Cash-flow, Capacity And COVID-19: India’s Airlines Face A Challenging Time Ahead


Indian aviation has dual narratives. On one hand, there is the double-digit growth, fleet expansion, and the race to be the 3rd largest aviation market by the end of this decade. But then the market has also seen airline failures, the current state of airlines (except Indigo) can only be described as fragile and further market failures cannot be ruled out.

This because with one exception, all other airlines are sitting on weak balance sheets, EBITDA are expected to fluctuate widely, and the risk mitigation measures are few and far between. By some accounts, the industry is already grappling with excess capacity and very few avenues to disperse that capacity or deploy it profitably. The coronavirus outbreak coupled with the crisis at Yes Bank (and associated impacts) is likely to wreak havoc for the airline sector. As it pertains to the airline sector, banks and the government may be facing their most challenging and complex liquidity challenge yet.

Undercapitalized airlines pose a systemic challenge

India’s airlines have witnessed profitability in varying degrees in the past five years. But for sustainable success, they not only have to position themselves for success but to also ensure to never run out of cash. Carrying excess cash is a luxury that a few airlines have thus access to credit facilities is important. But in the current market, this is extremely limited.

The drivers: the NPA crisis, unstable EBITDA and lack of independent management control. Add to that the situation in the banking sector where lending is severely constrained. It also does not help that the Jet Airways shutdown continues to haunt bankers with exposure of INR 8500 crore. Air India’s financial position is also very fragile and only propped up by sovereign guarantees. For the industry as a whole, undercapitalization is widespread. 

Just as banking more specifically credit fuels the modern economy, airlines are at the apex of the aviation and tourism value chain and fuel the entire aviation economy. Undercapitalized airlines pose a challenge as cutting off credit to the airline means a significant impact on the “aviation economy.” However, with bank lending or sovereign guarantees to struggling airlines – it arguably has an impact on the sector overall as pricing power, capacity utilization and borrowing rates of healthier airlines are affected. In the long run, lending to undercapitalized airlines leads to capital loss, employment loss and limited recapitalization (if at all).

Weak balance sheets are cause for concern

While “cost control” is a very familiar term in the aviation industry the focus though is mostly on operational costs which overlooks the cost of capital and that the capital demands a return in excess of a hurdle rate. When woven into management goals it can often lead to very different decisions. But this nature of management has yet to be seen.

Combing through annual reports and analyst commentaries, there is little or no coverage of unencumbered assets, cash position as it relates to the overall business and a focus on strengthening the balance sheet. Short management tenures where managers are measured on quarterly performance disincentivize this further.

Compared with global airlines this is quite telling. For instance, the International Airlines Group (IAG) which is the parent company of British Airways and other airlines, highlights disciplined capital allocation, a focus on margins and capital efficiency. These are woven into management goals.

Similarly, Delta Airlines in its most recent presentation to investors indicated that amongst several balance sheet measures it will be targeting adjusted debt to EBITDAR target range of 1.5x–2.5x. What this implies is that the cost of new initiatives must be such that the debt levels are covered within the range at all times – and this inherently drives cost discipline. Without such a target, there is an inordinate focus on operations costs while other costs may be overlooked. This is exactly what India’s airlines are facing. Indeed, while looking for actions that show airlines focus on the balance sheet one is left wanting.

Weak balance sheets are the norm for Indian airlines as of now and with a slowing economy coupled with the Coronavirus impact a drastic decline in demand is forecasted. Ergo, cash-flows will be severely depressed and airlines will be forced to shore up liquidity. But asset-light business models, multiple liens on assets, sophisticated and irrational financing structures (such as the first claim on cash-flow), unstable revenue streams and declining liquidity on aircraft (impacting sale-and-leasebacks) are likely to aggravate the situation. The remaining options: equity infusion or bank lending. The likely option: bank lending. 

A constrained liquidity environment may lead to contrarian lending

The current situation with weak airlines and a constrained lending environment leads to an interesting dilemma. Specifically, when airlines approach banks while on the basis of fundamental analysis loans would not be approved yet banks may do otherwise. That is, banks (especially those with exposure to airlines already) will have the tendency to make bad loans. Because recognizing existing underperforming loans to airlines and cutting off credit will increase the chances of airline failure.

As such, it means that the bank loses all capital on such loans. Recognizing underperforming loans also means several questions on why these loans were extended in the first place. Consequently, banks may engage in lending to distressed airlines in the hopes they will get better and thereby repay the capital to the bank.

But this contrarian lending where a bank extends credit in spite of poor fundamentals has impacts that permeate to the overall industry. Effectively weaker airlines are extended credit at a cost of borrowing that is lower than that extended to the stronger airlines. A spiraling effect follows. And most of this capital is used towards continuing operations rather than growth.

Consequently, effects on employment, capital deployment and improving the balance sheet are negative. In a text-book case of intent versus impact, distressed airlines are kept afloat while the industry suffers from diluted pricing power, reduced capacity utilization and distortion in borrowing rates. Weak balance sheets that are partly responsible for this fragile situation become weaker. The situation actually worsens.

As it stands, there are no simple solutions. While the government is working on an interim relief package, the best alleviation measure may be structural reforms. But looking at the political and economic implications, the outlook for these reforms is fairly pessimistic. The chances are that the status quo will prevail. Indian airlines, as a whole, are looking at a very turbulent time ahead. 

Satyendra Pandey is an India market expert and has held a variety of roles within the aviation business. His positions include working as the Head of Strategy & Planning at Go Airlines (India) and with CAPA (Centre for Aviation) where he led the Advisory and Research teams.  Having lived and worked across four continents, he is also a certified pilot with an Instrument rating.