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With the rapid spread of the coronavirus pandemic, airlines have experienced the largest demand shock in history. Overnight demand has evaporated and each passing day brings with it news of airlines grounding entire fleets. International markets are shut and for India’s airlines, contrary to the narrative that domestic demand will help mitigate the impact, the situation is actually worse.
This as the corona crisis comes at a time where the country is also dealing with a banking crisis. Add to that the asset-light balance sheets, voluminous aircraft orders of 1100 aircraft, a weakening rupee down 7% against the dollar, limited mitigation measures and extremely price-sensitive demand.
At least two airlines are looking at extremely grim outcomes and are down to a few days of cash. It is almost certain that the government will have to step in. News reports indicate that a bailout package of INR 1200 crores is being discussed. Effectively the tax-payer is being asked to help the airline industry. Thus such a package must also carry provisions that force consumer-facing structural reforms.
India’s airlines were already grappling with challenges
Even prior to the crisis, India’s airline industry was already grappling with excess capacity and with the quality of cash-flows. This was reflected in the high load-factors of 88% (percentage of seats filled), pricing levels and last-minute discounting. Costs were high and the rupee-dollar equation had a forex outflow impact each quarter.
Add to that the situation in the banking sector with severely constrained lending. It also did not help that the Jet Airways shutdown continues to haunt bankers with exposure of INR 8500 crores. Additionally, widespread undercapitalization, operational losses, a loss-making national carrier and all business models chasing similar demand. As such the industry was not in the best of health.
A lack of a united front = weak lobbying efforts by airlines
Airlines are unique in that while they have historically provided low returns on capital, their impact to the aviation value chain is irreplaceable. Airlines sit at the apex of the aviation and tourism value chain and fuel the entire aviation economy. Interestingly, almost all other elements of the value chain make money.
Whether it is the travel agents who sell tickets; or the airports that facilitate travel; or the lessors that lease aircraft to airlines; or service providers that dry-clean uniforms for the airline staff; or the hotels that house crew; or the training providers ensuring pilots are always proficient – the list goes on. Yet all of this trace back to the functioning of an airline.
Thus in the case of airline failures (especially large airline failures), there is a significant impact on the “aviation economy.” This is the situation that stakeholders including the industry and government want to alleviate.
Yet for India’s airlines, there is no united body with all airlines as members that can lobby the government towards reforms. Thus each airline approaches the government with their own recommendations and this does not make for a very aggressive push.
Any bailout package will necessarily include a large cash element
Indian airlines have witnessed profitability in varying degrees in the past five years. Yet when one looks at cash-balances for the industry they have been low. With the exception of Indigo, balance sheets are extremely weak and this is driven by a management focus towards a profit and loss statement as opposed to the balance sheet.
But for sustainable success, airlines not only have to position themselves for situations where its bright and sunny outside but also for rainy and story days. Carrying cash, credit and access to liquidity are items that don’t magically happen. They require discipline and have to be planned for. And a failure to do this can lead to very precarious situations. That is exactly what the airlines are facing.
With booking volumes falling, cash-flows are severely depressed. But asset-light business models, a collapse of the share market (impacting value of pledged shares) and declining liquidity on aircraft (impacting sale-and-leasebacks) effectively mean that access to collateralized credit is all but over. The only remaining options are equity infusion, bank lending or government-funded bailouts.
Equity infusions should be the resort of the first measure but in the current market scenario, these will likely not happen. Bank lending is also an unlikely option because with no certainty on when demand levels start to recover banks have no basis on which to make the loans (and in light of the Yes Bank crisis bankers will be overly cautious and rightly so). The only option towards liquidity support: a government-funded bailout.
Effectively any bailout package has to address the concern of airline cash-flows. Thus it must have a large element that addresses cash-flows. Both outflows – via waivers on charges, taxes and deferral of other expenses; and also inflows – by means of loans and grants and even a refund of taxes.
Parallels with the auto-bailout in the US?
As a proxy, we examined the auto bailout in the United States. Here the three largest auto-manufactures namely GM, Chrysler and Ford were facing extreme challenges. And a failure of either of the three would lead to contagion across the supply chain and extensive job losses. Thus the government came together to provide the auto industry loans to the tune of approximately USD 80 bn. Of this USD 70 bn were recovered but the auto industry arguably never got better. What it did help to do was to ease the pain and abate job losses.
India’s airlines currently face a similar situation. The market is one whereof six airlines there are only two that were registering profits. A national carrier is in a fragile position and lending to it is only made possible by sovereign guarantees. More than one Indian airline is behind on lease rent payments and termination notices and unpaid leave notices to staff are already being handed out in an effort to conserve cash. As it stands, for the industry as a whole, significant challenges abound.
That said due to the varying size of airlines (where one can use market-share as a proxy), not all airline failures will carry similar impact. But in terms of a bailout, this poses a challenge because any bailout has to be applied equally across airlines.
Eventually, the outcome a bailout drives at is to recover the money lent and stabilize the industry. But for that structural reforms are needed.
A bailout requires strong monitoring and evaluation
A bailout is a complex endeavour. Because eventually, the accountability is to the tax-payers. Thus any package has to be constructed carefully. Provisions must stipulate what the cash can and cannot be used for. Because weaker airlines will use most of this capital towards continuing operations while stronger airlines can take this cash to further strengthen the balance sheet or even to bleed the weaker carriers (if not monitored). As such the root causes that led to this situation are never tackled.
Interestingly, in case the government takes a stake in airlines in exchange for the money lent, it effectively will mean that the government owns a portion of the airlines. Consequently, the situation may move from the government owning one airline (Air India) to one where it has stakes in several airlines. A complete reversal of sorts and one can’t quite fathom who the government will hire to monitor the airlines.
Yesterday, the US Senate, approved a $25 bn bailout package in the form of government grants for the American passenger airlines. Another $4 billion was approved for cargo airlines while $3 billion is for groud contractors like catering workers and ground service providers.
The bailout requires airlines to have a cap on certain employee salaries, golden parachutes and prohibits dividends and stock buybacks till September 2021. Employees cannot be laid off or have wages reduced until September 2020.
Even with these basic requirements, it is rumoured Southwest may choose not to accept the bailout and instead trim their workforce.
Any bailout of the Indian airlines will need to carry covenants on use of funds, a focus on the balance sheet, pricing discipline, capacity discipline and consumer-facing measures. And approving, implementing and monitoring this within the short timelines will be critical. Whether this can be done continues to be a matter of much discussion and debate. But if not done, the industry may find itself asking for another bailout when the next crisis hits. The need for strong monitoring and evaluation cannot be overstated.
