Heavy Lifting

Sunny Leone may have  found herself in midst of a controversy over her scheduled New Year’s performance in Bengaluru, but the Bollywood actor stoked a fire of her own after she tweeted about the lousy performance of the country’s second-largest full-service airline. A frequent flyer, Leone recently tweeted, “Seriously, it’s crazy the amount of delays @jetairways is having every day. Was on a plane all week and usually only with Jet but everyday was delayed at least 1hr. Ruined my week of sleep! Something needs to be done.”

It is not just Sunny Leone’s sleep that Jet Airways has been ruining. With one-third of its aircraft failing to take-off or land on time in October, Jet Airways has been faring poorly on its on-time performance. This performance has been calculated on the basis of data from four major airports — Bengaluru, Delhi, Hyderabad and Mumbai. Facing such reputational risks at a time when the aviation sector, after a dud phase, is seeing a turnaround in its fortunes is hurting Jet Airways in more ways than one. For its part, Jet Airways has recently laid out a road map to cut its operating costs. While the stock has definitely gained from the overall euphoria surrounding the sector, analysts continue to remain sceptical on the airline’s ability to take off.

Full flight
The aviation industry has seen a good year among domestic flyers, with a healthy growth of 17.27% during January-November 2017. In fact India saw the highest-ever number of domestic flyers in the month of October. According to DGCA data, 10.4 million people flew within the country in October. This along with low crude prices has given the aviation industry a fresh lease of life. 

No wonder, this renewed optimism is reflected in the price of airline stocks. Over the past two years, SpiceJet has gained 197%. followed by Jet Airways (67%) and InterGlobe Aviation (52%). These gains have come after a long and painful wait for investors. The past 10-year period was marked by poor load factors, high fuel prices, low fares and expensive financing, which cost the aviation industry around Rs.42,000 crore. Even as the industry is entering a sweet spot of higher utilisation and increasing yields, Jet Airways with a 17.2% share in the domestic market and a 39% share on international routes is struggling with some of its old demons.

Running into turbulence
Despite turning profitable in FY16 after eight years, Jet Airways’ operating performance has barely stayed in the black since then. In fact, if its recent earnings are adjusted for non-operating income, then the company has been making losses. After adjustment, Jet Airways posted a loss of Rs.104 crore in FY17, a loss of Rs.176 crore in Q1FY18 and a loss of Rs.104 crore in Q2FY18

The company’s failure to make money in one of the better years of aviation is definitely a cause for concern. Much of its struggle to turn profitable is on account of the airlines’ high cost structure and huge debt burden. Jet Airways has a cost per available seat kilometer (CASK) (ex-fuel) of Rs.3.1/km, which is 53% and 26% higher than IndiGo and SpiceJet. Jet Airways’ older fleet is another reason for its high maintenance costs, compared with the relatively new fleets of domestic carriers like IndiGo and SpiceJet. A full-service carrier also needs to maintain different models of aircraft in its fleet given the different routes that it plies. It is relatively easier for a low-cost carrier, which just needs to maintain one type of model in its fleet, to re-negotiate maintenance contracts.

Jet Airways recently laid out a road map to cut its operating costs. The airlines has a target of 12%-15% savings in CASK (ex-fuel) by FY20, which would take Jet Airways to the same level of profitability as IndiGo. But, are these targets achievable?

Analysts feel these are highly ambitious targets and would be tough to achieve. “It becomes difficult to control costs when all the airlines are in an augmentation mode. You can’t focus too much on costs. It is a tricky situation. They are planning to change the seating arrangement in their large aircrafts which would increase their throughput,” says Ashish Shah, analyst at IDFC Securities. At present, the airline has three seating arrangements – business class, first class and economy class. It has done away with first-class seats in its B777 aircrafts and has made the aircraft denser by increasing the number of seats from 346 seats to 400 seats. This increase in seating capacity has helped in bringing down unit costs.  

 Analysts expect Jet Airways to cut CASK (ex-fuel) by 6% over FY17-20, undershooting its target by 600–900 basis points. “Salaries, distribution costs, aircraft rentals, maintenance and airport charges account for their largest non-fuel costs. You can’t cut these costs beyond a point,” Shah adds. These costs eat into 42% of the company’s revenue. 

In FY17, Jet Airways spent Rs.0.55 per available seat km (ASKM) in employee costs and Rs.0.47 in selling and distribution costs which include agent commissions. When it comes to employee costs, IndiGo’s costs are 27% lower, while SpiceJet’s costs are 56% lower. When it comes to selling and distribution, IndiGo’s costs are 59% lower, while that of SpiceJet are 72% lower. 

For now, Jet Airways is doing what it can do to lighten up its cost structure. With its large fleet of 100-plus aircraft, it is looking to re-negotiate its maintenance contracts, which are due for renewal in January 2019. In FY17, Jet Airways spent Rs.0.41 per available seat km (ASKM) on maintenance of its fleet, which is 2.7x that of IndiGo and 1.7x that of SpiceJet.  

As another cost-cutting measure, Jet Airways will be adding 12 new 15% fuel-efficient 737 MAXs from FY19. Deliveries of new generation 737 MAXs under sale & lease back commence from June 2018 at a rate of one every month (over 25 deliveries expected by March 2020). Sale and leaseback is a financial transaction in which the asset is sold and taken back on lease. Jet Airways had initially followed ownership model but gradually shifted to the sale and leaseback model. Of its current fleet of 117 aircraft, only 15 are owned by the company.  “The new aircraft will lead to 20% saving in fuel costs. This means that Jet Airways can add 5 paise available seats per km to its bottom-line by saving on fuel costs,” says Gagan Dixit, analyst at Elara Capital.  

Headwind
Bringing down its large debt (FY17 net debt stood at Rs.7,800 crore) is also a priority for Jet Airways as interest costs shred 3.7% of its operating income, which is 152 basis points higher than IndiGo and 264 basis points higher than SpiceJet. Vinay Dube, CEO, Jet Airways says that improving internal accruals is the best way the airlines can bring down its debt. “We need to increase our operational cash flow. That can be done by running an efficient business; by improving topline and reducing costs,” he says.

Of the total debt sitting on Jet Airways’ books, Rs.5,400 crore accounts for non-aircraft debt which includes debt for working capital and for general corporate purposes. Jet Airways has historically struggled with high debt. The airlines’ total debt had more than doubled in FY08 to Rs.12,000 crore after it acquired Air Sahara in April 2007. The challenging business environment sparked off by the financial crisis led to eight loss-making years between FY08-15.

Amid its weak operating performance, the debt continues to be high. As per analysts, Jet Airways’ average interest cost for its overall debt is high at 11.7% given the fact that non-aircraft debt tends to be costlier (analysts estimate it to be 200 basis points higher).

Analysts expect to see only a marginal growth in Jet Airways’ topline (6% CAGR over FY17-20) given the management’s guidance that capacity (available seats per kilometer) is only likely to increase at an average of 8-10% over the medium-term. Yusufi Kapadia, analyst at Edelweiss, estimates Jet Airways’ FY17-19 earnings before interest, taxes, depreciation, amoritization and rentals—(Ebitdar) to grow at 12% CAGR given its muted revenue growth, while IndiGo’s Ebitdar is expected to see 29% CAGR and SpiceJet’s Ebitdar is expected to grow at 24% CAGR. (see: Fall in cabin pressure).

The management’s confidence in the company’s ability to generate enough cash to pare down its debt may be overstated given analysts’ projections of weak profitability. “Jet Airways has very thin profit margins and will spend around Rs.530 crore on capex, while at the same time, it will need to repay around Rs.2,300 crore of debt over the next two years. These commitments total Rs.2,800 crore, while the company will generate only Rs.2,000 crore in free cash over this period,” say analysts at HSBC in a recent client note. For FY17, Jet Airways’ net profit margin stood at 1.7% compared with IndiGo’s 8.9% and SpiceJet’s 6.9%. The management remains confident that it can improve the company’s profit margin. “We need to improve our load factor by 2-3 percentage points without decreasing our yields a lot. If we manage to do that we would be able to improve our profit margin,” says Dube of Jet Airways.

Analysts’ bleak outlook also stems from the sluggish traffic on its Gulf routes, which account for 50% of Jet Airways’ international capacity; this lackluster demand is expected to continue with low oil prices taking a toll on the economies in that region. Jet Airways’ higher international capacity (60%) prevents it from making the most of passenger traffic growth on domestic routes. Domestic-oriented IndiGo (84%) and SpiceJet (93%) have been reporting better passenger load factors than Jet Airways (81.5%). As a result it has been steadily losing market share to the other two. “Jet Airways’ domestic market share over the past three years has come down from 21.2% to 17.2% despite domestic passenger traffic growing at over 19% CAGR between FY14-17. Meanwhile, other players have gained market share during this same period,” says Rashesh Shah, analyst, ICICI Securities. At present, Jet Airways is trading at one-year forward EV/Ebitdar of 6.9x, which is a 10% discount to the average valuation at which the industry is trading. IndiGo is currently trading at an FY19 estimated EV/Ebitdar of 7.7x, while SpiceJet is trading at EV/Ebitdar of 7.5x. Analysts say that Jet Airways despite its best efforts will continue to lag its listed peers. “Even if Jet Airways achieves its targets, it would not give it any competitive advantage. It is not just Jet Airways, cost rationalisation will be done by all the players. Jet Airways would still be catching up with SpiceJet and IndiGo which definitely look better poised to grab a larger share of the market,” says Aditya Jaiswal, analyst at Stewart & Mackertich. While it is cheaper on a relative basis, given the low probability of Jet Airways reaching its FY20 targets and better operating performance of SpiceJet and IndiGo, analysts are not so keen to board Jet Airways.