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Thursday, 11 October, 2018, 11 : 41 AM [IST]

Turbulent times for the Indian aviation industry

The domestic airline industry is going through difficult times. The industry is facing a double whammy with increasing aviation turbine fuel (ATF) prices on one hand and depreciation of INR against the USD. Coupled with pressure on yields, this has aggravated the turbulence in the industry.

Before coming to the moot point, it ought to be mentioned that the domestic air passenger traffic registered a healthy compounded annual growth rate (CAGR) of 20.9% over the period FY2015-18. With a robust Y-o-Y growth of 19.7% during 5M FY2019, the growth trajectory has continued in the current year as well. Healthy capacity addition of 16.9% during the period supported the growth to a large extent. With relatively low penetration levels, favourable macro-economic environment, support from regulatory environment (i.e. regional connectivity scheme, RCS) and development of new airports, ICRA expects domestic passenger traffic will continue to grow at a healthy pace (i.e. 15%-17% per annum) over the medium-term.

The industry’s capacity addition during FY2018 (available seat kilometers, ASKM) was impacted by delays in aircraft deliveries on account of technical glitches with engines for the domestic market leader. Resolution of some of these technical problems has boosted the domestic capacity growth during the current year. ICRA estimates the domestic ASKM growth at ~18% in FY2019. Key drivers for the industry capacity growth continue to be the sizeable order book of airlines, which is in excess of 1,000 aircraft at present.

The passenger load factors (PLFs) for the domestic aviation industry have been on an uptrend starting from FY2015 and the same continued during FY2018, with a superlative 87.0%, a Y-o-Y improvement of 270 bps, that too on a high base. The improved PLF, however, has been accompanied by lower yields, reflecting weak pricing power. The healthy capacity addition and demand underscored by low yields have resulted in continued high PLF for the industry – at 86.5% in 5M FY2019.

Of the twin blows that have hampered the aviation industry, ATF represents the single largest cost element for airlines, accounting for 30-40% of their total operating expenses. As such, the profitability of the airlines is significantly impacted by the ATF prices, which have been subject to high volatility. Post 10.4% increase in average ATF prices in FY2018, they have further witnessed a Y-o-Y increase of 34.5% during April-October 2018. This is the combined impact of an increase in the US Gulf Coast jet fuel price and 7.3% depreciation of the INR against the US$ during this period. After witnessing continuous depreciation over FY2015 to FY2017, the INR started appreciating against the US$ from January 2017 onwards. However, starting May 2018, the INR has been witnessing a steep sequential depreciation against the US$. Sequentially, the ATF prices have increased by 20.3% in October 2018 over March 2018, and the INR has depreciated by 12.3%.

This has resulted in a notable increase in fuel cost/ ASKM for the three listed airlines during Q1 FY2019. IndiGo, Jet Airways and Spicejet witnessed an increase in fuel cost/ ASKM to 1.52, 1.60 and 1.56, respectively, in Q1 FY2019 from 1.22, 1.27 and 1.25, respectively, during FY2018. However, despite this increase in ATF prices, most airlines have witnessed a pressure on their yields owing to increased competitive intensity fuelled by the capacity growth. The revenue per available seat kilometer (RASK) of Jet Airways thus declined to 4.09 during Q1 FY2019 from 4.20 during FY2018, while that of Indigo and Spicejet improved only marginally to 3.65 and 4.29, respectively, in Q1 FY2019 from 3.62 and 4.00, respectively, in FY2018.

Furthermore, 35-50% of the airlines’ operating expenses – including operating lease payments, fuel expenses and a significant portion of aircraft and engine maintenance expenses – are denominated in USD. This means every additional rupee depreciation i.e. 1.37% depreciation at current levels, will impact the operating profit margins of the airlines by 0.48%-0.69%. In addition, some airlines also have foreign currency debt. While the domestic airlines also have partial natural hedge to the extent of earnings from their international operations, overall, they have net payables in foreign currency. The recent significant plunge in INR has resulted in substantial increase in operating expenses, including mark-to-market losses on foreign currency debt and other payables.

Further rise in ATF prices and INR depreciation during Q2 FY2019 is bound to squeeze the RASK-CASK (cost per available seat kilometer) spread further. The above two factors - sharp rise in ATF prices and rupee depreciation are estimated to exert significant pressure on operating profitability of airlines in the medium term.


Exhibit: Movement in Fuel CASK, CASK and RASK for the three listed airlines combined


Source: Company results, Directorate General of Civil Aviation, ICRA research

While the airlines have resorted to rationalisation of non-fuel costs, they are not adequate to compensate the large hike in ATF prices. Our analysis shows that other things remaining constant, if the average ATF price for FY2019 were to increase by 35% and the increase cannot be passed on to the customers, the three listed players consolidated will witness an operating loss of 3.9%, as against an operating profit margin of 7.3% for FY2018.

The Indian aviation industry (consolidation of Air India, Indigo, Jet Airways and SpiceJet) is thus likely to report an aggregate loss of INR 88 billion in FY2019. Furthermore, some of the airlines have large capacity expansion plans, which may be either owned (through debt funding) or on operating lease. The industry is expected to require capital infusion of INR 200 billion over FY2019-FY2021.

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