It has been a little more than two years since India’s mercurial Kingfisher Airlines suspended operations and went belly-up, but the headwinds that have long troubled India’s aviation sector are still going full force. Over the last couple of weeks, news has emerged that discount carrier SpiceJet is in pretty dire financial straits of its own, and may be in significant danger of collapse itself. This is certainly bad news for the industry, but SpiceJet’s troubles are a microcosm of the problems that have plagued Indian aviation for much of the past decade, if not longer – oversaturation, unrealistic growth strategies, and the inability of any carrier to instill pricing power due to the extreme price sensitivity of the local market.
NOTE: Fellow UPGRDr Rohan wrote a detailed analysis of Kingfisher’s collapse and the broader troubles in Indian aviation in early 2012. I recommend reading his post for a good primer of the issues; they really haven’t changed very much today.
The Rise of Private Carriers in India
Until fairly recently, if you wanted to fly domestically within India, you had one choice – Indian Airlines, which merged with similarly state-owned Air India in 2007. That changed in the early 1990s, when the then-Congress government, forced to liberalize the country’s economy after a foreign exchange crisis in exchange for IMF assistance, opened up the country’s skies to private carriers. The real explosion came in the mid-2000s when, as a result of India’s explosive economic boom, a large contingent of low-cost carriers arrived on the scene, including Air Deccan (later bought out by the now-defunct Kingfisher), GoAir, IndiGo, and SpiceJet.
SpiceJet enters the crowded domestic scene, sees some success
SpiceJet actually began life in 1993 as ModiLuft, a short-lived joint venture between industrialist S.K. Modi and Lufthansa Group. That experiment lasted only 3 years, but in 2005, businessman Ajay Singh resurrected the airline under the name SpiceJet using a standard LCC model – no frills, single aircraft type (Boeing 737-800s), single class of service, and with the egalitarian slogan “Flying for Everyone”. The airline grew rapidly, and by the end of FY 2008 (March 31), carried just under 4.1 million passengers, good for a 9.2% share of Indian domestic traffic. SpiceJet was hurt by the 2008 economic crisis along with other carriers, but by the end of FY 11, seemed to be humming along in decent shape. The airline had posted small net profits1 for both FY 11 and FY 10, at Rs. 101.16 crores ($12.871 million) and Rs. 61.45 crores ($22.039 million) respectively (one crore is 10 million rupees). In June 2010, media magnate Kalanidhi Maran, owner of Tamil Nadu’s Sun Group, purchased a 37.7% stake in the airline, providing access to the family’s deep pockets. Market share increased to 11.0% on just under 7.4 million passengers. And the airline posted competitive numbers compared to industry averages2 on important metrics like load factor (76.0 vs. 73.6 industry average), and operating expenses per revenue passenger kilometer (Rs. 3.59 vs. Rs. 5.28)3 during the period FY 06-FY 11. Operating revenue per available passenger kilometer did trail the industry, Rs. 3.10 vs. Rs. 4.64, but overall, financial metrics fit the profile of a low-cost carrier competing on price while maintaining an efficient operation. These averages are deceptive, in that they are weighed down significantly by the abysmal financial results of state-owned Air India and Indian Airlines, but even compared to private domestic carriers, SpiceJet performed decently. Of the five major private carriers operating in FY 10, SpiceJet’s operating margin of 2.78% was second behind IndiGo, and even beat the much larger and well-known Jet Airways, which clocked in at 2.17%. That being said, that shows that even in a couple of the better years for Indian aviation, this is a tough market to make money in.
Novel but ill-advised expansion, presence of IndiGo breeds trouble
Despite the modicum of success, by FY 2012, SpiceJet faced serious challenges in the form of rising jet fuel prices, along with the explosive growth of fellow LCC IndiGo. Founded approximately a year after SpiceJet, IndiGo had already surpassed its older brother in terms of market share by FY 11, taking 17.6% of the domestic market4 with an appealing combination of new Airbus A320 aircraft, low fares, and punctuality (just for reference, IndiGo’s on-time performance averaged 90.6% from June through November of this year – an incredible performance by any standard). To respond, SpiceJet began international service in earnest in FY 12, starting off with nearby Colombo and Kathmandu, but eventually expanding to eight destinations throughout Southeast Asia, the northern Subcontinent, and the Gulf States, while also aggressively competing on price. But the real blunder occurred in 2012, when SpiceJet announced the second phase of its expansion, this time to tertiary Indian markets like Chandigarh and Amritsar. The general idea wasn’t a bad one – gain a first mover advantage into markets not previously served by LCCs – but the airline decided to serve these smaller markets using 78-seat Bombardier Q400 turboprops, transforming the airline from a fleet of 27 B737s at the end of FY 11 to 42 737s and 16 Q400s by the end of FY 14. LCCs like to maintain a single fleet type for a good reason, and it seems SpiceJet underestimated the added cost and complexity of maintaining a split fleet. Meanwhile, all airlines in India faced pressures sharply rising fuel costs due to the double whammy of rising oil prices and a sharp decline in the value of the rupee, which fell from 45.212 to the dollar at the beginning of FY 12 to as low as 67.984 to the dollar by August, 2013, before settling into the high 50/low 60 range of the last year or so. Additionally, the weakness of the currency further aggravated consumer inflation and already soft economic conditions, causing the number of passengers carried to decrease 5.1% in FY 2013, before rebounding 5% in FY 2014.5
The results of this toxic brew were predictable. Although operating revenue per RPKM increased to Rs. 3.86 in FY 2012 and Rs. 4.60 in FY 2013 and 14, operating expenses per RPKM skyrocketed to Rs. 4.46, Rs. 4.76, and Rs. 5.22 respectively. Fuel costs certainly played a large part, rising from Rs. 1.17 per RPKM in FY 11 to Rs. 1.71 in FY 14, but clearly, the loss of efficiency from the second fleet type and from operating at smaller stations were a large factor. Overall losses ballooned to Rs. 1,003.24 crores ($166.0 million) in FY 14.5
Uncertain future for SG and Indian aviation, though some glimmers of hope
It has been an ugly FY 15 for SpiceJet, as its financial woes have begun to adversely affect its operations. Market share has fallen from 21% in July to 14.9% in November, while customer complaints have soared and cancellations reached an astonishing 16.2% of scheduled flights, per DGCA statistics. Things reached crisis proportions by early December, as SpiceJet was forced to cancel more than 1,800 flights through year’s end as it faced a cash crunch, and was even ordered by the DGCA to refrain from taking bookings more than one month in advance (since lifted). The crisis reached a fever pitch early last week, when the airline shut down entirely for much of December 16th when the airline’s fuel suppliers refused to refuel the company’s planes without advance cash payment. SpiceJet did manage to weather that crisis and has since resumed services, but numerous canceled flights remain for the rest of the year, and SG has already cut its fleet to 38 planes (23 B737s and 15 Q400s) while reducing daily departures from 331 to 232. And while news reports suggested late last week that founder Ajay Singh was prepared to infuse up to Rs. 1,200 crore ($200.4 million) to rescue the airline, Singh has already asked the government for more time to finalize funding, making the prospects of an actual rescue questionable.
Meanwhile, the Indian aviation sector as a whole remains a mess. Fuel prices, of course, remain a big problem; despite the recent drop in oil prices, and the relative stability of the rupee over the past 12 or so months, the combined federal and state excise tax levy on jet fuel can run as high as 30%, blunting the benefits of lower prices. But on a broader level, pricing power, or rather the lack thereof, remains the largest impediment to profitability in the Indian market. Hyderabad to Delhi is roughly the same distance as DFW to ORD, but currently, even after a modest increase in airfares over the past couple of weeks, a round-trip, advance purchase fare, including all taxes and fees, for mid-January weekday travel (actually a time of decent demand due to the Pongal holiday) runs Rs. 12,695 ($200 at current exchange rates) on SpiceJet, with fares only a couple of dollars more on full-service carriers Jet Airways and Air India. Fast forward to the end of February, a slower period, and fares drop as low as Rs. 7,405 ($117) on SG, and $148 on AI/$163 on Jet. It should be noted, at longer time intervals, SG is undercutting fares of even other LCCs, coming in approximately Rs. 1,200 lower than even the el cheapo IndiGo. SG’s 738s carry 189 passengers, and if you assume a 75% load factor (roughly SG’s average since FY 06), that equates to 179,346 revenue passenger kilometers each way (189 capacity X 75% X 1,263 km) – which would mean a fare of Rs. 3,067 each way just to cover fuel costs. Yet the base fare each way in the February example is only Rs. 2,800.* Not to mention, airlines inevitably complete with the country’s long-distance train system for leisure travelers; Hyderabad to Delhi on the train is roughly Rs. 2,500 each way for an air-conditioned sleeper, and those fares aren’t going up anytime soon. Bottom line, it’s very, very tough for anyone to make money at those fares.
*(This is admittedly deceptive, since this is assuming all 142 passengers will purchase the lowest current nonrefundable fare, and that none will purchase any ancillary services, but still, you see the problem.)
Furthermore, the Indian market will be facing even more LCC competition with the arrival of Air Asia India on the international side, and Air Costa on the domestic side. Air Costa in particular could pose a substantial threat to SG’s secondary/tertiary market strategy, as it aims to serve several smaller markets such as Ahmedabad (Gujarat) and Visakhapatnam (Andhra Pradesh) using a fleet of Embraer E-170 and E-190 aircraft that SG began serving as part of their expansion push. Air Asia India, meanwhile, reportedly claims that they can operate at a cost of Rs. 1.25 per RPKM and a break-even load factor of 52%. I’m skeptical of those claims, but still, given their track record across Southeast Asia, they almost certainly will be a further drag on fares.
All that being said, it’s not all bad in the Indian market or for SpiceJet. The rupee has been relatively stable for the past year, inflation has decreased from 10.92% in 2013 to 6.65% in 2014, and the overall economy also appears to be finally improving, with GDP growth projected at 5.63% in 2014 (up from 5.02% in 2013), increasing to the mid-6% range in the 2015-18 period. Additionally, the new government led by Prime Minister Narendra Modi has promised significant economic and structural reforms, and it has been rumored that one item on the table is relief from federal and state excise levies on aviation turbine fuel. Meanwhile, despite its financial troubles over the last three fiscal years, SG has a considerably smaller debt load than the doomed Kingfisher did at the time of its collapse, at Rs. 1,506 crores ($237.4 million) as of September 30th vs. Rs. 7,500 crores ($1.182 billion) for Kingfisher. That’s at least a manageable load, assuming SpiceJet can put its operational problems behind it and the recent fleet/schedule reduction can cut costs to a more sustainable level.
I’d put the odds at somewhat less than even that SpiceJet is still in business at this time next year. The fleet reductions and culling of (presumably) unprofitable routes helps, as does the improving state of the Indian economy, which will undoubtedly stimulate demand. But it’s hard to see how exactly SG will generate the additional revenue to break even. The same Economic Times article suggests that the airline would require an operating margin of 4-5% to comfortably service interest on its debt. Even in a good year (FY 10), SG’s operating margin was roughly 2.8%, and more tellingly, even if fuel costs fall to the FY 11 level of Rs. 1.17 per RPKM, the result would still be a slightly negative operating margin. The expense side of the equation is also going to need some work, but it’s hard to see how that happens, since SG seems to be determined to continue its two fleet strategy to service smaller markets.
In addition, during the 7 years I traveled back and forth to India for work, I had the opportunity to sample most of the country’s airlines, SpiceJet included. My experience on SG was OK. The planes were mostly on time and the crews reasonably friendly, but the planes were old, somewhat dirty, and had some minor issues such as broken seats. In other words, I saw no compelling reason to pay more to fly SpiceJet than its direct LCC competitor, IndiGo, which flies on pretty much all of the same routes, operates new and clean aircraft, and has some of the best on-time performance in the industry. Yet that’s exactly what they’re going to have to do, unless they cut expenses to a level more typical of an LCC – and get full-service Jet Airways and Air India to go along, since they tend to cut their price pretty close to LCC levels on any given route. To top it all off, the fact that Singh has already asked for more time to put together his rescue package suggests investors remain wary of the airline and the industry. On the other hand, the government seems determined to avoid the embarrassment of yet another airline failure, so perhaps they will put pressure on the various parties to play nice and give the airline sufficient time to recover. I certainly hope they pull it off, but if you’re the type that like to take chance on shares in foreign companies, I wouldn’t put my money on an SG turnaround.
Data Source Footnotes:
1. Annual reports of SpiceJet Limited for the years ended March 31, 2011 and 2010
2,4. Yearly Statistics section of “Air Transport” reports, Directorate General of Civil Aviation of India, available at http://dgca.nic.in.
3. Revenue and expense per available passenger kilometer excludes FY 11, as DGCA FY 11 Air Transport Report excludes data from several airlines.
5. Annual reports of SpiceJet Limited for the years ended March 31, 2013 and 2014.