To IndiGo or not to IndiGo, that is the question

The marquee airline was flying through an air pocket when the pandemic hit. Will its cash hoard see it through? 

The headline around IndiGo for well over a year now has been about its warring co-founders. Rakesh Gangwal and Rahul Bhatia are two diametrically opposite personalities — one methodical and operations-oriented, and the other driven and people-oriented — and all has not been well between the two billionaires.

Corporate India has a long history of founders — both professionals and families as well — not getting along. On many occasions, the discord is played out quite embarrassingly in public view. An onlooker may be reminded of the drama that unfolds in a big Indian family. At InterGlobe Aviation, the company that owns the IndiGo brand, the conflict has been bitter with allegations relating to corporate governance and misuse of position flying thick and fast. For an airline that prided on high efficiency levels, with its on-time USP being one such, it could have done without this high-profile dispute.

Just as the cracks began to widen, the COVID-19 crisis started to unfold. The pandemic then took centrestage. The aviation sector has been among the worst hit with planes grounded for two months and then taking off with reluctant flyers. It has reflected in the numbers and for the last quarter of FY20, IndiGo was in the red by Rs.8.7 billion (compared to profit of Rs.4.96 billion in the preceding quarter and Rs.5.96 billion a year ago). It included a foreign exchange loss of Rs.10.1 billion due to weakening of the rupee, primarily comprising mark-to-market losses on capitalised operating leases. With much of India staying indoors, the story was nothing remarkable for this June quarter, too. For Q1FY21, the company’s revenue stood at Rs.11.4 billion with a net loss of Rs.28.44 billion.

Understandably, airlines across the country have run out of ideas and they can do precious little except wait for the overall business climate to change. There was a sigh of relief when airlines commenced operations on May 25. However, barely 30% of the flights were in the skies.

The scenario has been no better. To be fair, airlines across India (and the world as well) have been brutally hit by the pandemic. Right now, it is only about holding on to cash to weather the crisis well. By virtue of its leadership position with a 48% market share, IndiGo is relatively better placed than its peers. Combine that with a tight cost structure, an innovative model (a sale and leaseback model where IndiGo buys the aircraft, sells it to a lessor and then leases the plane back), network connectivity and you do have a good story.

Besides, this is for a company whose debut flight took off only in mid-2006. Many others have had a headstart of at least a decade. IndiGo has seen the likes of Jet Airways shut shop and SpiceJet going under before it was revived.    

How things stack up

The real issue is how long can IndiGo hold out at a time like this, where about 40% of its costs are fixed. A look at the numbers gives you more visibility. The gross cash on its balance sheet stands at Rs.18.4 billion with free cash at Rs.7.53 billion (See: Flying through rough weather). If one knocks off the debt of Rs.2.37 billion (kept in check because of the sale and leaseback model), the actual cash on hand stands at Rs.5.2 billion.

Just how do IndiGo’s expenses stack up monthly? The biggest is lease rentals for a fleet of 245 aircraft; in all, it has 274 aircraft, of which 29 are owned. Taken at around $350,000 per aircraft per month, that adds up to Rs.5 billion. Top that up with salaries and wages for its 25,000 employees which is another Rs.3.5 billion. With these two adding up to Rs.8.5 billion, and another Rs.1 billion for minimum guarantee payments for maintenance, software, rent and administration, the fixed cost totals to Rs.9.5 billion.

In this extraordinary situation, the airline operates at 40% of its usual capacity and the passenger load factor is 61% today (above 80% at its peak). The two taken together means (40% of capacity, of which 60% is occupied) the revenue is 24% of what it would normally clock. The December quarter revenue of little over Rs.100 billion is taken as the base since that was the last quarter unaffected by COVID-19. A monthly revenue of around Rs.33 billion then translates to a reduced quarterly revenue now of around Rs.79 billion.

On the issue of variable costs, which normally account for 60% of the total outgo, the monthly number is about Rs.18 billion. At 40% capacity, that number drops to Rs.7 billion. Ergo, the monthly revenue generated is barely enough to service the variable costs. As a result, the monthly cash burn is around Rs.10 billion. However, post the Q1FY21 earnings announcement, IndiGo’s CFO Aditya Pande told Outlook Business, “While the variable cost was being covered through our flight operations, now with roughly 500 flights a day, we are covering some part of the fixed cost as well.”

Now, IndiGo has done its bit to reduce its wage bill. A key decision to implement a salary cut of 5-25% (this was across the organisation barring those with lower pay grades, apart from deferring merit-based salary increments) was announced this May in addition to leave-without-pay for May-July for its senior employees. 

Due to those measures, Pande says within 40% fixed costs, on an employee-cost basis, “we expect to save 25% on our total employee cost on a full-year basis.” With more cost reduction measures to come, the company is confident it can survive for 10-11 months with the current free cash balance of Rs.7.5 billion. The company has already laid off 10% of its workforce.

In terms of the load factor needed for business sustainability, an airline needs upwards of 50% to recover variable costs and over 75% for fixed costs. KG Vishwanath, partner, Trinity Aviation Consultants and earlier head of commercial strategy at Jet Airways, emphasises that higher revenue is the barometer and not so much the load factor. “You can drop your fares and have a full flight but will still struggle to recover costs. It really is a question of how much you can increase your revenue per flight,” he says. But, due to the pandemic, it is very hard to increase the yield. “A situation as peculiar as this, will not have passengers jumping on to a plane if airlines drop fares. Travel today is being undertaken only if it is necessary and that is the big challenge for airlines.”

For IndiGo, the conference call held in early June, to announce Q4FY20 earnings, was an indication of the change in tack. “In times like these, we must shift our focus from profitability and growth to managing cash and liquidity. Given the need to preserve cash, we are not looking to pay any dividend this year,” said CEO Ronojoy Dutta, who assumed the top job last January. Liquidity again was a key focus area in the June quarter and he spoke of how “through all our efforts of cost reduction and revenue generation, we have managed to reduce our fixed cost burn.”

Gagan Dixit, vice president – institutional equity research, Elara Capital, thinks the focus on liquidity is quite logical since demand has been severely curtailed. “It is really down to what it was four to five years ago. For anyone in the business, it is only about survival and those who can manage that will be around for a long time,” he says.

Symptoms of all not being well in the industry were evident in January this year, though IndiGo’s revenue for that month and February was up 2.6%. “However, as we entered March, our unit revenue started declining sharply and resulted in an operating loss of Rs. 3.8 billion for the month excluding the foreign exchange loss,” said Dutta in the conference call to announce the FY20 numbers. Just by way of comparison, SpiceJet, (with 13% market share), at the end of September 2019 had cash of Rs.870 million on its books with gross debt of Rs.10 billion. “The current fiscal is a washout and it will be another 18-24 months before anything starts to recover. In that kind of scenario, it is important to preserve cash since an airline will need it as and when demand picks up,” says Elara Capital’s Dixit.

Deepak Jasani, head-retail research, HDFC Securities, concurs about the near-term challenge for the aviation industry. “However, IndiGo is better placed than its peers and is likely to emerge stronger from the current crisis. A cash-heavy balance sheet, cost efficiency and strong management team are factors in the airline’s favour,” he says.

Steady flight

As it looks to further optimise its cost structure, the question arises if IndiGo might temporarily prune its fleet to deal with the low capacity utilisation. The airline and its lessors have a stellar relationship and that goodwill could come in handy in this troubled situation. While Pande affirms that they are “honouring all short term commitments,” Dixit thinks the airline does have pricing power, enough to force lessors to cut back their charges. “It is the most obvious thing to expect at a time like this.”

To knock off costs is only part of the story, with the other being returning some of the planes. If one goes strictly by the rule book, a penalty could be imposed on returning the aircraft, since these are typically watertight contracts. However, since the industry is under stress globally, options may be limited for the lessor. During the latest earnings call, Dutta mentioned that conversations with suppliers for more favourable credit terms are underway. Of the 274 planes, the A320ceo (current engine option and an older version) accounts for 123 and another 108 being the A320neo (new engine option). Then, there are 18 A321neos and 25 ATRs.

During the Q4FY20 concall, Dutta said 120 A320ceos, a model with high maintenance costs, would be going out of the fleet over the next two years. The rate at which this is done will depend on revenue reviving. “We will be taking deliveries of new NEOs this fiscal, which are much more cost efficient and are in discussions with manufacturers regarding deliveries beyond this period,” said Pande while adding that they have already financed majority of these deliveries through operating lessors. Jasani though does not expect this to play out smoothly. “In an uncertain demand environment, we do not expect the rate of induction of fuel-efficient A320neos to match the exit of A320ceos,” he explains. Elaborating on the domestic capacity surplus and the plan to replace aircraft over the next two years, he thinks there will no new net capacity additions during FY21 or FY22.

More turbulence?

The foremost question in the minds of investors is whether the worst is over for IndiGo. After recently hitting a low of Rs.772 in March, it now trades at Rs.1,100. In October 2018, it was down to Rs.800 when crude oil crossed $80/barrel. It also bore the brunt of a price war and a weakening rupee. The dispute between the co-founders was still a while away from the public eye.

By any yardstick, the situation today is far tougher as load factors have plummeted. The management is trying to make up some of the revenue loss by expanding their cargo business. Earlier they used to reserve capacity of 6 tonne to 9 tonne, now they have converted 10 airplanes to full-fledged cargo flights that can deliver 17 tonne to 20 tonne. The lockdown has deepened their commitment to this vertical but ancillary revenue, of which cargo is a part, accounts only for 12-15% of the total.

There are other challenges as well. Right on top is the cap on fares announced by the government. On reduced occupancy, that is a difficult proposition. Elara’s Dixit says, at 20% capacity, an ideal situation for IndiGo would be if any competitor faces threat to survival and crude remains at less than $40 per barrel, apart from the timely delivery of new Airbus-A320neo. “If things get back to normal and, if one assumes revenue coming only from domestic operations, then the company could potentially earn annual revenue of Rs.60 billion,” he thinks. The problem is no one quite knows when things will go back to normal. There are no encouraging signs yet.