India’s Airlines and the credit conundrum
Indian aviation history stands at a crossroads. With the recent sale of the national carrier Air India to the Tata Group, the market structure now has two ownership profiles (Indigo and Tata Group) which control over 80% of the market. Into the mix comes a well-capitalized startup, namely Akasa. The rest of the players, which also includes Jet Airways, which is trying to revive itself, are looking for ways to access credit.
And by all indications, credit flows to airlines are limited. At an industry level, cash positions are weak, collateral is a precondition and without corporate guarantees, credit simply does not flow. This is a situation that poses challenges for weaker airlines.
The new market structure has had an impact on credit risk profiles
The airline industry is known for its high fixed costs, limited variable costs and extremely thin margins. For Indian airlines, fundamental structural challenges have only added to these costs. Take for example the large number of fleets, the financing of the fleet and future orders. At present, Indian airlines are collectively sitting on some six hundred and fifty aircraft, the majority of which are leased. This means that there is a monthly cash outflow associated with these aircraft.
Given the structure of demand and the price of that demand, the opportunities to deploy these aircraft in profitable flight are scarce and given the fragile balance sheets and a banking sector totally opposed to aviation. To make matters more complex, market leader Indigo has a monopoly market share of over 55%. It is also the airline best positioned to weather the storm and the one deemed the most creditworthy, primarily due to its shifting focus on the balance sheet and emphasis on engagement with suppliers throughout. of the pandemic.
Asset-light balance sheets, once touted as management mantras, are now haunted by limited assets that can be collateralized or leveraged. For airlines that rely on the sale-leaseback mechanism, limited credit is a double-edged sword. Because they board planes to realize the gains of sale-and-leaseback but the possibilities of deployment are limited. Again, an untenable situation.
Cash flow challenges abound
While domestic travel has effectively resumed and demand is expected to exceed pre-covid levels by the end of the year, the start-stop-start nature of demand, which in turn is driven by the pandemic, was detrimental. Cash flow over the past twelve months has been tepid and erratic at best and, with respect to lending, liens on such cash flow are not sustainable due to cash flow uncertainty. This in turn forces all lenders to limit risk by requiring collateral.
As far as airline cash flow is concerned, returns are held back by government-mandated price floors. In effect, citizens are funding a sort of bailout for the airlines, because if there were price floors to be removed, fares would almost certainly come down. With continued restrictions on international flights, airlines are limited in terms of the capacity that can be added, which has consequent impacts on cash flow. Again, once the restrictions are lifted, consumers are almost certain to benefit from lower rates.
For now, price floors and international restrictions continue. No doubt because at the industry level, the cash position shows no signs of easing and without these measures, one or more airlines could consider a situation of closure.
Prudent lending and limited lending will continue in the short term
If the macroeconomic environment was not challenging enough, the lending environment only compounded the difficulties. Banks are extremely cautious when lending to the weakest airlines in the industry, given the extremely thin margins and credit risk profile.
As people celebrate the increase in domestic passenger numbers, seen through an investment lens, the picture is very different. While demand is skyrocketing, prices are supported by government-mandated price floors. When these are lifted, airlines with weaker cash will find it difficult to compete. Prices and capacity returns to levels that help to at least cover the cost of capital are not quite on the radar; international traffic is not expected to return to stable levels before 2024; and both cash and credit are limited. And all of that is assuming the third wave doesn’t strike and wreak havoc again.
For lenders looking for comfort, there is little on the horizon. Especially for weaker airlines that have thin balance sheets, a lack of equity injections and no other source of revenue. In such a situation, if lenders lend anyway, it is likely in the hope that previous loans will not go badly. And past precedents in this regard have not worked too well. Until the market receives a strong signal from weak airlines regarding skin in play, the credit situation is unlikely to improve.
When it comes to Indian airlines, the credit conundrum persists.
—The author Satyendra Pandey is the managing partner of aviation services company AT-TV. The opinions expressed are personal.
(Edited by : Priyanka Deshpande)
First post: STI