Funding India’s airline growth plans and why an overhaul is needed

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Funding India's airline growth plans and why an overhaul is needed
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With interest rates rising, the rupee depreciating and yields falling, some airlines are facing a real challenge. Namely, finance growth. The old ways won’t hold up. An overhaul is needed, writes aviation expert Satyendra Pandey

The past decade has seen voluminous aircraft orders by Indian airlines. Collectively, Indian airlines operate a fleet of around 600 aircraft. More than 80% of this fleet is rented. Add to that an aircraft order pipeline of 850 aircraft that need to be funded and deployed. For weaker players without the support of a strong parent company or balance sheet, deploying and funding these assets slowly becomes a challenge. And with interest rates rising, the rupee depreciating and yields falling, some airlines are facing a real challenge. Namely, finance growth. The old ways won’t hold up. A reflection is necessary.

Overreliance on sale-and-leaseback

The sale-leaseback model was made popular by Indigo and guided by the three pillars of planning, volumes and pricing. Specifically, Indigo focused on two years of extensive planning, including contingencies; a large order of 100 aircraft in 2005 with several subsequent orders; and asset pricing that was expertly negotiated. Together, these elements have helped the airline to establish itself firmly in the Indian market. Other airlines quickly saw proof of this success and moved forward with their own large orders. But they only focused on one or at best two pillars of the Indigo model. Sale-leasebacks were the main method of financing orders.

A sale and leaseback (SLB) model is where the airline acquires the aircraft at an attractive price and sells it to a lessor – ideally at a profit – and leases it for its own use. SLBs are important because they generate cash and also help the airline manage its fleet flexibility. Additionally, as the airline introduces new aircraft, operating costs, including maintenance costs, remain competitive. Shorter fleet replacement cycles also allow the airline to introduce new technologies more quickly. But the flip side is that airlines end up with thin asset balance sheets, over time they end up paying more for the asset. And when clauses are not fully provisioned, it causes difficulties for both the airline and the lessor. This is a fact that is gradually emerging.

The end of the last decade saw an era of low interest rates, smooth aircraft orders and a highly competitive leasing industry. With several new lessors eager to do business, airlines were offered very attractive terms without the solvency that would normally be required. But unfortunately, that’s just not the case with the industry today.

Structural issues, including balance sheet strength, continue to be overlooked

With changing macro-economic and geopolitical conditions, the aircraft finance market, particularly the sale-leaseback market, has seen marked changes. Donors are reviewing risk profiles and there is a flight to quality. Add to that the fact that the cost of capital across the globe is rising, and in the aircraft leasing space, lessor consolidation is underway. In the Indian market, this means that the strongest and best capitalized airlines are able to negotiate fairly competitive deals while the weaker ones struggle. Some airlines are considering a scenario where planes have been ordered, but other aspects such as maintenance, lease terms and asset recycling are not where they need to be. Competitive funding for these is simply not to be found.

Worse, due to weak balance sheets, some airlines are entering into financing deals, including sale-leasebacks, to free up working capital. Add to that the fact that the airline then finds itself with an additional aircraft to deploy and it has an impact on industry returns. And therefore the capacity and tariff wars which will intensify in the short term to the detriment of cash flow and profitability. Capital calls are almost certain.

As of this writing, structural issues, including balance sheet strength, continue to be overlooked. The pandemic laid bare the loopholes and for lenders looking for assets on the balance sheet, they were rare. So came cash flow liens, promises of future funding, and continual deferral, delay, renegotiation, and demands. And for some fault lines were never quite addressed. This situation is untenable to say the least and only postpones the inevitable to a future date.

Diversification of funding needed

For the future, a diversification of funding sources is necessary. Both because sale-and-leaseback without aligning all the fundamentals remains a very expensive form of financing and also because management needs to focus on balance sheets. Otherwise, cash flow liens, emergency lines of credit or, at worst, closure will be the norm and not the reality. And any airline closure is very painful and the scars of the closure continue for years. Indeed, no discussion of Indian aviation is complete without a mention of Kingfisher and the former Jet Airways. Not to mention a host of smaller airlines that have come and gone.

Despite the talk of traffic growth and market potential, when Indian airlines are viewed through the lens of profitability, very few succeed. Consistent profitability that provides an adequate return on capital is lacking. And aircraft being the largest investment costs for airlines, they must be planned, negotiated and deployed with risk in mind. All hopes cannot simply rest on growth. Because when that growth stalls, there’s simply no recourse.

As the market matures, aircraft financing is also set to evolve. Airlines are well advised to look at structures that allow them to have the right to the asset at the right costs and terms. Finance leases and asset purchases that were once avoided could very well be the way forward. Likewise, structures that are fit for purpose and designed for the Indian market taking into consideration market risk, currency risk and credit risk can be the way to go. But these require focused, deliberate and decisive planning. And some departments find themselves so intensely involved in day-to-day firefighting that these are left out.

For Indian aviation, demand is certainly well oriented. And capacity will follow. But this capacity must be financed. And funding Indian airlines’ growth plans is a task in itself. And a reflection is necessary.

—Satyendra Pandey is the managing partner of aviation consultancy AT-TV. Opinions expressed are personal

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