Poised for strong growth

Private players have a pivotal role in the modernisation of airports. Timely determination of policy framework with respect to user development fee for the airports involving PPP will serve as the primary force for drawing private developers.

The Indian airport sector is in a sweet spot with strong passenger (pax) traffic for two consecutive years (first double digit growth of 12.5 per cent after two years) and economic growth led improvements in cargo movements. As a function of on-going fall in fuel prices, low cost carriers (LCCs) could add more resources to its balance sheets and full service carriers (FSCs) could cut losses.

There were some policy changes like adoption of GPS led navigation and roadmap for developing airports as an integrated hub in the last financial year. At the same time, policy directive from Ministry of Civil Aviation (MoCA) regarding approval of shared-till mechanism was a breath of fresh air for the Hyderabad Airport.

Over the last few years, lack of clarity on the regulatory front has been one of the biggest pain points for all major private airports in the country. Hence, timely determination of policy framework, especially with respect to the regulatory aspect of determination of user development fee (UDF) for the proposed PPP airports would go a long way to attract developers.

GROWTH IN PAX VOLUMES
India is the ninth largest civil aviation market in the world and ranks fourth in domestic pax volumes in FY15. The pax volumes of all airports increased by 12.5 per cent in FY15 similar to pre-FY13 levels. The pax volumes were driven by the sharp decline in oil prices and flash discounts by the airlines. India has over 400 airports, of which nearly 120 are owned by AAI. Until June 2015, the pax volumes of all airports grew at 16 per cent. With the current run rate, the total pax volumes would cross 210 million pax in FY16, and could make India the third largest aviation market after US and China in another seven to eight years. Historical number and Q1FY16 numbers suggest a strong growth for rest of FY16 and FY17.

The current recovery after FY13 crisis in pax volumes is strong and sustainable. The resistance from the airports to tide over the adverse economic scenario reinforces strong recovery path.

Freight cargo is generally one of the first sectors to signal the slowing economic condition and frail business sentiments. The decline in freight volumes carried by air transport precedes the contraction of industrial output. The historical pattern suggests that freight is an important forward indicator of passenger traffic. International Air Transport Association (IATA) forecasts India to be the second fastest growing cargo market (CAGR: 6.8 per cent) after Iran (7 per cent) over 2014-2018. The economic growth of the individual states underpins the cargo traffic growth, and there is a strong correlation between the industrial growth of the state and airborne cargo trade. The government efforts to open new airports and growing e-commerce industry augur well for the future cargo traffic.

NOTABLE IMPROVEMENTS
Major airlines´ passenger load factor (PLF, a measure of capacity utilised) in CY2015 improved over CY2014, indicating the strong performance. Although the new airlines are yet to stabilise their performance, the trend suggests reasonable full year performance. Additionally, revenue passenger kilometres (measure of sales volume of passenger traffic) and available seat kilometres (passenger carrying capacity) improvements in FY15 are attributable to the market stimulations by the domestic airlines and the consumer confidence in the business-supportive government regime. With the entry of new regional airlines, the capacity enhancements are swifter and appear more sustainable.

Although there is spare capacity, carriers´ traffic performance (CAGR: 14.34 per cent) surpassed capacity creation (12.37 per cent) over FY04-FY14. In early 2013, airlines trimmed their capacity to manage the existing unsustainable seat capacity. However, due to resilient traffic, the capacity enhancements were undertaken in FY14 and FY15. The air turbine fuel prices dropped over 35 per cent until now in FY16 and could up-tick the EBITDA margins of the airlines. CAPA report highlights that all the airlines in India generated a combined revenue of $11.1bn with a net loss of around $1.21-1.27bn (losses declined by 30 per cent on a yoy basis). Fuel costs accounted for 50 per cent of the overall operating costs for the airlines and due to adverse fuel prices, the airlines were bleeding in the past years. Looking at the existing trend of fuel prices, the fuel prices are expected to remain closer to the current levels. With the growing pax volumes, contraction of fuel prices and depreciating rupee has become a blessing in disguise for the aviation industry. These changes have altered the price dynamics of the sector in the past two years and many airlines have employed market stimulation measures to prop up demand. Given the intense battle for PLF among the airlines, we could see continued flash sales to stimulate demand in the near future.

Visible signs of improving airlines perfor¡mance were reinforced by the fall in debtors´ collection period for all the private airports. However, the chunk of the receivables (about 50 per cent to 60 per cent) continues to be from state-owned Air India.

PRIVATE AIRPORTS WORKING AS INTENDED
Five private airports (Delhi, Mumbai, Hyderabad, Bangalore and Cochin) constitute 58 per cent of the overall pax traffic in FY15. These private airports are rated fairly high in their respective pax handling capacity by Airport Council International. India plans to add over 200 airports by 2030, propped by the leisure and business travel due to increasing per capita income. Nevertheless, air travel continues to be a distant dream for large sections of the population. As per an IATA press release in February 2012, ¨The average person in the US travels by air 1.8 times per year, while in Germany the equivalent is one trip annually. For China the average is 0.2 air trips per person per year and for India it is just 0.1.¨ That said, air travel will continue to complement the other modes of transport.

All the airports have gradually enlarged their non-aero revenues´ pie. Higher footfalls in the airport have and will continue to provide salutary effect on the non-aero revenues. An integrated model of holistic development aided the growth of these airports. Retail, advertising, vehicle parking, food and beverages aided one of the private airports to offset the revenue loss due to no UDF. No complementary meals in LCCs have also boosted the restaurant sales at airports. The private airports have strong underlying demand for air travel and are well-placed to handle non-aero revenue. In some cases the non-aero revenue is even expected to comprise 50 per cent of the total revenues of the airport.

Brownfield airports´ future revenue is not only dependent on UDF but also on the realisation of commercial property development. Hence, a favourable atmosphere for monetisation of real estate would buttress the future revenues. In fact, timely realisation of revenue from real estate monetisation is crucial from a debt servicing perspective as well.

CRITICAL REGULATORY CLARITY
Regulatory risk is one of the major factors for all the private airports in India. Prior to every regulatory control period of five years, Airports Economic Regulatory Authority (AERA) evaluates various plans of the airport owner (including the timetable for delivery of capex programme works, the operating and financing efficiency of the company and the pax volume forecast over the period) and decides UDF for the regulatory control period.

Once UDF is decided, it remains in place until the end of the regulatory control period. Therefore, if any of the assumptions fail to materialise, it would create a temporary economic imbalance for the airport. For example, if the actual pax volumes are significantly lower than the forecasts, the imbalance would remain for a maximum of five years, after which it may be rectified in the next control period. Reconciliation frequency may be increased to avoid such imbalances. Absence of same tends to impact the debt servicing ability of the airports. The UDFs could be fixed through any one of the following mechanisms.

Although PPP framework had plugged the infrastructure deficit in major cities, the success of this model in the future is contingent on the proposed regulatory roadmap for these new airports. The existing airports revenues were affected when there were adverse regulatory rulings. Developers appeal in the court against these regulatory rulings, delaying the timely receipt of revenues, and thereby jeopardising the debt service metrics. Certainty of regulatory policies would create a suitable investment climate for the private developers as well for foreign investors who have stakes in major airports of the country already.

Two factors are critical for the existing and future private airports once the project is operational.

Timely decision on UDFs before every control period: This allows reasonable window period for the airport management to understand the order and appeal before the AERA Appellate Tribunal (AERAAT), if any is required.

Fixation of the time limit for adjudication by AERAAT: The entire process should be complete latest before six months of the next control period to avoid the hassles highlighted above.

Against the backdrop of disputes related to the adoption of till-mechanism, it is advisable to set the method of arriving at the UDF initially as part of the bidding process. Although AERA has favoured the single-till mechanism, considering the nascent stage of the infrastructure development in the country, shared-till could be palatable to all the stakeholders. The government´s intention to adopt shared-till mechanism for the proposed Navi Mumbai airport is a harbinger of hope for the investors.

WAY AHEAD
The government´s initiative to invite private participation in the modernisation of metro airports has benefited the stakeholders. The illustrated success of these airports indicates it is difficult to eliminate the private players´ pivotal role from the future programmes. The proposal to build new airports within 150km limit in case of congested airports is a welcome change and could stimulate sectoral growth. The XII five year plan also projects 75 per cent of the sector´s contribution to stem from private participation. That said, PPP format should be looked at carefully because metro airports are a different animal compared to non-metros. Several private airlines are withdrawing from tier II and tier III locations providing some jitters to the market. Despite grants, these non-metro airports under PPP framework may not be viable. Hence whitewashing several airports under PPP model could jam the levers of the evolving infrastructure sector. Challenges and risks encountered in the past should be adequately addressed while chiselling the next round of airport refurbishment in the country.

Till-Mechanism Description Observations Beneficial Party Single-tillBoth the aero and non-aero revenues are considered to arrive at UDF. UDF will generally be the lowest for passengers and the revenues will be lower for evelopers. Passenger Double-tillOnly aero revenues are considered to arrive at UDF. UDF will generally be higher than single-till and therefore the revenues. Developers Shared-tillSome portion of non-aero revenues would cross-subsidise the aero revenues. UDF will be higher than single-till but lower than the double-till. Adopted for a few greenfield airports in India. Mid-path for both the parties

This article has been authored by Siva Subramanian and Chintan Lakhani, Associate Directors in India Ratings & Research Private Limited.