Indian aviation flies into a perfect storm

When Iranian missiles slammed into US bases in Iraq last week in response to the killing of Iranian General Qasem Soleimani, airline executives in India were keenly following the fallout. They were on edge because a flare-up in crude oil prices—at a time when the Indian aviation industry is at a crucial crossroad—could signal not just deeper losses but also the potential shutdown of at least one leading private airline.

Two of India’s leading airlines —IndiGo and GoAir—are already struggling with repeated snags in Pratt and Whitney (P&W) engines on their fleet of Airbus 320neo aircraft, while another, SpiceJet, has been hit by the grounding of Boeing 737 MAX planes after emerging as one of the largest global customers for the aircraft, which has been in the middle of a global firestorm after two suspicious crashes.

Meanwhile, debt-ridden state-run Air India faces a possible shutdown if a second attempt at privatization fails. The aviation sector in India suddenly looks a lot like the spooked telecom sector.

Both in telecom and aviation, the clock seems to have come a full circle in the two decades since the late-1990s. Despite exits and business failures along the way, customers managed to get a relatively good deal. But that extended party seems to have come to a sudden end. With telecom tariffs going up after a long lull, the question is: will a similar turn of events play out on the aviation front too? If even one airline goes under, a capacity crunch— which surfaced following the collapse of India’s largest private airline Jet Airways last April—may re-emerge.

In their quest to capture the capacity vacuum left by Jet Airways, airlines had cut fares and added capacity, but nearly every incumbent is now facing a profit squeeze. They had also bet on ordering the latest and most fuel-efficient engines and aircraft to squeeze out a profit wherever they could. But that strategy appears to have spectacularly backfired.

Airlines are now facing either long-delayed aircraft deliveries—such as Boeing 737 MAX for SpiceJet—or tight timelines mandated by aviation regulator Directorate General of Civil Aviation (DGCA) to replace faulty P&W engines for the Airbus 320neo aircraft in the case of IndiGo and Go Air. Anticipated volatility in fuel prices is now only adding to this combustible mix.

Volatile crude prices

If the crude oil price rises by another $4-5 a barrel, another airline could go bust,” said a senior airline official, speaking in hushed tones, hunched over a table. “Airlines are finding it difficult to make money,” the official, who requested anonymity, said, adding that the situation is looking like the proverbial double whammy as airlines are finding it difficult to increase airfares due to cut-throat competition.

Airlines are likely to end this fiscal year with huge losses, hampered by their ability to raise fares even during the traditionally strong October-December quarter. Since the closure of Jet Airways, airlines have seen a couple of good quarters, followed by quarters that saw huge losses.

Indian airlines are expected to lose over $600 million in FY20 as compared to a previous estimate of a full-year profit of $500-700 million, consultancy Centre for Asia Pacific Aviation (CAPA) India said in a recent report.

The cash position of the industry remains under pressure, with corresponding risks. Most airlines other than IndiGo are precariously placed, with cash balances available—in some cases—to cover only a few days or weeks of expenses, it added.

The Capa India report assumes crude oil price to remain at $60-65 per barrel. Crude oil prices are currently trading at around $65-66 a barrel. Though tensions in the Middle East have eased a bit, matters could easily heat up again if there are any violent incidents.

Airlines are likely to remain under pressure not only because of high oil prices, but also due to the weakening of the rupee against the dollar, said Kapil Kaul, chief executive officer and director of CAPA South Asia. “Expect pricing (of air tickets) in Q4 (January-March 2020) to be soft as was seen in November,” he added.

Brent crude prices have risen by more than 30% in the last one year, while the rupee has slipped against the dollar, which has further increased cost pressures given India’s dependence on fuel imports. The burden is being felt more acutely by the country’s airlines as taxes on aviation fuel are also one of the highest in the world.

Aviation fuel purchases make up 30-50% of an airline’s total costs, which is why the simmering tensions in the oil-rich Middle East have made the country’s airlines all the more vulnerable.

“Most Indian airlines are comfortable when oil price stays at about $60-65 a barrel, and rupee at 60-65 per dollar. When the rupee or oil prices breach this mark, airlines find it difficult to control costs,” said a senior official with a New Delhi-based low-cost airline.

Faulty aircraft and snags

Problems for SpiceJet in getting deliveries of the Boeing 737 MAX aircraft—which has been grounded since March following two fatal crashes in Indonesia and Ethiopia—appear to be growing amid fuzzy timelines for an approval from the US Federal Aviation Administration (FAA).

Only last week, internal documents from Boeing Corp. showed that the company’s employees called India’s DGCA “fools” and “stupid” for having approved the aircraft earlier.

SpiceJet had ordered as many as 205 of these planes in 2017, out of which 13 have been delivered but have been grounded due to the ongoing FAA review. In the July-September quarter, SpiceJet reported a consolidated net loss of ₹461 crore, with fuel cost accounting for nearly 40% of its revenue of ₹3,076 crore.

If delivery of the aircraft is delayed beyond 2020, then the airline could potentially face more trouble, said an aviation analyst, requesting anonymity.

Its rivals IndiGo and GoAir are unlikely to fare much better due to snags in the P&W engines on Airbus 320neo planes, with frequent incidents of trouble reported every few days leading to temporary grounding of the aircraft.

“There will be a drag on capacity as well as on costs due to the problems with the Pratt and Whitney engines,” said an airline executive with direct knowledge of the matter. “It looks like the engine will take some time before stabilizing.” The problems were mainly on account of the engine being new to India, he added.

IndiGo has 98 A320neo family aircraft, comprising 91 A320neos and seven A321neos, all with P&W engines. DGCA has extended a deadline to modify older P&W engines on Airbus A320neo aircraft to 31 May from an earlier deadline of 31 January 2020. While the relaxation may help the airline to avert grounding of its aircraft, it would still have to contend with capacity challenges in carrying out the programme.

IndiGo plunged to a wider-than-expected quarterly loss during the September quarter, with higher maintenance and overhaul costs outweighing the increase in passenger traffic. The country’s largest domestic airline posted a loss of ₹1,062 crore in the September quarter, compared with a loss of ₹652 crore a year ago.

With airlines desperate to cut costs, they are tempted to often overwork both men and machines. An official at DGCA said the regulator had cautioned IndiGo about the manner in which it revved up engines on A320 planes at full thrust in order to burn less fuel. “It is wearing the engines down,” said the official.

But regulations that could hit profits always face pushback. “Any low cost carrier will fly aircraft 14 and half to 15 hours a day, including IndiGo and GoAir,” said Mark Martin, founder and CEO of aviation consultancy Martin Consulting Llc. “Airlines are bound to utilize engines as long as they can. I believe P&W will have to take responsibilities for engine woes and not airlines.”

The regulator also had to recently warn GoAir against overworking pilots and crew, potentially causing safety issues. The airline had last month cancelled several flights on successive days after it was found violating a flight duty time limitation, which lays down mandatory rest periods for the crew.

Killing each other on fares

With no airline willing to raise fares, ballooning costs mean that the sector has entered into a worrying unsustainable cycle, prompting aviation minister Hardeep Singh Puri to warn industry participants to stop “predatory pricing”.

“We can’t regulate airfares,” said Puri, adding that the market must correct itself within the “deregulated” frame. Puri, however, maintains that excess capacity is not the key reason for low fares. “There is 11% (annual) growth in the sector with about 8% penetration (percentage of population who fly). Air traffic is not slowing down,” he added.

Another airline official, who declined to be identified, said: “Airlines are reducing fares on certain routes to attract traffic. But, this is not a robust model. You have to choose between flying half empty planes with higher fares and flying full planes with very low fares. And the latter always seems more sensible.”

Industry observers say the combination of high structural costs and mindless growth is hurting the sector.

“We are all held captive to the actions of the stupidest competitors, whoever they may be on a given day. They set the price and other airlines have no option but to follow,” said a third senior airline executive on condition of anonymity. “This has been causing a lot of financial distress in the sector.”

“All it takes is one discount, and the entire pricing discipline collapses like a pack of cards,” said the executive. “And, of late, the pricing discipline in the period of a week to a fortnight before departure has vanished.”

Previously, this booking period was considered a prime time slot where discounts offered would be minimal, but the country’s sluggish economy has prompted airlines to offer lower fares, said the second airline official mentioned above. “This is not a feasible model. Casualties in terms of closure of airlines are bound to happen,” the executive added.

The high double-digit growth in passenger volumes that the sector witnessed during past years is also unlikely to be seen again in the foreseeable future. Rating agency Icra Ltd expects a muted domestic capacity growth, and domestic passenger traffic to grow under 4.5% during 2019-20, after five years of double- digit growth

“Despite the expected passenger growth over the medium-term and the ongoing cost rationalisation initiatives of airlines, the financial health of the industry will continue to deteriorate,” said Kinjal Shah, vice president and co-head of corporate sector ratings at Icra.

SpiceJet promoter and managing director Ajay Singh has said that the aviation sector could follow the telecom industry into a bloodbath due to the intense price wars among competitors, which has resulted in a low-fare regime.

There are lessons to be learnt from the current state of telecom sector and the learning needs to be implemented to improve the health of domestic airlines, Singh told CNBC-TV18 in November.

“There is a struggling public sector unit in both sectors which the government is supporting...the system is heavy on regulations and high on taxes...and the largest player has a substantial share of the market,” he added.

The maharaja’s burden

The elephant in the room, in the midst of all the turbulent weather, is Air India. The first casualty of the current climate could be the state-run airline, which most experts say may struggle to find buyers despite having attractive airport slots.

Air India’s losses have mounted to about ₹69,576 crore over the past decade, burdened not only by a large workforce but also by government obligations that require it to fly a number of loss-making routes.

For FY19, the airline’s net loss is provisionally estimated at ₹8,556.35 crore. The government is hoping to divest its 100% stake in Air India and its low- cost subsidiary Air India Express after failing to attract a single bid during a similar endeavour last year.

The process of Air India’s sale got off to a start last week, with the government approving a draft document inviting expressions of interest that is to be issued before the month-end.

While all eyes will be on how that process pans out, the state of the rest of Indian aviation doesn’t inspire much confidence. And the fate of India’s first-generation air passengers hangs in the balance.