MoCA’s three inputs of pragmatism
* The Ministry of Civil Aviation (MoCA) has announced the resumption of domestic airline services in India, starting 25th May’20 (Monday). However, there has been no advice on international services as of now.
* Along with a detailed Standard Operating Procedure (SOP), MoCA has also introduced three key major guidelines after discussions with various stakeholders.
* Though prima facie the guidelines look administrative, in this note we have highlighted how the government’s three-inputs would aid airline companies to takeoff from the current runway of the COVID-19 led challenges.
* However, we reiterate that demand in the longer run would be a major headwind for the industry, and companies need to completely re-strategize their path ahead.
1. Starting services in a calibrated manner
* Domestic airline operations would commence with only one-third of the respective summer scheduled capacity of individual airlines.
* These restrictions are not applicable to UDAN (Ude Desh ka Aam Nagrik) flights that operate under the Regional Connectivity Scheme (RCS).
* Our interaction with industry experts and companies suggest that there might be various challenges in terms of enough number of seats being booked.
* However, we believe that reduced capacity would balance out the skewed economics of supply v/s demand in the current environment (as the guideline provides an airline more options to strategize their routes) and aid airline companies in achieving better utilization rates (PLFs) on respective routes.
2. Temporary new fare structure (for three months)
* MoCA has categorized all domestic routes into 7 sectors (bands A to G) based on flight duration (at an interval of 30mins), which will remain applicable for three months (starting 25th May’20 to 24th Aug’20). These band fares are excluding (5%) GST and other small charges (like UDF and PSF).
* For instance, a Mumbai-Delhi flight, which comes under Band D (90-120 mins) has a fare band of INR3,500-10,000. Our airfare tracker suggests that normal band rates for the same route stands at INR2,200-9,300.
* The second rider is that at least 40% of the seats have to be sold at a fare below mid-point of the band (i.e. 40% of the bookings at <INR6,700 as per the previous example). Our airfare tracker indicates that normal average rates on the Mumbai-Delhi route is INR4,100 (for 30-day ticketing window) and INR4,400 (for 15-day ticketing window).
* MoCA had to regulate fares to avoid sky-rocketing of airfares owing to reduced capacity (one-third would be operational) and (immediate) demand for mobility.
* According to our analysis (in exhibits 1 and 3), airline fares YTD have a lower floor and cap than the one prescribed by MoCA.
* Thus, we believe that (temporarily) regulated fares would at least not impact (if not boost) the current pricing of airlines.
3. No social distancing on aircraft
* The announced guidelines do not include (much speculated norm) social distancing on the aircraft (by keeping middle seat vacant).
* According to MoCA, even if implemented, the recommended separation for social distancing would be inadequate. Besides, various precautions would be taken before entering the aircraft like thermal screening, masks and kits, etc.
* At the beginning of May’20, International Air Travel Association (IATA) had opposed on-board social distancing (as middle seat is 0.5meters in size v/s recommended social distancing of 1-2meters), highlighting low risk of virus transmission on board an aircraft even without social distancing.
* Also, IATA and MoCA have both reiterated that operating with the middle seat vacant is not economically viable for airlines.
* We believe that zero social distancing on board would allow airlines to fly in an economic manner (v/s earlier feared cap of ~66% on aircraft utilization).
* Also, flight economies would be further aided by improving airfares (AprMay’20 saw improvement of 27-47% with YTD airfares down 2-11% now, refer exhibit 2 and 4) and lower current ATF prices (now at ~INR21,000/kl v/s prelockdown at ~INR57,000/kl).
Nevertheless, long-term story remains pivotal
* Last week, as part of the ‘Atmanirbhar Bharat’ announcements, Finance Minister, Ms. Nirmala Sitharaman announced certain long-term measures for the aviation sector in India (link to our earlier report):
* Air Space Management, in our view, was the key announcement to boost efficiency as it would lead to more direct routes between cities and limit airborne detours, thus increasing average aircraft utilization rates (block hours/day) and reducing fuel expenses (~35-40% of sales). According to our EPS sensitivity, aircraft fuel savings of even 5% would translate into an EPS change of ~20% for INDIGO. We also expect it to boost margins on MetroMetro routes (which are facing margin constraints) and further connectivity to Tier-II/III cities (facilitating the UDAN scheme).
* Public Private Partnership (PPP) for Airports (6 more airports to be auctioned immediately by the Airports Authority of India) is in line with the earlier plan to double airport strength in India by 2024 (from ~97 airports operational currently).
* Maintenance, Repair and Overhaul (MRO) are continuous efforts to make India a global hub. Further, tax reforms for the MRO ecosystem has been rationalized (in Mar’20, GST was brought down from ~18% to 5% with full Input Cost Benefit). Also, convergence between defense and civil sector is in the pipeline, which would create economies of scale.
* Nevertheless, we reiterate that demand in the longer run would be a major challenge for the industry and companies need to re-strategize their path ahead. Globally, various airline companies (link) have withdrawn their earnings guidance indicating uncertainty in the aviation industry. Likewise, even we remain keen on hearing management guidance and commentary from Indian companies before taking a leap of faith in the industry/stock.