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.

Out of the Ordinary Saga of Spicejet.

There are at least 8 budget carriers which regularly fly across the skies of India. As per a recent IATA disclosures, air travel in India has grown by more than 20 percent last year. In comparison, passenger traffic in China rose about 10 percent and less than 5 percent in the U.S. India is one of the key sources of aviation industry growth globally.

Aviation in India also poses numerous risks. Various airlines have fallen due to one reason or the other. ATF taxes, tariffs, low fares, to name a few. As many as 17 airlines in India have been shut down in the past 20 years. Accumulated losses of operating airlines have reached Rs 600 billion ($8.9 billion), as per a research paper published in June 2016 by consulting company KPMG and the Associated Chambers of Commerce of India.

One of such airlines, Spicejet, was on the verge of extinction till 2014. Its flights were regularly being cancelled; it was just struggling to survive. Its creditors had retreated, debts had mounted.

Liquor baron Vijay Mallya’s Kingfisher Airlines Ltd. had earlier flopped miserably in 2012. Mallya defaulted on payments to its lenders, vendors, airports and staff. Today, he is forced to assume an ostrich like position.

SpiceJet was almost about to tread the same path in December 2014. It was forced to ground its fleet for one day. Oil companies had refused to fill its aircraft on credit.

In 2016, less than two years later, the story is vastly different. Fortunes of the company have seen a remarkable turnaround. Spicejet’s customers and investors did not betray it. Today, Spicejet has bounced back in style. Its share prices have become more than 3 times in 1 year. (What more can an investor ask for ! ) It is compared with a 1.2 percent decline in the benchmark S&P BSE Sensex.  The signal was there for everyone to see that its co-founder Ajay Singh’s has returned to the helm. Enter Ajay Singh, exit Maran.

Read : Spicejet Shares Might Jump Another 300%

Stake for Spicejet.

Spicejet appears keen to catch up with IndiGo. It is believed to be looking to order close to 100 new aircraft. It is looking at all options for its ambitious fleet expansion plans.  Spicejet needs to ramp up its 43-plane fleet as soon as possible to pose a challenge to its competitors – IndiGo, GoAir and others. IndiGo presently has 38.5% market share with its 108-aircraft fleet. It has placed orders for 430 more Airbus A320neo planes, with an ultimate target to build a 1,000-jet fleet !

Read : Indigo in 100 Aircraft Club; Spicejet in 150 Aircraft League!!

Spicejet’s recovery also reflects a boom in Asian air travel. It has given a bright spot for the plane makers of the world despite recent events, like last month’s so-called Brexit referendum, that have impacted the financial markets. Asian airlines were set to give big boosts to both the biggest plane makers of the world – Boeing and Airbus.

  • China’s Xiamen Airlines slated to buy 30 Boeing 737 Max 200 planes valued at $3.39 billion at list price.
  • India’s GoAir to purchase 70 more A320neos worth $7.5 billion.

Both Boeing and Airbus are upbeat for the aircraft market over the next 20 years. They see a demand driven by a growth in travel, especially in Asia. They estimate that Asia will account for nearly 40 percent of demand.

The Chicago-based company, Boeing: It expects demand for 39,620 new planes worth $5.9 trillion over the next 20 years.

Europe’s Airbus Group SE Airbus: The Company forecast demand for more than 33,000 new planes worth $5.2 trillion. By 2035, the world’s fleet will have doubled from 19,500 to nearly 40,000 planes.

Read : Airbus or Boeing: Whosoever Delivers early, wins Spicejet’s Order

Stake for Boeing.

A Spicejet order like this would be the key for the U.S. manufacturer Boeing. It is lagging behind Airbus in India’s burgeoning budget-airline market.

Segment leader IndiGo and the local units of Singapore Airlines Ltd. and AirAsia Bhd., have only Airbus jets. They have dampened Boeing’s prospects in India’s market.

Stake for Airbus.

“Airbus enjoys 70 percent market share in India and most Indian carriers are growing their business with us,” said Airbus spokesman Justin Dubon. “We’d be delighted to help SpiceJet too.”

Apart from Boeing and Airbus, Spicejet is also going to buy 50 small planes. “The Indian market can absorb as many as 60 narrow-body aircraft a year,” said KPMG’s Amber Dubey, adding that Prime Minister Narendra Modi’s push for regional connectivity will help expand the flier base significantly. “Looking at the delivery schedule of existing orders, there’s clearly space for more,” he said.

Thus, 3 other plane makers – Bombardier Inc., Brazil’s Embraer SA, and the Avions de Transport Regional, or ATR, are in a separate race for more than 50 smaller planes that SpiceJet is buying.

Bombardier Inc. is enjoying a revival with its C Series narrow-body jet starting service and winning a benchmark deal with Delta Air Lines Inc.

Spicejet is now in a position to dictate terms to the plane makers of the world. Today the situation is that the biggest such players – Airbus and Boeing, along with other plane makers are trying to appease Spicejet to win a potential blockbuster order worth $12 billion (approx). Both Boeing Co. and Airbus Group SE are eager to supply SpiceJet with as many as 100 planes with hefty discounts as per speculations that negotiations have intensified in the past few months.

“Losing SpiceJet would be a big blow to Boeing,” said Amber Dubey, “SpiceJet Chairman Ajay Singh knows this and hence is perhaps having interesting conversations with both.”

Win-Win situation for Plane Buyers.

It is now clear that the Airplane market has now become the buyers’ market. Thanks to aggressive Indian buyers like IndiGo, GoAir and Spicejet. They dictate terms now. The sellers have no option but to negotiate hefty discounts. This precisely is the situation where the saga of Spicejet has reached. Sitting comfortable.

All these airline operators now need not worry about the day-to-day operations of the aircraft and any possible frequent fare-war. A major part of the Investment can be easily recovered through the resale of the machine. It will surely return attractive profits. 

Operating an aircraft may not yield any noticeable profit, but reselling it surely will.

Thus, an airline might consider itself becoming an Airplane dealer!

However, the catch is : One must possess the money required to be paid as advance while confirming the order.

Bizarre Story of VRL Logistics: Will its Airline Idea Prove Deadly ?

Not many airlines in India have succeeded. This is a well known fact.

In 1992, the airline business in India was opened up to private companies. 6 private airlines—Damania Airways, Skyline NEPC, Modiluft, East West, Gujarat Airways and Span Air—started operations, but could not last more than five years.

Religare Voyages Ltd, which ran Air Mantra, stopped operations within 8 months of operations in March 2013, owing to very poor response.

MDLR Airlines Pvt. Ltd, the only regional carrier that started operations in 2007, stopped flying after 1 November 2009.

Others such as Star Aviation Pvt. Ltd, ZAV Airways Pvt. Ltd, Jagson Airlines Ltd and King Air Pvt. Ltd, were licensed to fly as regional carriers, but none of them could survive.

In 2014-15 Ventura Airconnect flew its aircraft for 541.08 hours and carried 4470 passengers only which indicates less than 56% occupancy. The company struggled to break even despite government’s subsidy support.

Other airline operators operating currently do not have any  exciting business story to tell.

The numbers of Air operators and aircraft have shown a down trend.
The numbers of Air operators and aircraft have shown a down trend.

Against such a dubious historical background of India’s aviation, Hubli based VRL Logistics’ promoters decision to launch a Regional Airline did not go well with its investors.

Businesses of current Air Operators can not be termed as brisk.
Businesses of current Air Operators can not be termed as brisk.

VRL Logistics has been into passenger and goods transportation business. It is also a parcel delivery service provider and has interests in wind power generation and air charter operations.

In 1983 it had 8 vehicles and a modest turnover of Rs 2.8 million. Its goods transportation fleet includes 3,872 owned vehicles, and passenger transportation fleet includes 381 owned vehicles as on March 2016.

downloadThe company was listed on the bourses on 30 April 2015. Till May 23, 2016, VRL Logistics’ stock (52-week H/L — Rs 478.70/253.00) had gained as much as 92% from its issue price of Rs 205 per share. It was being traded at an impressive 26 times estimated earnings for the current fiscal year.download (9)

But, on May 24, 2016 the stock hit the lower circuit in the early trade. It fell 20% to close at Rs 315.10 per share on the BSE, giving up most of its gains followed by another 13 percent slump the next day. In those two days, the company’s market cap fell to Rs 25,130 million which had risen to Rs 42,550 million in August 2015.

By June 2, 2016, the share price had reached Rs 268. It somehow recovered later and reached Rs 282 level by June 7, 2016. Now trade analysts see it as a good BUY. Till April 21, 2016, analysts had suggested BUY @ Rs 433 !! 

The Fall. Prime Reason: The company’s promoters—Vijay Sankeshwar and Anand Sankeshwar—decided to venture into the Regional Airline Business through a separate company. They own a 69% stake in the transportation and logistics firm. 

images (5)The performance of VRL Logistics shares indicates that investors had great hopes from the stock. Investors had anticipated that VRL Logistics would be a consequential beneficiary of pickup in domestic macro and the roll-out of the much awaited tax reform, GST (goods and services tax).

But the news of promoters venturing into aviation came as rude shock to investors in VRL Logistics. They seem to have been disenchanted by the promoters’ aviation plans. Investors worry that the promoters may resort to selling their 8-10% stake in VRL in order to raise funds for the airline business. An estimate indicates that the promoters might have to sell 9.5 – 10.5 million shares of VRL.

The promoters had hinted a few days ago that they do intend to enter the civil aviation industry by incorporating a separate company to undertake the business of a regional airline.

But after May 24, 2016, when the shares of VRL Logistics fell sharply, the company and its promoters have been coming up with clarifications in an effort to calm the investors.

Sunil Nalavadi, CFO, VRL Logistics: “The promoters want to start this business in their individual capacity.”

Vijay Sankeshwar, Chairman and Managing Director: “The proposed regional airline venture would be a personal investment and would not impact the firm’s balance sheet. The investment in the airline venture will be about Rs 14,000 – 15,000 million. Out of that, I may dilute to the extent of Rs 3,000-4,000 million worth of shares over a period of next 3 years. A further Rs 10,000 million will be debt to fund the regional airline business.”

In a release submitted by the company to the stock exchanges, he has mentioned that he would primarily play the role of a financial sponsor for the planned airline business. The proposed airline business when set up would be run by professionals with strong sector experience.

To soothe the investors’ sentiments further, Vijay Sankeshwar has stated that the said airline proposal was at a very premature stage. “We remain the largest shareholders of VRL with a 69% stake in company today and do not anticipate our stake to significantly decrease in the company. VRL Logistics will continue to be the primary focus and interest of promoters and I will continue to be in full charge of the day to day operations.” Sankeshwar has said.

The popular perception in India is that no regional airline has been successful so far in India. Its business is enormously different from that of the goods/passenger road transportation because of several inauspicious factors.

Against this backdrop, and with the recent Vijay Mallaya experience, the bankers, too, are less generous in extending funding to any new airline venture. The lenders may ask for bigger security margin.

Will VRL Logistics foray into aviation meet with the same fate as the earlier airlines? Vijay Sankeshwar does not think so. He has different ideas and has maintained that the airlines that ran into huge losses or shut down did not lay their plans properly.

He is currently finalising plans to start a regional air carrier from Bengaluru. He sees a huge potential in the Regional Aviation business as air connectivity in South India is inadequate.

VRL promoter Anand Sankeshwar sees room for another player in world’s fastest growing aviation market. As per Anand, lower crude oil prices, growing passenger traffic, and the emergence of regional airports supporting travel to tier-II and III cities make India attractive for Regional Airlines business.

According to Sankeshwars, the opportunities in the airlines business were phenomenal and they were excited to be a part of the fastest growing aviation market in the world.

The media did raise the natural question – “What would be the preferred airline model”

Vijay Sankeshwar has replied, “Definitely not Kingfisher Airlines. I will create my own business model.”

Stories like that of the Kingfisher Airlines, do not seem to deter VRL Logistics promoters’ resolve. “My principles of cost focus and high utilisation have made us a leader in domestic transport, which I think are key attributes to succeed in the aviation sector as well. Spike in oil prices and shortage of pilots can play spoilsport,” Vijay Sankeshwar has said.

21_Kapil-Kaul-1Kapil Kaul, CEO (South Asia) at aviation consultancy firm CAPA India, agrees that there are significant opportunities in regional aviation, but cautions that promoters tend to underestimate the long-term needs of the aviation business.

Craig Jenks, president at New York-based aviation consultancy firm Airline/Aircraft Projects Inc., noted that India still has limited surface connectivity, including for short-medium distances, which leaves room for regional airlines.

1464065481VRLPresently, VRL Logistics is also involved in Air Charter operations. In 2008, VRL Logistics had diversified into Air charter business and purchased a 6-seat twin-engined Premier IA aircraft from Hawker Beechcraft Incorporation. In 2013, the company added one more Aircraft to the Air Charter business. Its brief particulars are:

Rs in million
As on 31/3/2015 As on 31/3/2014
Assets 358.39 381.54
Liabilities 3.49 2.03
Segment Revenue 116.84 77.51
Earnings in foreign currency (accrual basis) 39.66 24.06
Loss 23.39 21.39
Segment depreciation and amortisation 19.00 18.98

During 2014-15, the company’s Air charter activity reads as:

Aircraft Hours Domestic Departures International Departures Domestic Passengers carried International Passengers carried
Domestic International
97.33 6.42 104 4 35 0

It appears that VRL Logistics has been serving Air Charters to Corporates and HNIs only. Evidently, the company did not make any money with its aircraft. But, at the same time, it served as its status symbol, a brand image. Mere possession of an aircraft acted as an ornamental aura that boosted its core business. Herein lies the significance of aviation. 
The company has not yet reached the bigger audience, namely, the Indian Middle Class. The opportunity is there. Once tapped, the floodgates will open. The great Indian Middle Class does have the capacity to make or break a business.

Vijay Sankeshwar is well aware of all this. He has said that he was looking at having a fleet of 8-10 aircraft and that he had not yet decided on the type of aircraft or pricing. “We are still working things out and have to get regulatory approvals. We have not yet started negotiation with manufacturers,” he said.

The Sankeshwars are slated to invest Rs 13,000 million in the airline venture over the next 3 years, putting in Rs 3,000 million in equity and raising debt for the balance amount. They have repeatedly stressed that they will run it independent of VRL Logistics. They have taken this in principle decision after a lot of study and inputs from industry experts. They have already expressed their intent to enter into the new business activity in a letter to the Board of Directors.

Factors Affecting Sankeshwars’ Enthusiasm.

Despite various negatives, analysts are not so perturbed yet as they believe that VRL Logistics aviation business news has been probably blown out of proportions.

There indeed has been some encouraging positive trends in Indian Aviation in recent past. The circumstances in 2016 are quite different from those in 1992-96. The timing of Sankeshwars’ decision coincides with the announcement of India’s new policy on civil aviation. 
As on today, Tier II and Tier III cities around 300-400 kms of Bangaluru are not very well connected by air. VRL Logistics knows this very well as it has been operating its fleet of trucks and buses for the past several years in the region. 
A wide network of travel agents, warehouses, transit stations, branches are already in place who rigorously deal in movement of men and material. A number of such people could become Business Associates and may be willing to offer the requisite guarantees. Unlike a start-up airline, marketing and sales, as such, should not be any issue to worry about.
These thoughts must have been weighing in Sankeshwars’ minds apart from other facts and figures:

– The Union Cabinet is expected to clear the national civil aviation policy by June 8, 2016. The policy is likely to offer a slew of sops to Regional Airlines in the form of exemptions such as airport charges, service tax on tickets, and excise duty on aviation fuel.

– Low ATF prices,

– India has world’s fastest growing aviation market, 

– The emergence of regional airports supporting travel to tier-II and III cities, and 

– The support of agents extending buy-back offers.

The decision to start a Regional Air service in its own stronghold does make a prudent business sense as analysts point out that the apprehensions, if any, are misplaced. 

It now remains to be seen whether that decision would become a Masterstroke after it is implemented.