State of Aviation Industry – Second Quarter Review

Second quarter financial results are available for Jet Airways, Spicejet and Deccan; Deccan has also declared its annual results for an extended period of fifteen months (April-June). The following table presents a summary of the performance

	Jet Airways		Spicejet		Deccan
Type	Un Audited		Un Audited		Un Audited
Date Begin	01 Jul 06	01 Apr 06	01 Jun 06	01 Mar 06	01 Jul 06	01 Apr 06
Date End	30 Sep 06	30 Jun 06	31 Aug 06	31 May 06	30 Sep 06	30 Jun 06
Description	Value (Rs. Million)
Net Sales	16150.4	16465.4	1594.69	1487.59	3587	3979.9
Other Income	2061.9	322.2	208.65	51.99	1773.8	321.6
Total Income	18212.3	16787.6	1803.35	1539.58	5360.8	4301.5
Expenditure	-17392.4	-15852.9	-1946.89	-1647.28	-5586.7	-5250.3
Operating Profit	819.9	934.7	-143.54	-107.7	-225.9	-948.8
Interest	-578.1	-642.4	-6.66	-10.27	-94.3	-86.8
Gross Profit	241.8	292.3	-150.2	-117.97	-320.2	-1035.6
Depreciation	-966.9	-887.4	-22.58	-7.35	-101.2	-67.4
Profit before Tax	-725.1	-595.1	-172.78	-125.32	-421.4	-1103.1
Tax	173.8	145.3	-5.41	-5.33	-8	0.5
Profit after Tax	-551.3	-449.8	-178.19	-130.65	-429.4	-1102.6
Net Profit	-551.3	-449.8	-178.19	-135.47	-429.4	-1102.6
Equity Capital	863.3	863.3	1843.39	1843.39	981.8	981.8
Reserves	-	-	994.19	1060.9	898.5	1259.5
EPS	-6.39	-5.21	-0.97	-0.73	-4.37	-13.58

Source: BSE website

Jet Airways: Rising cost and falling seat factors resulted in Jet Airways turning in a loss of Rs. 55 crore for the September quarter. Had it not been for the higher other income, of which around Rs. 160 crore was realised from sale and lease back of aircraft, the loss would have been higher. In fact, if we take out other income the airline posted a loss of Rs. 124 at the operating level and the EBITDA (earning before interest tax depreciation and amortisation) declined to 2.1% from 12.6% in the corresponding quarter of the previous year.

On year-on-year basis seat factor has come down to 63.5%, mainly due to competition. The airline has attempted to maintain yields at the cost of falling loads, resulting in revenue per km remaining flat at Rs. 4.82. However, due to higher expenditure on account of employees’ remuneration and benefits, fuel cost and distribution expenses; cost per available seat km has gone up to Rs. 3.6 from Rs. 3.08 during second quarter of last year. With discounted fares accounting for 65 per cent, the break-even level in Q2 FY07 moved up to 74.6 per cent from 63.9 per cent in Q2 FY06.

Jet’s market share is around 31 per cent, down 7 per cent y-o-y. The international operations will take time to stabilise with flights on new routes. The bulk of the losses came from international operations. These contributed to 17 per cent of Jet Airways’ revenue but it ran up a loss of Rs 111.4 crore during the reporting quarter. With fuel prices having eased and online bookings (10 per cent now) picking up, cost pressures will ease somewhat. Moreover, the management hopes to maintain yields and improve seat factors in the second half. However, unless capacity addition is delayed, both loads and yields are unlikely to improve significantly. The litigation over the Sahara deal is yet to be resolved, this may prove to be a drag on Jet’s performance for the remaining period of the year.

Spicejet: A write back of unclaimed payables of Rs 18.9 crore helped Spicejet keep down losses for the August quarter to Rs 17.8 crore, though this was still higher than the Rs 13.5 crore posted in Q4 FY06. With no aircraft added this quarter, which is the weakest for airlines, net sales grew 178 per cent y-o-y to Rs 159.5 crore, but just 7 per cent q-o-q. The loss at the EBITDA level was Rs 35.2 crore compared with a loss of Rs 16 crore in Q4 FY06. While high aviation fuel costs—prices were up 32 per cent y-o-y—were the main culprit, the load factor too was down at 82 per cent from 87.5 per cent in Q4 FY06. However, both loads and yields are likely to pick up in the November and February quarters given the holiday traffic. Besides, fuel costs should come off by about 10 per cent in the current quarter. Yields, according to the management are up 20 per cent in the current quarter, and two more aircraft will be added soon. Revenues from ancillary services currently at around 7 per cent of total revenues are likely to go up to 10 per cent by the end of FY07. The company has also started doing hotel bookings a few weeks back and is looking to start on-board advertising. Spicejet has tied up the funding for 22 aircraft—it will have 28 aircraft by end 2008. By remaining faithful to the LCC model the airline has managed to leverage the cost advantage rather well and been successful in keeping its loads at 80 per cent.

Deccan Airways: The market expectation was Deccan Aviation to turn in a loss of around Rs 150 crore for the 15 months ended June 2006. But the amount has been more than twice the estimate at Rs 340 crore. For the year ended March 2006 too, the loss at Rs 230.29 was way higher than anticipated. While higher aviation turbine fuel costs—which were up at 48 per cent of sales in FY06 compared with 30.3 per cent in FY05 and 56 per cent in the June 2006 quarter-were the biggest culprit, other costs too have gone up. For instance, employee remuneration is up around 400 basis points, while operating expenditure — including leases — have gone up by about 500 basis points. In all this, though the carrier has cornered a market share of around 19 per cent. Revenues are up 174 per cent y-o-y in FY06 at Rs 839 crore. However, the market share is obviously coming at a price because yields (revenue per passenger km) for the Airbus at less than Rs 3 are way below costs (cost per available seat km) of around Rs 3.60-Rs 3.70. The management has hinted that it would be no longer possible to pass on lower costs of oil given the competition. The Deccan stock was up around 4 per cent at around Rs 112 on 3-11-06 (Friday), possibly because the company has managed to find $100 million of funds, which would give it some breathing time. Meanwhile, if oil prices continue to fall, Deccan, as also other airlines, will continue to gain, as operating leverage is fairly high. In the June quarter, Deccan posted a Rs110 crore loss mainly owing to higher ATF costs. However, more than oil prices what is worrying is the capacity coming up in the industry. Unless demand grows at over 40 per cent, it will be difficult for the industry to maintain loads and yields.

State of the Aviation Industry

The aviation industry appears to be either on a threshold of turmoil or is already there. Financial results recently announced by a few airlines points towards deteriorating financial performance. The low cost Spicejet has reported a net loss of Rs. 41.42 crore during the first year of operation on a total income of Rs. 453.15 crore. Jet Airways has reported a net loss of Rs. 45 crore during the first quarter of the current year. This is paradoxical because the financial performance follows on the back of a healthy 25% growth in passenger traffic during 2005-06 which further improved to 40% in the first quarter of the current year. Quite clearly the airlines industry is in the midst of a profitless volume growth, which raises the question whether the industry is headed towards sickness.

In the perception of the market too the aviation industry does not appear to be of great value. Price of Jet Airways shares which; in 2005 averaged Rs.1144.70 is down to Rs. 556.35 in August 2006; whereas during the same period the Sensex moved up from 9397 in 2005 (yearly average) to 11406 in August 2006. Similarly price of shares of Deccan Airways, which debuted at Rs. 148 on June 12, 2006, has fallen to Rs. 75.95 on August 9, 2006. Factors that are hampering profitability and arousing investors’ anxiety are well known; these being, rising fuel and labour costs, stringent competition and rapid entry of new players. In fact how grim the prospect is can be judged by the reported story that Indigo, the newest low cost airline on the horizon, has already budgeted a loss of Rs. 100 crore in its first year of operation. The issue that needs to be discussed is whether there is a malaise that is well set or is it a temporary aberration that the industry is likely to correct itself.

To examine the above issue the study has been divided into three parts. First we analyse the financial performance of a few airlines, this is an attempt to make out whether financial fundamentals are sound or not. Next, we analyse the present context and try to understand the factors that have led to the present growth of the sector and whether these growth drivers are sustainable in the future as well. and finally we examine the current performance of the aviation industry.

Financial Performance

To be fair, this is not the first time that the industry is going through turbulence. A few years after the sector had been opened up in the nineties, the industry went into a tailspin due to closure of several newly floated airlines. However, there are two major qualitative differences in the developments then and that which is taking place now. The airlines that came into existence in the earlier period were all full service carriers; the concept of low cost airlines had not yet arrived. To establish both their brand equity as well as market share the airlines competed on quality of service and not on price (i.e.; fares). The image of superior service provider that Jet Airways built up in those days survives till date. Also, the nineties did not witness any significant spurt in passenger growth, which meant that on the demand side the market size by and large remained unchanged while on the supply side capacity was added. Compulsion to provide better and better service inevitably led to increase in cost, in particular variable cost, which put severe pressure on the finances of the airlines and since passenger growth was not forthcoming in the desired volume it led to winding up of several airlines.

Unlike the past, present day Indian aviation is clearly divided into two categories that of full service carriers and low cost carriers. The advent of low cost carriers has resulted in making significant changes in the nature and development of the industry. Low fares have worked in expanding the size of the market; there has been phenomenal explosion in the number of passengers travelling by air. One fall out of the expanding market has been that the airlines now are in a better position to both recover their variable cost and simultaneously offer lower fares. This is reflected in the operating profit that some airlines have been able to make despite registering overall net loss.

Jet Airways

In the case of Jet Airways a distinction has to be made between its domestic and international operation. As the following table shows Jet made profit in the first quarter of 2006-07 on its domestic operation, it suffered losses only on its international operations.

First Quarter Financial Highlights of Jet Airways

(Rs. Million)

	Domestic		International		Total
	Q 1 06-07	Q 1 05-06	Q 1 06-07	Q1 05-06	Q 1 06-07	Q 1 05-06
Total Revenue	14,431	12,704	2,356	750	16,788	13,454
Total Expenditure	14,313	10,508	3,069	1,394	17,383	11,903
Profit Before tax	118	2195	(713)	644	(595)	1551
Profit After Tax	-	-	-	-	(450)	953

The important point that needs to be noted here is that the profit in the first quarter of 2006-07 is much smaller than the corresponding period of the previous year. Clearly, performance of Jet Airways has declined somewhat this year. There are two performance parameters that point towards the apparent inability of Jet Airways to keep pace with competition. Jet could not match with the capacity growth; while industry capacity grew at 48% that of Jet grew by only 19%. Further, while the industry witnessed 52% growth in passenger, Jet could manage an increase of only 21%. All this resulted in seat factor going down to 73% in Q1 06-07 from 75% in Q1 05-06. But here again there is difference in the performance in the domestic sector and that in the international sector.

In the domestic sector there is nearly two-percentage point decline in passenger load factor and almost four percent decline in revenue per revenue passenger kilometre, as a result gross revenue per passenger has declined by 6%. Add to this a 17% increase in cost per available seat kilometre and the end result is a decline in yield leading to 95% decline in profit. The key factors that have affected performance may be summed as follows:

• Pressure on yields due to excess capacity
• Shift in passenger mix (full fare/discounted fare): 35/65 in Q 1 06-07 vs 65/35 in Q 1 05-06
• Gross yield is lower by 6% over Q 1 05-06. If fuel cost is included then gross yield goes down by 9%.
• Sharp increase in salaries (up by 89%), lease rentals (by 86%) and fuel cost (by 51%)
• Increase in average flying time by 5-10%
• Pressure of competition that would not allow fare to be raised to the same extent as cost

In the international sector though Jet Airways operating parameters show improvement in Q 1 06-07 over that of Q 1 05-06, the airlines continues to register loss mainly due to the following reasons:

• Combined impact of lean season and incremental capacity year-on-year
• Average 20% increase in seats offered per week overall
• Over 50% increase in capacity by key competitors
• Competitive pressure on yields due to fare discounting by incumbents and higher component of origin and destination traffic at lower yields
• Increase in ATF costs; fuel surcharge is in place in almost all sectors
• Prevailing yields continue to be lower than previous year levels
• Low passenger seat factor, as against international average of 75% achieved in the first half of 2006 Jet Airways could achieve only 66%
• The gap between achieved passenger load factor and break even load factor continues to remain very large

There is little doubt that finances of Jet Airways are under pressure. The airline has been much less successful in managing competition than on earlier occasions. Its international operation continues to be a drag on the company finance; the current break even load factor of 94% is too high to infuse any confidence that the airline would be able make a turn around in this sector in the near future. Competition in the domestic sector has intensified manifold. The merger issue with Sahara possibly shifted Jet’s focus away from the challenges being posed by competition. Perhaps too much quality management time was spent in managing a successful merger than on airlines operation. Normally one would have expected Jet Airways to benefit the most from the decline in the performance of Sahara, however, Jet’s preoccupation with other matters has meant that the benefit has gone to airlines like Kingfisher and Deccan. Thus poor performance of Jet Airways in the first quarter can be given the benefit of doubt of being an aberration; there are mitigating factors that work in favour of Jet Airways. First, a single quarter performance is inadequate to reach an absolute conclusion. Second, the domestic passenger market is in the midst of an expansion phase, a phase that is likely to continue till the rest of the year. Third, which is the most important one; Jet has taken note of the wake up call and drawn up a strategy for turn around, which briefly is as follows:

Revival Strategy of Jet Airways

Revenue enhancement

· Enhancement of yield management process

– up-selling to higher fare buckets

• Increase in web sales:

– Dedicated on-line booking engines for corporate and travel agents to increase net retention per passenger (target: September 2006)

– Lower 3 fare classes to be available only for on-line bookings (target: September 2006)

– Target of over 25% of total bookings by end FY07

• Focus on increasing corporate deals
• Re-structuring of cargo/courier uplift rates; emphasis on corporate agreements
• Leverage the brand by generating incremental collateral revenues
• Focus on improving revenue per flight

Cost control / reduction

• Fuel cost optimisation

– Re-negotiation of agreements with fuel companies

– Reduction in effective aircraft weight

– Winglets to be installed on existing aircraft in a phased manner

– Increased hedging of international fuel uplift

• Reduction in maintenance cost
• Improved management of non-technical inventory
• Reduction in selling and distribution cost

– GDS costs

– enhanced web bookings

• Reduction in payroll cost and other operating expenses

– Stringent monitoring of other overhead costs and renegotiation of major contracts

Air Deccan

Air Deccan’s experience with its first public issue in May 2006, has had a major impact on the psyche of the Indian aviation industry, so much so that other airlines that were planning to launch their IPOs have decided to postpone the event, some by two years. Did Deccan’s IPO deserve the treatment that it got from the market or was it plain bad luck; just a matter of poor timing? It is important to separate the two issues and seek an answer for the industry may indeed have something to learn from the answers that may ultimately emerge.

Air Deccan started its scheduled flying operations in August 2003 and it financial results is available up till November 2005. The income of the airline primarily comes from sale of tickets, which roughly make up 85% of its total income. The main items of expenditure are (i) fuel, which accounted for a third of its total expenditure in 2004-05 (ii) direct operating expenses (20%) (iii) aircraft repairs and maintenance (11%) (iv) wages (10%) and (v) administrative and general expenses (7%). Though in 2003-04 Deccan reported a profit of Rs. 8.68 million the airline service had not been fully launched, that year the airline had a fleet strength of one aircraft flying one route between two airports. Fiscal 2005 represented the first full year of operation the fleet size went up from 4 aircraft at March 31, 2004 to 16 aircraft at March 31, 2005. While this resulted in impressive growth in physical performance like a 150% increase in the number of airports served and a 186% increase in the number of routes operated it did not translate into financial gains as the year ended with net loss of Rs. 195.32 million. In the following year the airline further expanded its operation but ended up with a loss of Rs. 1238.64 million (as on November 31, 2005). As a result of these losses the net worth of the company in November 2005 was negative at Rs. 1141.48 million, up from Rs. 123.73 million in the previous year.

From the investors point of view Deccan’s numbers do not present a pretty picture. A company, which was only into the second year of full operation, had a negative net worth. In November 2005 the value of its assets were just sufficient to cover the expenses on fuel and aircraft lease, the revenue model was based on a heavily discounted fare structure and an absolutely stripped down passenger amenities. While the business model of low cost was bringing in the passenger it also meant that margin had to necessarily remain small, significantly this implied that even if the company was to earn a profit the volume of profit was likely to be low unless the volume of passenger carried was very large. However, increasing the number of passengers might have required increasing the number of destinations, number of aircrafts and so on, which would have implied added overheads and added costs. Thus, for the investor there were too many imponderables that were impacting on the attractiveness of Deccan’s IPO[1].

To the uncertainties surrounding the Deccan IPO one must also add the peculiarities that surround the aviation sector. Though aviation is regarded as a service sector it has certain characteristics that are closer to manufacturing industry. Like manufacturing and unlike service industry in general, aviation has a high fixed cost. Fixed cost are expenditures that need to be incurred prior to the delivery of a service and are independent of output. Once these costs have been incurred the average cost of producing output will decrease as output increases. For airlines high fixed cost works to limit the choice of pair of destinations that can be served. Since the firms have to invest in capacity in order to provide service, it will provide service only in markets or city pairs where there is sufficient market. Secondly, aviation employs workers who are highly skilled and specialised and consequently expensive, like pilots, aviation engineers and air traffic controllers. Thus even the operating expenses are high. Doing business in the aviation sector involves more risks than many other service industries. Add to these the perception commonly prevalent that aviation is not a very profitable business the investor’s general lack of interest gets explained.

The IPO launch could still have succeeded if it were done in the midst of a bull run; this was precisely the strategy adopted by Deccan. Though there were no official announcements, nevertheless from time to time reports kept appearing in the media about probable date of Deccan’s IPO launch and finally when in April 2006 the airline filed its Red Herring Report with the SEBI the Sensex had moved up from 11,342 at the start of the month to 12,042 at close of the month. In May 2006 when Deccan filed its Final Offer Document with the SEBI, the Sensex stood at 12,103 at the beginning of the month. At that point the launch period was set from 18^th May 2006 to 24^th May 2006. Everything seemed to be in order till now, there was no indication of any impending start of a bear run, as the following table shows even during the week prior to the launch the movement of the Sensex had been range bound.

Sensex For the period: 18-May-2006 to 30-May-2006
Date	Open	High	Low	Close
11 May	12,631.54	12,671.11	12,397.02	12,435.41
12 May	12,400.71	12,421.76	12,224.44	12,285.11
15 May	12,272.64	12,272.64	11,770.76	11,822.20
16 May	11,861.18	11,954.51	11,378.96	11,873.73
17 May	11,962.87	12,238.81	11,962.87	12,217.81
18 May	12,163.98	12,163.98	11,330.45	11,391.43
19 May	11,549.67	11,697.11	10,799.01	10,938.61
22 May	11,071.63	11,142.90	9,826.91	10,481.77
23 May	10,590.67	10,859.20	10,185.48	10,822.78
24 May	10,830.98	11,000.96	10,504.59	10,573.15
25 May	10,520.90	10,720.67	10,274.93	10,666.32
26 May	10,735.14	11,050.77	10,735.14	10,809.35
29 May	10,855.03	10,992.38	10,781.61	10,853.14
30 May	10,886.61	10,988.23	10,722.92	10,786.63

It is a matter of unbelievable coincidence that the market started sliding from 18^th May, the opening day of the IPO. The Sensex that day fell by a massive 772 points and the downward journey continued right through the month of May during which the Sensex lost over 2000 points in a single month.

There is little doubt that to an extent Deccan’s IPO was a victim of a market correction that came about quite unexpectedly. Ever since the Sensex crossed the 10,000 mark there had been intermittent talks of a possible market correction, but observing the relentless upward climb of the index investors perhaps perceived that the correction would come at a distant date and not now; consequently Deccan was caught unawares. Still the question remains whether even after making discounts for unexpected market behaviour Deccan’s IPO would have performed better. As noted above Deccan’s poor financial performance did not make its IPO a hot favourite with the investors. In the light of the airlines strong physical performance, under normal conditions the IPO no doubt would have been subscribed but was unlikely to be a runaway success. Thus, Deccan’s IPO failure cannot be viewed as failure of the aviation industry or as a commentary on its health; on the contrary it was a combination of unfortunate timing and poor financial fundamentals.

Spicejet

Spicejet has just completed first year of its service and ended the year with a net loss of Rs. 41.42 crore. In the media reports a spokesperson for Spicejet was credited with claiming that the airlines made an operating profit of Rs. 71 crore in the first year, however the audited accounts of the company available at the Bombay Stock Exchange website show that the company made a operating loss of Rs. 34.69 crore during the period 1^st June 2005 to 31^st May 2006. Spicejet has an equity base of Rs. 184 crore; can this be considered sufficient to successfully run an airline company? At present there is no prescribed capital adequacy requirement for starting an airline company, but in the light of high risk-low margin business model being adopted by most of the newly launched airlines the issue comes up whether for the sake of ensuring a stable aviation industry there is a need to prescribe a minimum limit in this respect.

Indian Airlines

The first quarter financial performance of India Airlines shows that the airline has made operating loss of Rs. 88.5 crore despite showing improvement in physical performance. During 2005-06 the airline made an operating profit of Rs. 100.5 crore. Passenger load factor in the first quarter has gone up by four percentage point as compared to the full year performance of 2005-06. On a pro-rata basis performance in respect of other physical parameters, like passenger carried, available seat kilometres and revenue passenger kilometres, is better in the first quarter than in the previous year. Current quarter’s expenditure has gone up mainly due to increase in expenditure on fuel that now accounts for 36.1% of total operating expenditure compared to 34.7% in the previous year. Proportion of labour cost and distribution cost to total expenditure has remained unchanged.

Air India

Trend in Air India’s performance in the first quarter of 2006-07 is quite different from that of last year. Against a small operating profit of Rs. 9.38 crore in 2005-06, the airline has registered an operating loss of Rs. 195.91 crore during Q1 2006-07 and passenger load factor has fallen by three percentage point. Like other airlines fuel cost has risen sharply in the first quarter and at the current the airline would end up spending nearly Rs. 600 crore more on fuel than last year. Trend in expenditure on labour and distribution expenses has remained the same.

Kingfisher Airlines

During the first quarter of 2006-07, passenger load factor has increased from 59% in 2005-06 to 74%, that is a growth of 25%. If the trend of this quarter continues then the airline will end the year with operating revenue that would be 2.25 times higher than the previous year. The quarter has also witnessed sharp increase in expenditure on cost items, like labour, fuel and distribution, however due to increase in the number of passenger carried expenditure on per passenger basis has come down in respect of labour and distribution and gone up by only 10% in respect of fuel.

Key industry characteristics and Growth drivers

Current Status	Future Outlook
Key industry characteristics Under-penetrated markets Despite recent growth in air passenger traffic, India continues to have relatively high under-penetration of air services. According to the CMIE, domestic air traffic in the year ended March 31, 2005 reached 20 million.	For a country with a billion plus population, this amount to an average Indian making 0.02 trips per annum, which is one of the lowest in the world, compared to an average of 2.02 trips per person per year in the United States for the same period. Consequently, there is a high level of potential demand that may be generated as the Indian economy grows and air travel becomes more affordable for a larger population.
High fixed cost operating environment Domestic aviation sector in India continues to experience high input costs particularly in terms of fuel and airport related charges. These fixed costs often represent a substantial portion of the operating costs of most airlines	Situation is unlikely to alter in near future
Regulatory framework The domestic aviation sector is largely free from government intervention. The only regulatory provision in place is the Route Dispersal Guidelines issued by the DGCA that require all scheduled airlines operating in India to provide a minimum number of ASKMs on routes that service certain rural or smaller urban destinations that are classified as Category II and Category IIA	Conditions should substantially remain the same
Infrastructure constraints With the entry of four new players in the short span of a year and with more having announced their intentions for the same, the continued growth of the domestic aviation sector is presently being hampered by shortage of enabling infrastructure, such as airport facilities, parking bays, air traffic control facilities and takeoff and landing slots.	With modernisation and upgradation work of a number of airports already underway and plans for many other drawn up these infrastructure related problems will reduce, if not get completely eliminated, to a great extent.
Relatively limited reach across the country Historically, many areas of the country have not been served by scheduled airlines. Although the Route Dispersal Guidelines have helped to ensure that certain areas of the country are serviced, airport infrastructure and economic feasibility have meant that many airports do not have scheduled airline service. Of the approximately 450 airports in India less than 100 airports have a daily flight.	With the advent of low cost airlines and competition getting tougher on metro routes and on routes covering tier 2 cities spatial dispersion of aviation will shift towards smaller cities. Smaller airlines may find it profitable to fly on routes like Lucknow-Allahabad-Varanasi-Gorakhpur or Lucknow-Kanpur-Varanasi etc.
Demand Drivers High economic growth Growth in air transport (both passengers and cargo) is closely associated with growth in GDP. According to the IATA (International Air Transport Association) air transport can be projected to grow at roughly twice the rate of GDP growth. With Indian GDP expected to expand at a rate of 7.5% for 2005-2007, the IATA expects air traffic in India to grow approximately 15% for the same period.	The Approach Paper to Eleventh Five Year Plan has set the growth target at 7.5% per annum. However, there are many who believe that in reality growth may be in excess of 8%. Either way growth prospect for the eleventh plan look to be positive and therefore it would be reasonable to expect that air transport will grow at 15% or more.
Rising disposable income and affordability The aviation market in India consists of leisure travellers, business-related travellers and corporate travellers. Leisure and business related traffic tends to be more price-elastic. Corporate travellers, who fly at the expense of their employer or client, have historically formed the majority of the domestic air travel market in India. However, with increasing income levels and the emergence of flexible fare schemes and low-cost carriers, middle- to high-income leisure travellers and business travellers paying their own travel costs are likely to shift more from premium class travel in trains to air travel.	According to Centre for Monitoring Indian Economy, In contrast to the 15.25 million passengers carried by domestic Indian airlines in fiscal 2004, the Indian railways carried approximately 52 million passengers in its premium class products, i.e., air conditioned and first class coaches during the same period. If Eleventh Plan growth targets are met then this trend is likely to get further strengthened.
Growth in tourism The Indian tourism market has been growing at a significant pace over the last few years, with the Government giving impetus to the industry through various schemes and organised events.	According to the World Travel & Tourism Council India 2004 report, domestic tourists visits in India grew by 19% from 309.0m to 367.6m in fiscal 2004. During the same fiscal domestic air travel has grown by 13% while in fiscal 2005 domestic air traffic registered a growth of approximately 27%. The same source has predicted that travel and tourism expenditure in India is expected to achieve an annualised real growth rate of 8.8% over the 10-year period from fiscal 2004 to fiscal 2014.
The emergence of low-cost carriers Low-cost carrier airlines have created a transformation in the aviation sector. These airlines have sought to provide lower, if not the lowest, fares along with relatively high margins.	In the light of trend in income distribution observed in the past, economic growth is going to further add to the number of Indian middle class population for whom only low cost airlines can keep air travel affordable.

Current Performance of the Aviation Industry

In this section we examine the current performance of the aviation industry for a few selected parameters.

Parameters	Indian Airlines		Air India		Spicejet
	05-06	1st Qr 06-07	05-06	1st Qr 06-07	05-06*	1st Qr 06-07
Pax load factor (%)	67	71.1	66.2	63.1	83.72	88.25
Pax carried (million)	7.89	2.13	4.36	1.17	1.16	0.56
Available seat kilometres (million)	16256	4185	30965.5	8219.5	1414.42	662.57
Revenue per pax (Rs)	7657.58	7313.91	20056	18523	2671+	3030+
	Down by 4%		Down by 8%		Up by 13%
Labour cost per pax (Rs)	1595.43	1609.26	2051.98	1908.38	308.07	296.56
	Up by 0.01%		Down by 7%		Down by 4%
Fuel cost per pax (Rs)	2616.36	2790.65	6921.92	7864.64	1276.22	1439.43
	Up by 6%		Up by 14%		Up by 13%
Distrbn. cost per pax (Rs)	419.78	413.30	1194.60	1177.48	158.11	155.03
	Down by 1.5%		Down by 1%		Down by 2%
	Kingfisher		Jet Airways		Sahara
	05-06	1st Qr 06-07	05-06	1st Qr 06-07	05-06	1st Qr 06-07
Pax load factor (%)	59	74	72	72.9	70	62
Pax carried (million)	1.23	0.62	9.56	2.81	2.95	0.68
Available seat kilometres (million)	1963.94	839.68	13300	4037	5054.95	1353.04
Revenue per pax (Rs)	3719.81+	4120.91+	6417	5974	6060+	7569+
	Up by 10%		Down by 7%		Up by 25%
Labour cost per pax (Rs)	623.92	519.06	593.20	815.30	694.92	751.10
	Down by 20%		Up by 37%		Up by 8%
Fuel cost per pax (Rs)	1920.50	2108.91	1756.17	2084.69	2342.37	2916.05
	Up by 10%		Up by 19%		Up b y 24%
Distrbn. cost per pax (Rs)	176.13	162.01	809.62	733.09	Not available
	Down by 9%		Down by 10%

*May 2005-March 2006 +Operating revenue

If we look at the physical parameters it is seen that except for Spicejet none of the airlines could improve their passenger load factor. On the other hand when we compare the first quarter achievement in respect of passenger carried and available seat kilometres with that of 2005-06 the achievement is more than 25% of previous year. Thus, on a pro rata basis the airlines carried more passengers in the first quarter than in the previous year but there was also an excess capacity in the industry which resulted in passenger load factor remaining at the same level as that of the last year. In the transport sector capacity has two unique features. First, capacity is created to meet peak hour demand; therefore an average figure of capacity utilisation would generally show a low figure and suggest surplus capacity. Second, capacity cannot be created to meet the exact requirement; for example, if there is a demand for 73 passengers a plane cannot be bought having exactly 73 seats. Therefore at any given point of time there is likely to be surplus capacity. Hence, so long as the outlook for passenger demand is good a constant passenger load factor and excess capacity is not necessarily a bad sign.

Moving over to revenue and cost components it is noticed that Spicejet has managed its revenue and cost much better than rest of the airlines; improved passenger load factor in the first quarter has come on the back of improved revenue per passenger along with lower per passenger labour and distribution costs. In the matter of fuel cost Spicejet has managed to show the lowest increase in comparison to other airlines. There is buoyancy in the performance of Spicejet, which is not a sign of an airline that is about to fall sick.

For Jet Airways, first quarter performance has indeed been disappointing while revenue per passenger has gone down both labour cost and fuel cost per passenger has gone up affecting its profitability. Between labour cost and fuel cost, fuel cost has affected the airlines uniformly, increase in cost ranges from 13% to 24%. On the other hand labour cost has affected Jet Airways most severely while both Spicejet and Air India have managed to reduce it on per passenger basis. The decline in distribution cost perhaps reflects the impact of net booking, which has brought down the cost of ticketing for the airlines. Rising fuel cost is cause of worry, with the Middle East crisis not showing any sign of abatement it is a worry that is likely to remain with us at least in the near future. Labour cost is less of a worry, as shown by some airlines the trick is in better productivity. The two most public aspects of the cost structure of airlines are fuel and labour. Therefore, as fuel prices increase, or pressures on profitability arise, airlines not surprisingly seek to reduce labour costs in conjunction with increased productivity. Since in India due to perennial shortage of aviation manpower reduction in labour cost is difficult to attain, the focus has to be on productivity.

Conclusion

This study has attempted to analyse the present state of the aviation industry in the country; in particular it has tried to examine whether the latest financial performance of some of the airlines was indicative of a serious malaise that is in the making. The conclusion that emerge from the study are the following:

• · Jet made profit in the first quarter of 2006-07 on its domestic operation, it suffered losses only on its international operations.

• Jet Airways reported loss in the first quarter of 2006-07 can be attributed to two factors

─ Inability to keep pace with competition while industry capacity grew at 48% that of Jet grew by only 19%.

─ Inability to register growth in passenger at the same rate as that of the industry, while the industry witnessed 52% growth in passenger, Jet could manage an increase of only 21%.

• The key factors that have affected Jet Airways performance are pressure on yields due to excess capacity, shift in passenger mix (full fare/discounted fare); Pressure of competition that would not allow fare to be raised to the same extent as cost.

• There is little doubt that finances of Jet Airways are under pressure but that has more to do with a lack of foresight and a general lack of direction witnessed in recent period than any inherent financial shortcomings of the company. To begin with, quality management time was spent on the Air Sahara deal. This was a time when the airlines managers should have been working out ways to counter the aggressive low cost airlines. Players like Kingfisher, Air Deccan, and Spicejet have cashed in on the trunk routes, which used to be milked by Jet Airways for almost a decade in a duopoly market.

• The most encouraging aspect in this whole episode is that Jet Airways has not chosen to stay in denial mode and believe that nothing is wrong and as such nothing needs to be done. They accepted the reality and subsequent to the first quarter result Jet Airways has put into operation a revival plan to regain the lost ground. Hopefully, subsequent quarters will witness better results.

• Deccan’s IPO was hit by a combination of poor timing and poor financial performance. Deccan’s balance sheet showed two consecutive years of negative net worth. Seen in conjunction with Deccan’s revenue model of low margin the investors had doubts whether the company would be in a position to wipe out the deficit in the near future. Due to these reasons, even during the pre-launch period Deccan’s IPO did not receive a favourable response from the investing public. Start of the bear run on the day of the launch of the IPO, of course, further worsened the situation. To conclude, Deccan’s IPO failure cannot be viewed as failure of the aviation industry or as a commentary on the industry’s health.

• There are several factors that have contributed to the present spurt in growth of the aviation sector. On the demand side factors like GDP growth, under penetrated market, rising disposable income, growth in tourism will continue to operate in the immediate future as well. On the supply side factors like infrastructure constraints, high fixed cost operating environment, relatively limited reach across the country are likely to ease in the course of the eleventh Plan. Thus, both on the demand as well as supply side there are strong reasons to believe that growth in the aviation sector will last for some time.

• Problems that are currently facing the aviation sector are high fuel cost, rising cost of operation, an inability to raise fare due to tough competition, high fixed cost. These are serious problems that have the potential to cause a market disruption. Analysts have been talking for some time about a possible shake out, but when or how soon and which airline/s no one is able to predict. Two things are certain though, at the current fare level running a airline is getting increasingly difficult, much sooner than later the airlines, particularly LCAs, will have to raise fare, whether they do it either by imposing some kind of a surcharge or by revising the basic fare is a matter of detail for airlines to decide. And secondly, only those airlines that have adequate capital to back up their operations will manage to survive competition.

• One of the reasons for high fixed cost is high airport charges. Though airport business is being gradually opened to private sector but it is not going to undo the monopoly nature of the business, the present policy will only affect ownership. In the absence of competition monopoly pricing will prevail. As has been explained above due to low operating margin high fixed cost affect LCAs the most and yet they are the ones who are going to be drivers of future growth. For bringing down airport charges setting up of secondary airports or secondary terminals in existing airports can provide a solution.

• High labour cost is primarily due to shortage of trained manpower. One way to tackle the problem would be to promote tie up with institutions like IITs and others for running courses relevant to aviation. This would besides ensuring production of good quality manpower be more economical than setting up of independent aviation universities and less time consuming as well.

• Regarding fuel cost, two options are available. One would be to allow airlines to enter into price hedging arrangements for fuel supply. The other is recalibration tax burden on ATF. The two options are of course not mutually exclusive.

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[1] Around the time Deccan’s IPO was launched, out of curiosity I had been following the developments on various online discussion forums of investors and noticed that the consensus that seemed to emerge in these forums was (i) investors should observe caution; the IPO was not particularly promising (ii) if invested, one should be prepared to hold on to their investment for a long time because (iii) price of the share was sure to fall almost immediately after closure of the IPO. Whether the scrip was over priced or not the jury was divided.