1. Course Correction: SpiceJet in a sweet spot, but will it last?

Course Correction: SpiceJet in a sweet spot, but will it last?

A sustained turnaround for the airline will hinge on total capacity and passenger traffic

By: | Updated: August 3, 2015 12:43 AM
spicejet

SpiceJet currently operates about 252 daily flights compared with over 300 at the peak. (PTI)

FROM the brink of bankruptcy, the country’s second largest no-frills carrier SpiceJet has bounced back to report a bottom line of Rs 71.8 crore in the three months to June. That’s a second consecutive quarter of profits and compares with a loss of Rs 124 crore in Q1FY15.

The turnaround has resulted from a confluence of several factors: lower fuel costs which fell 53.6%, a cut in capacity and a good summer holiday season. A sweet spot, which may or may not be enough to keep it going. As HSBC assessed it, the turnaround was primarily led by a 13 percentage point improvement in the load factor—the highest ever in SpiceJet’s history—and a 12% lower unit fuel costs.

Earlier this year, the Gurgaon-headquartered airline was taken over by co-founder Ajay Singh from Kalanithi Maran’s Sun Group after the government stopped the carrier from selling tickets for periods ahead. Singh agreed to arrange for a capital infusion of Rs 1500 crore of which only Rs 600 crore has come in, according to Sanjiv Kapoor, the airline’s chief operating officer.

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Since Singh took over the reins at SpiceJet, there has been an effort to cut costs, re-route flights and re-negotiate deals with vendors and lessors. By pulling out flights on some less-profitable or loss-making routes, the airline was able to cut capacity by as much as 50% and drive up load factors to as high as 90%.

But one swallow does not a summer make. Which is why there are those who believe SpiceJet isn’t quite out of the woods yet. For one, even as fuel prices remain stable, having slumped from $110 per barrel in June 2014 to levels of around $55 in July this year—the rupee could depreciate negating some of the gains from a weaker crude oil prices. More important, there’s enough competition and capacity: several new airlines have entered the market in the last couple of years—Vistara, AirAsia, Air Pegasus and Air Costa. That’s not lost on the management. As Kapoor said recently, “We need to consolidate our position, rebuild our fleet to make the most of the busy season and perform well during the off seasons too.”

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SpiceJet’s flash sales and low-priced prices helped lift the load factor but hurt the bottom line which is why its strategy is being questioned. It can however take comfort from the fact that passenger  traffic increased by 20% year-on-year in the January-June period compared to a growth of 4.5% in the same period of 2014. In June 2015, however, of the 83.74 lakh domestic seats only 66.01 lakh were occupied so that the industry PLF was 78.83%. DGCA data puts the total domestic air passengers at 67.9 million, in 2014, up from 61.4 million in 2013; while this number could hit 100 million by 2020, there is almost enough capacity to carry them all. DGCA data shows SpiceJet had the highest seat occupancy of 93.2% in June followed by IndiGo, the largest carrier by passengers, with 86.6%.

Indeed, while a slowing economy has hurt demand in the last three years—compelling carriers to discount fares heavily—the problems in India’s aviation industry also have to do with a fair amount of oversupply. Strangely, however, there hasn’t been any meaningful consolidation with private promoters rustling up equity contributions or roping in foreign partners and the government reluctant to wind down Air India. With supply only expected to go up in the next few years—HSBC estimates the growth in the supply of narrow body seats will rise from 8% in FY14 by about 11-15% between FY15-17—and the entry of two deep-pocketed players, the market is likely to become a lot more fragmented. SpiceJet currently operates about 252 daily flights compared with over 300 at the peak.

There’s talk the airline is negotiating for aircraft with Boeing Co. (Boeing 737) and Airbus Group to buy more than 100 single-aisle jets worth about $11 billion at the list price, in what would be the Indian budget carrier’s largest-ever plane order. The fleet size is currently 35—including 20 Boeing aircraft (18 operational) and 15 Bombardier aircraft, down from 58 aircraft during early 2014. Rival IndiGo had in October 2014 signed an initial agreement with Airbus for 250 A320neo planes; the companies remain in talks, according to Indigo.

However, Indian airlines have lost more than $10 billion combined since FY 2009. Airline debt currently stands at around $1.3 billion, rising to close to $1.4 billion if liabilities to vendors are included, according to CAPA data. At an industry level, airline debt is now equivalent to more than 100% of airline revenue.

According to CAPA, traffic in FY15 increased and losses declined but this was largely a function of lower fuel prices.

Fuel prices are expected to stay close to current levels while India’s economic outlook is improving. “Robust traffic growth is expected to continue, and with modest capacity expansion, Indian carrier financials should see further improvement,” CAPA believes. However, the greatest risk to recovery and profitability—other than an increase in fuel prices—is a failure to maintain pricing discipline. “In 1Q 2016 airlines have already been seen to visibly compromise yields in order to generate cash,” CAPA points out.

Interestingly, despite the change in ownership SpiceJet had a negative net worth of Rs 1,264.52 crore and debt close to Rs 1,400 crore at the end of March 31, 2015. “We are operationally cash positive and the pressure on cash has reduced so there is no rush to bring in funding right away. However, when the funds come, it will be to fuel growth,” Kapoor says. But SpiceJet needs the money to sustain the business and as Singh believes, if the best is still ahead, the airline needs to see the money.

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