The exorbitant price of jet-fuel, the extreme price-sensitive behaviour of the market, currency risk, cash-flow risk, the taxation policy and the lack of a united front—for India’s airlines that ride has been anything but smooth. Even so, until the beginning of this year, India’s aviation sector was on an ascent. Passenger volume growth of 3.2X for domestic traffic and 2.1X for international traffic over the last decade and forecast growth of double digits through 2028 was the accepted narrative. Voluminous aircraft orders that touched 1200 aircraft at peak, mixed in with misunderstood load factor figures and a cash-accretive financing mechanism, helped gloss over cash-flow challenges. On a foundation of double-digit growth, airlines leveraged the future to raise liquidity and enhance borrowing. Yet with the Corona pandemic coupled with the now exposed fault-lines, it has all come crashing down. Liquidity is thin, leverage is high. Listlessness is common. Between cash-flow, credit and commitment, the situation is untenable.
Depressed cash-flows are here to stay
It was famously said that airlines make for good investments only for those who cannot distinguish between gross and net cash flows. But this time even the gross cash-flows have been impacted. Operational cash-flow is limited by reduced demand and the 45 percent caps on domestic schedules. International skies continue to be shut with the exception of repatriation flights and travel bubble arrangements. Non-operational cash-flows that were significantly enhanced by items such as sale-and-leasebacks are down to a trickle.
Historically if one looks at the exponential growth the sector experienced the core driver was price. As long as India’s airlines continued to discount fares the exponential growth followed. The proof was in the passenger throughput growth that went from—36 million passengers in 1996 to 73 million in 2006 to 344 million in 2019. But it is worth repeating that this growth was driven by discounting.
India’s airlines took discounting to new uncharted territory. The reasons were many but even pre-COVID the intense discounting was leading to a shift in booking behavior. And in a spiraling descent as cash-flow needs arose airlines discounted even more. Load factors rose and averaged 80 percent across carriers with some like SpiceJet consistently flying at 90 percent or higher.
Discounting reached its zenith with “Rail-Air parity” which pointed to the fact that railway fares were at or above air-fares. It was a cause of alarm yet was advertised as a talking point. Fast-forward to the present day and one finds the consumer anchored to a lower price point. The very nature of price and discounting that has come to haunt.
With the pandemic and the ensuing lockdown, everything came to a halt. When the skies reopened, airlines were hit with a government-mandated price cap on airfares. Effectively the airlines cannot price tickets below a certain level and 40 percent of total seats have to be sold below the median fare. Yet the intent and impact of this policy have seen wide variation. Effectively airlines cannot discount towards gathering cash and this also limits the ability to stimulate traffic. Further, a policy of not refunding cancelled flights and rather holding the money in a credit shell has also come back to bite (the matter is currently subjudice).
The cash challenge for weaker airlines is reflected in their payment profiles. Credit holds are common, forced leave to staff is the norm and defaults are a given. Some airlines have already seen cash-and-carry notices while others have seen bank guarantees being encashed. For some, the situation is so dire that forward sales and cash on hand can be counted in single-digit days.
Exhausted credit coupled with recalcitrant restructuring appetite
If the cash-flow challenge wasn’t bad enough, if one looks to the credit markets the appetite to lend to airlines is almost nonexistent. Creditors and financiers are just not buying into the Indian aviation story anymore.
While India’s airlines are no strangers to limited liquidity, in the past they were able to access robust credit lines. In no small part because of financing mechanisms and the promise of market growth. Thus in spite of weak balance sheets, perplexing pricing and eerily similar business strategies—lenders continued to lend. Supplier financing was also quite prevalent. Asset-light business models, multiple liens on assets and irrational financing structures helped enhance credit access. And in addition to debt airlines resorted to instruments such as standby letters of credit (SBLCs) and lines of credit (LCs).
These instruments enabled complex transactions without airlines having to dip into cash reserves. Backed up by collateral these instruments were used amongst other items to provision for maintenance and supplementary rent. In some cases these instruments themselves were cross-collateralised. But with limited cash-flow dried up the risk profiles have changed significantly. Especially the risk of not providing for major maintenance and the risk of default.
And in what may be a perfect storm the collateral behind these has also fallen in value. Given the state of affairs, one cannot rule out a scenario where the LCs may be dishonored by the issuing or confirmation bank. Such action in other times may not even be in the consideration set but in the current situation default risk for some airlines is high, debt service coverage ratios are all over the place, cash is simply not available and older credit lines are not even being renewed. New credit lines are simply out of question. On the basis of fundamentals, and without parent company guarantees, the credit stands exhausted.
Skin in the game is the signal the market is looking for
Legendary investor Charlie Munger famously has said that “the company that needs a new machine tool, and hasn’t bought it, is already paying for it. India’s airlines would do well heeding this advice. As it stands, India’s airlines find themselves at the edge of a precipice and notwithstanding significant capital infusions the outcomes are dire.
Stronger airlines like Vistara and Indigo have resorted to parent company guarantees and leveraging assets. For weaker airlines equity infusion is the only option. Not only for liquidity but also as a signal of intent. As a signal to lenders. And towards a claim on the future.
In spite of this, the signals are that equity infusions are not coming. A market that has already witnessed the failure of two airlines due to over-reliance on debt, the inability to raise funds and delayed equity infusions is repeating prior scenarios. Collectively, India’s airlines stand to lose between $3.5 billion—$4 billion in 2020. What started as a descent at the beginning of the year has become a nosedive. Efforts to pull up and stabilise have not been successful. The descent to the bottom continues.
-Satyendra Pandey has held a variety of assignments in aviation. He is the former head of strategy at a fast-growing airline. Previously he was with the Centre for Aviation (CAPA) where he led the advisory and research teams. Satyendra has been involved in restructuring, scaling, and turnarounds.
Read his columns here.