Airlines need a course correction

By Satyendra Pandey
As global aviation continues to grapple with the largest demand shock in history, India is no exception. With closed borders, demand for international air travel has evaporated. Domestic demand is showing large variability, and corporate demand is at an all-time low. The corona crisis comes at a time when the country is also dealing with slowing economic growth, rapid digitisation and constrained budgets. Add to that the asset light balance sheets, voluminous aircraft orders, a weakening currency, limited mitigation measures and extremely price-sensitive market.

At least two airlines are flying with a few days of cash, and the only certainty is that of uncertainty. The industry continues to fly, but it is locked into an unstable approach. Without a course correction—a hard landing could very well be the outcome.

Even prior to the crisis, India’s airline industry was already grappling with excess capacity and with the quality of cash-flows. This was reflected in the high occupancy factors of 88%, pricing levels and last-minute discounting. Costs were high, and the rupee-dollar equation had a forex outflow impact each quarter. Add to that the situation in the banking sector with severely constrained lending.

It also did not help that the Jet Airways shutdown continued to haunt bankers with exposure of Rs 8,500 crore, on which, they finally accepted waivers in excess of 90%. Additionally, widespread under-capitalisation, operational losses, a loss-making national carrier and all business models chasing similar demand mired the sector. Besides, the industry was not in the best of health.

The state of the industry was and is further reflected in profitability profiles—which showed large variation. The management’s focus towards a profit and loss statement, as opposed to the balance sheet, was based on the argument: we are in the growth phase. And, indeed, growth is a wonderful thing. Growth silences even the fiercest critics with perpetual growth forecasts several items can always be deferred to the future.

Yet, perpetual growth can never be a reality. What was overlooked was that for sustainable success, airlines not only have to position themselves for success but also ensure to never run out of cash. And, carrying excess cash is an item that has to be planned for. By way of access to credit facilities, by way of strong balance sheets and by way of continuously evaluating the margins.

With booking volumes falling, cash-flows became severely depressed, and airlines were forced to shore up liquidity. But asset-light business models, multiple liens on assets, sophisticated and irrational financing structures, unstable revenue streams, reduced capacity needs and declining liquidity on aircraft aggravated the situation. The only remaining options were equity infusion, bank lending or government-funded bailouts.

Equity infusions—usually a resort of the first measure—did not happen. Bank lending was also an unlikely option because with no certainty on when demand levels start to recover, banks had no basis on which to make the loans. Put simply, India’s airlines were running out of cash with limited means to raise additional funds. Consequently, the only option towards liquidity support was a government-funded bailout.

Effectively any bailout package would have to address the concern of airline cash-flows, both outflows—via waivers on charges, taxes and deferral of other expenses; and also inflows—by means of loans and grants. But, the industry kept wanting.

Fast forward to the present day, and while it is true that passenger traffic has shown a rebound, it is also true that the market situation is one where all airlines except one are tethering on edge. Cash-flow is constrained and to hold on to cash, airlines continue to hold on to refunds, delay payments, renege on contractual commitments, cancel and consolidate flights and rapidly reduce fleet.

For the airlines that counted on financing mechanisms such as the sale-and-leaseback to generate cash, the ability to induct new aircraft is limited, and cash-burn is high (again with one exception). The only silver lining is charters and cargo-volumes, which are delivering some much-required cash. Yet, these are temporary and only short-term in nature.

Between two full-service and four low-cost airlines, the national carrier is in a fragile position and lending to it is only made possible by sovereign guarantees. More than one low-cost carriers are behind on lease rent payments, and the total focus is on conserving cash as opposed to growth. The government-mandated price floors and ceilings continue effectively making revenue management an all but impossible task. As it stands, for the industry as a whole, significant challenges abound.

In this scenario, banks continue to be extremely reluctant to lend to airlines. Fragile balance sheets and very few assets further impact the ability of airlines to put up collateral against which they can borrow. And, on top of that, there are the aircraft orders.

On the macroeconomic front, while there is much debate on the GDP forecasts, everyone agrees that the GDP has slowed down. And that too significantly. This does not bode well for air travel, which is directly linked to how well the economy does. And, while there are debatable signals that the economy may once again be trending in the right direction, what continues to be a cause for concern is that the very nature of demand has changed. The metro-to-metro demand, which was dominated by corporate travel, has been decimated; the metro-to-non-metro demand which was driven by labour traffic has seen sharp declines; the non-metro to non-metro demand is seeing patterns where travellers are reverting to road travel.

The passenger volumes are trending up depending on what is used as a base. Short term memories have effectively forgotten the fact that even last year, volumes had started to show strain and repeated stimulation of demand was required. As of now, airlines are benefiting from the reduced capacity on railways and the price floors that ensure that weaker airlines are not engaged in mindless discounting. Yet, because all airlines chase similar demand, and because supply outstrips demand, the industry continues to suffer from diluted pricing power, reduced capacity utilisation and continuity of flawed practices. Indian aviation is locked into an unstable approach. A course correction is required.

Former head of strategy, GoAir. The author was also with CAPA (Centre for Aviation) where he led the advisory and research teams. Views are personal