Domestic airline passenger traffic growth is set to nosedive into negative territory in 2012-13 due to the ongoing economic slowdown, coupled with high airfares. Fuel prices too will remain high and the rupee will remain weak against the dollar. Yet, the airline industry will, ironically, be in a better position on the margin front this fiscal than it was in 2011-12.

Lower competition arising from Kingfisher Airlines’ exit due to financial turmoil and subsequent consolidation in industry will shore up realisations in 2012-13. This is borne out by data for the first half of 2012-13, which reveals that domestic and international realisations of Indian carriers [considering the financials of Jet Airways (standalone domestic) and SpiceJet] have risen by around 30 per cent and 14 per cent year-on-year, respectively.

However, unlike in the past when higher ticket prices resulted in lower passenger load factor (PLF), this time around the PLF is steady despite the hike in ticket prices because of the loss of seat capacity emanating from the problems surrounding Kingfisher.

Boosted by better realisations, operating margins of the airlines are expected to increase by 2-3 percentage points year-on-year to be around 3-5 per cent in 2012-13. This is notwithstanding the fact that aviation turbine fuel (ATF) prices will average Rs. 65-70 per litre in 2012-13, 5 per cent higher compared to last year. Moreover, around 30-35 per cent of a carrier's operating cost is denominated in dollars and the greenback is expected to average Rs. 55 this year, higher by around 15 per cent. For Indian carriers, a weaker rupee translates into higher operational costs as they have to shell out more for lease rentals, global distribution system (GDS) for ticket reservation, aircraft spare parts, salaries of expat pilots and other costs traditionally borne in dollars.

This boost to margins will be a respite to Indian carriers after the huge losses posted in 2011-12. While passenger traffic grew at a healthy 14 per cent in 2011-12, aggressive pricing by certain carriers ensured that domestic fares stayed stable at 2010-11 levels even as ATF prices rose by nearly 35 per cent. The situation was compounded by a weaker rupee, which increased the operational cost of carriers. Consequently, the carriers saw red at net level in 2011-12: Jet Airways made a loss of Rs. 1,236 crore , Kingfisher lost a whopping Rs. 2,328 crore , and SpiceJet Rs.605.7 crore.

By contrast, in 2012-13, domestic airline companies increased ticket prices, and simultaneously benefitted from lower competition (due to drastic capacity reduction by Kingfisher Airlines and minimal capacity addition by others).

Predictably, demand growth has been a casualty of this hike in ticket prices, accentuated by the slowdown in the economy. Domestic air passenger traffic is estimated to have recorded a negative growth of around 2 per cent year-on-year during April-September 2012. This is in sharp contrast to double-digit growth recorded in domestic traffic ever since the advent of low-cost carriers, five years ago.

This trend in passenger traffic is expected to sustain this fiscal and hit air travel adversely; therefore, we expect domestic passenger traffic to shrink by around 3-5 per cent year-on-year in 2012-13. However, India's international operations are expected to see steady growth as Indian carriers are still in a position to add capacities unlike international carriers who have more or less exhausted the seat quotas available to them under bilateral treaties. We expect international passenger traffic in India to grow at a muted 2-3 per cent year-on-year in 2012-13.

While the profitability outlook for 2012-13 seems to be relatively better, there are structural issues that continue to plague the airline industry. In India, the problem of high crude oil prices (translating into high ATF prices) is compounded by the fact that nearly 20-25 per cent of the ATF price is on account of both central and state taxes. Consequently, ATF prices in India are nearly 40-50 per cent higher than global prices. It is, thus, necessary for the government to rationalise duties on fuel prices to ensure that airlines remain financially viable even in an era of high crude oil prices.

Further, Indian carriers are saddled with a collective debt burden of around Rs. 900 billion as on March 2012 and a high debt-equity ratio. Given the poor financial health of the industry, bringing down the debt levels is essential.

On the operational front, the airline industry will have to ensure a healthy trade-off between high ticket prices and the need to maintain robust growth in passenger traffic and high PLFs.

Virgin Group founder Richard Branson once famously remarked: “If you want to be a millionaire, start with a billion dollars and launch a new airline!” Considering the woes that Kingfisher and Air India are presently battling, other airline players would do well to heed Branson’s warning and take steps to avoid a similar fate.

(The author is Director, Crisil Research, a division of Crisil)

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