SpiceJet Q2 FY2012~2013 quarterly results financial analysis

Earlier this week, Indian low cost carrier SpiceJet posted a Rs. 163.5 Crore net loss for the second quarter of fiscal year 2012-13. While this represented a 32% better result than the same period last year, it is still a heavily disappointing result, giving the recent surge in the fortunes of India’s airlines after the shut-down of full service carrier Kingfisher and the corresponding rise in fares.

Revenues grew a robust 57% to Rs. 1207 Crore, but even still, a net margin of -13.5% is almost flipped 180 degrees from the ideal result.

Revenues were certainly buoyed by general fare increases and the continued maturation of Q400 markets.

What makes the quarterly results particularly abysmal is that SpiceJet has finally gotten its primary challenge of the past few quarters, fuel costs, under control thanks to the general global stabilization in oil prices. Year over year gas prices grew by a relatively modest though still challenging 11.6% on a per seat-kilometre basis.

What is concerning is that the dizzying rise in fares over the past quarter, over 30% on some sectors, should have more than outweighed the fuel price growth. There seems to be poor cost discipline in the airline’s other cost-line items, primarily aircraft maintenance, which grew more than 17% on a per seat kilometre basis, and aircraft lease rentals, which jumped a staggering 26.2% percent year-on-year per seat kilometre.

These two cost line items, and indeed the fuel expenses as well, help drive home an essential point – SpiceJet’s losses are driven by capacity growth; i.e. poor capacity discipline by SpiceJet.

While a small part of SpiceJet’s maintenance cost increases are due to the natural aging of their 737NG fleet, the primary driver behind increased maintenance costs is the high rate of growth that SpiceJet continues to pursue. For the quarter, SpiceJet recorded a whopping 20% increase in available seat kilometers – and the increase in fleet size and aircraft utilization due to this capacity are the drivers behind the rise in maintenance and aircraft lease costs, as well as a primary factor in the 600% rise in depreciation costs.

Given the current environment in India, where fares are finally enjoying the sort of sustained quarterly fare increases necessary to overcome the ludicrous policy of over-taxation which double the impact of persistently high fuel prices, why is SpiceJet pursuing a 20% capacity growth?

Part of the answer is, undoubtedly, that their outstanding order for 20 737NGs, which locks them into almost continual route and fleet growth, at least for the next few quarters. But another part is what I see as the mentality that is prevalent amongst all of the Indian carriers, a market-share chasing mentality that values profitless growth over the profitable status quo. While there are exceptions to this rule, GoAir being the chief amongst them, Indian carriers have over the past decade consistently pursued growth at any cost.

Now this pathway has come back to haunt SpiceJet. Don’t get me wrong, there are profitable avenues of growth available to SpiceJet, chiefly on under-served regional sectors using the Q400, and on regional international routes out of Delhi. However, thanks to the over-commitment to new aircraft, SpiceJet’s strategy has instead been to add new routes and frequencies on heavily competitive domestic sectors, primarily on inter-Metro sectors. Then the accumulated losses on these flights simply add to SpiceJet’s debt load, making it harder for them to find financing for the Q400s and reinforcing the negative feedback cycle of profitless growth.

It is also interesting to note that SpiceJet has seen the steadily creeping interest expenditures. While SpiceJet is far away from the interest burden that crippled Kingfisher, and bankrupt US carrier American Airlines, and have hamstrung Jet Airways in recent months, this should be a cause for long term concern and constant observation.

Current finance charges are close to 4.8% of revenues, up sharply from less than 1% just a year ago. It is important to note, SpiceJet actually had Rs. 747.10 lakhs worth of interest costs, it has not accounted for, in this quarter, stating ongoing litigation at the Bombay High Court – a charge that would have made the already dismal results look even worse.

Moving forward, there is undoubtedly potential for SpiceJet to grow and improve its financial performance, especially if it can find financing for the next set of Q400 deliveries. The key for SpiceJet is capacity discipline – they need to find some way of bringing revenues in line with costs.

Cost-cutting is difficult since more than 75% of their costs are effectively fixed in the short to medium term. The easiest way to do this is by holding your supply (capacity) constant, which will in turn drive an increase in fares and thus increased revenues. However, this strategy will be tested by the constant fleet additions by competitors IndiGo and Jet Airways, as well as a constant observation by the government to keep fares “in check”, a populist interference that will only grow as elections get closer.

A more plausible strategy would be the Blue Ocean growth being driven by CEO Neil Mills. The carrier is applying and getting route permissions for un-served and under-served international routes like Kabul, Guangzhou, etc. SpiceJet has to follow a similar strategy for the domestic market too. SpiceJet is gradually serving tier two and three cities from Bangalore, but is still not basing a full Q400 fleet here. Bangalore Aviation is given to understand that the airline is looking for a “good deal” from BIAL, the airport operator, but is not finding one, since the airport is under-capacity at present.

Given these macro-economics, for the short term, SpiceJet may continue to pursue a aggressive capacity growth path of more than 15% per quarter, and this will keep pressure on profitability. The faster the airline shifts strategy the faster the chances of it flying out of the trap.