Ailing airlines need fresh equity to pare net loss

Falling crude oil prices are a big positive for airline companies.

The last few months have seen tailwinds converging for India’s airlines — such as improvement in demand and, therefore, passenger load factors (PLFs), a largely stable rupee-dollar exchange rate and, most importantly, a steep fall in crude oil prices. That would mean airlines are set to post their best operational performance in the last five years. 

Over the next couple of years, airlines are unlikely to face significant cost pressures due to lower prices of aviation turbine fuel (ATF), which accounts for 40-45 per cent of players’ operating costs, and a range-bound rupee. However, the industry is saddled with high accumulated losses and a huge debt burden and will, therefore, see the current situation as a way out of the morass that it is currently in. 

We expect only a marginal 2-4 per cent hike in ticket prices over the next couple of years, as airlines look to recoup their financial losses. 

However, rising competition will keep the price increases under check as existing players look to protect their turf from the new players. 

Domestic air traffic

The industry is likely to use the premise of an increase in demand to jack up prices. Domestic air traffic has remained almost flat at about 60 million passengers over the past couple of years. But growth is expected to soar to double digits by 2015-16, helped by economic recovery, relatively smaller price hikes and enhanced connectivity. Economic growth, after being sub-5 per cent for two consecutive years, is expected to pick up in 2014-15 and 2015-16. 

Also, the launch of new routes and direct connectivity between smaller towns will help passenger traffic growth. International air traffic growth is also expected to be slightly higher than in the past due to the expected recovery in both the domestic and the global economy and expansion of Indian carriers in the gulf region. The number of airlines operating in the Indian skies has also risen from five as of March 2013 to eight now. 

The past year saw two new airlines entering the domestic skies — Air Costa and AirAsia. However, surprisingly, despite the new entrants, aggregate PLFs are expected to improve by about 400-500 bps by 2015-16. Existing players will find it difficult to increase capacity significantly due to reduction in fleet of SpiceJet — the fleet size has come down from 58 aircraft to 37 aircraft in the current year.

 Also, we believe the new entrants will be measured and cautious initially in ramping up capacities.

Falling crude oil prices are a big positive for airline companies. We expect about 30 per cent lower ATF prices for fiscal 2016 compared with fiscal 2014. More importantly, the fall is accompanied by an improving demand scenario, unlike fiscal 2010 when the players were unable to benefit significantly due to weak demand. 

Interest burden on debt

At the current debt levels, we believe the sector will post net losses even in 2015-16, though some of the airlines with stronger capital structure will turn profitable. We believe reducing losses will be a function of airlines’ ability to sort out their capital structures. 

Today, about 15 of their revenues are used to pay interest on debt. Still, as a result of some very positive factors this year such as falling fuel prices and the stable rupee, domestic airline companies may post their best operational performance this fiscal compared to the last five years. 

At an aggregate level, we expect domestic carriers to post an operating profit of Rs.8,100 crore in fiscal 2016 — a complete U-turn from the Rs.1,500 crore loss posted in fiscal 2014. That translates into a spectacular 14 percentage point improvement in operating profit margin to around 11 per cent in fiscal 2016. The profitability will be driven by factors such as improvement in demand and, therefore, passenger load factors (PLFs), a largely stable rupee-dollar exchange rate and, most importantly, a steep fall in crude oil prices.

However, at the net profit level, the sector will continue to post losses due to high interest burden on account of high debt levels, through some of the airlines with stronger capital structure will turn profitable. To break-even at the net level, interest expenses will have to halve for the sector. 

This, in turn, will mean equity infusion of around Rs.35,000 crore — primarily for the three carriers Jet Airways, Air India and Spice Jet, which account for about 75 of the commercial aircraft fleet in India but over 93 per cent of the sector’s debt of Rs.70,500 crore as of March 2014. So, it is still fingers crossed for the sector. 

The author is Director, CRISIL Research.