The Indigo results announced for the fourth quarter ended March 2017 and for the full year 2016-17 betray a clear pressure on the company on the airline’s financials. This pressure is both in terms of squeeze in revenues as well as in terms of higher costs. While competitive pricing is taking a toll on the top-line of the airline, higher crude oil prices are taking a toll on the cost structure of the airline. Indigo is important because it is the largest airline in India with a domestic market share of 39%. Being a market leader with a margin, Indigo’s problems are representative of the challenges facing the aviation industry as a whole. Here are the important takeaways…
What do Indigo’s Annual results hold out for the Aviation industry?
• For the fourth quarter ending March 2017, Indigo saw 25% drop in profits and a drop of 16.5% for the full year 2016-17. This has been one of the most disappointing quarters for Indigo since it got listed in the bourses 18 months ago.
• Between March 2016 and March 2017, the price of Brent Crude in the global markets went up from $30/bbl to $52/bbl. This 70% increase in the price of crude has been largely responsible for the pressure on profits in the fourth quarter.
• Total revenues for the fourth quarter were up by 16.3% at Rs.19,369 crore. However, this growth has come at a time when average seat kilometres (ASK) has gone up by 27.5%. The ASK is the equivalent of output in the manufacturing sector and this clearly indicates that the lower growth in revenues despite a much higher growth in ASK is purely due to pricing pressure.
• Why exactly is pricing pressure becoming an issue for Indigo? Firstly, the competition is intensifying among the four key players in the aviation industry viz. Indigo, Jet Airways, SpiceJet and Go Air. Currently, Air India still has a healthy market share but they have their own set of problems to contend with. The four companies are simultaneously fighting for the same national market space and that is increasing the price war.
• To get a better perspective of the pressure on revenues, one needs to look at the revenue per average seat kilometre (RASK). The RASK has gone by just 9.2% to Rs.3.44/seat kilometre, which is again indicative of the pricing pressure on these aviation companies.
• The sustainability of any airline operation depends on consistently reducing the cost per average seat kilometre (CASK). In the case of Indigo, the CASK has come down by 2.5% to Rs.3.04. But then if we exclude the impact of fuel, then the CASK would have come down by 6.3%. That shows the inordinate impact that fuel is having on the cost structure of airline companies.
• There are 3 factors that go into the pricing of Aviation Turbine Fuel (ATF) for airline companies. Firstly, there is the global cost of crude which will depend on how the intense competition between OPEC oil and US shale pans out. Secondly, there is the INR/$ equation and a strong INR will work in favour of airline companies. Thirdly, there is the government duty structure which has normally tried to use taxes as an effective instrument of expanding revenues when global prices are low.
• Based on the above factors, the price of ATF is likely to remain high for aviation companies. The OPEC supply quotas will ensure that the oil prices do not fall substantially below $50/bbl. With the INR already at 64/$, the scope for further appreciation may be limited. Above all, the government is going to look at opportunities its revenues, especially in a year when its budget targets are likely to be remain under pressure.
• The real story of the aviation companies is visible in the margins and spreads of Indigo. Let us look at these in greater detail. The OPM of Indigo for the full year is down by 590 basis points to 29.3%. During the same period, the NPM has also shrunk by 340 basis points to 8.9%. The bigger worry for Indigo will be on the spreads. Over the last one year the spread (difference between the RASK and the CASK) has compressed from 66 basis points to just 40 basis points.
What does that mean for the outlook of aviation sector in India?
India has already emerged as the second largest domestic aviation market in the world after the US and China. In fact, Japan has recent fallen to fourth place. The recently announced Udaan program is likely to vastly expand the connectivity to semi-urban areas and smaller towns. That will bring about a quantum jump in the playground for aviation companies. The GST rate of 5% on air travel (economy) will be positive for aviation companies, but considering the current level of competition, that may have to be entirely passed on to the end customer. At the end of the day, the big challenge for the aviation companies will be how to manage the all-important spread between the RASK and the CASK. That will determine the trajectory of the market shares in the quarters ahead!