The Airlines’ “Hairline” Margins

We have always been fascinated by the art of flying!! Close your eyes, imagine traversing the world, along-with the clouds, with no noise or pollution, add to that the on board entertainment ,food and beverage service , isn’t life good?There is no greener pasture on the other side, many famous industrialists and conglomerates have bruised their hands in an attempt to try and run airline companies. Richard Branson once said “If you want to be a Millionaire, start with a billion dollars and launch a new airline.”

So many private players vacated the play field while the government owned one is literally crippling and crawling under a debt to the tune of Rs. 60,000 crores. This write up has nothing to do regarding the future prospect of “maharaja” It is up-to the buyers to put forth their bids if they feel that they can reinstated the national carrier back to the glorious days. One must be careful that history repeats itself, so the end of “maharaja’s” rule might be soon.

Airline being profitable has turned out to be a myth. Most of them are bleeding and operating with the fear that if they stop, then that would be the death-knell. Although some of them have been in the green but have not been able to manage them consistently over time. With Jet Airways and Air India (talks of disinvestment going on) out of the way. Let us look at Indigo.

Few facts about Indigo

• Started operations in August 2006.
• The Business Model is based on “no frills” for passengers and routes are directed keeping in mind the “point to point” concept.
• Connects to 52 domestic destinations and 16 internationals.
• as on 31st March 2019, it has a fleet of 217 aircrafts.
• In Nov 2019, it had almost 48% of the domestic market share.

Let us look at the numbers for the year ended on 31st March 2019

The total revenue and the main expenses are listed above. The expenses have been listed in absolute figures as well as percentage of total revenue. Passenger revenue is recognised on flown basis i.e. the amount of discounts given to the passengers, amount collected on behalf of third parties, applicable taxes and airport levies such as passenger service fee, user development fee, etc have been deducted from the selling price of tickets and the net amount is recognised as revenue.

We all know about the fuel cost, employe cost etc. So let’s start with the less obvious cost, Landing fees and enroute charges constitute 10.6% of the revenue. I have tried to compute the contribution for a typical flight, based on the charges levied by Airport Authority of India. (you can find the entire list of charges along-with the calculation methodology on their website)

Assumptions:-

• The average ticket price is what the customer pays and we have considered Rs. 4000/-.
• We have considered the capacity of A320 to be 170.
• An occupancy rate of 85% has been considered.
• We have taken a distance from Ahmedabad to Calcutta to be 900 Nautical Mile.
• We have assumed a weight of 60MT & fuel capacity of 15Kl.
• For ease of calculation we have taken fuel cost to be 40% of the revenue. The fuel intake is independent of the occupancy level but as we have considered a high occupancy rate hence this assumption won’t effect the calculation a great deal.
• The fuel cost includes the throughput charges.

While calculating the above expenses, we have not included the slotting fees. As we know slotting fees is based on demand and supply and is high for peak hours. Hence the percentage of landing expense as per our calculation comes out to be 6.31% which is lower than the reported 10.61%. We have now calculated the contribution level based on the above computation and represented them as percentage of revenue.

As we can see the airline lands up with a margin of 49% (after taking the slotting fees into consideration) before deducting expenses like employee benefit, finance cost, lease amortisation, depreciation (non cash) etc. hence the sector has historically been a cash constrained one.

Now we move to the obvious costs, the jet fuel cost which is almost 42% of the revenue. We know that price of jet fuel is highly volatile and is mostly on the rise. It is also affected by the occupancy level, because fuel requirements depends on the distance which is independent of the occupancy level. Before you take your guns out, yes fuel requirements also depend on the weight but the weight of 50 individuals is insignificant compared to the overall weight of the aircraft hence won’t have a great impact on the fuel requirements. So a higher occupancy rate will lower the % composition of fuel cost. Secondly the company should have tried to minimise the risk by hedging it in the market. There are many traditional channels available for them right from futures/forwards to call options. They can even enter into swaps. Certain amount of creativity and they could have come up with other synthetic hedge options.

The Lease payments made for the aircrafts accounts for 17.54% of the revenue. Maybe better payment terms can be negotiated with the vendors.

The Employee benefit expense has been clubbed with the travelling and the lodging expenses and it accounts for over 11% of the revenue. Pay cut is never a way out as it will lead to talents leaving the organisation. The company can save on certain other amenities like pick up service and hotels. Lockdown has already had an effect on this component. The airline paid full salaries for the month of March 2020 & April 2020 then implemented pay cuts from the month of May 2020. On 30th June 2020, the airline announced that it won’t be renewing some of the cabin crew and ground staff contracts thereby initiating the retrenchment process. It has also imposed compulsory leave without pay on some of the employees.

As we can see fuel, leasing & airport fees eats up most of the margin. Airline sector has always been highly sensitive to the falling rupee prices as it affects the buying cost, leasing cost, fuel cost etc. History has shown that survival is tough and even the old well reputed ones fail to continue to exist. Although, India is a price sensitive market, caping the ticket prices won’t actually help because a common man will be able to buy a ticket if an airline exists and is not extinct!