Air India On The Block – Can The Elephant Dance?

Yes, it can and if there was any opportune time, it is now, says ICICI Securities. According to it “The singular concern for any suitor of Air India is its overleveraged balance sheet and much will depend upon the ability of the Government to monetize the assets. Airline industry right now enjoys multiple tailwinds which have considerably de-risked the erstwhile nature of the business. Lower crude prices, lower interest rates, a prominent lessor community and favourable currency can turn around a loss making airline business as we have seen in case of SpiceJet and Jet Airways.

Air India, also, at least would surely be able to do the same at an EBITDAR level. Hence, it is not as much an operational challenge as perceived by many to manage Air India, but more of a one-time restructuring which should involve necessary monetization of assets and requisite write down of debt. Regarding valuation of Air India, possible EBITDAR margins of 15-18% and value of land and aircraft on books are the main drivers. The bilateral rights, international slots and the intangible institutional expertise will lend valuation premium.”

Like other airlines, Air India would also record significant improvement in operational earnings in FY16/17. Air India would record significant improvement in earnings between FY15-FY17 as has been the case with other airlines. The standalone EBITDAR is likely to improve from Rs4.5bn in FY15 to ~Rs35bn in FY16/17E. This is purely on the back of lower crude and other cost control exercises as a part of the turnaround plan of the company initiated in 2012. This would imply an EBITDAR margin of ~15% for Air India in FY16/17E, which would be only modestly lower compared to Jet Airways (~average EBIDAR margin of 18% in FY16/17). We have highlighted the cost structure leading to EBITDAR for Air India in FY15 and how it is likely to improve in FY16/17E and the similar comparison with the performance of IndiGo in FY16 (Charts 1-3).

The key takeaway, ICICI Securities believes is that the operational cost structure of Air India (ex-debt servicing and depreciation) has already seen a turnaround, while there is significant scope remaining to improve, especially on items like landing charges, maintenance and other expenses. A lot of these costs emanate from sub optimal route network and sub optimal fleet deployment. Further operational efficiencies can be achieved from improving PLF and OTP (both lowest among big airlines).

IndiGo is the first airline to express interest in Air India. IndiGo has evinced primary interest in the international operations of Air India, though also expressing alternative interest to acquire all of the airline operations of Air India as well. IndiGo currently does not have any meaningful international presence and Air India can fill that gap. The international operations of Air India will come along with a host of bilateral rights and international hubs which IndiGo would be able to use. Only an expression of interest at this point of time, the IndiGo management has also said that if IndiGo were to acquire it, there would be considerable restructuring required and the company will not take any debt or liability that cannot be supported by the restructured operations. However, the candidature of IndiGo will have the concerns of competition commission, especially the domestic business as if IndiGo were to acquire Air India, the combined market share would be ~55% in the domestic segment and ~25% in the international segment.

The international operations of Air India will come along with a host of bilateral rights and international hubs which IndiGo would be able to use. Only an expression of interest at this point in time, the IndiGo management has also said that if IndiGo were to acquire it, there would be considerable restructuring required and the company will not take any debt or liability that cannot be supported by the restructured operations. However, the candidature of IndiGo will have the concerns of competition commission, especially the domestic business as if IndiGo were to acquire Air India, the combined market share would be ~55% in the domestic segment and ~25% in the international segment.

Still early days, prolonged delay can seriously harm the chances of successful revival. The Government will form a GoM which will comprise of the Finance Minister, the Minister of Civil Aviation among others to consider all proposals for restructuring Air India, including divestment. This implies that disinvestment is not a given at this point of time and there may be alternative revival strategies. While there is a veritable chance of delay for any final decision to emerge, the value proposition of Air India will dilute with time as it is set to lose market share rapidly in FY18/19. With the talks of divestment, the lessor market will be more sceptical to lease aircraft to Air India and may do so with higher guarantees and other recourse structures. The competitors will actually benefit if there is a temporary suspension of the expansion plans of Air India which was supposed to induct ~15-20 aircraft in FY18, concludes ICICI Securities in an Aviation Sector update.

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S. Kapeed