India’s second largest airline, Jet Airways, continues to grapple with financial challenges. The airline has had to ground several aircraft due to non-payment of lease rentals, forward bookings have declined and the regulator is reviewing its flight schedule every 15 days. The approvals for debt restructuring are delayed, the working capital situation is challenging and the equity infusion is yet to materialize. Multiple negative news reports are only adding to the airlines woes. Regardless of the outcome, these challenges carry a systemic impact for Indian aviation as a whole. What are these?
1. Risk Premiums Likely To Rise, Driving Higher Leasing Costs
Airlines have the option to own aircraft or lease them. Fleet financing takes into account the costs and benefits of each option as they have different cash-flow and balance sheet impacts. In India, 75 percent of the commercial fleet is leased. That is, the aircraft in such arrangements are owned by lessors and then leased to airlines. The leases include cash deposit, a base rent which is a function of the aircraft price, and also a supplementary rent component towards covering maintenance risk.
While lease rates are airline specific they also factor in the country risk premium. The risk premium includes default risk, a country’s acceptance of the Cape Town Convention (which provides remedies for default), and also precedence. The Indian market has in the past witnessed an increase in risk premiums after the collapse of Kingfisher airlines and it took several years to rebuild confidence. Unfortunately, given the situation at Jet Airways several are already drawing equivalence as reflected in wary creditors and lessors. The risk premium for the India market is bound to rise which then will affect total lease costs.
2. Lending To Airlines Will Be Further Constrained
Airlines require large amounts of capital towards aircraft leases/purchases, supplier guarantees and working capital. Lending to the sector has been constrained in part due to the unstable EBITDAs, irrational pricing and high leverage. This challenge was exacerbated when banks were faced with the NPA crisis and a review of debt coverage ratios was undertaken. Usually banks will lend to airlines at multiples of EBITDA in the range of four to six times but this has not only been trending higher but new unique structures have been created which limit risks to banks but don’t quite work as well for airlines.
With Jet Airways, the banks find themselves caught between a rock and a hard place. The airline has working capital requirements estimated at Rs 7–14 crore a day (the large range is due to uncertainty on network and forward sales) and its debt of Rs 8,200 crore is unsustainable in the current form. In such a scenario, banks can either take a call of making no more loans which carries risk of the current loans not being paid. Or they can make additional loans, where they are essentially making a bet that the company will be able to restructure itself out of the current situation and repay the capital to the bank.
The unintended consequence is that banks will be extending credit to a weaker airline at a cost of borrowing that may be lower than that extended to the stronger airlines. This carries systemic effects as most of the capital will be used toward continuing operations and not growth thereby impacting the pricing power and capacity utilisation of the entire industry.
Thus, the conundrum banks face is whether to lend and drive an overall reduction in net margins due to additional capacity and inevitable fare sales. Or whether to constrain lending that may force Jet Airways and indeed some other carriers towards an extremely challenging financial position.
Overall, it is safe to say that lending to the sector will continue to be constrained.
3. Fares Are Bound To Rise – In The Short Term
As of January, Jet Airways, including its subsidiary JetLite, had a market share of 13.6 percent. As financial challenges came to the forefront, the airline started to rationalise its network. Frequencies were adjusted on routes (that is fewer flights between the city pairs) and there were several markets that it pulled out of completely including North-East airports such as Silchar, Aizwal, Jorhat and Imphal. Other stations that has seen drastic capacity reduction include Coimbatore, Trichy, Raipur and Vishakapatnam.
With each reduction, there is a change in the supply demand equation on routes. An ideal situation is where supply is taken out of the certain routes thereby giving existing routes greater pricing power. However, in a market that is growing at a compounded annual growth rate of 18 percent over the last five years, competitors are rushing to flood routes with capacity thus route reductions in many cases have a negative cash-flow impact. That said, Jet Airways has no choice but to continue route-rationalisation and this will lead to mark share changes.
Factoring in current fleet scenarios a loss of at least 3-5 percent is likely. Interestingly, this market share will not be immediately taken up by other airlines as they too face their own challenges with regards to fleet induction and expansion.
Assuming inputs costs remain at the current levels, a 5-7 percent rise in fares is sustainable without impact to volumes. However, a rise in fares beyond that will start to impact load factors. That is, while fare levels will rise, the volumes will go down which then carry overall cash-flow risk. Overall, in the short-term fare levels are bound to rise.
4. Boards Likely To Become More Involved In Specific Issues
The challenges at Jet Airways will also likely force increased board level involvement across airlines. Traditionally, boards have played a critical role in monitoring management performance and on broad strategic issues. Specific issues and execution capability is left to the core management team.However, the situation at Jet Airways has ignited debate on how closely boards should be involved and what tough questions were asked over the years on how the airline would compete in a changing competitive landscape. There are also concerns about key shareholders that move the airline in a certain direction and the entire debate of board seats at Jet Airways and the promoter and chairman giving up his board seat is evidence of the same. Perhaps summed up best in this quote by Alfred Rappaport:
The competitive landscape, not the shareholder list, should shape business strategies.
It is interesting to note that board information, especially on non-financial parameters, is traditionally prepared by the core management team. Thus, management can often guide discussions.
To that end, some issues such as high attrition, a demoralised workforce or a marked change in marketplace dynamics with potential for disruption may be not come to the forefront unless explicitly reported. The reporting of such issues carries an incentive mismatch. And due to no fault of the board, at times board effectiveness comes into question.
Finally, with the advent of technology there is no dearth of information on any issue specific to any airline. In the case of Jet Airways, the airline had debt levels that were unsustainable and a cost base where competitors could simply bleed them on routes with pricing alone.
Yet, the closest the airline came to addressing these was the enhanced co-operation agreement with Air France-KLM. If over time, the enhanced cooperation allows for joint coordination on certain elements, it could give a boost to Jet Airways. Even so, the question of how Jet Airways will compete with low-cost airlines in the domestic segment and especially when the low-cost airlines are eating into the corporate and SME travel market is yet to be addressed adequately? And this is something that the board will likely push for including specific details.
5. The Talent Wars Will Intensify Leading Higher Wages
For Indian aviation, talent across all levels is in high demand. Especially operational talent that is critical to running an airline. The country’s largest carrier has already faced a challenge
in this regard. This situation is likely to continue.
Specific to Jet Airways, engineers and pilots from Jet Airways have already been approached by competing airlines. The pilot situation is interesting as there is a regulatory provision that came into effect in 2017 that requires a one-year notice by pilots. This was appealed by several pilot unions.
In the case of Jet Airways, if there are delays in salary payments it is unlikely that a court will enforce the one year mandate. Thus temporarily, competitors may be able to source pilot requirements by poaching. Other areas where competitors are targeting personnel are those of revenue management, network planning and rostering – all of which are specialised skills that require expertise and experience.
Interestingly, Jet Airways is one of the few airlines in India that has had high loyalty in employee ranks including the odd phenomenon of folks leaving and then returning to the airline. This time though, it may be different. Especially because the plan for how the airline plans to compete and position itself for the future has not been adequately communicated to the entire team. And also because a delay in funding coupled with the 24-hour news cycle is driving anxiety.
Overall, despite uncertainty, good talent will find positions and be absorbed by other airlines. As the talent wars intensify, higher benefits and wages are almost certain.---
In summary, airlines are at the apex of the aviation value chain and fuel the entire aviation economy. Thus when airlines face challenges, it often has ripple effects. And when the airline is as large as Jet Airways – not only in terms of market share but also network spread, distribution, fleet (the second largest Boeing fleet in South East Asia) and financing — systemic impacts are inevitable.
Satyendra Pandey has held a variety of assignments in aviation over the past 14 years. Most recently he was the Head of Strategy & Planning at a fast-growing low-cost airline. Previously he was with the Centre for Aviation (CAPA) where he led the advisory and research teams. His experience includes restructuring, scaling and turnarounds.