[24-Sep’2020] Considering the COVID led collapse of the market, I was thinking about investing in stocks of Airline Companies. But when I saw their Profit & Loss Accounts for the last five years, I became hesitant. Why? Because even Interglobe Aviation (Indigo) reported loss in last FY ending Mar’20.
It is surprising how good airline companies like Air Deccan, Kingfisher, Jet Airways etc drifted from being a ‘good company’ towards bankruptcy. The first logical reason that comes to mind is probable cutthroat competition.
But if competition is the reason then why these companies reported losses in FY Mar’20? Kingfisher, and Jet Airways are out. There are only Indigo and SpiceJet being the dominant players now. AirAsia and Vistara are there, but their volumes are small.
In these conditions (less competition), why SpiceJet has reported losses in FY ending Mar’20 and Mar’19? The airline was also under loss in FY ending Mar’12 to Mar’15. Comparably, Indigo’s reports are better. In last 10 years, it has reported Loss only once (In Mar’2020). But its profit numbers have drastically declined in last 2 years. Why?
Where Airline Companies Spends its Money?
To understand why a company like Indigo is making losses, we need to first understand where these companies spends their money. I’ve prepared a small infographics to explain this.
Expense over which airlines have virtually no control.
- #1. Fuel Cost: Airlines have to spend nearly 35% of their income to buy Aviation Turbine Fuel (ATF). I used to think that ATF must be very costly. But as on today (24th-Sep’20) ATF’s rate is only Rs.41.9/Ltr. In last 12 months, average rate of ATF was Rs.48/Ltr. This is much cheaper than what we pay for our car’s fuel – diesel and petrol.
- #2. Lease & Rent: Majority assets of the airline companies are on lease. It’s major assets are aircrafts, engines, spare parts, airport premises etc. Under lease agreement, the company pays the lessors a monthly rent. Nearly 22% of their income goes on lease & rents.
- #3. Airport Charges: Under this head, airline companies pay charges to airports for aircraft’s landing, parking, route & terminal navigation, baggage X-ray etc. Under this head airline companies pay almost 8% of their income. Read: Business model of airports.
The above three expenses (65% of Income) are like confirmed and ever increasing expense for the company. Moreover, airline companies can do less about managing these expenses. Why? Fuel: They have no control over the rates that they pay for the fuel. They also can do less about the fuel efficiency of the aircraft’s engine.
Lease agreements that are done by the Airline companies with lessors. The lessors are companies which are in the business of leasing aircrafts, engines, spares etc to airline companies. There are only handful of aircraft lessors around the world. In a way they have a monopoly.
Two biggest names of this business (lessors) are Avolon and GESAC. Airline companies goes into lease agreement with these giants for a period ranging from 4 to 12 years. It is almost a fixed cost with virtually no negotiation power in hands of the airlines.
Expense over which airlines have control.
- #4. Salary & Employee Benefits: Typically an airline company spends close to 11% of the income on salaries etc of their employees. This is where airline companies have opportunities to save cost. Hence, these days airline companies maintains a tight hand on its employee size.
- #5. Other Expenses: Under this head, what mainly comes are the administration expenses. This includes travel and conveyance, accommodation, insurance etc. Typically an airline company spends close to 7% of their income under this head.
- #6. Sales & Marketing: The days of Kingfisher’s are gone. These days Airline companies can afford to spend less on their brand promotions. Even profit making company like Indigo cannot afford to spend more than 3% of their income here.
The above listed 3 expenses takes away another 20% of the airlines income. Though airlines can do some cost cutting here but it is not easy. Why? Because for any company, when they start cutting corners on salaries, benefits, administrative expense, marketing it only results in discourse and attrition.
Root cause of airline companies reporting loss
We have already seen that nearly 65% of the airline’s income is spent on expenses over which they have virtually no control. The next 20% is on employee care (18%) and marketing (2%).
Being a part of hospitality sector, it is not easy for airline companies to cut costs here. Why? Because it can lower their brand value. These numbers (65% + 20% = 85%) already pose a huge uphill task for the airline companies. But an even bigger problem is the inflation of these costs.
Check the above infographics. What you will find is a depleting profitability. Why it is depleting? Because the expense growth far exceeds the income growth rate.
In the period between Mar’16 and Mar’20, income growth of SpiceJet was at rate of 20.4% per annum. In the same period its major expenses grew at a rate of 24%.
Similarly for Indigo, income growth was at rate of 17.5% per annum, but expense grew faster at 22% per annum.
No matter how profitable is a company today, if it’s expense growth rate surpasses its income growth rate, it will eventually become unprofitable. Probably this is what is happening now with Indigo (Interglobe Aviation).
Aviation industry is plagued with high costs all over the world. Any airlines which is not managing its operations very intently and efficiently eventually becomes bankrupt.
Here the margins are very low, but volume is high. Making a high absolute profit numbers is not so difficult in this sector. One perfect example is Indigo. When it came around 10 year back, there were giants like AirIndia, Indian Airlines, Jet Airways, Kingfisher etc. doing good business.
But see, even they have to meet a loss. I’m not sure if the problem is with airline companies, or with the sector itself. The losses are caused by mismanagement of whom, Airlines or Aviation Ministry?
Anyways, if I’ve to invest in this sector, for sure Indigo will be the first choice. But problem is, what’s happening behind those close doors…no body knows. Today’s Indigo can be tomorrows Jet Airways or Kingfisher.
This is a sector which is not going to close down in next line 50-60 years. But does this positive outlook give an advantage to the existing airline companies? I’m not sure.
With my limited understanding of this business, I’ll say, there is some inherent problem with their current business model itself. As a long term investor, I would prefer parking my money in other hospitality based industry. Not airlines.
In this COVID climate, if ATF rates starts to go up, and air traffic is already scanty, I’m not sure what will happen to likes of Indigo and SpiceJet. I’m wary. Even my stock analysis worksheet is not so confident about these companies.
What do you think? Please put your views in the comment section below.
Have a happy investing.