While there still isn't clarity on when the lockdown will end, it is highly likely that it will end before we have a vaccine for this at hand. Which would mean that certain precautions like social distancing will have to be maintained even after we begin 'business as usual'.
The typical domestic airline in India runs a 180 seater plane, running at above 80% occupancy, meaning that on average it fills up around 150 seats. What happens when they are forced to operate at 33%, filling only 60. Do the economics still make sense for the firm, or will the firms need a sharp jump in prices to continue to stay in business? In today's ZappChai post, we look at all this and more!
When the firms operate at ~85% load factor (~150 of the 180 seat plan is filled), the market-leading firm in India generates a revenue per kilometer of anywhere between Rs3.7 to Rs 4.0. The cost excluding fuel which varies quite sharply based on macro-economic conditions is around Rs 2.1 to 2.4. Depending on the cost of fuel, the cost per kilometer can move to 3.4 to 3.7 per kilometer.
Fuel is the largest cost head for the firm at around 40% of the total cost. The most major cost head other than fuel, is their aircraft rentals at ~15% of costs, followed by employee expense at around 10%. Landing fees and repair and maintenance take another 10% each.
The most notable change is the drop in occupancy from 85% to 33%. But there are other hits too. Notably a reduction in ancillary revenue. Indigo has indicated that this might be the case when they indicated that they plan to discontinue in-flight sales when they restart post COVID. Although this forms a relatively small part of the total revenue stream, it does add up.
It is helpful to remember that the numbers above are for one of the best-run airline companies in the country. Smaller firms that are more levered will have a greater outflow on account of interest payments as well as inefficient operations.
The burden of fixed costs
The unfortunate reality for the sector is that a majority of their costs are fixed or pseudo fixed. Irrespective of the capacity the plane flies at the fuel cost you'll need will remain largely the same. You'll stay have to pay the pilot the same salary and lease the planes at the same rate. The slight advantage the sector has now is the weakening crude prices that will reduce the burden they face on the aviation fuel front. A reduction of taxes from the government or a longer moratorium on the debt could also help the sector plug a few other outflows, but with the new occupancy at 40% of what they used to run at, these measures will be nowhere near sufficient.
If the firms have clarity that the social distancing in planes will have to run for a longer period of time, there is likely to be a sharp jump in prices across the board, as firms move their financials towards more stable levels. If evidence suggests that this may last just a few months however, the reaction from the aviation firms could be starkly different. With a few firms financially better positioned than their peers, they might want to use the period to sharply undercut the competition, either gaining share or forcing the peer to underprice, pushing them further towards the brink of bankruptcy.
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About the Author: The post is written by Ganesh Nagarsekar. Ganesh is a graduate from IIM Calcutta and has worked with J.P. Morgan and Goldman Sachs, before founding GSN Invest.