Airliners-India.com

selecta · Member Joined: 24 Dec 2006 Posts: 813 Location: ORD

Even after taking a beating, airline stocks hold promise. A look at who could have the flights of fancy

Rajesh Naidu
The Financial Express
source

On a normal Monday morning at the Mumbai or Bangalore airport, you could see a crowd building up. By peak hour, the airport resembles a railway platform where passengers are clamouring to board the airplane and get a seat.

The airline industry in India has now been able to lure the critical mass of travellers who now prefer flying than travelling by rail. India’s domestic air travel has grown to 25.5 million passengers as compared to 10 million a decade ago. And the habit is only going to increase at a faster pace with the Centre for Asia Pacific Aviation (CAPA) estimating 60 million passengers by 2010.

A mix of a rising upwardly mobile population and a host of low fare carriers (LFCs), who have closed the gap of air travel with upper class rail fares, have caused the surge.

However, beneath this exciting potential lies a grim reality. Airline operators are grappling with the predicament of running a profitable operation. A cliché on Wall Street in the US is that the quickest way to becoming a millionaire is to be a billionaire and then buy an airline. Investors in India might be getting a sample of this.

Two of the three airline stocks have plummeted in the past year. After attracting much attention, the share price of Jet Air and Spice Jet have lost ground by around 17% and 21% respectively. Deccan Aviation has, however, recorded a 48% gain in share price since its launch during the turbulent market in June 2006.

While many analysts attribute this gain to the competitive pricing that Deccan had to offer investors during the market meltdown, others attribute it to a larger trend emerging in the Indian industry -- running an airline with the LFC model.

Newer skies

Globally, LFCs have been exemplary performers in the aviation sector. So will the LFC model work in India as well?

Says Sidhant Sharma, CEO, SpiceJet, “In the long-run, this is the only model that will stimulate air traffic in India.”

LFCs have the unexplored 49 million upper-class rail passengers as against 19.4 million air trips in FY06E in terms of conversion. In fact, it is also estimated that by FY08, the air- to-upper class rail passenger conversion ratio will increase to more than 75%. In this, the LFCs are slated to play a stronger role.

The trend is getting clearer. LFCs have been rapidly grabbing a sizeable market share in the Rs 25,000 crore Indian aviation market comprising domestic and international travel. In December 2006, the share of full service carriers dropped from 84% to 65%, while that of LFCs increased substantially from 11% to 35%.

GR Gopinath, MD, Deccan Aviation, a pioneer of sorts for the LFCs, adds, “In 2006, full service carriers were on an average bleeding more than 1.5 % of market share per month to LFCs. By the year 2010, LFCs will have control over 70% of the total market share which gives a clear idea of what the future has in store. Low cost is the way to go.”

And this makes sense considering the fact that all major full-service carriers are trying to protect their bottomlines in the face of competition from low-fare carriers. More so, it is believed that the LFCs will flourish more if they launch regional or state-level services scattered all over the country.

No-frills structure

Essentially, it is the model itself that lends to pragmatic operations, rather than the glamour attached with running an airline.

The Damanias and Modis figured this out quite quickly in the early nineties when the sector was thrown open to private participation. Regarded as a threat to the incumbent Indian Airlines (now Indian), the fancy airlines had to beat a hasty retreat when they could not match up.

It was in 2003, that the LFCs made an entry with Deccan leading the way with eye-catching promotional offers and aggressive advertising. Beneath the initial LFC hype is a sound business proposition that can cheer investors.

The LFC model entails two major things, one is cost efficiency and other being expansion in a phased manner. The key enabler here is the technology that simplifies operations supports containing the costs.

An ICICI Securities study claims that the LFCs save as much as 33% on key costs as compared to the Full Service Carriers (FSCs), by leveraging technology. This in turn allows the airline to be competitive on the fares front and attract passenger traffic.

A higher load factor, or seat capacity utilisation, a key metric in the airline business, is successfully impacted.

To boost the load factor, savvy ticketing tactics like pre-selling at huge discounts add up. LFCs like SpiceJet ensure that last day fares are higher than fares on tickets booked in advance.

And this results in forward sale of tickets generating cash and it gives a better picture for demand. Also, pre-sold discounted tickets do not get a refund on cancellation. Insiders suggest that airlines make a nifty packet from such cancellations.

Not just pre-selling, but savvy use of data mining and passenger flying patterns across locations allow airlines to offer extremely low cost fares with a view to utilising capacity on empty flights.

The cash generated from the business is then ploughed back to enhance the fleet. This leads to earnings growth in the long-run. And this cash register can ring better once the government scraps the 15% inland travel tax, reduces excise duty on fuel to 8% from 16% and the landing charges by 15%. The players are also banking on the new civil aviation policy to raise the FDI to 74% for domestic carriers. This will enable them to build capacity and expand.

However, the flip side is that this capacity build-up could then threaten the profitability numbers.

Full hangar

It is estimated that the capacity increase by 2010 could be 350%, far outpacing the passenger rise of around 250%, resulting in an over-capacity. A direct impact of over-capacity will result in a price-war. Recent developments have seen a move to cartelise airline fares.

Analysts, however, reckon that overcapacity should not bother airlines too much.

Rati Pandit from Networth Broking justifies, “Players in the sector are slowing down their expansion plans. Take for instance, Air Deccan. It has reduced its delivery of aircraft from 11 to 4 this year.”

This measure, along with capacity diversion from domestic to international routes and also entering into a cargo business, is a good option for players to tackle over-capacity.

However, competition is heating up in the international markets as well with the UK and the US routes being jam-packed and international LFCs are threatening to enter the lucrative Gulf route.

Cargo, then, is considered to be a line of business that could bail out airlines. In fact, for the past decade, Air India has been earning purely from its cargo operations. It has rarely achieved break-even load factor from its passenger business over the same period. Little wonder then that Deccan is eyeing this sector closely.

Constant craving

While there will be opportunities on the revenue front, the craving for cost cutting will have to be consistent; only the nimble and fleet-footed will have the ability to survive. And there is plenty to be done in this aspect.

Cost pain elements include maintenance and fuel costs. The latter has a telling effect. Around 35- 40% of revenues are accounted by fuel costs. Hence, when oil prices rise, like they did in the previous year, airline stocks take a beating (see chart). Fuel surcharges, applied by airlines to the extent of Rs 750 per ticket last year, are a solace at best. A move to rationalise taxes will only support the players.

Jet Airways CEO Wolfgang Prock-Schauer makes a pertinent point, “Also, the environment for the low fare carrier model in India is less conducive than Europe or the US due to the fact that 80% of the cost of an airline operation in India is independent of the business model.”

He refers to costs associated with lease rentals, depreciation and other impediments like lack of infrastructure and pilots to man the planes.

Therefore, for an airline player to be successful in India would require it to be extremely cost-conscious.

Opportunities

The third quarter saw Jet Airways demonstrate a turnaround and record a profit (Rs 40.4 crore). This was largely because of the reduction in crude oil prices. The investing community has become extremely watchful in cost control and does not get swayed by mere promise of growth.

Jet Airways, which was once considered the best exposure to airline industry, is now in the “wait and watch” category for most analysts. Some reckon that the airline looks at expansion in a phased manner and is slated to follow the LFC model soon.

Rationalisation and consolidation seem to be the order of the day for most airlines. Most are working hard at rationalising routes and working on getting the most of the load factor. For this, tier II cities are being targeted. Many have deferred their capacity expansion plans and therefore the threat of equity dilutions and higher interest costs, something that investors are wary of, is in abeyance for some time.

SpiceJet has been at the forefront of consolidating its strategy. It has been judiciously experimenting with new routes and working on off-peak timings, rather that looking at fare dilution.

This, analysts reckon, have helped it gain market share without suffocating passenger yield. It then has the highest load factor amongst domestic airlines. Little wonder that the pioneers of the airline business in India, the Tatas, want a share of the company.

At the moment, the industry is quite on the runway waiting for signals from controllers regarding tax relief (fuel excise) and increased foreign participation. As the signals emerge, the airline industry will be set for another takeoff. And whether the flight reaches its destination (shareholder value) or gets bird-hit will be determined by its speed to manoeuvre through turbulent climate changes.

At the moment, for the airlines, it works to have stringent cost control and rationalise routes to up the load factor. For investors wanting to take an exposure to airline stocks, it would be advisable to look for nimble players.

As they rightly say, he travels far, who travels light.
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