Civil aviation in India is now entering a new phase of development after two decades during which the sector has witnessed both stagnation and unprecedented growth. The industry has experienced some of the natural growing pains of a sunrise sector, but numerous lessons have been learned and are being acted upon. Despite the recent growth, less than 2% of Indians travel by air in any given year.

Decade long development:

2003‐2006: This was a period of unprecedented change. With the arrival of Ministers of Civil Aviation on both sides of parliament that recognised the importance of aviation for the development of business, trade and tourism, and who had a vision for delivering a vibrant and modern sector, the industry saw dramatic reforms across the aviation value chain. Developments included:

• Domestic open skies policy which saw market entry by several carriers;
• The arrival of the low cost airline model in India with the launch of Air Deccan, and subsequently SpiceJet, IndiGo and Go Air;
• Announcement of the airport modernisation plan, including the privatisation of Delhi and Mumbai, upgradation of 35 non‐metros and encouragement of Greenfield development;
• Placement of orders for 111 new aircraft for Air India and Indian Airlines;
• Liberalisation of the international sector with some private carriers permitted to operate overseas; greater access for foreign carriers and opening up of international routes for nonmetro airports;
• Increased foreign direct investment caps in certain sectors of the industry.

2006‐07: During this period, traffic continued to accelerate further, to levels approaching 40% in 2007. However it was at this stage that the realities hit home – although traffic was buoyant, yields were being slashed through overcapacity and fragmentation of the industry, and costs were increasing because of the poor state of airport infrastructure and a shortage of human resources.

• The bullish fleet orders placed by Indian carriers saw capacity being introduced at the rate of 6 to 6.5 aircraft a month, whereas the actual growth in demand was closer to 3 aircraft equivalents;
• Aside from the mis‐match between supply and demand, the rate of growth was simply too great for the industry to handle from a management and capital perspective.
• In a fragmented market, with multiple start‐ups chasing market share, loss‐leader pricing was widespread and Air Deccan in particular was responsible for setting fares well below cost as it fought to retain its first mover market share;
• The rapid increase in capacity at a time when the airport modernisation program was yet to deliver upgraded infrastructure, meant that airports and airways were highly congested, increasing airline operating costs;
• With the inadequate surface access and airport (and airways) infrastructure, airlines were unable to secure a significant competitive edge over other means of travel, thereby excluding huge parts of the still‐untapped leisure market;
• In a period of global boom, demand for skilled personnel such as pilots and engineers also outstripped supply leading to a sharp escalation in wages, and in some cases grounding of aircraft due a shortage of staff;
• Balance sheets were stretched as a result of the aggressive fleet induction programs, combined with the mounting operational losses.

2008‐09: The fragility of the sector ‐ which had overextended itself by growing at rates that it could not manage, in an environment that was not conducive to efficient operations – was exposed during the fuel price spike of mid‐2008 when oil reached close to US$150/barrel. In India, this situation was exacerbated by the taxation structure which increases the costs of fuel by up to 60% vis a vis international benchmarks. As costs spiralled upwards, carriers were forced to raise fares, and with a simultaneous slowdown in the Indian economy, there was resulting decline in traffic of around 10‐12% year‐on‐year.

2009‐10 and beyond: After the dramatic changes of the last five years, we are starting to see the emergence of a more favourable environment:

• India’s GDP growth slowed from over 9% in 2007/08 to 6.1% in 2008/09. However, given the contraction globally, this was a relatively a good result. The economy appears to be recovering earlier than expected, with GDP growth of 7.9% in the last quarter, ahead of expectations. The World Bank projects annual growth of 8.0% per annum from 2011 to 2014.
• Domestic traffic is also showing a return to growth. After 12 consecutive months of year‐on‐year declines in domestic traffic, July 2009 saw a return to positive territory, which has continued since then. This is partly due to the impact of a lower base resulting from last year’s decline, however discussions with the industry indicate a discernible increase in demand as business and consumer confidence increases, although yields continue to remain depressed.

AIRLINES

The airline landscape in India has been transformed in recent years. In 2003 there were just 4 carriers – Air India, Indian Airlines, Jet Airways and Air Sahara ‐ all operating full service models. And private carriers in those days were limited to operating domestic routes only. Today, there are effectively 7 airlines operating 11 different brands: Air India + Air India Express, Jet Airways + Jet Konnect + JetLite, Kingfisher Airlines + Kingfisher Red, IndiGo, SpiceJet, Go Air, Paramount.

On the domestic front, the 3 large airline groups – Air India, Jet Airways (+ JetLite) and Kingfisher Airlines command a 67% market share. Domestic market share November 2009 is: Paramount – 1.5%, Kingfisher – 21.1%, Jet Airways 19%, GoAir -5.3%, Jet Lite – 7.5%, SpiceJet – 12.2%, IndiGo – 14.1%, Air India – 18.8%.

In the 4 years to March 2010, it is estimated that Indian carriers will have accumulated operational losses of in excess of Rs. 260 billion, of which the three large airline groups (Air India, Jet Airways and Kingfisher Airlines) account for almost Rs. 230 billion. CAPA estimates that the losses for the current financial year will in the order of Rs. 65‐70 billion.

The most significant recent strategic development in the Indian domestic market is that it is rapidly turning low cost. An operating model which did not exist in the Indian market until 6 years ago, could account for almost 70% of domestic capacity within the next 2‐3 quarters. This is due to the decision taken by carriers such as Jet Airways and Kingfisher Airlines to reconfigure the majority of their domestic aircraft to operate all‐economy, no‐frills service. Air India is also planning to follow suit. There has been a clear recognition that there is a limited market for full service travel, particularly business class, beyond the key metro routes. Full service may in future be restricted to just a handful of services, or may even disappear entirely. It is driven by a decisive change in the demographic profile of the Indian domestic traveller. Whereas 5 years ago, approximately 80% of air travel in India was for business, today that figure is less than half.

This means that 2010/11 could be a very different year in Indian aviation, with Jet Airways, Kingfisher Airlines and Air India possibly being the largest LCCs in the market. The transition to lower cost operations, should allow the big 3 carriers to develop a more competitive cost structure, which is essential for their survival. Jet Airways and Kingfisher are both faced with a cash crunch and are urgently seeking to raise capital. De‐leveraging their balance sheets is a primary objective. The 3 large airline groups – Air India, Jet Airways and Kingfisher Airlines – have a combined debt of approximately USD10 billion. They will require capital raising of a further US$ 10‐12 billion over the next 2‐3 years to finance aircraft deliveries. In the short term, the carriers will need to increase equity by US$ 1.2 billion over the next 3‐6 months.

Air India: There is a clear recognition at all levels that Air India is in need of desperate restructuring and much is in fact underway in this regard. The restructuring plan is in the process of being implemented and 9 committees have been established to execute this process. The Air India management is working closely with the Committee of Secretaries, which is chaired by the Cabinet Secretary. Progress is further being reviewed by the Prime Minister’s Principal Secretary.

However, the restructuring of Air India is an extremely challenging exercise. The carrier will accumulate debt of Rs. 310 billion over the next 2‐3 years (consisting of INR160 billion for working capital and Rs. 150 billion for aircraft acquisition). Of this, around INR100 billion is expected to be raised this year, with the balance over the next 12‐24 months. The total interest servicing obligation over the next 3 years will be around Rs. 90 billion, a challenging requirement in the current low yield environment. Air India is planning to reduce annual losses from Rs. 50 billion to Rs. 13‐18 billion over the next 12‐18 months. The plan is to achieve this through an increase in revenue of Rs. 20 billion with the balance through cost reduction. With the strengthening of the market in Q3 and expectations of continued recovery, this should benefit Air India and assist with its revenue growth plans.

Air India will continue to have cash deficits for the next 5‐7 years which could cumulatively amount to US$ 4‐5 billion. Air India is expected to receive an infusion of INR20 billion from the government prior to 31 March 2010, a further INR20 billion in the next financial year and a further Rs. 10 billion thereafter. Receipt of funds is linked to achieving specific milestones laid out in the restructuring plan.

However the latter will be difficult to achieve, especially in the category of labour, where union resistance has already been encountered. In order to generate momentum, the carrier needs to achieve a few quick wins, and one area in which there has been a marked improvement is on‐time performance. There has also been a discernible enhancement in onboard and ground services, however the situation remains very precarious. Losses for Q1 2009/10 are expected to be around INR14‐15 billion. Massive restructuring will be required in order to achieve the desired financial targets as the current operating margins of ‐20% are far below industry benchmarks even in the current environment.

Plans to suspend loss making routes (most of the UK and US services fall into this category), will release up to 25% of the fleet, leaving Air India as largely a domestic and regional international carrier. The carrier intends to defer the delivery of 5 A320s and 6 B777‐300ERs, and to return up to 48 leased aircraft. A further 6 B747s will be sold to the government and 19 other aircraft (including 11 A320s) will be disposed via auction on the open market, however in the current environment receipts are likely to be depressed. Air India had placed an order for 50 B777s and B787s which are well suited to long‐haul routes, however the airline lacks a suitable aircraft in its fleet for medium‐haul operations for services to Singapore, Hong Kong or even Europe. Operating B777s on such routes could be extremely challenging to make viable, especially due to the fact that Air India has suffered from having weak commercial capabilities. However, any decision to withdraw from US/UK routes would call into question the current fleet delivery plans. Air India may need to re‐look at strategic fleet planning and acquisition post 2011.

Air India is expected to introduce its low cost subsidiary, Air India Express, on domestic routes in 2010/11, with up to 30% of capacity to be under this brand. Air India Express is also expected to take on additional Gulf routes.

Air India and Indian are still behind schedule with respect to achieving operations under a single carrier code, a pre‐requisite to induction into the Star Alliance. The continuing delays to its accession to the global alliance mean that it is a possible that Jet Airways may be considered for Star Alliance membership.

Air India’s interest burden and staff costs account for Rs. 70 billion per annum, equivalent to more than 50% of revenue. It will be virtually impossible for the carrier to make much of a dent in these costs in the short term, which means that reducing losses over the next 3‐5 years will be extremely difficult. These are compounded by the fact that the internal challenges are massive. The current Chairman and Managing Director has clearly identified the issues at the airline and has a vision and commitment to restructuring the airline, but he is faced with an almost impossible task due to the absence of a depth of talent at senior and middle management levels. He requires the support of a more capable team. While the Ministry of Civil Aviation and the Prime Minister’s Office are both very supportive of Air India’s turnaround, there are too many player involved, and continued political interference which inhibits the airline from taking the necessary business decisions to develop a viable business model.

Continued weakness at Air India could assist Jet Airways and Kingfisher Airlines, especially Jet if Air India cancels some of its key international European and North American routes.

Jet Airways: Jet has seen a strong recovery in Q3 in both domestic and international operations, which should see it achieve a profitable result for the quarter. After a rapid ramp‐up which was not supported by a robust sales, marketing and distribution strategy, Jet Airways is starting to see some stabilisation of its international operations, which now account for 62% of revenue. International load factor in Q3 is expected to be above 80%, with a particularly strong December. We expect the international operations to be consistently profitable during the 2010/11 financial year.

In the short to medium term, the carrier will continue to expand regional international routes to the Gulf and SAARC destinations using surplus B737 aircraft from the domestic fleet. However, further afield, the airline is also evaluating new destinations in the US such as Chicago and Los Angeles. The carrier’s next phase of long‐haul expansion is expected to commence from the Summer 2011 schedule, although it could possibly be brought forward to Winter 2010/11 if there is a faster than expected recovery in traffic.

On the domestic front, approximately 65% of capacity is operated under the Jet Konnect all‐economy brand, which is resulting in an improved cost structure and higher loads. CAPA believes that Jet Airways may exit the full service model on most domestic and regional international routes in 2010/11, which would be operated by Jet Konnect, leaving Jet Airways and its full service model on longer international routes and handful of key metro domestic city pairs. This strategy will allow it to compete more effectively against the standalone LCCs such as IndiGo and SpiceJet.

Despite the fact that domestic aircraft have been withdrawn for deployment on regional international routes, domestic capacity has been maintained as a result of the increased seat density arising from reconfiguration of 2/3 of its aircraft to all‐economy layouts (a 145‐seat, two class B737 converts to 189 seats in all‐economy).

Jet Airways and JetLite have a combined 47 aircraft on order (5 x A330s; 3 x B777s; 10 x B787s and 29 x B737s), with options for a further 10 B737s and 10 B787s. There have been some deferrals negotiated with manufacturers. CAPA expects that 2010 will see Jet Airways focus on strengthening its operations. Jet Airways currently has US$ 3.5 billion in debt and desperately needs to de‐leverage its balance sheet and reduce the interest servicing obligations. It has received conditional approval to raise US$ 400 million through Qualified Institutional Placements (QIPs), for which it is expected to achieve a price of Rs. 350‐400 per share.

Kingfisher Airlines: Kingfisher Airlines has seen an improvement in its operational performance over the last 2‐3 quarters. The carrier’s domestic operations are expected to break‐even in Q3. The impact of rightsizing capacity in line with demand has had a beneficial impact, however the interest burden on its debt continues to be a major challenge. The fact that a number of aircraft are grounded, especially its A340 fleet, is a further financial commitment. Yields also remain under pressure, hence it is important that the carrier restructures its cost base to a more manageable level. The increasing transfer of aircraft to the low cost Kingfisher Red brand is helping, but there may be a need to go a step further and transform domestic entirely to a single class configuration. Further right‐sizing of the capacity deployment in the domestic market is also possible.

The carrier has always had strong international ambitions, although in the short term it is more likely to concentrate on the regional international market using its A320 and A321 fleet, rather than further longhaul expansion using A330s. However, the airline is expected to launch Delhi‐London service prior to the end of this fiscal year in order to avoid losing its slots at Heathrow Airport. Kingfisher Airlines may need to re‐consider its fleet composition, particularly for its longhaul operations to North America. The A340‐500 which it ordered is unlikely to be competitive and this may lead it to consider the B777 as an alternative.

The key objectives for the airline are to reduce its interest burden, raise further equity and strengthen its senior management, particularly in the commercial and strategic planning divisions. Kingfisher needs to raise funds within the next 3‐6 months and reduce losses during the last two quarters of this financial year on order to prepare for a turnaround next year. CAPA expects that the promoters will also infuse substantial fresh capital within the next 3‐6 months, which will be supported by a diversified range of instruments such as QIPs, Global Depository Receipts and a rights issue, expected to generate a combined raising of USD400‐500 million. This will deleverage the balance sheet to an extent that will permit debt to be increased further. It is believed that a number of lenders have agreed to commit further debt after the increase in equity has been completed. CAPA expects that 2010/11 will be a defining period for Kingfisher Airlines.

IndiGo: Amongst the national carriers, IndiGo is the only carrier that has reported profits in 2008/09, however it is unclear as to what extent this is due to the contribution of sale and leaseback revenue to their profit and loss. Nevertheless, IndiGo continues to maintain a strong operational performance and is developing a reputation for consistency and reliability. The carrier has focused on costs, systems and processes. It has enjoyed an exceptional Q3 and its passenger load factor for the month of December may touch 90%, with a yield slightly higher than SpiceJet at INR3,300‐3,400. It is expected to deliver a profit for the current financial year but may face challenges next year due to the increased low cost competition from Jet Airways and Kingfisher Airlines, who will be able to leverage their brand strengths in the no‐frills segment. However, IndiGo has the advantage of reportedly being debt free and it has arguably the lowest cost structure in the industry. The carrier is planning to expand its fleet by 6 aircraft in 2010/11.

SpiceJet: It had a profitable Q1 in 2009/10, although this was negated by losses in the second quarter. The airline has achieved a very robust performance in Q3 with a passenger load factor of 80% and higher, and an average fare of just under INR3,300. Subject to a good result in Q4 (ie. a load factor of around 78% and an average fare of close to INR3,000), SpiceJet could achieve break‐even for the current 09/10 financial year.

The airline is however expected to deliver consistent profitability in 2010/11. SpiceJet becomes eligible to commence international operations from May 2010 when it completes 5 years of domestic service. The carrier has indicated plans to take‐up this opportunity, however it may be better advised to concentrate on stabilising its domestic operations first before embarking on international which can be extremely complex and place additional pressure on management. Internal challenges continue at the carrier, particularly at the Board level, and management is not as strong as some of its competitors, with some gaps in execution having been observed. SpiceJet is likely to be a key player in the expected consolidation in the industry, and has been driving this agenda.

GoAir: the smallest of the independent LCCs, is either expected to exit the market or induct a new financial partner. Discussions with a Kolkata based investor are reportedly at an advanced stage.

AIRPORTS: India’s airports have suffered from decades of neglect and underinvestment. When the Naresh Chandra Committee presented its report to the Ministry of Civil Aviation in November 2003, it remarked frankly that the country’s “passenger airports are for the most part an embarrassment”.

The inadequacy of the state of airport infrastructure was exposed as air traffic expanded dramatically from 2004 onwards, pushing several metro airports to well beyond their design capacity. Congestion in the terminals, on the runways and in the air, resulted in a deteriorating passenger experience and an increasingly inefficient (and costly) operating environment for the airlines. Recognising the potential for airport infrastructure constraints to stifle the aviation industry, in 2005 the Government of India announced a USD10 billion airport upgrade and modernisation programme over 5 years to 2010. A further USD20 billion of investment is expected in the following 10 years. Acknowledging that it possesses neither the expertise nor the capital to carry out such an undertaking by itself, the government has invited private sector participation in the process, with JV operators now in place at Delhi, Mumbai, Bangalore, Hyderabad and Cochin. All other airports remain under the control of the state‐owned Airports Authority of India (AAI).

Non‐Metro Airports: The government had identified 35 non‐metro airports for upgrade and modernisation with initial plans to complete all work by 2009. However, due to the slowdown in traffic over the last year and issues related to fund raising, completion has been delayed. It is now expected that work at 8‐9 airports will be completed by March 2010, and at a further 4‐5 airports by the end of 2010. The target is to have modernisation of all 35 airports completed by 2012.

It was also earlier intended that private sector participation would be invited in terminal operations and landside commercial development. However, it has subsequently been decided that terminal and cargo operations will be retained by the Airports Authority of India and only landside development will be opened to external parties. Tender documents for 10 of these non‐metro airports are expected to be issued shortly.

Greenfield Airports: The Greenfield airport projects most likely to progress to the tender stage in the near future are Navi Mumbai and Mopa in Goa, with Request for Proposal documents expected to be issued by March 2010. Navi Mumbai, which will be the second airport in Mumbai, is critical to ensure that sufficient capacity is available to serve India’s commercial and financial capital. The current airport in the city will reach capacity within the next 5‐7 years, with no opportunity for further expansion thereafter due to physical constraints.

Navi Mumbai airport is expected to be operational by 2014‐15, although the City and Industrial Corporation which is responsible for the development of Navi Mumbai, is pushing for completion a year earlier. The airport will have a capacity of 10 million passengers per annum at the time of opening, increasing to 65 million by 2030. Presently, 57% of the required land for the airport has been acquired, with the balance in the process of being transferred. The process will involve the resettlement of 3,000 families. A key obstacle to the development of the airport has been environmental considerations due to the fact that the proposed site falls within a coastal protection zone. An Environmental Impact Assessment is to be carried out by the Indian Institute of Technology Bombay.

Other Airports: In addition to the 35 non‐metro airports already identified, the AAI plans to modernise a further 13 airports and operationalise another 32 facilities which are currently not being utilised. Meanwhile, the upgrade of Kolkata and Chennai airport by the AAI continues, although costs have exceeded initial budgets. It is expects that a greenfield airport project may be announced for Chennai during the next financial year, which raises questions about the investment currently being ploughed into the existing airport.

Private Airports: The private operators of Delhi and Mumbai Airports are currently focused on achieving their deliverable targets for the Phase 1 of their upgrade projects ‐ however the very high revenue shares which they have committed to the government (46% in the case of Delhi and 37% in Mumbai) is hurting their financial position, given the traffic slowdown at a time of high capital expenditure. The structural shift in the industry towards low cost airlines will also have significant implications for the business models and infrastructure requirements for the airport operators.

OUTLOOK 2010

After a turbulent couple of years, 2010 should be a more positive year for Indian aviation, provided that the airline can remain disciplined on costs, capacity and pricing. CAPA projects the following key themes for the year ahead:

Domestic Traffic: Domestic traffic is expected to post expansion of 15% or more in 2010/11 as the industry returns to its long term growth trajectory. This is higher than the expected increase in capacity of just under 10%, which should assist carriers in achieving higher load factors and improved yields. It will be important for airlines to maintain capacity discipline and to keep control of costs, especially since fuel prices remain the great unknown and which continue to remain a constant threat to the industry. Airlines should not allow growth to distract them from focusing on restructuring their operations and profitability;

LCCs: The domestic market may become almost entirely low cost, as Jet Airways and Kingfisher Airlines transition to a largely all‐economy model. However, the lead performer in the market is expected to be IndiGo which has maintained the best focus on operational performance and costs;

International Traffic: International traffic (which has remained positive even during the downturn, particularly outbound travel) is expected to grow at 10‐12%. Yield in both economy and premium classes are expected to be firmer. Premium volumes and revenue overall are likely to recover faster ex India as opposed to inbound.

Financial Performance: The airline industry will return to profitability, although it will be some time before the accumulated losses of recent years are reversed. The private carriers (ie. excluding Air India) are expected to achieve a combined profit of US$250‐300 million in 2010/11;

Yields:It is expected that domestic yields will increase by 5‐7% in 2010/11 and possibly by as much as 10% in Q3 of next year, which will be the most profitable. Maintaining yields will be key and it was the loss of focus on this parameter that has contributed to the industry’s current difficulties.

Air India: Air India’s restructuring is likely to result in industrial action at various levels, which will be a major challenge for the carrier. The airline will continue to post losses. Completion of the merger between Air India and Indian under one code is unlikely to be achieved in 2010, although there will be one balance sheet under NACIL. Weaknesses in the organisation capability will a key challenge for Air India;

Jet Airways: is expected to achieve a full year profit in 2010/11. The key objective for the airline is to de‐leverage the balance sheet and reduce its interest burden. There also needs to be strategic clarity regarding its LCC strategy. The dual Jet Konnect and JetLite brands create operational inefficiencies as well as confusion within the market and it is expected that these will be combined in 2010/11 following the resolution of ongoing legal differences with the Sahara Group. A private equity investor or a public listing may be considered for JetLite in 2010/11;

Jet’s management is currently top heavy and there needs to be a re‐shuffle to ensure that the key executives remain closer to the frontline. The rapid growth of the last 5‐7 years and the attention that has been required for the international expansion, have resulted in management becoming more distant from the daily issues faced by the staff. The current acting CEO, Mr Kardassis, who was instrumental in Jet’s early success, is known to be a people’s CEO, and this will be an important quality. He will need to move quickly to re‐engage the staff.

Furthermore, a new challenge is emerging with the transition to low cost services on domestic routes – the group now operates quite different airlines, one a premium, full service international airline and the other a domestic LCC under the same management team. These are different businesses and require different organisational and management structure. Jet Konnect and JetLite need LCC cultures which the airline does not currently possess, and developing one from within a legacy airline is a major challenge. However, if this can be achieved over time, having separate management teams for full service and low cost business models could prove to be much more effective.

Kingfisher Airlines: is expected to achieve profitability in its domestic operations in 2010/11. The key requirement for the carrier to achieve this will be to maintain discipline in pricing, capacity and costs. Restructuring to reduce its cost base will need to be more aggressive than has been seen to date, and to ensure that this is implemented requires the appointment of a dedicated CEO and COO. At a balance sheet level, the carrier, like its peers, must induct additional equity and reduce the interest burden;

SpiceJet: The LCC is expected to post a full‐year profit in 2010/11, although poorly planned or premature international expansion could jeopardise this. With some stability now restored in the market with traffic and yields returning, there is an opportunity for the carrier address some its weaknesses in middle management. The Board also needs to play a more strategic role and this may require the induction of independent directors with specific domain expertise.

IndiGo: IndiGo has a clear leadership position in terms of operational consistency, the lowest cost structure in the industry, a positive brand image, huge supplier credits and is reportedly debt free. However, the challenge in 2010/11 will be to maintain this position and to continue its standards of operational excellence. It will need to retain talent and build upon its corporate culture as the airline grows further. The airline has shown discipline to date and it will need to continue to do so in the face of intensified competition from the Big 3 airlines who are each turning low cost.

Consolidation: Consolidation of airline operators is both desirable and inevitable, and market exit is also possible. SpiceJet will be a key player and is likely to be involved in any developments. Jet Airways will be open to opportunities which would allow it to once again dominate the domestic market.

Courtesy: Center for Asia Pacific Aviation

Indiabiznews, December 24, 2009