound location, India was losing the international game to aggressive competitors in hubs such as Dubai (Emirates), Doha (Qatar), Abu Dhabi (Etihad) and Singapore (Singapore Airlines). The Dubai hub, for instance, was providing connectivity to passengers from India to Europe and Americas with a one-stop flight. In 2021, the demand for one-stop (or two-stop) flights has shifted to direct flights because of Covid fears. Due to these overbuilt hubs around India, domestic carriers were hesitant to launch direct flights between Indian cities and Europe/US - Seattle to Bangalore or San Francisco to Hyderabad. The fact that Air India has launched a direct non-stop service between Chicago and Hyderabad in January, and United is planning to start non-stop service between San Francisco and Bengaluru in May shows the preference for one-stop has diminished quite a lot.

It also means there will be fewer wide-bodies of hub carriers coming into India, and hence local traffic to these hubs - whether Singapore, Doha or Dubai - will do better with narrow bodies of Indian carriers.

"Regional airlines like Emirates and Qatar have mostly wide-body planes. They would struggle to fill planes due to lack of demand, and economic slowdown. At this point, a LCC is well placed to cash in on international demand as and when it returns. People may ditch the frills but they still want to travel. They don't want to splurge on full-service economy tickets especially for short flights to Dubai or Thailand. IndiGo can take on any FSC (full-service carrier) like Emirates on pricing, network and frequency for regional travel," says Sarin & Co's Longani.

IndiGo also hopes to take away some traffic from the railways for two reasons - There's a more perceived safety inside an aircraft, and affordability. At this point, social distancing norms are similar in trains and planes. But mask compliance is enforced stricter in airplanes as there's no authority onboard a train to do that. Also, the Indian travel market is highly price-sensitive, and customers are ready to shift loyalty for even Rs 100. Nothing matters except fares and on-time travel. As long as consumers get airfares they can afford, they will switch to air travel.

"Train travellers are 100 times more than air travellers. If we can scratch the surface by creating the network that provides connectivity across the length and breadth of the country, and ensuring the fares, I think there's a huge opportunity for airlines," says Kumar.

Mark Martin, CEO of Martin Consulting, calls it a fanciful thinking. "The last entity who thought of competing with railways is Air Deccan, and railways gave them a tough time. Air never competes with rail, and rail never competes with road. It's an adversary that can kill you at any cost and instance. Railway networks are slated for privatisation over the next five years. It's not possible for IndiGo to compete with the mass inventory railways offers," says Martin, adding, tinkering with domestic network is a waste of time for IndiGo, and the airline should rather focus on long-haul flights (by inducting wide bodies like A330neo or A350) along with building a second hub outside of India.

"Our plans continue to be (operating flights within the range of) seven hours. That's a huge and high-growth geography. Although we have been studying wide bodies for some time, we have our hands full right now with the opportunities ahead of us," says Dutta.

The Headwinds

Many of IndiGo's plans could derail if crude oil prices continue to rise as they have been since November. Ratings agency ICRA's recent report suggests strong recovery in oil and gas volumes in 2021/22. ATF price, which accounts for 35-40 per cent of the airline's running cost, has nearly trebled since May 2020 to Rs 48,208.93 per kilolitre (in Delhi).

IndiGo's Chopra is sanguine though. "The domestic demand for petroleum products is expected to increase at 8-10 per cent annually in FY22. However, ATF demand is expected to lag due to the discretionary nature and the perceived risk of air travel. Given this projection, we believe we will be able to tide over the situation," he says.

One of the biggest side impacts of the pandemic on aviation is the destruction of business travel as corporate travel budgets have been vastly reduced. Second, the corporate world has realised they can manage the same amount of business using tech. This is a big hit especially because corporate business travel accounted for 50 per cent of overall air traffic. In the long term, the business travel won't disappear but it's going to take a significant step down, experts say. "What percentage of business travel is lost forever - nobody knows. It all depends on how the virus behaves," says an aviation consultant.

The airlines have been partially saved as essential business travel by SMEs has come back, and there's some improvement in demand from infra, heavy industries, construction, paints, and pharma sectors. "Corporate travel may take six months before we see large companies like TCS, Infosys and Wipro start travelling. But, due to less (business) travel and more disposable income (because of working from hometowns), people will travel more for personal reasons. Leisure travel will be the new way," says Kumar.

Less than two years ago, IndiGo was grappling with a bitter fight between its promoters Rakesh Gangwal and Rahul Bhatia. Within a breather of just few months, Covid-19 struck. For an airline lurching from one issue to another, laser-like focus on its basics of providing hassle-free connectivity with low fares makes IndiGo the most promising story in the Indian aviation.

@rmanukaushik