IndiGo's bottomline hit, other airlines will also suffer; why airfares should rise

New Delhi: India is one of the world’s fastest growing aviation markets, where passengers are enticed to fly with ridiculously low fares even as airlines’ costs remain among the highest due to high taxation of jet fuel. Frequent and bruising fare wars have scraped away about 7 percent from the net profit growth of market leader IndiGo for the June quarter.

 IndiGos bottomline hit, other airlines will also suffer; why airfares should rise

Reuters

The airline now says competitive intensity on fares is hurting its bottomline and it will continue to participate in such fares wars. The truth is air fares in India are among the lowest (a Bloomberg story says base fares are as low as 2 cents) and India generates volume of air traffic on the back of affordability. To make matters worse for airlines, there was a further 11 percent decline in year-on-year average domestic air fares during the June quarter this year. The average price at which IndiGo sold a seat was Rs 4,032 in Q1 this fiscal against Rs 4,525 in the same quarter last year. This is the reason for a decline in profitability for India’s largest airline by passenger numbers.

This story shows how the fare gimmicks have continued well into the second quarter. It says the cheapest fare for Delhi-Mumbai travel during the two-month period between August and September this year across three airlines hovered between Rs 2,681 to Rs 2,688. Fares for the same route booked a week in advance in 2015 was charged anywhere between Rs 5,000 to Rs 6,000. Indigo said it would open fares from as cheap as Rs 1,005 starting 27 July to 29 July.

For IndiGo, net profit fell to Rs 592 crore (Rs 639 crore) while total income from operations rose 8.7 percent to Rs 4,579 crore. The airline reported that average yield (measure of average fare paid per mile, per passenger) fell 8 percent during the June quarter because of fall in average ticket prices."We have posted yet another profitable quarter. However, profitability was lower than last year primarily because of competitive fare pressures," said InterGlobe president Aditya Ghosh.

So will India’s airlines think of raising fares to improve profitability? Not just IndiGo, every other airline will likely post a decline in profitability for the June quarter due to the same fare wars. They already operate on thin margins due to warped cost dynamics, despite historic low jet fuel prices, with IndiGo the strongest bet.

According to an analysis by Kotak Institutional Equities, IndiGo’s EBIDTA margin was 20.3 percent in the March quarter against Jet Airways’ 15.6 percent and SpiceJet’s 2.9 percent. A further decline in fares will obviously impact the already thin margins negatively. But much like many other commercial decisions, raising air fares too is an emotional issue in India. The Modi government has already made it plain that it wants air fares, especially last minute fares, to be lower. In fact, it has unleashed state-owned Air India to lower last minute fares by offering discounted fares four hours before a flight in select sectors. Though last-minute fares account for a small portion of an airline’s revenues, Air India’s move forces competing airlines to also drop fares. Not just last-minute, even advance purchase fares are down and IndiGo now says it will be forced to match declining fares of the competition in the coming quarters.

In a conference call with analysts after announcing the Q1 results, IndiGo’s management noted that all major airlines are running low fares across market segments, leading to continuous pressure on yield for all. IndiGo says it refrained from participating equally initially, but this resulted in a steep decline in its load factor in June to 78 percent, from 87 percent yoy. “This led to a rethink by the management, as it is scheduled to receive 26 aircraft (including 24 A230neos) in FY2017, and thus needs to ensure volumes growth. It is thus looking to match the market fares more aggressively going forward, implying that near-term margins will remain under pressure,” the Kotak analysis said.

An ICICI Securities analysis says there could be a 3 percent decline in average fares in India’s domestic aviation market this fiscal. But goes on to add that there is a case for fare hikes for domestic airlines based on the lagging capacity growth when juxtaposed with the strong 20 percent traffic growth seen in every month of 2016.

It also points to increasing congestion at India’s major airports and suggests that this unlikely phenomenon could actually help airlines like IndiGo raise fares in the coming months. Seats on direct flights from congested airports become expensive to focus on premium traffic, the brokerage says, while pointing towards other congested airports such as London’s Heathrow.

“There have been instances when the direct flights from Heathrow have been three times more expensive compared to nearby Gatwick airport. Without secondary airports in any Indian cities, the rise in domestic ticket prices is even stronger. Hence, in short to medium term, congestion in airports can be good for airlines.” A case in point is Mumbai airport. Some other top tier airports are already operating at maximum capacity or will reach that stage in the coming two to three years. This list includes airports like Pune, Bangalore, Hyderabad, Goa and Delhi besides Mumbai.

The bottomline is, unless airlines effect a moderate increase in fares in the next two quarters, all of them will be hit. Fare wars are good to increase aircraft loads but should be used sparingly as a commercial strategy.

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Updated Date: Aug 02, 2016 13:15:50 IST