Will IndiGo Continue in Air Fare War ?

IndiGo’s Results Disappoint.

In a press release dated August 1, 2016 India’s biggest LCC IndiGo reported its Ist Quarter fiscal 2017 report.

The results were so disappointing that its share price fell by as much as 7% to Rs 906 on the BSE and further by 4.3% to Rs 825 by August 4, 2016.

The market leader IndiGo had came up with such explanations as –
– Frequent and bruising fare wars have scraped away about 7% from the net profit growth,
– Low fares in a fiercely competitive market have been eroding margins,
– Competitive intensity on fares is hurting its bottom-line but it will continue to participate in such fares wars.indigo_adityaghosh

All that InterGlobe president Aditya Ghosh could state was: “We have posted yet another profitable quarter. Profitability was lower than last year primarily because of competitive fare pressures.”

The truth of the matter is, however, something else. India is one of the world’s fastest growing aviation markets; passenger numbers climbed 20% last year as there is an emerging middle class who are first time air passengers and are enticed to fly with ridiculously low fares. Air fares in India are among the lowest. India generates volume of air traffic by virtue of the affordability of such customers.

For the quarter, IndiGo’s passenger revenues were INR 39717.37 million and ancillary revenues were INR 5805.78 million. (39717.37 + 5805.78 = 45523.15)
It carried 98,51,345 passengers including 4,24,869 International passengers.
Based on this, IndiGo mentions that the average fare per passenger had been INR 4,032 as against INR 4,525 in the same quarter last year. This is one reason for a decrease in profitability for IndiGo by passenger numbers. But, the release also shows that the total income from operations had been INR 45,788.52 million. INR 265.4 million being accrued from other sources.

A320neos are more Fuel efficient.

During the quarter, IndiGo had 109 aircraft. Its each aircraft on an average flew 1192.08 hrs, and spent INR 13,674 million on fuel. ATF average prices (considering all the four metros together) had been INR 48.3 a litre. For the same period last year, IndiGo had 97 aircraft. Its each aircraft on an average flew 1068.23 hrs, and spent INR 13,477 million on fuel. ATF average prices although had been cheaper at INR 44.1 a litre.

A marked improvement in performance is visible here. It indicates that the newly inducted planes are indeed mucindigoh more fuel efficient. Despite costlier ATF, despite more flying hours, less fuel expenses per hour were incurred in this quarter as compared with the same period last year. Today, an Airbus A320 costs INR 6540 million while a A320neo costs INR 7160 million.

During the quarter, however, IndiGo’s load factor fell to 83.3% compared to 87.9% during the same period last year. In June 2016, the load factor became a dreadful 77.9%. This is another reason for IndiGo’s decreased profitability. This 4.6% decline in load factor turned out to be so decisive that IndiGo’s overall profit decreased 19.1% to INR 7466.96 million compared to the same period last year.

IndiGo admitted that it refrained from participating in fare war equally initially, but it suffered a steep decline in its load factor in June 2016 to 78% from 87% yoy. This led to a rethink by the management. It thus felt that it needed to ensure volumes growth. It is now looking to match the market fares more aggressively going forward.

Fleet expansion will be key to IndiGo’s volume growth plans. According to Kotak Securities, Indigo is aiming for a 34% increase in capacity this financial year. During the quarter, IndiGo had 109 aircraft; for the same period last year, IndiGo had 97 aircraft. But, the profits did not come as anticipated. On the contrary, there were more expenses and less income.

It is thus evident that mere operating of an aircraft fleet does not yield any notable profit. Besides, the airline is constantly under pressure to maintain its load factor at 85% while aggressively participating in a fare war with its competitors. Every airline may show a decrease in profitability for the April-June 2016 quarter due to this. They already operate on thin margins.M_Id_484285_Indigo

This raises the natural question:

Should IndiGo and other airlines raise fares to improve profitability?

Raising air fares is a sensitive and emotional issue in India. An increase in air fare results in decrease in load factor. An airline can not afford to bring this down to 75% level – the break even level. The Modi government has already made it clear that it wants to take flying to the masses. Air fares, especially last minute fares, must be lower. The state-owned Air India does offer lower last minute fares by giving discounted fares four hours before a flight in select sectors to keep its seats full. Other airlines are thus forced to match declining fares leading to continuous pressure on yield for them. More decline in air fares will impact the thin margins negatively. At the same time, to maintain the load factors at optimum levels, fare wars have become a necessity. 

The bottom-line is: Unless the airlines effect a moderate raise in air fares, they will be severely hit.

Or, they must search for other revenue earning sources.

InterGlobe president Aditya Ghosh has said that IndiGo may have to delay taking delivery of additional A320neo planes, because of the problems in the Pratt & Whitney engines. This appears contrary to the performance achieved by the newly inducted planes in this quarter as mentioned above.

When a buyer tries to postpone to take a delivery, citing one reason or the other, then in trade circles it is  often construed as an inability on the buyer’s part to pay for the balance. IndiGo clearly seeks delivery slowdown. It appears reluctant to buy the 430 A320neos it had ordered. IndiGo is to have 24 A320neos by the end of March 2017. A situation seems to have surfaced where IndiGo does not want more aircraft because IndiGo has realised that it entails more operating and enormous capital expenditures without any significant proportionate rise in income. It had less number of planes in April-June 2015 than in the same period in 2016. But it saw less profits in 2016 ! Besides, housing an aircraft in any of India’s airports is also an issue which, too, may be a costly proposition.

The saving grace for IndiGo.

IndiGo fleet’s current market value can be estimated to be at INR 7,16,580 million, though IndiGo, the biggest customer for Airbus Group SE’s A320neo jets, might have purchased its planes from its supplier after bargaining significant discounts. After further spending a sum of INR 38,784 million in a quarter on its operations, it manages to eke out an INR 7,004 million operating profit. After paying taxes, it is left with  INR 5,917.7 million net profit. This does not seem to be a prudent business activity. However, the saving grace can be provided by buying and selling/leasing of the planes because IndiGo gets its planes cheap and is in a position to sell/lease the same at a premium. IndiGo may find willing takers like Vistara, AirAsia India or others who are keen to expand their fleet size to the magical number 20 that would enable them to start International operations.

Will IndiGo lose market share by helping its rivals ?

For any airline in India, to come anywhere near IndiGo’s 10-year achievements is a tall order. IndiGo may not have astronomical operating profits to show but its stature, its brand value have grown from strength to strength in the world of aviation. Loss in market share, if any, would be more than compensated in monetary terms. IndiGo may see itself evolving into a new role of Airplane buy-sell-and-lease dealer from being just an airline operator. IndiGo would then need not get involved into market dynamics, fare wars, etc. These would be delegated to the new player. Captain Gopinath, Subroto Roy had done this much earlier and had made cool exits leaving behind the likes of Mallaya in wilderness.