Chocks-on at take-off: Why airline yields are in a tailspin despite boom

Domestic airlines are seeing unprecedented market growth, but rising fuel prices, weakening currency may make it tough for them to maximise gains

First the good news. India has become one of the world’s fastest-growing aviation markets: Domestic passenger traffic grew at 24 per cent in the first quarter of this year and airlines are adding aircraft to their fleets at a furious pace. 

Despite this boom, airlines are facing constricted margins and profits and dramatically falling yields. 

No carrier indicates the pressures more than IndiGo, India’s largest airline by market size and consistently one of the industry’s most profitable. Last week, IndiGo shocked the market with dismal fourth quarter results (January-March 2019), showing a precipitous 73 per cent drop in profit and a 5.6 per cent fall in yields.  The news saw all listed airline stocks, which include SpiceJet, IndiGo and Jet Airways, plunge up to 18 per cent a day later. 

That was not the only news that dominated the airline industry: within a few days of each other, IndiGo and AirAsia India (the joint venture between the Tatas and AirAsia) announced that their respective chief executives who ran the show were stepping down — Aditya Ghosh in IndiGo and Amar Abrol in AirAsia India. 

Insiders in the airline business say both airlines are now seeking new opportunities to fly international and that requires management restructuring to fit in with the new goals. IndiGo has already brought in a new team of expatriates with Gregory Taylor at the helm (replacing Ghosh), Wolfgang Prock-Schauer as chief operating officer and Willy Boulter as chief strategy officer in readiness for its foray into mid-haul flights in Europe later this year after it decided not to bid for state-owned Air India. And AirAsia, which is increasing its fleet, is also expected to fly short-haul international destinations this financial year.   

Both airlines may, however, find their flight plans crimped by growth pangs. According to the International Air Transport Association data for March, domestic revenue passenger kilometre, the number of revenue-paying passengers multiplied by the distance travelled, grew 28 per cent, the highest in the world with a passenger load factor of 87.8 per cent, again at the top of the global pecking order.  

Data released by the Airports Authority of India points to the same trend: Indian airports reached a new milestone by crossing the 300 million passenger throughput mark in 2017-18 (domestic passengers are counted twice here once for departure and arrival). The number of passengers handled (domestic and international) grew around 17 per cent to hit 309 million passengers. In 2014-15, the total passenger thoroughput was only 190 million.  Aircraft movements, which is a measure of additional capacity, grew 20 per cent in March over last year.

To cater to this demand, airlines have ordered huge numbers of aircraft— according to the Centre for Asia Pacific Aviation, as many as 124-130 new aircraft will be in the air in 2018-19 flying across the country. Airlines like IndiGo are expected to get two Airbus Neos every month apart from their ATRs, which are meant for regional connectivity thanks to the government opening up new destinations and airports. 

So why are airlines facing pressures on the P&L account? Partly because this unprecedented growth has been spurred by low fares, which IndiGo interim CEO  Rahul Bhatia described as  “unsustainable” in an analysts’ call after the results. Reinforcing the view, Sharat Dhall, chief operating office of Yatra.com, a leading travel online portal, says: “We have seen that the day one  to day 15 bookings (when the bulk of high-yielding passengers book tickets ) saw fares go down 15 to 20 per cent in April over last year”. April, he points out, is the first month of the peak season, where airlines were “focused on filling  new capacity by dropping prices and going for volumes and increasing plane load factor”. 

This, says an aviation expert, is akin to what is happening in ride-hailing or e-commerce business where prices of goods and services are kept low, even sold at a loss, to attract new customers. For airlines, this strategy was sustainable as long as fuel prices, which account for half their operating costs, were soft and the rupee was stable against the dollar (which helps with aircraft lease payments).

Airlines had not anticipated a double whammy in quick time. For instance, ATF prices in Delhi ranged from Rs 42,000 to Rs 49,000 per kl between April and October last year. Starting February this year, prices crossed Rs 60,000 per kl and this month, they have crossed Rs 65,000 a kl, the highest ever since October 2014, and a 26 per cent jump over last year. As the IndiGo management pointed out, fuel prices went up 11-12 per cent over the previous quarter last year. 

Worse, there are no signs of the price abating. Saudi Arabia, the world’s second largest oil producer, is already pushing for more output cuts and bringing up the price to around $80 a barrel to finance its wide-ranging domestic reform programme. HDFC Securities expects the average benchmark Brent crude price to  go up to $68 a barrel in FY 2019 (from $60 in FY2018). Based on this and other factors, it has reduced its earlier projection of profit after tax of IndiGo for FY2019 by a steep 40 per cent. HDFC Securities has also projected the dollar to be at around Rs 67 for FY2019, but many others predict Rs 70-plus, which will upset all airline’s calculations. 

So do airlines have the leeway to push up fares to fill the capacity that they are adding this year? In its analysts’ call, IndiGo’s management said it has seen some firming up of prices in the last week but could not comment on whether it would sustain.  Yatra.com data shows that there has been an average increase of 9 per cent in air fares in the first week of May over last year. Dhall says this could be because of a stiff increase in demand as summer holidays have started. But a senior executive of a leading airline says that the fare increase might be temporary. In the second week of May, he says, the fares are lower than last year, though still 2 to 3 per cent more than in April. 

It’s a Catch 22 situation: There are limits to how much airlines can cut fares to protect their margins; but if they raise fares to do so, they may be flying emptier aircraft. Even airlines don’t have a clear answer to this conundrum.