Richard Branson, the owner of Virgin Atlantic Airways, once said “If you want to be a millionaire, start with a billion dollars and launch a new airline”. A detailed study of the Indian aviation sector presents numerous thought provoking questions to us.
The Indian aviation industry is standing at crossroads. A very candid opinion upon analysis reveals that the industry has been bleeding for quite a while now, with even the likes of Air India and SpiceJet struggling to survive (let alone the thought of reviving). We have analysed Air India and SpiceJet to understand the industry dynamics and per unit economics.
It becomes almost unanimously imperative to understand the industry dynamics, to gain a better grasp of the unit economics.
The airline companies don’t own the aircrafts, i.e they take it on lease. Lease is a rental agreement wherein the lessee is required to service the lease (pay interest). This means that the airlines are usually immersed in debt payments.
Furthermore, the major components of an aircraft ecosystem comprises the personnel/workforce and Air Turbine Fuel (ATF). It is important to note that India imports its airline fuel requirements, which is tantamount to foreign exchange risks since payment is denominated in terms of dollars.
Furthermore, the crude oil market is unregulated which means that strengthening of the dollar increases the fuel cost for India. An interesting analysis further revealed that fuel costs comprises 40% of the total cost for the airlines (owing to the exorbitant taxes levied by the government).
This brings us to the relevant terms in the airline industry which will also help us quantify our analysis.
Available Seat Kilometers (ASK) – Suppose, an aircraft of SpiceJet has 200 seats, and that flight is going to fly a distance of 1000 kms, the ASK is (200*1000 = 2,00,000 kms). Thus, ASK is the passenger carrying capacity of a particular aircraft. (Supply mechanism)
Revenue Passenger Kilometers (RPK) – For all obvious reasons, the flights generally have vacant seats. If, in the previous example, out of 200 seats, if only 160 are occupied, RPK is (160*1000 = 1,60,000 kms). Thus, RPK reveals the number of kms travelled by paying passengers. (Demand mechanism)
Load Factor (LF) – Dividing ASK by RPK, we get the load factor. Thus, LF in our example is (1,50,000/1,80,000 = 83.3 %). LF, basically, is the proportion of seats in a flight that generate revenue for the company. (A higher number reveals a sound picture)
We now aim to understand the unit economics of the airline industry.
The flow chart above explains the typical revenue drivers and the cost heads of an airline company. The point that needs to be understood here is that the revenues of an airline company is fixed whereas the cost of service is contingent on the day of providing the service. This means that the companies are driven towards hedging their fuel costs. They achieve this by entering into futures agreements ( i.e. Oil Futures). To further add to the plight of the companies, intense competition in the industry forces the carriers to charge lower prices and entice customers through promotional campaigns. Thus, brand loyalty/brand equity becomes a major distinctive factor in this industry.
CASE STUDY: THE NATIONAL CARRIER
Air Indiais the national carrier and operates in 60 destinations, and it became the 27th member of the Star Alliance. It was started by JRD Tata in 1915 as an airmail service between Delhi and Madras. In due course of time, it became Air India International wherein 49% of the control was retained by Air India. The airline was nationalised in 1953 and this called for government intervention into the financial and operational affairs. The major turning point was its merger with Indian Airlines which caused operational hurdles due to intensive capital spending. Post that, the government has tried to divest their stake in the airline, resulting in futile attempts with Tata’s being the sole bidder.
In the wise words of Mr. Ratan Tata, “I have been constantly telling people to encourage people, to question the unquestioned, and not to be ashamed to bring up new ideas, new processes to get things done.” Mr. Tata has been an epitome of integrity and resilience, and an industrialist since time immemorial.
In 2018, the government offered to divest (i.e, offload stake in a business) up to 76% of its stake in Air India hoping that it could utilise the money received inimproving the debt situation.
There were a lot of discrepancies and fallacies in the operation which led to such a situation in the first place. The company sat under a huge pile of debt which overshadowed any positive aspect. Furthermore, the buyer’s net worth was required to be north of Rs 5,000 Cr. which was a major turn off. Even if the government was offloading 76% stake, the bidders would not be assured of an operational independence for obvious reasons.
This year (2020), the government again expressed their interest to sell its stake (this time 100%). Out of the total liabilities amounting to Rs 60,074 Cr, the bidder would be required to acquire debt to the tune ofRs 23,286 Cr.
Furthermore, it was recently reported that Air India has reduced the monthly allowancesof its employees by upto 50%, which clearly reveals cash crunch and operational illiquidity.
Thus, Air India has not been able to capitalise on the opportunities, and the pandemic has further exacerbated their plight. The skies are turbulent for the carrier and the future looks bleak.
This now drives us to our second case study.
CASE STUDY: FINANCIAL ANALYSIS OF SPICEJET
SpiceJet has been synonymous with strong promoter backing, ever since its inception. The company boasts of operating 630 flights daily. The company leverages its brand equity to minimise its customer acquisition cost, thereby enjoying decent operating margins. As of recently, the company is the second largest Indian airline after Indigo in terms of domestic passengers carried.
Key factors affecting the company:
- Shutting down of Jet Airways
The time-slots of a company for entering using an airport is the most valuable asset of an airline. Jet airways had premium time slots in many airports, 43% of which were distributed to SpiceJet at the time when Jet Airways was declared insolvent. This increased the horizon of operations of SpiceJet, and provided it with better timings, hence being able to charge more from its customers. In case Jet Airways stages a comeback, all the slots will be taken back by Jet, which will have a negative impact on the operations of SpiceJet.
- Grounding of Boeing 737 Max Planes
SpiceJet is the largest customer of the Boeing 737 aircraft in India, with the 737 Max accounting for 13 planes in its fleet. With the grounding of the 737-Max 8 aircraft, SpiceJet had seen a drastic fall in its revenues, as the 737-Max accounted for some 70-odd routes in SpiceJet’s flight plans. The fixed cost of leasing the 737-Max aircraft also came as a blow to the company, and combined with the opportunity cost of the lost revenue, SpiceJet suffered huge losses. The company expects Boeing to compensate for the lost revenue due to the grounding of this fleet of aircraft.
- Covid-19 Pandemic
As lockdown restrictions were imposed at the beginning of the First Quarter of the Financial Year 2021, SpiceJet’s operations suffered a huge impact, but it managed to lower the magnitude of losses with the help of its dedicated freighter fleet. The Govt. of India allowed freight operations to continue despite the lockdown, and SpiceJet managed to transport 50,000 tonnes of cargo on more than 7,000 flights, cushioning its losses.
The airline is also said to have leased and chartered widebody aircrafts to cities like London and Toronto for rescue operations.
- Oil Prices
The rising oil prices have had a negative impact on the workings of the airline. Crude oil prices have been on a one-way rise since December 2018, after making a low of $42.4/barrel, and had touched rates of $65.62/barrel in the dawn of January 2020, before prices started to crash due to the pandemic. Currently, the prices of crude oil are around $40/barrel, and with operations resuming round the world and going back to normal, the demand is expected to rise, pushing the prices of fuel further to an expected $47/barrel by the end of 2021, according to a report by the U.S Energy Information Administration.
- No Layoffs
SpiceJet is one of the companies which had decided not to lay off any of its employees at the onset of the pandemic. Although salary cuts were made, the substantial cost of paying its employees had to be incurred at a time when revenue for the airline was at a bare minimum, and the only income was from the cargo operations of SpiceJet, which accounted for only 3.4% of the airline’s revenue. 
We can safely conclude that as the restrictions are being eased in more and more States by the day, SpiceJet expects a full recovery, and a possible increase in its business with the normalization of operations post-Covid.
The freighter business of the airline is also expected to grow at a higher pace than the current situation in the coming quarters, and the comeback of the Boeing 737-Max aircraft after the year-long grounding of the planes is also seen as a positive note for the business.
SpiceJet has had an increasing revenue since the past 5 years, and there was a 42% rise in its revenue from 2019 to 2020. The lockdown restrictions imposed due to the onset of the coronavirus pandemic has drastically reduced the Q1FY21 revenue as compared to the Q1FY20 revenue, and the first quarter revenue of Financial Year 2021 stands 77% down at Rs. 7098 million. This is better than other players in the aircraft segment like Indigo, which suffered a 91.9% reduction in revenue, and it can be attributed to the fact that SpiceJet continued its Freight operations, which was permitted by the Government of India even during the phase of lockdown. The cargo arm of SpiceJet, which works under the name SpiceXpress, transported 50,000 tonnes of cargo in over 7,000 flights, and helped SpiceJet earn revenue even when other airlines were restricted from flying or confined solely to rescue operations. With an easing of restrictions upon flying, SpiceJet is slowly seeing operations get back to normal, and is expected to gross normal revenues soon.
EBITDA: (Earnings Before Interest, Taxes, Depreciation and Amortization)
EBITDA is an indicator of the overall profitability of a business. The EBITDA margins of SpiceJet have been increasing consistently at par with the revenues, with the Financial Year 2019-20 EBITDA margins reported at Rs. 12739 million. The operating expenses, employee benefit expenses as well as other subsequent expenses have more than doubled in the last five years, whereas sales and marketing expenses have also dramatically gone up. In 2019, the airline had seen a 92.5% fall in its EBITDA, majorly attributed to the grounding of the Boeing 737-Max. This model constituted 13 aircraft in the fleet of SpiceJet and accounted for 20% plus of the revenue. The lost revenue plus the fixed payments for the leased aircraft, coupled with reduced operations have taken a toll on the EBITDA of the company.
Source: Annual Reports of SpiceJet
SpiceJet was initially profitable, but the trend has been reversing and the airline is now incurring losses, most recently in the Financial Year 2019-20 to the tune of Rs. 9348 million. This is attributed to various reasons, the coronavirus pandemic and the grounding of the 737-Max planes being major contributors. Depreciation has almost increased four-fold from Rs. 1175 million to Rs.4482 million, and finance costs have also increased significantly over the years. The falling EBITDA of the company along with the increasing costs has caused the net profits of the airline to plummet.
Source: Annual Reports of SpiceJet
As of June 2020, promoters currently hold 59.93% of all shares, FII/FPI holding marginally changed to 0.85% & Mutual funds holdings changed to 9.5%.
The number of FPI/FII holding stocks fell by 20 to 58 and institutional investors decreased their holdings by 1.83% whilst the number of mutual funds holding stocks remained unchanged. 
Promoters holding remaining unchanged are a positive sign despite the great losses and fall in share price caused by the pandemic. However, the number of FPI/FII holding stocks decreasing is a red flag since over the course of the same time period the overall number of FII/FPI have increased substantially in the Indian Market. 
Quarter 1, 2020: Analysis of Profits/Loss: –
Spice Jet has reported a net loss of Rs 593.4 crore in the first quarter of the current fiscal as against a profit of Rs 261.7 crore in the same quarter of the previous year, as flight operations remained suspended for most part of the quarter following the nationwide lockdown announced by the government. SpiceJet continues to include future compensations from Boeing for its 737 max aircrafts and has included 140 crores under “Other Incomes.” 
The silver lining was definitely the massive 144% year-on-year increase in cargo revenues to 236 crores. 
Figure Q1 profits for SpiceJet Ltd:
Source: trendlyne.com. Figure: SpiceJet Ltd, current ratio
The company’s current ratio has improved from the financial years 17/18 to 19/20 with an increase in 0.8.
SpiceJet Ltd has undergone a ratings downgrade from CRISIL owing to its currently stressed liquidity position. The downgrade factors in deterioration in SpiceJet’s liquidity profile, as reflected in the invocation of standby letter of credit, which remained unpaid for more than 30 days as on June 29 
Source: trendlyne.com Figure: SpiceJet Ltd Total Non-Current Liabilities in crores
Total Non-Current Liabilities have increased by 418.69% from March-2019.
Whilst having a meagre 86 crores in cash reserves as of end of march 2020, SpiceJet Ltd will need an estimated 1300-1500 crores to meet its fixed costs and sustain itself, this amount includes a 500 crores compensation from Boeing which is yet to be paid. Analysts have predicted that SpiceJet’s core debt—sans future lease rent liabilities will— could triple by Q1 FY 2021. 
However, the management remains unperturbed and is still banking on a resurgence of demand, the Boeing compensation and support from the Government as primary factors in ensuring its future survival.
Cash Flow Scenario:
SpiceJet has undertaken various measures to better manage cash flows like 1) Deferring payments to vendors including lessors 2) Renegotiating rentals and maintenance contracts 3) Rightsizing fleet size 4) Reduction in employee bill through pay cuts, leave without pay and 5) Cutting down all possible discretionary expenses.
In addition to this, the likely return of Boeing 737 Max (more fuel and cost efficient) in 4QFY21 will further aid operations. With a dedicated fleet of 11 aircrafts, SpiceJet has emerged as the largest air cargo operator in the country and the cargo operations are enabling in reducing the cash burn. Although the limited scale of operations remains insufficient to cover all costs thereby putting further pressure on the finances, SpiceJet continues to look at new revenue streams like 1) Increasing cargo operations and 2) Charter operations (including wide body long haul charters).
SpiceJet underwent a significant depletion of its cash reserves following its attempt to capture as much market share as possible following the collapse of Jet Airways. In the FY-18/19, taking advantage of the grounding of Jet Airways, SpiceJet was able to raise its fleet size to 100 aircrafts. On the network front, it began 106 new services out of Delhi and Mumbai, and signed a codeshare deal with Emirates.
Source: trendlyne.com Figure: Cash Flow from operating activities for SpiceJet Ltd
Source: trendlyne.com Figure: Cash Flow from Investing Activities for SpiceJet Ltd
This leaves us contemplating, “What is the way forward for the airline industry?”
Although the graph above shows y-o-y increase in the number of passengers, the actual picture is somewhat disturbing. According to IATA, fuel accounts for 24% of an average airline’s cost structure vs. 34% for Indian airline companies. The current tax framework that impacts fuel costs puts Indian airlines at a significant disadvantage versus other international carriers. The recent COVID induced slowdown has only added to the misery.
Furthermore, Indian carriers are expected to lose revenues to the tune of $11.61 bn during 2020, and this is expected to potentially impact 3.06 million jobs in aviation and sectors dependent on aviation. Aviation counts as a crucial support service in every economy, being an enabler of economic growth. This sector has state-imposed entry barriers, and new entrants are very few owing to the capital intensive nature of this industry. Thus, even a single airline’s exit could cast a domino effect on the entire industry.
An interesting analysis revealed that corporate travelling constitutes a major chunk of air travel demand. Now, with the advent of video conferencing platforms like Zoom and Jio Meet, online meetings have started substituting physical meetings.
Will this impact the travel demand further or is it just a temporary phenomenon?
Coming as a beacon light of hope to emancipate this industry from the operational struggles, India is expected to be the 3rd largest aviation market by 2025. Just that this sector needs due attention and relief packages to stir growth.
The Airports Authority of India (AAI) has planned a total expenditure of Rs 250 bn by 2022/23 for airport infrastructure related development projects. This includes the addition of over 270 aircraft parking bays at various airports.
The question remains to be answered in due course of time. As they say, there is always light at the end of the tunnel.