The great investor Warren Buffett once joked that if a far-sighted investor had been present at Kitty Hawk, North Carolina, in 1903, that person could have done the world a major favour by shooting Orville and Wilbur Wright before the Flyer got off the ground. The Wright brothers were the pioneers of powered flight. According to Buffett, the airline industry, which their invention brought into existence, has caused more massive wealth destruction than any other industry.
As always, there is a kernel of truth in Buffett’s statements. Commercial flights have great benefits for those who use them, and they enable multiple other industries too. But airlines rarely make serious profits. In fact, the industry seems to run on losses more often than not. This has been the case globally and is the case in India now.
Many factors are responsible for this.
First, commercial airliners are monstrously expensive gadgets. Airlines take on large debts to buy them. The usual process is for airlines to buy a plane, sell it to a lender and lease it back. This eases their debt burden somewhat because the airline repays the lender via periodic instalments rather than a one-time huge sum. In addition, maintenance and repair is expensive. Second, aviation turbine fuel (also known as kerosene) constitutes a large proportion of operating costs (often between 40%-45% of all operating costs) and is completely outside the control of the airline. Third, trained pilots and crew and engineers are expensive. Four, parking slots are expensive.
All these are costs that have to be paid, regardless of occupancy or load factor, a term used to describe how efficiently a transporter fills available capacity in order to generate revenue. At the same time, competition in the industry and the existence of alternative modes of transport ensures that fares cannot be pitched too high. So most airlines lose money because they cannot squeeze their costs enough or get a decent fare-occupancy that covers all costs, including debt-servicing. Airlines that do make money usually have to rely on several things working well at the same time. It helps if crude prices are down because Aviation Turbine Fuel costs will be low. It helps if costs can be squeezed by running operations efficiently. It helps if the load factor is high enough.
Profit and loss
In India, complex regulations and poor infrastructure add to the problems. Among other things, airlines have to fly non-remunerative routes, there are restrictions that reduce the pool of potential investors, and poor airport facilities and capacities lead to higher fuel consumption.
Only one Indian commercial airline makes money consistently. That is Interglobe Aviation or Indigo. Jet Airways has made money intermittently, usually when Aviation Turbine Fuel costs are down. Several others – Kingfisher, Sahara, Air Deccan, have gone out of business. (Air Deccan, however, restarted operations last month after a decade out of business). Spice Jet has required infusions of capital to pull it around.
One Indian airline has lost money consistently. That is Air India. It has all the problems referred to above. Massive debt – about $8 billion worth, much of it forex-denominated – has been taken on to order new planes. It has poor load factors due to perceptions of poor quality of service. With 27,000-plus employees, it also has a bloated workforce that creates an immense wage-bill and an aggressive union that fights attempts to downsize. Its massive losses have required the government to pump in new capital ever so often.
In the last 20 years, every Indian government has flirted with the possibility of selling off Air India, and every government has baulked at the last mile. This one appears to have gotten a little closer to finalising details. The government has eased investment norms, allowing overseas partners, including airlines, to own up to 49% stake in the national carrier. It is prepared to sell upto 51% stake, which will hand over control to a strategic buyer. It is prepared to split the airline up into multiple different entities that will be separated and sold as different companies. It is prepared to forgive some of the debt (by pulling it out into a special purpose vehicle, where it might be sold at a large discount) so a buyer will face less of a debt-service burden. It says it will take care of Air India’s workforce, though it is unclear how it would do this. It has announced that it hopes to sell the core airline business, including what is now Air India and Air India Express, by the “end of 2018”.
Aviation market outlook
India’s aviation market has some things going for it. Passenger growth is the quickest in the world and this is now the third-largest market. Passenger growth is expected to stay in double-digits even if it moderates. Plus, there are ambitious plans to turn India into a maintenance, repair and overhaul hub to service not only Indian fleets but also fleets from overseas, which would otherwise have to fly to Europe, America or Brazil for these facilities. That could reduce costs. There is also room for faster cargo growth. The government says it is committed to increasing airport capacities, which could reduce fuel consumption and parking fees. However crude prices are in an upcycle, which means that Aviation Turbine Fuel costs could go up for the next year or longer.
There would be a significant improvement in government finances if the stress of running the loss-making airline is removed. At the same time, anybody who buys into an airline is probably going to lose a lot of money over the long-term.
