MAKING SENSE OF THE CIVIL AVIATION MESS: AIR INDIA & KINGFISHER

Overview of the Civil Aviation sector :

In early 1948, a joint sector company, Air India International Ltd., was established by the Government of India and Air India (earlier Tata Airline) with a capital of Rs 2 crore and a fleet of three Lockheed constellation aircraft. Its first flight took off on June 8, 1948 on the Mumbai (Bombay)-London air route. At the time of its nationalization in 1953, it was operating four weekly services between Mumbai-London and two weekly services between Mumbai and Nairobi. The joint venture was headed by J.R.D. Tata, a visionary who had founded the first India airline in 1932 and he himself piloted its inaugural flight.

Before the dawn of the 90s aviation in India was dominated by 2 public sector behemoths, namely Air India and Indian Airlines. In 1994 the Air Corporation Act of 1953 was repealed with a view to remove monopoly of air corporations on scheduled services, enable private airlines to operate scheduled service, convert Indian Airlines and Air India to limited company and enable private participation in the national carriers. However, beginning 1990 private airline companies were allowed to operate air taxi services, resulting in the establishment of Jet Airways and Air Sahara. These changes in the Indian aviation policies resulted in the increase of the share of private airline operators in domestic passenger carriage to 68.5% in 2005 from 0.4% of 1991.

Sector Highlights

CIVIL AVIATION
Table23.1- INDIAN SCHEDULED OPERATIONS
Item/Year	Unit	2000-01	2001-02	2002-03	2003-04	2004-05	2005-06	2006-07	2007-08	2008-09	2009-10 (P)
1	2	3	4	5	6	7	8	9	10	11	12
I. Domestic  Services (1)
1. Hours flown	'000 hr.	250	267	295	344	399	475	648	806	808	821
2. Aircraft kilometres flown	Million km.	137	147	166	189	214	253	350	440	430	410
3. Passengers carried	'000 no.	13712	12854	13951	15677	19445	25205	35793	44355	39467	45359
4. Passenger kilometres performed	Million Nos.	12283	11572	12848	14566	18030	23709	33520	41720	37700	43970
5. Passenger load factor	Percentage	61.7	55.5	56.3	58.4	64.9	67.6	68.8	68.9	63.7	71.9
6. Cargo carried	'000 tonne	167	161	179	198	245	256	266	302	278	325
(i) Freight	'000 tonne	144	138	156	177	218	225	246	282	253	295
(ii) Mail	'000 tonne	23	23	23	21	27	31	20	20	25	30
7.Tonne kilometres performed	Million Nos.	1223	1155	1273	1467	1816	2340	3180	3930	3520	4020
(i) Passenger	Million Nos.	1052	989	1086	1257	1558	2067	2910	3640	3260	3710
(ii) Freight	Million Nos.	152	143	164	191	229	238	250	270	240	280
(iii) Mail	Million Nos.	19	23	23	19	29	35	20	20	20	30
8. Weight load factor	Percentage	57.5	52.2	53.5	57.5	63.9	67.1	67.1	65.7	59.6	65.5
II. International Services
1. Hours flown	'000 hr.	98	111	129	146	175	237	269	338	403	433
2. Aircraft kilometres flown	Million km.	66	75	85	98	120	162	190	240	290	300
3. Passengers carried	'000 no.	3828	3698	4201	4493	5326	6547	7561	9108	10049	11626
4. Passenger kilometres performed	Million Nos.	13928	13408	15819	18108	22272	27858	30360	36130	40740	45510
5. Passenger load factor	Percentage	76.0	69.4	73.9	72.5	71.6	68.9	44.6	54.6	62.2	63.97
6. Cargo carried	'000 tonne	102	98	104	98	112	112	126	146	174	210
(i) Freight	'000 tonne	100	96	102	96	110	110	124	143	171	207
(ii) Mail	'000 tonne	2	2	2	2	2	2	2	3	3	3
7.Tonne kilometres performed	Million Nos.	1709	1631	1884	2092	2579	3138	3420	4180	4940	5420
(i) Passenger	Million Nos.	1294	1248	1473	1680	2058	2561	2800	3390	3950	4300
(ii) Freight	Million Nos.	404	371	401	399	509	562	610	770	960	1090
(iii) Mail	Million Nos.	11	12	10	13	12	14	10	20	30	30
8. Weight load factor	Percentage	72.9	66.4	70.4	66.3	65.8	61.0	59.7	55.1	56.0	60.3
Source : Directorate General of Civil Aviation

Key Issues Plaguing the Civil Aviation Sector :

·       Regulatory Vacuum : Today, the DGCA (Directorate General of Civil Aviation) looks after aviation safety, issues licences and investigates crashes. There is no regulatory authority overseeing issues like Ticketing, Air traffic control practices, fair practices and customer grievances. The government's decision to expand the powers of the Directorate General of Civil Aviation (DGCA) and form a Civil Aviation Authority (CAA) is therefore a welcome step.

·       Safety : “There were several times when routine checks of landing gear and flaps were ignored. In fact, I know of several pilots who were forced to take off even though routine checks were not conducted. I could no longer justify it to my conscience. I had to quit.” - An aircraft maintenance engineer (DNA, Mumbai).

·       Taxation: Sales tax on ATF (Aviation Turbine fuel), Airport landing charges, and UDF at new airports are the real issues that are hurting our airlines. Sales tax on ATF for domestic flights (IATA prevents governments from charging sales tax on International flights) has always been a contentious issue with State Governments who derive huge revenue from imposition of such taxes.

·       Capital Constraints: High fixed outlay, stiff competition, seasonality of demand etc have ensured that airlines take longer period to break-even then most other infrastructure companies. Due to their high operating losses airlines find it difficult to raise capital from the domestic or international capital markets.

·       High Debt Component: Inability to raise capital from the capital markets has resulted in airlines accumulating huge long term and short term debts in the form of Term Loans and Working Capital Loans from Banks. This is utilized for meeting their capacity building and operational requirements.

·       High Operating Costs: The regulatory system affects where, how and when airlines can fly. Thus it affects airlines’ ability to operate efficient routes and their revenue. To the extent that airlines cannot use the least cost combinations of aircraft types to carry passengers and freight, the costs of operating existing routes are higher than they otherwise might be (technical inefficiency). Further, they may be prevented from flying the optimum sized and configured network (allocative inefficiency).

·       Aircraft Acquisition / Leasing Cost: Leasing was the preferred route adopted by many Indian airline companies for inducting new aircrafts to meet capacity problems. However acquiring new aircrafts on lease basis became costlier with the withdrawal of income tax exemption granted on lease rentals paid on aircraft leased from foreign companies, subsequent to 31 March 2007.

Kingfisher Airlines Ltd.

Since inception, Kingfisher Airlines is yet to post profit on annual & total cost basis. Following are YoY financial results of Kingfisher Airlines, all numbers are in Indian rupee (INR) crore except EPS, which is in INR.

#	From	To	Months	Total Income	Cost	Net Profit	EPS	Share Price
1	5-Apr	6-Jun	15	1,352	1,692	-341	-68	85.85
2	6-Jul	7-Jun	12	2,142	2,562	-420	-42	137.65
3	7-Jul	8-Mar	9	1,546	1,734	-188	-11	122.05
4	8-Apr	9-Mar	12	5,577	7,186	-1,609	-55	33.40
5	9-Apr	10-Mar	12	5,271	6,918	-1,647	-54	46.75
6	10-Apr	11-Mar	12	6,496	7,523	-1,027	-16	43.60
7	11-Apr	11-Jun	3	1,991	2,255	-264	n/a	19.65**
Total			75	24,375	29,870	-5,496
** As of Nov 2011						Source : Money Control.com

One can see that the stock performance of Kingfisher Airlines has gone down drastically after 2007. On 19 December 2007, the company announced the merger with Air Deccan. (Since Indian aviation regulations prohibited domestic airlines from flying on international routes until they had operated in the domestic market for five years, it was decided to merge Kingfisher Airlines into Deccan Aviation, following which Deccan Aviation would be renamed Kingfisher Airlines. This was because Air Deccan was the older of the two airlines, and therefore would be the first to qualify for flying on international routes). Most problems faced by Kingfisher Airlines began with this very acquisition.

Following are the factors responsible for the dismal performance of the airline after acquisition of Air Deccan :

1)    2008 Economic Meltdown: The 2008 Economic Crisis led to a remarkable decline in airline passenger traffic worldwide. Kingfisher had acquired Air Deccan based on the assumption that it will be able to ply profitable international routes like Dubai. However the economic crisis and the resulting lower passenger density made even plying on such routes unprofitable.

2)    High Cost Business Model:  Kingfisher started with a high cost, high quality service model. The acquisition of Air Deccan and subsequent launch of Kingfisher Red (LCC service) marred its high brand equity and led to shifting of customer loyalties towards Jet Airways. Kingfisher also found itself competing on two ends with Jet Airways for HNI customers and with LCCs like Spice Jet, Indigo and Go Airways for the Low cost customer. Needless to say, it lost on both fronts. On 28th September 2011, the Chairman of Kingfisher Airlines, Vijay Mallya announced that the company would soon stop operations of Kingfisher Red as it did not believe in low-cost operations any longer.

3)    High Debt : As of 31^st March 2011 the company had current liabilities of Rs.4104 Crs. And Loan funds of Rs.7057 Crs. (after the debt recast exercise done in Dec-Jan 2011) Revenues during the period stood at Rs.6496 Crs. – Source : Audited Financial Results for FY 2010-11 of Kingfisher Airlines, available on its website.

4)    Higher Interest Burden : Interest rates started inching upwards from January 2010 after a long period of low interest regime. Increase in interest rates increased the interest burden of the company. Since revenues were not pouring in at the same rate the company soon found itself battling a tight liquidity situation. Most of the debt acquired by the company was done at a time when interest rates were fairly low, it seems the management then believed that interest rates would continue to remain low indefinitely – a case of wrongful assumptions.

Kingfisher, realizing its inability to service such high interest burden (Rs.1312 Crs for the year ended 31.03.2011) asked its lenders to restructure its debt (an exercise where short term loans are converted into loans of longer tenor to reduce size of regular repayments, it also includes conversion of longer tenor loans into equity in favour of the lenders). The exercise was carried out by a consortium of lenders led by SBI Capital Markets in Dec-Jan 2011 who obliged with the restructuring to avoid being left with a large non performing asset in their books. This provided some much needed relief to the airline.

5)    Liquidity Crunch: The servicing obligations of most airlines include lease servicing in addition to usual debt servicing obligations. These expenditures tend to run into hundreds of crores in yearly repayments for a large airline like Kingfisher. The liquidity issues faced by the company resulted in its default in lease rental payments, delay in payment of staff salaries, default in payment of fuel bills, default in payment of dues to Airports Authority of India (AAI).

In Sep 2011, the Chairman & Managing Director of Kingfisher Airlines made following disclosure to BSE – “The Company has incurred substantial losses and its networth has been eroded. However, having regard to improvement in the economic sentiment, rationalization measures adopted by the Company, fleet recovery and the implementation of the debt recast package with the lenders and promoters including conversion of debt into share capital, these interim financial statements have been prepared on the basis that the Company is a going concern and that no adjustments are required to the carrying value of assets and liabilities".

As per media reports, in November 2011 Kingfisher Airlines approached lenders for yet another debt recast.

Indian Airlines / Air India/ NACIL.

In 2001, Air India was put up for sale by the then NDA government. One of the bids was by a consortium of Tata Group-Singapore Airlines. However the re-privatisation plans were shelved after Singapore Airlines pulled out and the global economy slumped. In 2004 the UPA Government led by Congress and Left parties came to power and placed brakes on the disinvestment policy initiated by the previous government.

In March 2007, The UPA government came out with a grand plan to energize the state run domestic and international airlines and accordingly National Aviation Company of India Ltd. (NACIL) was incorporated. The scheme of amalgamation of Air India Ltd. and Indian Airlines Ltd. into NACIL was approved in August 2007, with the “appointed” date of the merger being set as 1 April 2007. Subsequently, in November 2010, NACIL was renamed as Air India Ltd. (AI).

Following are notable points from the CAG (Comptroller and Auditor General, a body which audits all government accounts) “Performance Audit of Civil Aviation in India (Ministry of Civil Aviation)” report for the year ended March 2011.

On Acquisition of Aircrafts

·       On 30 December 2005, the erstwhile Air India Ltd. (AIL) signed purchase agreements with Boeing and General Electric (GE) for supply of 50 Boeing aircraft (with GE engines) at an estimated project cost of Rs. 33,197 crore,

·       In addition, Air India Charters Ltd. (AICL)1 also signed purchase agreements with Boeing and CFM for supply of 18 short range B737 aircraft with CFM engines at an estimated project cost of Rs. 4,952 crore.

·       The original proposal pertained to the acquisition of 18 Short Range + 10 Long Range Aircrafts. This was however revised by the Ministry and the final revised order was made for 18 Short Range + 50 Long Range Aircrafts (IAL also made a similar acquisition of 43 Airbus aircrafts.

·       Clearly, there was a massive inflation of aircraft requirement.

·       Whatever chances AI had of increasing market share through increased capacity share were severely hampered by the decision to liberalise bilateral entitlements from 2005 onwards.

·       NPV for the acquisition was calculated at a different rate than normal to arrive at positive cash flows.

 On IAL and AIL Merger

·       The main focus of the process leading upto the implementation of the  merger was on consideration of alternative options for merger, stamp duty and tax implications,  creation of top level posts for accommodating existing incumbents etc. However, the financial case for merger was not adequately validated, prior to the merger.

·       One of the biggest potential  benefit of merger – viz. fleet integration – was not available, since the two airlines had  just concluded huge and long drawn out fleet acquisition exercises independently.

On Operational Performance

Key Financial Performance Table - Source : CAG Report 2011

·       The performance of IAL (Merged entity) vis-a-vis its competitors on various parameters (PLF, domestic market share, Passenger Revenue per RPKM) was consistently poor. IAL’s On-time Performance – a critical parameter of service – was low, compared to both full service carriers and low cost carriers. Further, the market share of IAL in cargo operations dropped dramatically, despite conversion of five B737 aircraft into freighter aircraft.

·       The India/USA route was the single biggest factor adversely affecting AIL’s operations. The grossly exaggerated nature of the assumption relating to increased yield on account of non-stop USA operations (projected in the revised project report for 50 long range aircraft) is clearly revealed.

·       Clearly, even in 2005-06, erstwhile AIL’s funds/ liquidity position was precariously poor, while in 2009-10, in case of merged entity, it was teetering on the brink of disaster.

Two companies, one private another state run. But don’t the similarities of the ill conceived decisions taken by each of them strike you.

I watched a lot many pseudo intellectuals battle their blunt wits about the Kingfisher/AI solvency issue on television channels. Such discussions or debate (The Almighty Goswami Show) seldom leave you the listener/viewer any wiser. At best, it leaves you with more questions, while answering none. This post is an attempt at providing some answers related to the issue, for those who seek them.

Keep Thinking.

YF-IThink