A study of the Indian Aviation industry

A study of the Indian Aviation industry

8/19/2015Submitted to: Professor Prakash SinghSubmitted by:

Table of ContentsChapter 1: Aviation Industry in India

1. Reasons for the choice of this industry.22. Industry overview.33. Business Model..54. Porters 5-Force analysis of the industry..75. Macroeconomic factors affecting the industry86. A few M&As in the aviation industry.10

Chapter 1: Aviation industry in India

1. Reasons for the choice of the industry:The Indian aviation industry has gone through a phase of turmoil in the past due to increase in crude oil prices, limited pricing power due to subdued demand and wide over capacity. As a result of which most of the firms in this industry face high debt burden and liquidity constraints. The balance sheet need to be improved which requires sufficient equity infusion. Improvement in financial condition is a necessity so that viability increases and branding is possible. To address all these concerns that surround the operating viability of Indian carriers, the Government on its part has initiated a series of measures including (a) proposal to allow foreign carriers to make strategic investments (up to 49% stake) in Indian Carriers (b) proposal to allow airlines to directly import ATF (c) lifting the freeze on international expansions of private airlines and (d) financial assistance to the national carrier. Now, with favorable demographics, increase in disposable incomes and low air travel penetration, there are chances of huge investment in this sector. There are various challenges involved in the implementation of the stated government initiatives. Foreign airlines already enjoy significant market share of international route so they may not be interested in investing in the Indian airlines. Also, the difference between sales tax and import duty promotes the import of ATF but the problems associated with storing, importing and transporting air fuel may act as a major roadblock in the import. Given all these circumstances, we felt it would be interesting to know which accounting policies the major players in the industry use and also which items they expense and which of them do they capitalize. Also, we found it challenging to study, interpret and analyze the impact of various initiatives and changing consumer demand on the accounting policies. This was the reason that we took up the aviation industry so that we can get a glimpse of the accounting strategies that firms follow to show themselves in a better financial position at the time of financial crisis.

2. Industry Overview:Market SizeIndia is the 9th largest aviation market in the world with a size of around US$ 16 billion and is poised to be the 3rd largest by 2020. India aviation sector promises huge growth potential due to large and increasing middle class population, rapid economic growth, higher disposable incomes, rising aspirations of the middle class and overall low penetration levels. Civil aviation industry in India is experiencing a new era of expansion driven by factors such modern airports, low cost carriers, FDI (foreign direct investments) in domestic airlines, advanced information technology interventions and growing focus on regional connectivity. Civil aviation sector has been growing steadily registering a growth of 13.8% during the last 10 years. The air transport in India has attracted FDI of over US$ 569 million from April 2000 to February 2015. Major PlayersThe companies operating in Indian Aviation sector can be broadly categorized into three types of player a) Public Player Government owned airline carrier - Air Indiab) Private Player Privately owned airline carrier like Jet Airways, Jet Lite, Spice Jet, Go Air, Indigoc) Start-up Player Privately owned but relatively new player like Air Asia, Vistara, Air PegaususAirlinesOwned ByFounded InFounder & YearCEO

Air IndiaGovernment of India1932JRD Tata, 1932Rohit Nandan

Jet AirwaysTailwinds Private Limited1992Naresh GoyalCramer Ball

Jet LiteTailwinds Private Limited1991Subrat RoyCramer Ball

Spice JetSun Group2005Ajay Singh, Bhupendra KansegraSanjeev Kapoor

Go AirWadia Group2006Jehangir WadiaGiorgio De Roni

IndigoInterglobe Enterprises2006Rakesh Gangwal,Rahul BhatiaRahul Bhatia

Air CostaLEPL Group2013L.V.S RajasekharCaptain K.N Babu

Air Asia IndiaAirAsia,Tata Group2013Tony FernandesMittu Chandilya

VistaraTata Sons2013Tata Sons,Singapore AirlinesPhee Teik Yeoh

Air PegaususDcor Aviation2014Pegasus AirlinesShyson Thomas

AirlinesMarket Share (%)

Air India15.80%

Jet Airways18.70%

Jet Lite3.20%

Spice Jet11.60%

Go Air8.70%

Indigo38.40%

Air Costa1.00%

Air Asia India1.40%

Vistara1.30%

Air Pegausus0.10%

In our study, we have selected following five companies on the basis of their market share-1) Air India: Air India is the flag carrier airline of India owned by Air India Limited (AIL), a Government of India enterprise. It is the third largest airline in India (after Indi Go and Jet Airways) in domestic market share, and operates a fleet of Airbus and Boeing aircraft serving various domestic and international airports.

2) Jet Airways: Jet Airways is a major Indian airline based in Mumbai. It is the second largest airline in India, both in terms of market share and passengers carried, after IndiGo. It operates over 300 flights daily to 74 destinations worldwide. Its main hub is Mumbai, with secondary hubs at Delhi, Kolkata, Chennai, and Bengaluru.

3) Spice Jet: Spice Jet is an Indian low-cost airline. It is the country's second largest airline by domestic passenger share. The airline operates more than 270 daily flights to 41 destinations, including 34 Indian and 7 international cities using a fleet of Boeing 737 Next Generation and Bombardier Dash 8 Q400 aircraft.

4) Indigo: It is an Indian budget airline company headquartered at Gurgaon, India. It is the fastest growing and also the largest airline in India with a market share of 35.8% in July 2015. The airline offers more than 633 daily flights connecting to 38 destinations including 5 international destinations with its primary hub at Indira Gandhi International Airport, New Delhi. It presently operates a fleet of 97 aircrafts belonging to the Airbus A320 family.

5) Go Air: It is an Indian Low cost carrier based in Mumbai. It commenced operations in November 2005. It is the aviation foray of the Wadia Group. As of January 2014, it is the fifth largest airline in India by market share. It operates domestic passenger services to 22 cities with over 140 daily flights and approximately 975 weekly flights.

3. Business Model Indian aviation industry operates in two different business model Low Cost Carrier (LCC) and Full Service Carrier (FSC) model, and they differentiate on below parametersLow Cost Carrier (Indigo, Go Air, Spice jet)Full Service Carrier (Air India, Jet Airways)

Product Feature

Fare Structure Multiple fare structures with various restrictions.Simplified fare structure.

DistributionLow direct sales, high dependency on travel agents.High direct sales and low dependency on travel agents

Route StructureHigh frequency Hub and Spoke route structure.High frequency Point to Point route structure.

Seating Multiple classes with mixed seating density (Economy/Business/First). Pre assigned seating.Single class high density seating, unreserved seating

In flightHot meals and in-flight entertainment.No hot meals. Snacks and light beverages only, no in-flight-entertainment

Frequent FlyerFrequent flyer program.No frequent flyer program

Operating Feature

Aircraft Multiple aircraft types and low utilization of aircraft (9 hours/day)Single Aircraft type, high utilization rate (12 hours per day)

Trip lengthMedium to longShort to medium

AirportPrimary airport with major international connections.Secondary/uncongested which facilitates fast turnaround of aircraft.

StaffHigh wage but low productivity. No profit sharing.Competitive wage, profit sharing plan and highly productive employees

Major Issues Confronting Indian Aviation Industry1) Intense Competition: As more players are attracted towards Aviation industry because of increasing growth prospects it will lead to more competition. All this has resulted in lower returns for all operators

2) High Cost Environment (Tax on ATF): ATF is usually responsible for around 40% of total cost for a typical airline company. State and central government levies high tax on ATF which make it more costlier compare to global average.

3) Shortage of trained Employee: There is a shortage of trained and skilled manpower in the aviation sector as a result of which there is cut-throat competition for employees which, in turn, is driving wages to unsustainable levels. Moreover, the industry is unable to retain talented employees.

4) Regional connectivity: To provide regional connectivity is one of the biggest challenges facing the aviation sector in India. The lack of airports is hampering the growth of regional connectivity.

5) Rising fuel prices: As fuel prices have risen, the inverse relationship between fuel prices and airline stock prices has been established. Moreover, it also led to increase in the air fares.

6) Gaps in infrastructure: Airport and air traffic control (ATC) infrastructure is insufficient to support growth. While an initiate has been made to upgrade the infrastructure, the results will be visible only after some years.

7) High input costs: The input costs are also very high because of some of the reasons like Withholding tax on interest repayments on foreign currency loans for aircraft acquisition. Increasing manpower costs due to shortage of technical personnel

Cost Structure of Airport IndustryAn airline company operating in Indian Aviation sector incurs different kind of cost, which are described as below ATF costs contributes 30-45% of overall operating costs for Full Service Carriers (FSCs) & 40-55% for Low cost carriers (LCCs). Domestic ATF prices are linked to fluctuation in crude oil prices and movement in INR vs. USD. High central and state levies translates into a 60-70% higher ATF prices in India over the global average. Significant congestion at major domestic airports increases fuel costs considerably. Given the fact that Indian airlines have been in aggressive expansion phase, dearth of experienced pilots require airlines to employee foreign pilots which command higher salaries and are often paid in foreign currency Most airlines follow an operating lease model for large part of their capacity. Lease rentals are also denominated in foreign currency thereby exposed to fluctuation in forex movement; Depreciation costs mainly for owned aircrafts (FSC)

4. Porters Five forces Model for the Aviation Industry

5. Major economic factors affecting the industry:

1. Rise in per capita income and an increasing working population: With a growing proportion of the population entering the middle income group, the disposable income per person has increased, making air travel easier, affordable and preferable for them compared to road or rail which consume time and have increasing costs associated.Currently, 64.8 percent of the total population in India belongs to the working age group (16-60 years) and the percentage is expected to grow further. This indicates that the employee base is increasing and so is the frequency of business air travel.

2. Rising domestic and foreign tourism: The tourism infrastructure in India is improving and successful ad campaigns attract both Indian and foreign tourists to various parts of the country. The share of travel & tourism in Indias GDP increased 7.3 percent in 2014; and is expected to grow by 7 percent per annum over next 10 years. The increase in tourism traffic had significantly improved the demand for air travel.

3. Emerging businesses: India is one of the fastest growing economies in the world. With a large number of existing businesses expanding not just in India but also across international borders and the new businesses thriving, the number of business travellers has increased manifold. Delhi, Mumbai, Bengaluru, Hyderabad are the leading business hubs, with maximum business travellers preferring the airways due to faster and better connectivity offered.

4. Expanding trade: About 30 percent of trade in India is undertaken via airways. In the financial year 2014, the domestic freight traffic was 0.8 million tonnes (7.1 percent growth compared to financial year 2013) and the international freight traffic was 1.4 million tonnes (2.4 percent growth compared to financial year 2013). Growth in import and export are the key factors for growth in freight traffic and the freight traffic is expected to be five times the current level in the next twenty years.

5. FDI in aviation and liberalised aviation policy: The Government of India has notified foreign direct investment of up to 49 per cent by foreign carriers in the Indian aviation industry. The NRIs are allowed to pick up 100% equity in the airlines. This move will, in the long run, draw more serious global players into the sector, given the size of the Indian aviation market and its growth potential. However, addressing issues relating to taxes and levies on aviation turbine fuel will be critical to attract substantial FDI in the sector.

6. Crude Oil prices: The crude oil price significantly impacts the airline industrys cost structure since fuel costs form about 30% of an airlines operating costs. In 2011, the cost of crude oil accounted for ~75% of the cost structure of jet fuel, excluding taxes. Refining margins accounted for 13%. The rest was for transportation, storage, and logistics. Due to the recent fall in Brent crude oil prices, the airline fuel cost decreased to 26% of airlines operating costs by 2015, from 30% in 2013.

7. Investments: The Indian aviation sector is likely to see investments totalling USD 12.1 billion during the Twelfth Five Year Plan. Over 70 percent of this investment is expected to come from the private sector. Adoption of the Public Private Partnership (PPP) model in aviation industry has substantially boosted the private sector investments in the industry. Success of PPP formats will raise investment in existing and Greenfield airports.

8. Taxation: At present, the cost of servicing an aircraft in India is very high owing to a number of taxes.The civil aviation ministry is working to seek a tax break for the maintenance, repair and overhaul (MRO) sector.The proposal for tax break, if accepted, will lead to servicing costs becoming 40% cheaper than neighbouring nations and will provide jobs.The Aviation Turbine Fuel (ATF) forms about 40-50 percent of the airlines operating costs. The aviation ministry is working with the states to bring down taxes on ATF. Moderate fuel prices are a key component to making the industry more competitive.

9. Profitability: Increased competition in the industry among the private players, has resulted in intense price wars (in many cases below cost pricing) to gain maximum travellers, decreased yields and increased the debt levels & interest costs. All these factors have severely impacted the profitability margins of the airline industry with some major carriers e.g. Spice Jet incurring steep losses.

6. Cases of M&A in the Aviation industry:

1. Merger of Air India and Indian Airlines Approved by the Government of India on March 2007 The combined entity was registered on March 10, 2010 The merger had created a mega company with combined revenue of Rs. 15000 crores. The new entity had seen a number of changes in its operating model. It was much less restricted by government control and is therefore much more agile and could churn better returns than the two different entities. Air-India would have a combined fleet of 112 aircraft and would be among the top 10 airlines in Asia and among the leading 30 airlines globally.2. Acquisition of Sahara Airlines by Jet Airways Became effective on 20th April 2007 Jet rebranded Sahara as Jetlite and announced that the new entity would offer reduced frills but would be over and above low cost carrier (LCC) in terms of service. Since Sahara Airlines would operate as an independent carrier with its own Operating Permit, it would have access to available traffic rights for international operations.3. Kingfisher Airlines and Air Deccan In 2007, Kingfisher Airlines acquired a 26% equity stake in Air Deccan and became the largest single shareholder in Deccan Aviation Ltd Kingfisher later increased its stake to 46%, and took control of the management of Air Deccan, upgrading it to a value-based airline with higher airfare and repositioned it as 'Simplifly Deccan'. After the merger, the company has a combined fleet of 71 aircrafts, connects 70 destinations and operates 550 flights in a day. The combined entity has a market share of 33%.

References:http://www.legalservicesindia.com/article/article/mergers-&-acquisitions-in-aviation-sector-805-1.htmlDirectorate General of Civil Association http://www.dgca.nic.in/reports/stat-ind.htmInternational Air Transport Association www.iata.org/Indian Brand Equity Foundation www.ibef.orgAir India Website http://www.airindia.in/about-airindia.htmSpice Jet Website http://www.spicejet.com/Fleet.aspxIndigo Website https://book.goindigo.in/Go Air Web Site https://www.goair.in/menu/about-usJet Airways http://www.jetairways.com/EN/IN/JetExperience/about-jet-airways.aspx

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