Traders can take advantage of potential short positions.
Some businesses are inherently unviable but worth funding for the positive externalities. For example, no metro project can make operating profits on fare-revenues though they also generate a lot from real estate plays. But loss-making metros allow urban centres to flourish, generating higher tax collections overall.
However, long-distance railway operations can be very profitable, That’s due to freight revenues. Also, railway stations are natural hubs. Airports are also natural hubs, as shopping centres with a captive clientele, and often, attractive duty-free rates. All global air-hubs earn more from cityside (non-aerial traffic) revenues than from airside revenues.
The airline business itself is very cyclical. Capital costs of fleet acquisition are high, so is maintenance and repair, and even parking fees. Salary overheads are high. Operational costs like aviation turbine fuel (ATF) are high. Pricing power is low, due to competition. Traffic can fluctuate alarmingly. Many airlines end up drowned in debt and run up huge losses.
But cheap convenient air-travel is a key infrastructure component. The Indian government recognised this a decade ago. It has embarked on an ambitious airport-building and renovation plan. It has also loosened controls on new airlines. The low-cost model is now a fair alternative to high-end rail travel.
The Indian aviation industry is, like other semi-liberalised industries, mired in more problems than its global counterparts. There are bizarre controls on FDI, and restrictions on joint venture partners. There's an insistence uneconomic routes must be flown. An airline must also operate domestically for a long time before permission is granted for overseas operations.
ATF, which contributes 40-45 per cent of operating costs, also suffers from massive state tax imposts that makes it more expensive than refining costs or central taxes warrant. Since ATF price varies considerably from state to state, airlines have to juggle routes and refuelling plans.
In a crowded sector, consolidation attempts such as the Kingfisher-Kingfisher Red (Deccan) merger and the Jet-Jetlite (Sahara) mergers have run into trouble, for various reasons. Air India-Indian Airlines has also, to put it mildly, been an unsuccessful merger.
The slow pace of airport modernisations has meant huge fuel wastages and erratic schedules, due to flights queuing up for landings and departures. It's unclear how exactly the Airports Authority of India, which is in charge of operations and renovations at most airports, intends to boost cityside revenues for these assets. The independent regulator for airports, the Airport Economic Regulatory Authority (AERA), which is to set airside tariffs like aircraft parking fees, has only just got off the ground.
Amidst all this, the twin Kingfisher and Air-India-Indian Airlines imbroglios highlight the problems with badly-run aviation operations. Both airlines have huge debt, and massive accumulated losses. Kingfisher is in the ICU on a ventilator and Air India is clinically dead. Neither has realistic hopes of turnaround. The sane, if cruel decision, would be to let both airlines fail. Whatever productive assets are left could be sold off. Given staff shortages, some employees would be absorbed by other operators. The rest would have to be pensioned off. For political reasons however, this is very, very unlikely. Air India in particular, will continue limping along with massive periodic bailouts.
The problem is, the presence of sick players who cannot be consolidated, also queers the pitch for other, relatively more healthy operators. While India has seen very fast traffic growth compared to the global norm, it is now in a recession. This means over-capacity and lower fares, in general. Most operators also have made massive fleet expansion plans, which they will have great difficulty funding, or justifying economically. The financials of listed players suggest that most airlines will run up more losses. That makes IPOs, private placements or big debt issues difficult.
There are rays of hope. When economic growth picks up, so will traffic. A second possibility; the government could rationalise ATF taxes though this will require cooperation from various states. It's also possible that plans to turn Nagpur into an international maintenance, repair, overhaul hub will fructify. The cargo segment could also provide higher revenues.
But net-net this sector looks to be in a big mess. It would take a lot of determined, and politically unpopular action, to help aviation turnaround. That doesn't look to be happening any time soon. Tycoons, including hard-headed legends like Carl Icahn, have bought or started up airlines because they want bragging rights and don't care about return on capital. Any sane investor should however, steer clear of the aviation sector. A trader can look for the occasional bounce and a steady stream of potential short positions.
