Airlines: The pursuit of happiness

With the global airlines industry set to lose $400 bn in revenue due to the pandemic, we have taken a closer look at the sector.

Travel and tourism sector is one of the hardest hit sectors by the global pandemic. This sector adds $8 Trillion to the world economy indirectly! Yes, you read it right. It’s more than 10% of global GDP. We’re discussing this sector’s darling – Airlines.

The airlines industry is characterized by high fixed costs, thin margins and intense competition. If this is not enough, the industry is affected by the ever-changing oil prices. The airlines have to adhere to strict regulations and safety guidelines. The demand is shaped a lot by geo-political events and the state of the economy. Lastly, the industry has witnessed multiple bankruptcies, mergers, terrorist attacks and global pandemics. To put it perfectly –

“You can’t have a mid-life crisis in the airline industry because every day is a crisis.”

– Herb Kelleher (Co-Founder, Southwest Airlines)

In this edition, we’ll look at the implications of Covid-19  on the aviation sector. Then, we’ll see what’s happening with the aviation industry back in India and then ponder upon what lies ahead for this sector and us – the consumers. So, you better fasten your seat-belts before we take off!

Airlines and Crisis

According to IATA’s impact assessment of the coronavirus pandemic, airlines across the world are expected to lose $84.3 billion in 2020 leaving nearly 25 million jobs at risk. The global revenue will come down by 50% this year from $838 billion to $419 billion.

Now, these are some big numbers. For comparison, let’s look at the last big crisis that airlines faced – the 9/11 twin tower attack. The demand plummeted post 9/11 due to shutdown of airspace and fear of flying. The airlines saw a rise in costs due to significant changes in security. The attack cost US airlines $55 billion in losses and 160,000 in jobs. It nearly took them three years to recover from that crisis. Airline executives realized the structural problems with the industry and came up with a new management philosophy and thus changing the landscapes of the domestic markets. The industry  witnessed the wholesale shift to low-cost carriers and regional airlines. If we are to draw parallels between the 2001 crisis and the prevailing pandemic situation, we have to first understand the nature of today’s crisis.

The Ongoing War with Coronavirus

Factors affecting this industry are economic situation, fuel costs and travel demand. Economists are comparing the unfolding economic downturn with the great depression and it may take at least a couple of years to recover from this. With the possibility of many shale oil companies going bankrupt in the near future, supply-demand gap may increase which will drive fuel prices up. COVID-19 has taken a heavy toll on tourism and corporate travel which drive the demand. Airfare in the popular domestic routes have been reduced by 20-25 per cent and fares are expected to remain low throughout financial year 2021 because of subdued air travel demand.

Airlines, especially low-cost domestic carriers, have been operating at very thin margins. Cash reserves of airline companies are running low and many are almost at the brink of bankruptcy. Air Deccan, a low-cost carrier, has already filed bankruptcy in April. According to the Centre for Asia Pacific Aviation (CAPA) which closely monitors civil aviation in India, the industry could bear losses of up to $3.6 billion in the April-September (2020) period. Many airlines are resorting to the options such as unpaid leaves and pay cuts. With most of the fleets grounded, many airlines have cancelled their upcoming leases. Disappearing revenues have forced the carriers to postpone their expansion plans.

As we said earlier, coronavirus is one of the latest additions in the long list of crises that airlines witnessed. The global aviation industry though seems to find its way back every time. But at home, the Indian airlines seem to be always struggling!

(Not so much) Fun Fact – ‘12 Indian airlines went bust in just 21 years!’

After reading this, there are a lot of questions that you might be having. Why do we have so many airlines in the first place? Why don’t they just exit the business? What happened with Jet and Kingfisher? What lies ahead for Air India? How can we revive this sector? Let’s deep dive into the Indian market to get our heads around some of these questions.

Why Indian Airlines are always struggling?

Indian aviation sector is one of the fastest growing in the world, with ~18% y-o-y passenger growth . As the middle class is increasing in size, more and more people are turning to the skies. IATA (International Air Transport Association) predicts India will be the third largest market globally. So, the market size makes India a very lucrative one. Let’s be honest, owning an airline is pretty cool. A lot of players have tried their hands in this sector, sadly with not so good results. On one hand, we have the numbers on our side as far as the demand is concerned, yet Indian aviation industry has been struggling over the years.

The Indian low-cost airlines spend staggering 40% on fuel alone compared to just 20-25% for US airlines. The depreciating rupee doesn’t help either. Indian government’s protectionism on this sector has also hurt the sector. Airlines were not allowed to fly on international routes, which are more profitable, due to the 5/20 rule (domestic airlines were required to have 5 years of operational experience and 20 carriers to fly overseas). This led to the rise of budget carriers in the domestic market – creating a hyper price sensitive market, which led to the fall of Jet and Kingfisher. Barring the popular routes (connecting metros), it’s unprofitable for airlines to fly on a let’s say Mumbai-Chandigarh route due to lower occupancy rates. On top of that, we have price-caps by the government as well. And, the airlines can’t just shut operation when they are making losses. There is a huge (very huge) sunk cost. Bankruptcies and acquisition are the only norms left. To get the gist, read the following excerpt from the Economic Times:

‘The truth is that the sector has also been weakened thanks to a combination of errors by both the private sector and, crucially, the government. Companies have lobbied as if their lives depended on it; governments have intervened as if their reelections depended on it. The consequence is that, for decades now, market forces have been stifled in the sector.’

Indian players – Air India, Indigo & SpiceJet

Air India is the flag carrier airline of India. Well it may come as a surprise, Air India was founded in 1930s by JRD Tata and was originally called Tata Airlines. The airline was nationalized post independence. The government has been trying to reverse its folly (by re-privatizing Air India) since the last two decades.

The airline has been making losses for many fiscals now. Air India has a debt of Rs 58000 crores. After its failed attempt in 2018 to sell the airline, the government has made the deal much more lucrative the second time. The government will sell 100% of its stake. The government will pass on Rs.35000 cr debt on a Special Purpose Vehicle leaving the airline with a debt of Rs. 23000 crore only. Air India also has a huge share in the international routes which will come handy to the buyer.

Even after all this, the sale has not garnered much interest. Apart from huge debt, Air India comes with a massive baggage of employee costs. New buyer will increase operational efficiency. That means firing current employees. That means huge backlash from trade unions. Lastly, the dark clouds of pandemic are looming over the industry. The government has deferred the sale to a later date. As a last resort, the government might be forced to shut down the airline and sell off its assets.

The two largest domestic players – IndiGo and SpiceJet – could report combined losses of INR10,000 crores across 4QFY2020 and 1QFY2021. IndiGo’s hitherto enviable free cash reserves which stood at Rs8928 crores according to Q4 results may almost be wiped out by the end of September. As passenger operations remain down globally, SpiceJet has started converting passenger planes to fly cargo which may help its financial condition to some extent. Budget carrier GoAir is on the ventilator and has extended leave without pay for many of its employees till month end.

What lies ahead – Bankruptcies and Bailouts

The picture is going to get gloomier with an imminent increase in M&A deals where only the strongest players will survive. When the demand resumes to the normal levels, the near monopoly situation may result in skyrocketing airfares. Air travel may again become a luxury for most of us. It is thus imperative for the governments to step in to save the industry.

The United States declared a $71 billion support package while the UK government subsidised 80 % of salary payments for up to three months. Countries such as Singapore and the UAE which are greatly dependent on civil aviation, have provided direct cash infusion to save key airlines.

Indian government must take global cues and come forward with separate bailout packages for the aviation industry. Minimum 6 months moratorium should be provided to the airlines and interest should be waived off during moratorium period. VAT charged on aviation turbine fuel (ATF) by states ranges from 0-30 % and it should immediately be rationalized by the central government. Perhaps it is the right time to bring ATF within the purview of GST. Government would do well to provide assistance for airport charges and guarantees for unsecured borrowings. To revitalize the airlines industry, a multi-pronged approach is required where policy support and strategic restructuring are crucial than just immediate relief measures. Private participation in aviation infrastructure and removing unnecessary regulatory barriers can be good starting points.

The future of travel!

It is a no-brainer that the pandemic will fundamentally change the way we travel. The changes could range from mandatory testing before flights to having an emergence of ‘social friendly class’ along with business and economy. Most of the experts do believe that travel is going to bounce back – it’s just a question of when. Well, one thing that looks most likely is that air travel is going to become expensive. IATA predicts upto 54% rise in air fares due to social distancing norms. The rich have resorted to exclusive travel, as the demand for private charters has been soaring. But for the mortals like us, we’ll rely on work from home, defer our future plans for a year and maybe watch ZNMD till then!