Tony Fernandes is pissed with Gillem Tulloch, founder of Hong Kong-based research firm GMT Research, for urging clients to sell or short AirAsia’s stock for lack of transparency in its accounting practices and alleging in a report that the airline overcharged its associate airlines for aircraft, maintenance and other services to artificially boost profits. “The point is that if profitability does not improve from these levels soon, AirAsia is bust,” Tulloch wrote in an email to clients. “If it improves, as AirAsia believes, then the company still needs to raise $1.9 billion.” The development was enough to send the stock of the Malaysia-based low-cost airline — Asia’s largest —crashing 28% to a five-year low. “I am so damn determined now to shut some people up. I’m best when my back’s against the wall. We aren’t going to give up because of one report,” an agitated Fernandes was quoted as saying.
Making matters worse for the 51-year-old is the Indonesian government’s warning to AirAsia to beef up its balance sheet by July 31 or face an operational freeze. Indonesia, which is a loss making venture for AirAsia, wants to reinforce the country’s safety credentials following a plane crash that killed 140 on board, followed by last year’s crash of AirAsia’s jet with all 162 people on board. “If they don’t meet the requirements, we will suspend them. If they don’t have enough capital, how will they ensure the safety of passengers?” Indonesian transport ministry spokesman JA Barata was quoted as saying by news wire agency Reuters.
The adverse turn of events for the poster boy of low-cost airlines in Asia will be music to the ears of his rivals back home in India, where AirAsia has just completed a year of operations. The Federation of Indian Airlines (FIA), which includes the likes of IndiGo and GoAir, has not made life easy for AirAsia after the industry association moved the Delhi high court challenging AirAsia’s permit to operate in the country on the grounds that the previous government’s move to allow 49% foreign investment in civil aviation was for existing players and not new entrants. Incidentally, AirAsia India is a three-way joint venture between AirAsia Berhad of Malaysia (49% stake), Tata Sons (30% stake) and Telestra Tradeplace (21%). But overcoming the odds, since its inaugural flight from Bengaluru to Goa in June last year, the airline has flown over 5.14 lakh passengers in the six months of 2015 against 3.6 lakh in 2014, connecting 11 cities with its 5-aircraft fleet.
Though still a marginal player with a just over 1% market share, AirAsia has managed to get the competition to respond to every move it has made. While Fernandes has been quite vocal about naming IndiGo, the market leader with a 38% market share, as the incumbent that is making life difficult, the Rahul Bhatia- and former US Airways chief Rakesh Gangwal-owned low-cost carrier has maintained a studious silence by choosing not to respond to Fernandes’ ranting. Instead, it has countered every move made by AirAsia in India, be it by cutting fares or adding more flights on existing routes where AirAsia flew its own.
Even as the Malaysian carrier finds its feet, the Tata-Singapore Airlines joint venture has taken wing and so has the beleaguered SpiceJet, which is slowly making a comeback with the Marans selling out to the airline’s erstwhile promoter Ajay Singh. The latter has invested ₹800 crore in the airline, which was briefly grounded in December 2014. Put simply, competition is rearing its head, albeit slowly but decisively. In just six months since it began operations in January this year, Vistara, the long-haul carrier, has flown over 3.57 lakh passengers with a passenger load factor (PAX) of 59%, while AirAsia clocked a PAX of 84% and SpiceJet clocked the highest PAX of 93% with over 40 lakh passengers.
However, with a PAX of 87% and over 14 million passengers flown this year, IndiGo is still the Goliath, and it cannot choose to ignore what the Davids of the aviation world are up to. That could possibly be one reason why Rahul Bhatia is going public with the airline that he launched in 2006. The management of IndiGo chose not to participate in this article.
IndiGo’s parent company, InterGlobe Aviation, has filed a red herring prospectus to raise ₹2,500 crore by selling an 11% stake, which includes a part sale by the promoter and fresh equity shares. In doing so, IndiGo is being valued at over ₹25,000 crore, which is nearly four times the combined market cap of SpiceJet and Jet Airways. Though SpiceJet and Jet both have a negative net worth of over ₹1,000 crore and ₹4,000 crore, respectively, compared with IndiGo, which is sitting pretty at over ₹400 crore, a stable crude price era and a nascent economic recovery are fuelling hopes that things will start looking up for the rest of the industry as well.
IndiGo clearly cannot wait for things to get better for its rival. KG Vishwanath, former head of commercial strategy at Jet Airways and currently partner, Trinity Aviation Consultants Pte, says, “Now that crude has gone down to $50 levels and is unlikely to breach $70-75 per barrel at least for the next three years, suddenly it has become a level playing field where every airline can, potentially, make money. This is going to draw more competition and additional supply into the system as other airlines get aggressive in adding capacity.” That is something that IndiGo has not been used to: it has thrived in a market where competition — comprising upstarts and established players — got carried away and bungled up big time. The global crisis of 2008 only added to the airlines’ existential crisis, even as IndiGo soared into the skies. But, to be fair, IndiGo got a few things right that others did not.
“If you talk to Aditya, he would say, ‘I want to run a boring but consistent airline.’ He runs a really tight ship,” says Airbus India’s managing director, Srinivasan Dwarakanath. The man is pretty appreciative of his largest buyer from India and how its lawyer-turned-CEO has managed to not only keep IndiGo afloat but given it wings. Ghosh is correct on both counts — IndiGo has been both boring and consistent and even consistently boring. But being boring is a business strategy that seemed to have worked for the airline.
The opposite of it — being flamboyant, hiring hotties for calendars and crew, doling out hot meals at 30,000 ft — has in the recent past meant lessors knocking at the door to claim aircraft. IndiGo’s door gets knocked on often, too, but for delivery of aircraft. The budget carrier debuted in 2005 with a century of sorts — it placed an order for 100 Airbus 320 aircraft, something unheard of at that time. The last aircraft was delivered in 2014. In 2011, it ordered another 180 Airbus A320neo aircraft and followed it up with 250 more in October 2014. Though the 250-aircraft order has lapsed since, the order for 180 aircraft still stands.
Unlike its peers, IndiGo stuck to ordering a single type of aircraft. The mother of all low-cost carriers — Southwest Airlines of the US — pioneered this practice by buying only Boeing 737 in large numbers at a discount. IndiGo has followed the same strategy. It placed a 100-aircraft order, all of them Airbus 320. Consequently, it saves millions in maintenance costs, spare parts inventories and pilot, crew and mechanical training. This gives the airline the unique flexibility of being able to deploy its existing fleet of 96 aircraft throughout the route network, replace them in no time and deploy pilots and crew anywhere without costly disruptions and reconfigurations. But this practice is no secret — others could have emulated it, too. Airbus head Dwarkanath reasons that the “promoters of IndiGo started the airline with a vision, saying they are in it for the long haul”.
Clearly, it is more than just vision that has worked for it. As a start-up in 2005, IndiGo barely had $82 million as promoters’ capital plus loan. For another rookie airline of its size, striking a 100-aircraft deal would have been tough. But IndiGo had Gangwal as co-founder, who had struck several aircraft purchase deals at United Airlines, American Airlines and Air France in the past. That must have comforted Airbus. “You can imagine — they (the promoters) had not even applied for an no-objection certificate. On their letterhead, they signed a 100-aircraft order. So, somewhere, you have a relationship with the seller. Otherwise, how do you place such a large order for aircraft?” says an aviation expert who did not wish to be identified.
The same expert goes on to say that, in a way, airlines (read: IndiGo) work as fronts for sellers (read: Airbus). “The 250-aircraft order was placed and then did not materialise. I think it was just a strategy to create a buzz in the Indian market,” he says. Dwarkanath of Airbus India immediately denies this, “In my career of 18 years, I have never heard of something like this. Concept-wise and idea-wise, obviously, people are getting too creative. But I don’t think people take that approach at all in this industry, whether it’s us or the airlines.”
It should be noted that bulk orders get airlines discounts ranging from 20-60%, with early buyers of new models getting preferential pricing as well. For better discounts, getting the timing right is very important and IndiGo did manage to strike a good bargain in 2005. It was post 9/11, the aviation market was slowly coming out of the doldrums and it was the right time to strike a discount deal with the seller. It is not unusual to observe several airlines suddenly embarking on a shopping spree. In 2011, Emirates, AirAsia, Lion Air and Qatar Air all ordered aircraft within weeks of IndiGo placing an order for 180 Airbus neo aircraft.
Airlines generally have teams in place watching aircraft pricing and deals — it’s like buying stocks at the right time, after observing several cycles. 2011, when aviation was recovering from the shock of the economic slowdown of 2008-09, was again a weak year — just the right time to avail discounts on aircraft purchases. When, in 2011, IndiGo placed its second order, it was no more an upstart. It negotiated with Airbus as a profitable, credible airline, with a good credit rating in a market that was opening up and with rival aircraft manufacturers knocking on its doors. It is safe to presume that IndiGo struck an even sweeter deal in 2011. And being the early buyer for a new model, it is expected to have received a handsome discount on the next generation of 180 Airbus A320neo aircraft as well.
Sale and leaseback
The discounts negotiated with bulk orders don’t stop there; the benefits accrue later. Starting from 1980s, the aviation industry gradually embraced the leasing of aircraft (as opposed to owning). And today, the top four owners of airline aircraft in the world are GECAS (over 2,000), AERCAP (1,305), Delta Airlines, and United Airlines. First two are lessors. Over a third of airline fleet is now rented.
Many low-cost carriers have also adopted the sale-and-leaseback model, which is expensive in the long term but takes the burden off in the short term. Typically, it is like renting a house vis-a-vis buying one, since the latter requires more capital. Under this model, IndiGo pays a marginal percentage (let’s assume, 5%) as advance to Airbus at the time of placing the order and assigns the rights to purchase the aircraft to a lessor. When an aircraft ordered in 2005 gets delivered in 2010, its market value has already gone up.
Now, on the date of delivery, IndiGo sells it back to the lessor and pays outstanding dues to Airbus. On the sale of each of these aircraft, which IndiGo got at a discount five years ago, it reportedly makes good money. According to Flightglobal, a popular aviation news portal, IndiGo has been the most active user of sell-and-leaseback financing among low-cost carriers and it makes as much as $4 million-5 million per aircraft under each sell-and-leaseback transaction.
Immediately, it rents or leases the same aircraft from the lessor for a short period of time (let’s say, five years). So, leasing has three benefits for IndiGo — immediate profits (cash flow), a young fleet (low maintenance costs) and savings on depreciation cost (as ownership of the aircraft remains with the lessor).
However, IndiGo’s management has in the past downplayed the importance of sell-and-leaseback transactions as a key profitability contributor. “They have certainly performed better than others but I don’t subscribe to the claim that there are substantial profits,” says Harsh Vardhan, former MD, Vayudoot and head, Star Air Consultancy. He feels that the company’s survival has largely been due to the sell-and-leaseback model. “With this, it has been trying to get back the cash upfront to maintain its cash flow. Luckily, IndiGo has credibility in the market, so it has been able to pursue this model [while others have not].”
But many other experts question the singling out of IndiGo for adopting this model. Former Air India executive director and author of Descent of Air India Jitender Bhargava, says, “Singapore Airlines sells its aircraft every six years. It’s a standard financial model.” Incidentally, other domestic airlines, too, follow this model. Jet Airways has 89% of its fleet on sell-and-leaseback, GoAir has 92%, SpiceJet 70% and IndiGo 90%.
IndiGo enjoys best in class operating margin in the industry,
thanks to lower running costs
But pursuing this model has tremendously helped IndiGo maintain the youngest fleet in India at 3.1 years, compared with nearly six years for Jet, four for SpiceJet and over 10 for Air India. “Reports suggest that IndiGo’s aircraft leases are for a six- to seven-year period. By returning the aircraft in such a short span, it saves on heavy maintenance (D check in aviation parlance) that is required thereafter,” says Amber Dubey, partner and India head (aerospace and defence) at global consultancy KPMG. Three years implies a very young fleet — fuel efficiency is high, maintenance is low and passenger experience is good. No wonder, then, that IndiGo has the lowest maintenance cost among Indian carriers at US cents 0.18 (see: Better placed). “All that has added up to profits on the balance sheet,” says Dubey.
What has also worked for IndiGo is its razor-sharp focus on the classical low-cost model, which has been perfected by the likes of Southwest Airlines and Ryanair in the US and Europe, respectively. Under this model, what not to do is more critical than what to do. Globally, in mature, established markets such as northern Europe or America, it’s the low-cost airlines that consistently do well, as they stick to short distances in the two-three-hour travel range. There are three formats — long-haul, two- to four-hour and less-than-an-hour. Even after 44 years in operation, Southwest doesn’t go beyond the two- to four-hour range to compete with the likes of United, Delta or any other US-based airline.
Not one of its flights has crossed the Atlantic in 44 years. Similarly, Ryanair restricts itself to Europe and doesn’t compete with British Airways. Secondly, these airlines don’t go and buy smaller jets to capture regional markets or get wide-body aircraft to provide luxurious services, nor do they set up services in other countries. So, while IndiGo has stuck to the model, what has also helped it reach to the top, was more a function of how the competition messed it up.
Building on rivals
The advent of low-cost, no-frills airlines was with the launch of Air Deccan in 2003-04. Subsequently, three more — SpiceJet, GoAir and IndiGo — began operations between FY06 and FY07. Two full-service carriers — Kingfisher and Paramount — also entered the market in FY06. Thus, the number of carriers in the domestic airlines industry tripled from three in FY03 to nine in FY07. “When the going was good and the economy seemed in better shape, the carriers started offering tickets at much lower prices as compared with full-service carriers and managed to capture 42% of the domestic market by FY07,” states a Crisil Research report. But FY08 saw trouble brewing as the new entrants and incumbents began expanding and in just under one year, the share of low-cost carriers went up to 47%. But this expansion heavily eroded player profitability.
Even as crude prices and manpower costs rose sharply, the players were unable to hike fares owing to intense competition. This led to pressure on realisations and most airlines slid into the red. The industry’s combined losses amounted to ₹4,900 crore in FY08. The capital structure of most players deteriorated. While some carriers faced a liquidity crunch and had to raise further debt to stay afloat. This led to a bout of consolidation, wherein Air Sahara was acquired by Jet Airways and renamed as JetLite, Kingfisher bought Air Deccan and Indian Airlines was merged with Air India to form a new entity, the National Aviation Company of India (Nacil). As a result, the share of the top three players (Nacil, the Jet Airways group and Kingfisher) rose to around 70% by FY09, states the Crisil report.
As the low-cost carriers kept expanding, the full-service carriers could no longer contain themselves, and Jet Airways and Kingfisher joined the circus by introducing low-fare operations under the Jet Konnect and Kingfisher Red brands, respectively. Suddenly, there was too much competition once again, as Jet Airways converted two-thirds of its seating capacity to Jet Konnect by the end of the second half of FY10.
Consequently, aggressive price cuts and fares became the norm. Soon, all the three big players floundered with mounting losses, Jet struggled between the full-service and low-cost model, Kingfisher went bankrupt and SpiceJet with its complex aircraft and aggressive pricing slipped into the red (see: In dire straits). The subsequent five years proved to be a shot in the arm for IndiGo. “With no new entrants, there were a lot of advantages that came IndiGo’s way. The fact is that the collapse of competition helped it,” points out Bhargava.
In dire straits
Indigo’s key rivals still have a huge hole to fill given
their negative net worth
Much has been written in the media about how the-then aviation minister Praful Patel pushed Air India into intractable financial trouble. Even former Comptroller Auditor General Vinod Rai mentioned in an interview that Patel pushed the Air India board to purchase 68 aircraft instead of 28 in 2004, sinking the ₹7,000-crore company into ₹50,000 crore worth of debt. The Air India and Indian Airlines merger, too, proved disastrous, as both were misfits. The fall of Air India opened up the aviation field — in the real sense of the word — for all private operators after 2004.
Over the same period, IndiGo silently rose up the ranks from the fourth spot (at 12.5%) in FY09 to be the largest airline in terms of passenger volumes in FY12, with a 27% market share. During these five years, Jet Airways’ focus was clouded after buying Air Sahara in 2007. Its international operations suffered and now, post the Etihad deal, it seems more like a feeder airline for the Gulf carrier than anything else. Jet and SpiceJet managed to reduce their losses during Kingfisher’s fall but, given that they were faced with financial troubles, the gains proved to be momentary. Thus, within five years, the tables turned and IndiGo grabbed the crown — and the market share — from Kingfisher (see: In pole position).
In pole position
IndiGo’s rise to the top came amid a weak competition and a spate of failed mergers
So far, so good
Airbus forecasts India to be the world’s fastest-growing airline origin-and-destination market, growing at an average annual rate of 9.5% between 2013 and 2033. IndiGo’s strategy is pretty simple, then — as the most successful and profitable player, it is best placed to purchase and quickly deploy aircrafts in the country. With the 180 Airbus A320neo aircraft order, it is at the top of order book from India. Its peer, GoAir, which has 19 aircraft, has an order book of 72; Jet Airways (not a low-cost carrier) flies 107 and has an order book of 65; SpiceJet, with 34, has an order book of 42 (see: The new order).
The new order
Among all the domestic players, Indigo has placed a record order for fuel-efficient aircraft
While the order for 250 more aircraft may have expired for now, the airline can renegotiate the same in future. With such a massive order book, IndiGo has put itself in a sweet spot for the next 10 to 15 years. All the ordered aircraft are single-type, in line with its low-cost carrier model. This shows that the idea is not to change the existing strategy in any way. Even the Airbus A320neos ordered have a range of four-five hours. In other words, the airline will remain focused on the domestic market for now, instead of putting more flights on international routes.
Interestingly, the red herring document states that IndiGo may have to focus on international markets for the next level of growth. But Bhargava believes that the airline may choose not to do so. “Foreign carriers have been given a head start, a stranglehold on the market. For any Indian to make a foray abroad is a difficult proposition,” he says. More importantly, the company will have to change its model if it wants to chase international routes. Adding long haul international routes could also cause a significant disruption in Indigo’s system as it may require a different fleet and that brings in added complexities - different set of pilots, engineers, cabin crew, spares and other contracts. “So, one option is to stay away from long haul market and instead become a clear leader in the domestic market. They may become an ideal code-share partner for global airlines looking at the growing Indian market,” adds Dubey.
Four years ago, more than 400 planes were in the air; today, less than 300 are flying. With passenger volumes growing by 9%, even if all airlines become aggressive, they won’t end up putting more than 15-20 new aircraft in service. Even to sustain the current load factor, the industry would need 35-50 planes by next year, which may not happen. This justifies the aggressive fleet strategy by IndiGo and its attempts to raise capital through an IPO — the idea is to fill this gap as quickly as possible. Airbus claims that the 180 A320neos that will be delivered in 2016 burn 15% less fuel than the existing Airbus 320s. And IndiGo is counting on this promise — its strategy is to further lower its costs and increase profitability with the quick induction of the A320neos. Fuel accounts for 50% of its total costs and since airlines generally work on a 3-5% margin, a 10% reduction in fuel costs will help increase margins by 5-6%.
Currently, IndiGo’s strategy is to focus on major passenger routes within India. The airline’s top five routes by capacity for FY15 were Mumbai-New Delhi, Bengaluru-Mumbai, Bengaluru-New Delhi, Kolkata-New Delhi and Bengaluru-Hyderabad. However, Delhi-Mumbai remains the volume/revenue churner for all airlines. It accounts for 42% of all passenger traffic and airlines have deployed almost half of their fleet capacity (that is, 150 aircrafts) on this route. IndiGo enjoys a 30% market share on this lucrative route, followed by Air India (21%), and Jet Airways (18%). The airline’s strategy thus far has been to milk metro-to-metro connectivity by deploying most of its capacity on these routes. At the end of December 2014, over one crore passengers travelled between metros, 61 lakh travelled between metros and non-metros and only 12.3 lakh travelled between non-metros.
IndiGo has shown no intention of buying smaller aircraft to tap very small markets. The strategy is to focus on metros for now. There are at least 40 million-plus-population cities where IndiGo can deploy its services. Currently, IndiGo doesn’t fly to Amritsar, Tiruchirappalli, Bhopal, Surat, Udaipur, Silchar, Mangaluru and more. As more aircraft are delivered, the airline is expected to service these markets as well. But for now, with SpiceJet, AirAsia and Vistara in the thick of the action, IndiGo has to counter the emerging competition.
SpiceJet is in talks with Boeing and the Airbus Group to acquire about 100 new narrow-body jets, chief financial officer Kiran Koteshwar told Reuters. SpiceJet wants to buy more Airbus A320neos and Boeing 737 Max aircraft and would look to raise fresh equity or debt to pay for the planes once it decides how many to buy. The airline has less than 20 Boeing narrow-body jets, and its market share shrunk to 12% in June from 20% a year ago after it reduced capacity.
AirAsia has already upped the ante. The airline has won up to 50% discount on airport charges after its decision to declare Bengaluru airport as its hub. On each new route started by AirAsia, IndiGo has followed suit, setting off a price war. IndiGo also launched several flights from the cities AirAsia was aiming at, looking to foil the new carrier’s efforts to tap niche routes. When AirAsia announced a non-stop flight between Bengaluru and Chandigarh, IndiGo took off on the route before it could. IndiGo has taken competition head-on, not making it easy for new entrants.
Last December, AirAsia launched a direct flight between two cities (Pune to Jaipur), adding 5,000 seats per month on the route. The Indian carrier also offered ‘all-inclusive, one-way’ fare from as low as ₹699 for flights from Bengaluru to Chennai, Kochi, Goa, Jaipur and Chandigarh and vice versa. On the Bengaluru to Kochi route, IndiGo had to cut its fares, which were around ₹4,000. After AirAsia started a week-long sale offering promotional tickets priced as low as ₹380 (all-inclusive) on travel dates between June 10, 2015, and January 17, 2016, IndiGo announced special fares starting as low as ₹1,647 (all-inclusive).
The fare quoted by AirAsia was less than half the price of AC bus tickets that run on the routes. Similarly, IndiGo announced all-inclusive fares starting ₹1,499 to take on rival SpiceJet earlier this year, ₹100 lower than the latter’s ₹1,599 offer. In January this year, Vistara debuted Delhi-Ahmedabad and Mumbai-Ahmedabad routes. Soon, IndiGo added a fifth daily flight between Delhi and Ahmedabad and a sixth daily service between Mumbai and Ahmedabad.
Putting the fare war in context, travel portal Yatra’s president Sharat Dhall, says, “IndiGo does not initiate low fares but tends to match the fares offered. It has been more selective on a case-to-case to basis, rather than introducing blanket discounts. It manages to hold on to its volumes, because it needs to. IndiGo looks at it from the point of view of capacity availability. If it has a high load factor, it can’t match the offers. Typically, IndiGo matches promotions of this kind on weaker routes.” But if the past is any indication, though IndiGo has managed to stay profitable since FY09, it has not exactly been immune to competition and the vagaries of the industry. On two occasions, in FY12 and FY14, profits fell 80% and 60%, even as the competition slipped into losses (see: Playing spoilsport).
While currency depreciation and the resultant spike in crude prices did play their role, pricing discounts, too, have hurt the business. The rupee went into a free fall against the dollar last year, dropping to record lows in August. About 70% of IndiGo’s expenses are dollar-denominated, but owing to limited overseas connectivity, it gets less than 15% of its revenue in the same currency. In fact, when IndiGo started flights from Mumbai to Singapore and Bangkok, it had a tough time pulling it off. “It had to cancel the direct flights for two reasons. One, its aircraft could not get 100% payload and, on the pricing side, it could not match airlines such as Jet and Thai Airways, among others. So, it had to effectively pull out those flights,” points out Vishwanath.
Besides crude and currency swings, Indigo’s bottomline has also been hit by aggressive competition
But on the flip side, AirAsia is keen to connect international cities, as it stands to benefit from the move. While it has been clamouring for the scrapping of the 5/20 rule, which mandates a carrier to have completed five years in service and to possess a 20-aircraft fleet in order to be eligible to fly internationally, domestic airlines are opposing the move. Here, again, Fernandes feels that vested interests are playing spoilsport. Though IndiGo has placed an order for 180 aircraft, a lot of them, observers feel, would be replacement fleet. “They have 100 aircraft and only 180 in order, out of which, I suspect, 100 would be replacement aircraft. If that’s the case, they only have 80 additional aircraft over the next ten years, which is a slow rate of growth,” opines Vishwanath. But, for now, that is not what the market is worried about, as IndiGo has shown consistent profits and is better placed than its rivals.
Though the jury is still out on whether IndiGo will end up creating value for investors in an industry that only bleeds, Rahul Bhatia is surely going to add much more to his billions. Thereby proving to be an exception to the truism Richard Branson had once espoused, “The easiest way to become a millionaire is to start out as a billionaire and invest in an airline.”