Why Jet Airways crashed?

India has witnessed yet another airline debacle and this time it’s Jet Airways. Aviation sector is considered so vulnerable to cyclical changes that many of them are ailing, whereas very few of them are able to sustain profitably. Jet has been on a roller coaster ride for quite some time now. Let’s discuss about how it landed with crash this year and what lies ahead?

Before we move to analysis, below is a brief on sectorial factors.

Fleet size / ASKM - Available Seat KM

Indicates the capacity of the enterprise. Directly proportional to the fleet size and the type of aircraft.

RPKM – Revenue Passenger KM

Indicates available seats kms converted into revenue. RPKM indicates available seats kms converted into revenue generating seats kms. Higher RPKM results in higher revenue and recovery of fixed costs, which shall further increase earnings.

Load factor

Load factor indicates the total occupancy of the available seats by revenue passengers. It is the ratio of RPKM to ASKM, indicating revenue generating capacity utilisation.

RASK = Revenue per ASKM;

CASK = Cost per ASKM

Revenue comprises of passenger and cargo. (both domestic & international)

Higher RASK indicates higher fares charged per ASKM. Higher RASK with increased volumes is a healthy sign of effective pricing. However, it if leads to falling volumes, then such higher pricing shall have negative impact on the earnings.

RASK = Revenue per ASKM;

CASK = Cost per ASKM

Revenue comprises of passenger and cargo. (both domestic & international)

Fuel CASK = Fuel cost per ASKM

Fuel cost is a variable of international oil price movements. Rise in oil prices is one of biggest challenges for aviation sector as due to tight competition, airlines may not be able to pass on the inflation impact in pricing, whereas any significant increase in the air fares may impact the market share

Lease Charges

This is another major component of cost after fuel cost. The aircrafts operated by the company are on operating lease or finance lease or on sale & leaseback. In these cases, lease charges are payable annually. However, in case of finance lease, there are tax savings on depreciation of leased asset that is capitalized. However, there is a financing cost involve. In sale and lease back method, the company can create a cash inflow by selling the owned aircrafts to the leasing company and lease bank on operating basis.

Aircrafts

Airlines deploy various sizes of aircrafts based on their scale of operations. Low Cost Carriers (LCC) deploy smaller aircrafts. Automation across array of operations and newer aircrafts which have cost advantages, reducing the maintenance cost and other aircraft related costs as well.

Government policies

Under the UDAN and Regional connectivity scheme, airlines are exploring the untapped network connecting Tier 1/2/3 cities. Airlines having monopoly at certain routes may enhance its competitive advantage.

Economic Growth

In India, the no of trips covered per capita is mere 0.9, thus there is immense growth potential. With stronger economic growth of India and resultant increase in the per capita income, development of smart cities and proposed green-field airports will steer the increase of airline business and tap the untapped growth potential.

SCALE OF OPERATIONS

As per Exhibit B, the fleet size has been expanding. Aircrafts are mainly taken on finance lease or operating lease. Operating lease involves regular lease payments. Those on finance lease or owned are funded by long-term borrowings.

With the expansion of fleet size capacity, as in Exhibit A, resultant ASKM has been increasing. On account of factors like growth in domestic passenger, lower oil prices etc. Jet has been able to utilise its capacity at increasing rate as load factor has increased from 77% to 84%, which is evident in the form of higher RPKM. Effect of demonetisation can be seen due to fall in RPKM in 2017.

There was spike in load factor is 2014-15 from 78% to 82%, post which it has remained in the range of 81%-84% till 2018. This can be seen due to multiple factors, like industry growth, increased passenger growth, aggressive pricing due to reduced fuel cost. Thus, factors leading to growth were more of external.

When compared to its peers, Jet’s rise is much tepid. Spicejet and Indigo having market share of nearly 13.5% and 41% respectively, registered load factor of 94% and 88% during 2017-18. Whereas, Jet has lost its market share by 1% during recent years.

OPERATING PROFITABILITY

As per Exhibit C(i), The spread between RASK and CASK over the period of last 8 years has remained quite sticky and volatile. Till 2013, spread was positive but narrow. In 2013, spread was negative despite decrease in Fuel CASK, which was mainly due to spike in lease charges by 30%, a portion of non-fuel CASK. Thereafter, due to relaxation in global oil prices in 2015 – 2017, the overall cost for enterprise reduced for that period.

If we look over Exhibit C(ii), yield is gradually rising till 2017. In 2018, yield started falling. This means that the revenue earned per mile flown had started decreasing. Reasons for such decrease can be higher discounts, aggressively lower pricing to fight competition or passing on the benefit of lower costs to market. As long as lower yields are on account of cost reduction, it’s not much of concern. But, when the gap between yield and cost narrows down, it’s a sign that the profits would diminish.

With sharp rise in crude prices coupled with competitive pressure trending the RASK downwards, margins diminished & turned negative in 2018. Recent increase in customs duty on ATF has also contributed to increase in fuel cost.

In Fiscal 2019, the overall CASK has reduced mainly due to decrease in non-fuel CASK through cut in employee cost, sales and marketing expenditure, and other costs. However, the fuel CASK and Lease CASK continue to remain higher. Rupee depreciation and its increased volatility during year 2018 has also put an upward pressure on the fuel prices, lease charges and foreign debt, reducing the repayment capacity of the enterprise.

SOLVENCY POSITION

Enterprises which are on cash and carry business, normally carry negative working capital, which reduces the cost of funds. Such current obligations are expected to be met with the future operating cash flows. In cash of shortfall in future cash flows, short term financing is sought. Now, if the cash flows fall short to meet the short-term obligations and the enterprise is unable to obtain additional financing, business may default on it payments. To avoid default, it may take recourse of sale of long-term investments/ fixed assets.

It is evident from the Exhibit D, the working capital position has been quite adverse for Jet. Post 2011, the net working capital for Jet has turned red. The net short term payable position is significantly higher than the operating cash profit earned in the next year. And this trend has continued since 2011 till date. In this scenario, short term obligations are met through short term financing, thus increasing its interest cost.

Exhibit E, shows fall in the interest coverage ratio, but for exceptional years of 2015 to 2017 when the fuel prices were low. Post 2018, the negative ratio implies complete insufficiency of operating profits to meet the interest obligations, which has led Jet to default.

The severe cash crunch, default on loan repayment and finance lease obligations has compelled the airline to ground few aircrafts and hold owned assets for resale, the sale proceeds of which would be used to repay the debt. However, the debt levels are too high to have Jet continued as a going concern, until options like conversion of debt into equity etc. which are being considered now are acted upon.

Thus, Over leverage without saving room for volatility and cyclical changes has led to the tumble.

Source: Annual Reports, DGCA database

By Ushma Zunzavadiya

Think Fin with Ushma

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