Focus: The Indian market

Hyderabad
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India is rich with opportunities, but carriers have been struggling to make ends meet. Will overcapacity continue to outstrip the potential of this huge market?

Uncertainty, says a veteran of India's airline industry grimly over a spicy masala tea in Hyderabad, has been the only certainty for the country's aviation sector over the past few years. And looking at the roller-coaster ride Indian carriers have had, it is hard to disagree. The liberalisation of the airline sector early last decade, along with India's economic growth that led to a boom in air travel demand, led to a spurt in the start-up of new airlines.

Around 2004, businessmen who were scrambling to start carriers projected double-digit growth rates as the middle class abandoned the country's trains and poor surface links and took to the skies. Meanwhile, airframers were selling aircraft by the dozens to established and new airlines alike.

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 © Rex Features
Demand has continued to grow, but so have losses and debt levels at airlines that appeared to put business sense second to a relentless chase for market share. Full service carriers, such as Air India, Kingfisher Airlines and Jet Airways, have been forced to change business models to keep up with leaner low-cost start-ups, such as SpiceJet and IndiGo (see table).

"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," says the Centre for Asia Pacific Aviation.

New Delhi allowed new carriers to join the segment in 2003, following a worldwide trend in which a sustained period of economic growth led to a burst of activity in the airline industry. Alcohol baron Vijay Mallya started Kingfisher, promising to bring the "good times" to Indian skies by offering five-star service provided by cabin crew who looked more like models. Low-cost pioneer Air Deccan promised fares that were pegged just above the cost of a train ticket. SpiceJet, IndiGo and GoAir followed in the segment, while Paramount Airways offered business class services on Embraer regional jets.

Incumbents Air India, Indian, Jet and Air Sahara all planned new aircraft purchases and a rapid expansion of their network to meet the challenge and survive in this new climate.

Amid a growing recognition that a vibrant airline industry was necessary to help economic growth and connect this vast country, the government also began to privatise airports in larger cities and modernise others in dozens of non-metro locations.

ALARM BELLS

But, from early 2007, warning signs began to appear. Airlines, in a cut-throat rush to gain market share, were introducing aircraft at a rate of around six a month when demand was growing. Yields began to fall and high costs began to bite. Meanwhile, fares were being kept artificially low as full-service carriers tried to retain market share against the low-cost carriers. Profits were hard to come by and debt levels were on the increase.

Consolidation was pushed by the government as a panacea. State-owned Air India and Indian merged, Kingfisher bought Air Deccan to move into the low-cost market, while Jet finally acquired Air Sahara after an unsuccessful attempt to walk away from the deal. The mergers, however, were untimely and drained balance sheets.

In 2008, with fuel prices reaching $150 per barrel, rising taxes and an economic slowdown that resulted in traffic falling by up to 10%, airlines started to reel. National Aviation Company of India, which runs the merged Air India, saw its losses more than double to Rp56 billion ($1.24 billion) in the year to 31 March 2009 after accounting for the merger. Over at Kingfisher, losses increased fourfold to Rp16 billion, while Jet's losses were 50% higher at Rp10.3 billion. In the four years to March 2010, Indian carrier operating losses reached Rp260 billion - with Air India, Jet and Kingfisher accounting for almost Rp230 billion.

"The fragility of the sector - which had over-extended itself by growing at rates that it could not manage, in an environment that was not conducive to efficient operations - was exposed," says CAPA, which estimates that cumulative losses for the financial year to end-March 2011 reach Rp65-70 billion.

Full-service carriers have been the worst affected, given their high cost base and unwieldy business models that include low-cost operations and a multitude of aircraft types. They were already tottering before the crisis, but the higher oil prices and low demand plunged them further into the red.

Air India, which is expected to post a loss of Rp54 billion for the year to 31 March 2010, has received the most attention after it asked the government for a capital infusion. The state, its owner, has committed to giving it Rp20 billion in two tranches. In return, it has asked the airline to embark on a turnaround plan to cut costs and grow revenue by rationalising its fleet and network, divesting several non-core businesses and shedding jobs. The airline's problems, however, run deeper as it has historically been run more like a bureaucracy than a commercial entity.

"While the top management is keen to introduce changes that would transform the carrier and make it competitive, they have been frustrated by politicians with an eye on short-term gains, slow-moving bureaucrats and employees who are afraid of losing their iron rice bowl," says an observer.

There was a public outcry when Air India asked the government for help, but it had little choice. Highly prohibitive rules prevent it from going to the market for capital, and a much talked about initial public offering is unlikely to be successful until the airline is able to sort out its balance sheet and revamp its business model. Allowing it to fail, on the other hand, would have a high political cost, given the large number of state employees on its books. "It may be too big to fail, but it may also be too big to restructure unless there is political will to support the necessary changes," says the observer.

While Kingfisher and Jet may mutter about the unfairness of state aid to Air India, they were largely responsible for their own mess. They competed against each other viciously in the full-service segment, and then announced plans in 2008 to embark on an alliance to improve efficiency and increase profits. Nothing, however, has come of the plans. Both carriers have said the government has yet to approve the plan, but sources say they have not mooted any concrete measures either. While a merger of Kingfisher and Jet has been suggested, others say it would simply result in one large messy operation.

Jet appears to be in a better position to take advantage of the recent upturn, swinging to a net profit of Rp1.05 billion for the three months to 31 December after two consecutive quarters of losses, and a net loss of Rp2.14 billion a year before. While income from traffic fell 4% to Rp28.9 billion, expenditure fell 17% to Rp26.2 billion.

QUEST FOR INNOVATION

"As the tide turned, Jet was well positioned to consolidate its gains on all fronts," says chief executive Nikos Kardassis. "The achievement is a result of Jet's constant quest for innovation in product and service, its fiscal and marketing initiatives, the introduction of new routes, continuous effort to reduce operating and non-operating expenses."

Kingfisher, on the other hand, remained in the red during the same period, posting losses of Rp4.2 billion on top of a similar sized loss the year before. Revenue fell 5% to Rp13.7 billion, while expenditure was cut 12% to Rp17.9 billion. It appointed management consulting firm Seabury Aviation & Aerospace to help improve its financial performance.

"Seabury has been hired to come in and assist us in sustaining long-term profitability by further strengthening the operational and financial performance of the company, so that we are well poised to ride the upturn and capitalise on this opportunity using the best global practices," says the airline.

At least both Jet and Kingfisher are still in business. In a further vindication of the necessity of a viable business model in the industry, Paramount has been virtually grounded because of its failure to pay lease charges on its Embraer aircraft.

With the recent upturn, Jet and Kingfisher are likely to continue bringing in new aircraft and starting new routes. Kingfisher has also announced plans to join the oneworld alliance in 2011. While Jet and Kingfisher have converted a large portion of their domestic operations into the no-frills model, they still need to restructure their operations to compete against the dedicated low-cost operators such as SpiceJet and IndiGo.

"The most significant recent strategic development in the Indian domestic market is that it is rapidly turning low cost. An operating model that did not exist in the Indian market until six years ago, could account for almost 70% of domestic capacity," says CAPA.

"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. It is driven by a decisive change in the demographic profile of the Indian domestic traveller. Whereas five years ago, approximately 80% of air travel in India was for business, today that figure is less than half."

Both SpiceJet and IndiGo have a clear business model - they operate one class of aircraft across a gradually expanding network with an eye on keeping costs low. That has proven to be successful. SpiceJet returned to the black in the quarter ending 31 December, posting record profits of Rp1.1 billion, versus a loss of Rp179.6 million. Privately-owned IndiGo has not released its financial results, but company officials say it is in the black.

GROWTH PLAN

They plan to accelerate the induction of new aircraft and start a competition to buy new narrowbodies in the next year, for delivery beyond the middle of this decade. International services are also on the cards. SpiceJet is due to start with flights to Kathmandu, Dhaka and Colombo in June, followed by IndiGo next year. International links, however, will complement core domestic flights.

"The aim of our international expansion is aircraft utilisation, not to become a global player, as this is one of the key fundamentals of our success. Others may want to fly to the Middle East and South-East Asia, but we believe there is enough domestic demand and around India to keep our aircraft busy," says SpiceJet chief executive Sanjay Aggarwal.

There is constant speculation about a merger involving SpiceJet, IndiGo and their smaller low-cost counterpart GoAir. But all three have consistently denied that such talks are talking place.

Airbus and Boeing also say demand for narrowbodies will continue to outstrip that for other aircraft types, reflecting the optimism they have for the low-cost model. Domestic airlines in India operate 336 aircraft, with another 293 ordered and expected to be delivered over the next three years. Consultancy Ernst & Young forecasts that domestic and international passenger numbers from India are expected to increase 20% and 16% annually respectively over the next few years.

Civil aviation minister Praful Patel says growth is returning in 2010, and expects the worst to be over by the end of 2010. But numerous challenges remain, with fuel prices remaining a major worry and taxes continuing to be a bugbear. Kingfisher, in particular, has been lobbying the government to allow foreign carriers to take a stake in the Indian airlines. But infrastructure is the key challenge.

"Congestion at airports, both on the ground and in the air, has resulted in significantly increased costs for Indian carriers. The inability to schedule faster turnarounds, the need to carry increased fuel and spend more time in holding patterns has resulted in inefficient operations," says CAPA. Patel admits: "With such a large geography and with such a large population, we have only 90 operational airports. That's not enough. We need to have at least 400 operational airports. We cannot do without less and that is the challenge for us."

In the year ahead, the prognosis appears to be brighter. While domestic traffic is projected to increase by around 15% this year, capacity is likely to grow by only 10%. International traffic is also expected to grow steadily. The increase in yields should help the airlines return to the black over the next two years, and boost cashflows. Low-cost operations will dominate the domestic market, although Air India will keep its focus on the full-service segment to capitalise on the appeal of its fleet renewal plans and the strong support it gets from India's civil servants. But debt will remain an issue, and CAPA estimates that Air India, Jet and Kingfisher are likely to require up to $12 billion over the next three years to finance their aircraft purchases.

"Looking forward to 2020, the upside potential in Indian aviation is massive. India has barely embarked upon its growth path," says CAPA. "The number of trips per capita is low even by the standards of other developing countriesDespite the recent growth, less than 2% of Indians travel by air in any given year, highlighting that we have barely arrived at the threshold of the growth potential of Indian aviation."