An Outlook on the Domestic Aviation Industry.

Gradual recovery in domestic passenger traffic; however, credit profile of domestic airlines to weaken over the near term, writes Kinjal Shah, Vice President, Corporate Sector Ratings, ICRA Limited.

In view of the ongoing Covid-19 outbreak, the Government of India (GoI) had suspended all scheduled domestic passenger air services from March 25, 2020. Subsequently, the scheduled domestic flights were allowed to recommence operations with effect from May 25, 2020 to a limited extent i.e. maximum 1/3rd of their respective approved capacity of Summer Schedule 2020. However, the domestic airlines witnessed a rather slow uptick in their capacities in June and July 2020.

Subsequently, the Ministry of Civil Aviation (MoCA) permitted increasing the capacity to 45% with effect from June 27, 2020 and further to 60% with effect from September 02, 2020. While in August 2020, the domestic airlines operated at a much lower capacity - ~33% of their August 2019 capacity, the same witnessed a significant increase in September 2020, with the airlines operating at ~46% of their September 2019 capacity (~39,323 departures in September 2020, as against 86,221 departures in September 2019). On a sequential basis, the number of departures in September 2020 increased by ~37%.

While the scheduled international operations are yet to start, the MoCA has permitted international operations under the Vande Bharat Mission (VBM) and Air Transport Bubbles (ATB). Under the VBM for evacuation of Indian citizens from foreign shores, which started from May 07, 2020, the international passenger traffic (inbound and outbound) has been 841,634 for the period May 07, 2020 to September 30, 2020. This is as against international passenger traffic of 9,268,336 during May 2019 to September 2019. While the initial flights under VBM were operated only by the Air India Group, other domestic private carriers (Go Air, Indigo, SpiceJet and Vistara) have also operated a few flights with effect from June 14, 2020, and are expected to continue to participate in the next phases.

Challenges grappling the industry

The Indian aviation industry is characterized by high fixed costs. ~35-42% of the airlines' expenses, including operating lease payments, aircraft parking charges, airport charges, aircraft maintenance charges, and employee costs are fixed. Such impact to operations is thus a significant credit negative for the industry, which is already reeling under pressure, as this is resulting in the airlines finding it difficult to meet their operating expenses in the absence of adequate cash inflows.

Though the industry gained some respite from the benign aviation turbine fuel (ATF) prices during the current year, the low passenger demand and consequently the low pricing power of the industry further accentuated by the restrictions on fares (now extended until February 24, 2021) have resulted in losses for the airlines. While the ATF prices have increased from the low witnessed in May 2020, it declined sequentially by 5.6% in October 2020, which is also lower by 38.1% on a YoY basis. The prolonged shutdown of manufacturing activities in several countries and the subsequent impact of the outbreak on the global economic activity will keep the crude oil prices and thus the ATF prices low.

Furthermore, ~35-50% of the airlines' operating expenses - including operating lease payments, fuel expenses and a significant portion of aircraft and engine maintenance expenses - are denominated in US$. This means every additional rupee depreciation i.e. 1.3% depreciation at current levels, will impact the operating profit margins of the airlines by 0.45%-0.65%. In addition, some airlines also have foreign currency debt. While the domestic airlines also have partial natural hedge to the extent of earnings from their international operations, overall, they have net payables in foreign currency. The depreciation of INR thus results in substantial increase in operating expenses, including mark-to-market losses on foreign currency debt and other payables.

Policy and Regulatory Framework

The competitive intensity in the domestic aviation industry is expected to remain high, with the industry likely to have significant over-capacity over the medium term if the demand recovery is sluggish. For the industry to revert closer to its historical growth trend and sustain healthy PLFs, besides economic revival and pick-up in business and tourism demand, the Government will also need to address India's aviation infrastructure requirements and other matters like tax of ATF, which have constrained the performance of airlines. Certain key metro airports in India are already experiencing slot constraints, and there is a need for growth in airport infrastructure to ensure a healthy airline transport sector.

With relaxation of foreign direct investment (FDI) norms, investments from foreign airlines appear to be the most viable option for domestic airlines to raise funds. So far, only one domestic airline has been the beneficiary of the policy change. We believe if the Government addresses some of the regulatory hurdles on foreign ownership, the industry would benefit, as foreign airlines continue to scout for a share of the Indian aviation pie.

Outlook

ICRA has a Negative credit outlook on the Indian Aviation industry. The medium term impact on the Indian aviation industry would depend on the economic shock to the global economy. Since consumer sentiments are likely to remain weak in an adverse economic environment, the recovery in air travel is expected to be gradual once the Covid-19 threat is allayed. ICRA expects FY2021 to witness a de-growth of ~41-46% in domestic passenger traffic, with the domestic passenger traffic reaching much lower than the FY2016 levels. The impact of the Covid outbreak will last longer on international travel than domestic travel. Thus, ICRA expects the FY2021 international passenger growth for Indian carriers to witness a significant YoY de-growth of ~67-72%. Furthermore, ICRA expects the profitability of the industry to be adversely impacted in FY2021 due to lower revenues and high fixed costs.

As the demand for air travel will be impacted in FY2021, not only are the airlines delaying / expected to delay their aircraft purchases / deliveries, but the lower demand also means that airlines will continue to operate at much lower PLFs and / or continue to see many of their aircraft grounded even when demand improves.

While some airlines have sufficient liquidity and/or financial support from a strong parentage, which will help them sustain over the near term, the airlines, who were already in financial stress, are now facing existential crisis. Furthermore, even for the former, it has resulted in significant weakening of their credit metrics and liquidity profile. Many airlines have already undertaken several cost rationalisation measures.

These include salary cuts for their employees, including leave without pay and laying off pilots and crew members to cut costs. Some airlines have also sought deferment in their lease rental payments. However, until the cash inflows improve, the airlines will require funding support to meet their expenses. The credit profile of domestic airlines will thus weaken materially over the near-term.

Due to the low base of FY2021, the passenger growth in FY2022 for both domestic and international operations will be robust.

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