The economics of the airline industry has always been a concern for stake holders. Deep N Mukherjee and Ashoo Mishra explore the various challenges involved in this sector.
The airline industry is a sector where reputation, skill and luck do not play a major role. A case in point is Warren Buffet who lost heavily in his investment in US Airways. The challenges for the Indian aviation industry increase further on the back of regulation driven cost inefficiencies and a nascent market. While this provides long-term potential, profitability in the short to medium term in sufficient quantity will remain a challenge. Thus, capital, such as equity, which can absorb losses over sustained period may be more suitable than pure debt.
Cyclical Downturn Disrupts Long-term Growth
Over the FY05-FY11, both domestic and international passenger volumes have seen growth of 18.5% and 14.0%, respectively. However, growth expectations were belied, to the extent that the number of passengers carried by the scheduled domestic airlines during the period January-November 2012 actually fell to 53.4 m compared to 55 m in the same period last year. The deterioration in the passenger load factor (PLF)1, given the moderation in economic growth, is not surprising, considering the hyper cyclical nature of the industry. The gap between available-seat-kilometre (ASKM)2and revenue-passenger-kilometer (RPKM)3 has increased since FY07. Any profligate plans for expansion of fleet size by any of the players may potentially de-stabilise the sector further.
PLF dipped in FY09, FY12 and during the first nine months of CY12 due to the economic slowdown. This dip would have been severe in CY12, had there been no substantial reduction in ASKM at one of the major airlines. However, no such impact is apparent in the international division as PLF continued at around 73%-78% during the last two to three years till September 2012 despite traffic having slowed to 34.5 RPKM during the first nine months in CY12 from 54 m RPKM in FY12. The major reason was that one of the FSCs (Full Service Carrier) was non-operational for a substantial part of 2012.
As such, supply of airline services cannot be adjusted in the short-term to match the fluctuating demands. This sector, with high operating leverage, could have done itself a favour by limiting the debt on the balance sheet of individual entities. The profitability impact of cyclical slowdown in demand is accentuated by the high debt levels of the Indian aviation sector, which is estimated to be around USD 20 billion as of end-FY12.
Structural Weakness Restricts Margins
Most of the Indian carriers have been booking net losses consecutively for the past couple of years which makes structural change a must for Indian aviation. Despite Foreign Direct Investment (FDI) being allowed in Indian aviation, the current structural issues make it difficult for the domestic airline industry to attract any foreign source of capital and expertise.
Taxes Stress Industry Sustainability
The major cost driver for the Indian airline industry is the price and taxes payable for Aviation Turbine Fuel (ATF) which is around 47%-56% of total revenue of airlines compared with a global benchmark of 35%-39%. As shown in the adjacent table, Indian operators pay 65% to 70% more (in USD/kilolitre) for fuel due to higher taxes on ATF at around 40%-45%. As per the Ministry of Civil Aviation (MoCA), the pricing regime of ATF in India is not clear and sometimes it moves contrary to the price of crude oil. The downside risk to operating margin increases due to the risk of rupee depreciation (against USD).
In addition, Indian air carriers are subject to relatively higher taxes on aircraft leases, air tickets, airport charges, navigation service charges, maintenance costs, fuel throughput fees and into-plane fuel charges, etc.
Higher Maintenance Cost
Domestic airlines currently outsource major maintenance repair and overhaul work to hubs like Dubai, Singapore and Malaysia. High tax regime in India like high service tax and, custom duties, VAT and octroion imported spare parts, offset the advantage of low labour costs, and constrain the development of maintenance, repair and overhaul (MRO) industry in India.
Route disbursal guidelines also put pressure on the profitability of airlines as it makes mandatory for airlines to operate on the routes that are commercially unviable.
Civil aviation must be made viable as it is the most reliant and efficient mode of transportation and could contribute to the high productivity and economic growth of the country.
Constraints to Profitable Pricing
Since majority of expenses for airlines are fixed in nature (are not dependent on the number of passengers being carried), the marginal cost of carrying an extra passenger is low which, in a competitive environment, lures the airlines to cut airfare to gain maximum market share.As such, this is a universal feature of this industry.
The other constraining factor for airfare is the availability of quality services at much affordable prices. The minimum airfare from Mumbai to Delhi in February 2013 is above INR4,500compared to AC 2 tier fare charges of INR 2,300 in Mumbai Rajdhani Express. As per MoCA, a 10 per cent rise in air ticket price results in a 12 per cent decline in demand for air services.
Operating Parameters of Domestic Carriers4 VS Global Airlines
Block hours per day per aircraft of domestic airlines which ranges between 9 -11 hours except Air India (6.1hour) are comparable with other global profitable airlines5 with utilisation of 8.5 hours -13.4 hours per day per aircraft. PLF of domestic carriers at 75%-79% is close to global profitable airlines' PLF of 77%-82%.
However, in FY12, ASKM/employee of domestic airlines is very low at 1.7m-3.1m compared to Singapore Airlines of 8.2m, Emirates Airlines of 6.0m and Riyan Air of 13.6m. Also, FY12, fuel cost as percentage of revenue was in the range of 47%-56% compared to global airlines of 35%-39%.
As it can be seen, the traffic density (defined as 1,000 passengers per million Urban Capita) of India is as low as 72 which is almost a quarter of that of China and Mexico. Domestic passengers in China were 564m in 2010 almost four times higher than India. India is expected to achieve this number only by 2023-24 (As per MoCA report 2012 which refers to CAPA). As per MoCA, India's per capita domestic trips is only 0.045 compared to China, Brazil and Malaysia's 0.15, 0.25 and 0.54 respectively which even assuming the growth in domestic passengers as stated above and a population of 1.38bn in 2021-2022, the number would improve only to 0.115.
While theoretically, the potential is huge, one needs to consider certain ground-level realities. In India, no more than top 10 per cent (still optimistic!) of the households have an ability to use airlines services. For the overall market to expand, inflation-adjusted per capita income should improve at a very significant pace to change the potential to reality. That may require a year-on-year real GDP growth rate of 8 per cent, with reasonably more equitable distribution of wealth. Clearly, the 'trickle-down' growth story is unlikely to benefit the aspirational level of growth of the Indian aviation industry. Given the operating cost related challenges and the inherent cyclicality of this sector, the debt tolerance of the Indian aviation sector may actually be much lower than even some of the emerging nations. Rationalisation of regulations and higher equity infusion (as opposed to debt) may be required to see this sector come out of the current 'air pocket'.
1 PLF = RPKM/ASKM
2. ASKM = aircraft capacity (Available Seats) x Distance (Kilometres travelled)
3. RPKM = distance travelled x passengers on board
4. Includes only SpiceJet, Jet Airways, Kingfisher Air¡lines and Air India
5. Reference is to Singapore Airlines (standalone), Emirate Airlines, Air China and Riyan Air