Aviation sector to improve over the next 12 months despite its share of problems.
The civil aviation sector has been in the news for the wrong reasons in the recent past. Most private carriers made sharp fare hikes in the Diwali season and a similar pattern was anticipated over the Christmas- New Year period. If the current trend in rising crude prices is maintained, fares will rise for sure in 2011.
In fact, the flying-experience is very likely to get more expensive in 2011. Apart from rising fuel costs, User Development Fees (UDF) have been hiked at quite a few airports, including smaller centres like Ahmedabad, Mangalore, Amritsar, Udaipur, Jaipur, Trichy and Vishakhapatnam, after the new AERA (Airports Economic Regulatory Authority) took charge.
There was plenty of other action as well. Kalanithi Maran took control of the profitable Spicejet. In the meantime, Kingfisher lurched from crisis to crisis as its dues to oil suppliers mounted. The red ink also continued to accumulate on Air India’s balance sheet .
On the ground, expansion and modernisation of the airport network continued. Various non-metro airports are being modernised. After a lot of back-and-forth, the environmental ministry has finally cleared the Navi Mumbai airport with a revised project plan that should minimise environmental damage to the local mangroves. .
Like any other mode of transport, aviation is highly sensitive to economic cycles. Traffic plummets during recessions and pricing power disappears. Balanced against that, fuel costs do fall during recessions and for most private Indian airlines, fuel accounts for between 35-40 per cent of all operating costs. However, experience suggests that traffic slows and pricing power drops far more than is compensated for by lower aviation turbine fuel prices.
Airlines are just starting to stabilise after taking a beating over two years with losses in 2008-09 and 2009-10. Aggregate industry losses reduced in 2009-10 and a couple of airlines did make profits. First half 2010-11 results suggest that profitability has further improved but it’ll take a while before most airlines become profitable.
Airports can smoothen out the cyclical issues by generating higher non-aeronautical revenues. In fact, most modern airports around the world generate close to two-thirds of revenues from "cityside" as it’s sometimes called. This pattern is likely to be replicated at privately operated terminals in Delhi, Mumbai, Hyderabad and Bangalore where the trend towards a higher share of non-aero revenue is clear.
But at all other Airport Authority of India (AAI)-run and modernised airports, it’s going to be a slow process. In theory, the private sector is to be pulled in to develop non-aero revenue - it’s around 20 per cent at most AAI airports and less in some places. In practice, this process could take ages. The most ambitious experiment is perhaps, the aerotropolis under planning at Durgapur. That envisages building an entire new township centred on the airport.
Other potential new revenue streams could be expansion in cargo capacity with the advent of several cargo-oriented airlines like Deccan 360, Blue Dart Express and others. There are also grandiose plans to turn Nagpur into a regional maintenance, repair and overhaul hub. Maintenance, Repair, and Overhaul (MRO) could rapidly develop into a major revenue source since, quite apart from the domestic fleet, India could develop the capacity to service the entire region.
As in most sectors, there’s untapped growth potential. For one thing, the expanding middle-class is getting hooked to inexpensive and convenient airline travel. This growth is of course, dependent both on continuing GDP growth and on fares staying competitive vis-a-vis the railways.
At the same time, the sector has the usual issues of flip-flop policy and major delays . In particular, new projects require multiple clearances, which take a lot of time.Another silly rule is that only 49 per cent foreign direct investment (FDI) is allowed in airlines and what is more, that investment cannot be from a foreign airline. This hampers flow of capital and technical expertise.
The sector is guaranteed to absorb quite a lot of investment in the next couple of years. Some airlines will make IPOs, airport projects will also need financing. The listed aviation stocks have actually been a good bet through the first couple of years of cyclical recovery. Both Jet and Spicejet have given extraordinary capital gains of better than 600 per cent since 2008. Kingfisher Airlines on has been less rewarding but even there, the returns have been positive.
Are those capital gains likely to continue in 2011? The sector, as we’ve noted, has both high potential as well as its fair share of problems. It’ll always be a highly risky trading play - share prices can easily dip 90 per cent in downturns. But it’s worth watching because revenue and income should both improve over the next 12 months.
