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IIMA Consult Club Newsletter - Oct 2010

IIMA Consult Club Newsletter - Oct 2010

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Published by Amber Maheshwari
The October issue of Panorama, the monthly newsletter of the Consult Club of IIM Ahmedabad. View the other issues on Visit our blog at http://iimaconsulting.blogspot.com/
The October issue of Panorama, the monthly newsletter of the Consult Club of IIM Ahmedabad. View the other issues on Visit our blog at http://iimaconsulting.blogspot.com/

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Published by: Amber Maheshwari on Dec 24, 2010
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 After two decades which saw bothunprecedented growth and stagnation,the Indian Civil Aviation sector isentering a new phase of development.Despite tremendous growth in recent years, less than 2% of Indians travel byair each year indicating that muchremains to be explored within the sector.
 A Brief History:1912
Domestic air route betweenKarachi and Delhi becomesoperational, initiated bycollaboration between IndianState Air Services and Imperial Airways UK. In reality just anextension of the London-Karachiflight operated by Imperial Airways.
.R.D Tata himself flies a DeHavilland Puss Moth fromKarachi to Bombay, carrying postal mail of Imperial Airlines.This marks the instigation of theIndian Aviation Industry in theform of Tata Airline.Tata Airline was transformed into Air India in 1946. At the dawn oindependence, India operatednine air transport companiesproviding both cargo andpassenger services.
 All airline assets were nationalisedand Indian Airline Corporationand Air India Corporation wereformed for domestic andinternational services respectively. 
These two companiescommanded a monopoly in Indiauntil 1991. In this year, privateairlines were allowed to operatenon-scheduled services andchartered flights under the ‘
airtaxi scheme
’ to uplift Indiantourism. In 1994, resulting from arepeal of the air corporation act,private airlines companiesobtained permission to functionscheduled air services.
2003 proved a landmark year inIndian Aviation being marked bythe entry of the low-cost carrier Air Deccan, which slashed pricesup to 17% of existing fares. Sincethen the Indian aviation landscapehas witnessed the entry of morethan 12 low –cost players, whichnow dominate the aviationlandscape. Such players nowinclude Spice Jet, Go Airways andKingfisher Air.
Current Outlook
The Airlines Industry in India hasdisplayed explosive growth since 2003,with average year-on-year growth inpassenger traffic between 2003 and nowtouching 20%.India’s eight domestic airlines carried atotal of 4.08 million passengers in Julythis year, compared with 3.59 million a year earlier. The average number of flights per person per year for the 1.1billion Indian population is 0.03compared to 1.6 in the United States.This indicates that there is huge room forfurther penetration. There are currently136 airports in India, compared to over400 in the United States, one of the mostdeveloped markets for air-travel.Due to the global meltdown in2007-2008, for the Indian AirlinesIndustry and even worldwide the growthtrend in the aviation sector, displayedsince the entry of low cost barriers wasreversed. Following the fuel-price hike inmid 2008, airlines were forced to raisefares and the 12 months proceeding July2009, saw consecutive year on yeardeclines in passenger traffic.The airlines industry worldwide, however,is showing distinct signs of recovery. Theglobal aviation market is expected togrow at a CAGR of 5.9% over the next
Overview of the Airline Industry
five years, as estimated by GlobalInformation Inc. While the market shareof the more mature markets such as theUS and Europe has witnessed a fall to thepresent proportion of 52%, emerging markets offer tremendous growthpotential. According to Kapil Kaul, CEOIndia & Middle East, Centre for AsiaPacific Aviation (CAPA), India's civilaviation passenger growth is among thehighest in the world. The sector is slatedto cruise far ahead of other Asian giantslike China or even strong economies likeFrance and Australia. The number of passengers who will be airborne by 2020is a whopping 400 million. This in turnimplies much room for growth within thein Indian Aviation Sector.
 Airport Infrastructure
The present number of airports in Indiais 136, of which the Airports Authority of India (AAI) owns 94. Of these 136airports, 82 are used for scheduledservices. Wide-scale modernisation of airports across the country has takenplace recently,with the HyderabadInternational Airport being rankedamongst the world's top five in the annual Airport Service Quality (ASQ) passengersurvey along with airportsat Seoul, Singapore, Hong Kong and Beijing.
The Airports Authority of India(AAI) has planned to spendover US$ 1.02 billion in2010, towardsmodernisation of non-metro airports. The city-side development of 24airports is being planned,including those at Ahmedabad and Amritsar.Moreover, 11 Greenfieldairports have beenidentified to reduce theload on existing airports.In 2007–08, theinternational airportstogether handled about 80per cent of aircraftmovement, 88 per cent of passenger traffic and 97per cent of freight traffic.
Industry Characteristics
The airline industry business is cyclical,and the major factors that affect theearnings are economic conditions, excesscapacity and oil prices. Thus, investmentin this industry is prone to higher risk butlower profitability, compared toinvestments in other industries.Inaddition, the airlines industry is extremelycaptital intensive requiring a range of expensive equipment and facilitiesranging from airplanes to flightsimulators to maintenance hangars. Additionally, the industry typicallyrecords high positive cash flows and islabour intensive, employing a virtualarmy of pilots, flight attendant,mechanics, baggage handlers,reservation agents and the like.
Cost Drivers:
The biggest cost driver in airlines istypically power and fuel followed bymaintenance and employee costs.The latter includes the salaries of pilots as well as costs assosciated withaircraft and traffic service such as thesalaries of baggage handlers,dispatchers and airlines gate agentsand passenger service. In additiongiven the capital intensive nature of the industry, depreciation is a criticalexpense for all airlines companies. Theamount of depreciation varies acrosscompanies, as some buy aircrafts, othersdecide to lease and there are some whodepend on 2
hand aircrafts.
Revenue Drivers:
The primary revenue drivers in Civil Aviation are Ticket sales. Ancilliaryrevenue comes in the form of excessbaggage charges, commissions throughhotel accomodation, travel insurance andcar rentals as also revenue from sales of food and beverages. Ancilliary revenuehas become increasingly important lately,given that the Low Cost Carriers derivemuch of their income from the same.
  With regard to segmentation, the industrymaybe broadly segmented into twocategories based on the airline unit costsand average fares
Low Cost carriers (LCC)
 Among the various carriers, the LCCprovide the lowest fares and operate atthe lowest costs. They offer no-frills one-class service. The entry of LCC intoIndia was marked by Air Deccan in 2003and today this category includes playerssuch as JetLite, Kingfisher Red, Spicejetand Indigo amongst others.
Full Service carriers (FSC)
 A Full Service Carrier provides in-flightmeals, entertainment and othercomplementary services. Hence, FSCfares are typically higher than LCC fares.It also offers a variety of air travel classessuch as first (F), business (C) and economy(E) classes. FSC’s in India include Jet Airways and Indian Airlines. With intense competition however, thegap between these two categories appearsto be diminishing. One the one hand, Jet Airways and Kingfisher have movedmore than 60% their passenger capacitiesto no-frills and all economy services. Onthe other hand, LCC’s are offering services and discounts- traditionallyoffered only by the FSC’s. While Spice Jethas introduced online check-in andfacilities for supervision of unaccompanied minors, GoAir offers
AirportsNumbeInternationalairports,including ointventureairports17Domestic air ports79Customs airports8Civilenclaves24Others8
complimentary beverages at selectairports and Indigo informs passengers of their flight status through texts messageson their mobiles.
International vs. DomesticPlayers:
The industry can also be segmentedas international carriers and domesticcarriers. The major players in theinternational segment along with theircapacity contribution are NACIL and Jet Airways. Kingfisher has recently enteredthis segment. All other players haveoperations in the domestic segment. Interms of passenger traffic, 18.5% iscontributed by the international segmentat present and the rest is contributed bythe domestic segment.The parameters for judging airlineperformance are varied and may be asfollows:
 Aircraft Utilization
: The most basicmetric for an airline is aircraftutilization. This measures the averagenumber of hours that each aircraft isflying in each 24 hour period.The basic idea is that planes that are inuse are probably making money.Utilization is a statistic that varies fromcarrier to carrier and is normallyconsidered a closely guarded corporatetrade secret and is not tracked bygovernment. Part of the "art" inrunning an airline is keeping utilizationhigh.
Load Factor
: This measures thepercentage of available seats that arefilled during a specific period. Thepassenger load factor for the aviationsector in India as a whole towards theend of 2009 was estimated at about75%.
 Available Seat Kilometres(ASKM)
: ASKM is equal to thenumber of available seats times thenumber of kilometres flown. The ASKM metric is used to track seatsupply among airlines.
Revenue Passenger
: RPKM measures thenumber of seat kilometres flown forwhich the company earned revenues.That is, RPKM equals the number of filled seats times the number of kilometres flown.
: The amount of revenue earnedper RPKM is known as the airline's yield. This metric is generallyexpressed in cents and ranged from9.8-13.1 cents for the major airlines inthe first half of 2007
Fuel Costs
: Most factors that affectthe profitability of airlines are fairlystable, except for fuel costs. Fuel costsare facing extreme risk from the threatof Peak Oil.
Unit Cost:
It is the ratio of operating expenses to ASKM, an indicator of unit costs.
Daily Aircraft Utilization/hr:
 Ratio of the number of aircraftsutilized to the number of operating hours- indicator of the effectiveness of fleet utilization by the airline.
Break Even Seat Factor:
Ratio of Unit Cost to Yield. It signifies theaverage number of seats an airlineneeds to sell to cover its operating costs,indicator of operating margins.
Financial Standing and FutureTrends
In the aftermath of the financial crisis,Indians reported a sharp drop in airtravel. Fuel prices were on the rise and sowere costs. All together, Indian airlineslost an estimated $2 bn in the 2009financial year. Kingfisher and Jetpostponed the delivery of new planes andleased out or sold off surplus planes.But things have changeD since.Indian carriers are now regaining altitude. This year, barring February,traffic has grown at an average of 20% year-or-year in 2010 so far. In July 2010the year on year growth in domestic airpassenger traffic growth slowedmarginally to 13.64%, following the endof the peak travel season.Passenger loads are at a healthy 78 percent, from 65 per cent during the crisis.Low-cost carriers are doing even better,with passenger load factors ranging between 85 to 90%. At industry level,both the ASKM and RPKM have beenon the rise. While most airlines were suffering lossesthrough 2009, things are now starting tolook up. While Kingfisher narrowed itsfirst quarter losses to Rs. 1.87bn from Rs.2.37bn last year, Jet Airways evenreported a small profit of Rs.35.2m in thefirst quarter of the current financial year,compared to a loss of Rs.2.25bn at thesame time last year. For Jet, domesticoperations accounted for 44% of totalrevenues (or USD 285.1 million) andgrew by 23.8% year-on-year in thequarter.
Both Jet airways and Jet connecthave now broken even on seat factor andpassenger load factor. Even SpiceJet’s firstquarter net profit more than doubled toUS 11.8 million in the three monthsended Jun-2010.If the expected projection by Boeing of afuture average growth rate of 8.4% forSouth Asia’s Aviation Market for the nextdecade materialises, it would translateinto a $ 130bn market for around 1150planes for the next decade. With suchoptimistic projections, expansion plans of several airlines are in place. While Jet’sChairman, Naresh Goyal, recentlyannounced that Jet plans to expand itscapacity by 10-15% by adding another 5planes to its fleet, SpiceJet announcedthat it has ordered 30 Boeing planes fordelivery from 2014 for $2.7bn.
Growth drivers
The factors contributing to the air trafficgrowth may be broadly classified intoeconomic and policy factors. Entry of low cost carriers, rise in disposableincome--expected to increase at anaverage of 8.5% p.a. till 2015, the 300mstrong middle class, increased FDIinflows, surging tourist inflow, increasedcargo movement, strong business growthand supporting government policies arethe major drivers for the growth of aviation sector in India.
Regulatory Trends
 At present, the domestic air transportpolicy debars foreign airlines from equityparticipation in the companies formed fordomestic air transportation. The policyallows participation of foreignindividual/companies up to 40 per centand the participation of Non-ResidentIndians (NRIs) / Overseas CorporateBodies (OCBs) up to 100 per cent in thedomestic air transport services. The issuerelating to permitting foreign airlinesequity investment in companies formedfor domestic operations is being reconsidered by the Government at thebehest of both international and Indianplayers interested in strategic alliances.Moreover, overall increase in the foreignequity limit in domestic airlinesoperations may also be considered with a view to attracting new technology andmanagement expertise.The foreign equity limit in theinternational services is 26 per cent. Inorder to attract investment in this sector,the possibility of increase in foreignequity participation may also beconsidered.The Government approved the FDIlimits in the civil aviation sector which areexpected to bring in more foreigninvestments to the sector. This includesupto 49% on automatic route and upto100% for NRI in air transport servicessubject to no direct or indirectparticipation by foreign airlines; upto74% on automatic route for non-scheduled airlines, chartered airlines andcargo airlines and up to 100% for NRIssubject to no direct or indirectparticipation by foreign airlines in non-scheduled and chartered airlines; upto74% for ground handling services and upto 100% for NRIs on
utomatic routesubject to sectoral regulations andsecurity clearance; and upto 100% onautomatic route for maintenance andrepair organisations,flying training institutes, technical training institutionsand helicopter/seaplane services.Current regulations also requiredomestic airlines to operate for at least 5 years and operate a minimum fleet size of 20 aircraft before being permitted tooperate on international routes.

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