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Special Report: Jet Airways 2012 Financial Analysis and 2013 Outlook

Jet Airways reported a large net pre-tax loss (Jet Airways and JetLite combined) of Rs. 1,331 Crore for fiscal year 2012, a very disappointing result. Revenue and passenger growth were robust as usual at 14.8% and 16.3% respectively. But the carrier’s net margin of -8.5% is indicative of tangible flaws in the business, and goes beyond the explanations of higher fuel prices and rupee depreciation given by Jet, though these factors did play a major role.

To be sure, Jet Airways did have to deal with a large rise in fuel costs; a 51.8% rise in absolute terms, or 39.2% per ASKM. And the decline of the rupee to around 55 Rupees to the dollar, from 45 INR per dollar just a year ago has certainly hurt Jet, who accrues a larger share than normal of its operating costs in US dollars thanks to its international presence. But these are challenges faced in common by all of the Indian carriers, and most of the world in terms of fuel prices. In times of rapidly rising inputs, the onus is on the carrier to make the changes necessary to maintain profitability.

The best thing an airline can do in response to a rise in costs beyond its control is to maintain cost discipline in the inputs which are controlled by the airline. Yet not only did Jet fail to cut costs, it actually allowed its non-fuel costs to appreciate at levels greater than the growth in capacity.
The general rule of thumb is that as an airline’s cost rises, it should maintain capacity discipline, taking a hard look at the profitability of its network and cutting out the most marginal routes. But Jet, to a large degree has simply maintained the status quo, growing capacity as if nothing has changed. ASKM growth for fiscal year 2012 was 12.6%, hardly indicative of a carrier that is cutting marginal routes from its network. To a large degree, the US carriers have embraced capacity discipline, with Delta Air Lines in particular taking sharp steps to cut marginal and unprofitable European flights from its network. And while the US carriers haven’t been world beaters in terms of profitability, they’ve managed to stave off losses, while Jet Airways saw net margin decrease by 10 percentage points while inducting 5 more aircraft and increasing fleet utilization.

International Cuts to Boost Profitability

Recent weeks have seen Jet Airways sharply curtail its international services, with a slew of gauge reductions, frequency cuts, and outright cancellations. The full list of cuts can be found below, but the most recent reductions were the cut of 2 flights (seasonally for now) per week on the Delhi-Milan route, and the downgrade of daily Delhi-Singapore service from widebody Airbus A330-200s to narrowbody Boeing 737-800s.

Chennai – Dubai ~ Cancelled
Hyderabad – Dubai ~ Cancelled
Thiruvanantapuram – Dammam ~ Cancelled
Brussels – New York JFK ~ Cancelled (Chennai – Brussels remains in operation)
*Chennai – Kuala Lampur ~ Cancelled
Delhi – Colombo ~ Cancelled
**Mumbai – Johannesburg ~ Cancelled
Delhi – Milan ~ Frequency dropped from daily to 5 flights per week
Delhi – Singapore ~ Service downgraded from A330-200 to 737-800
_______________________________________________________________________________

*Following the Jet cancellation, Malaysia Airlines added 4 weekly flights Kuala Lampur-Chennai to take their offering on the route to 11 flights per week
**Following the Jet cancellation, South African Airways re-deployed capacity from its cancelled Cape Town – London Heathrow service to add 2 extra weekly flights on Johannesburg – Mumbai, bringing its total up to 6 flights per week on 222 seat Airbus A330-200s.

While the footnotes above might give the appearance that Jet Airways simply mis-managed the flights and allowed other carriers to profit from their loss, the reality is that this list of cuts was hard but necessary in order for Jet’s international operations to get a step closer to profitability.
Having just lambasted Jet for not showing enough capacity restraint over the last year, similarly I must applaud them for taking steps to shore up their international operations which have been critically weakened by the loss of value in the Rupee. Jet bears a large percentage of its international costs in US dollars and as such, its international operations have become a lot harder to support fiscally (because its financial results are tabulated for the most part in Rupees, and much of Jet’s international sales are done in Rupees as well). The nearly 25% drop in the value of the Rupee essentially pushed Jet’s seat-kilometer costs (CASK) up at least 10-12%, with a corresponding rise in break even fare and load factor. For the 4th quarter, international breakeven load factors reached a dangerously high 92.2%, unit revenues (RASK) were up 18.0% to 2.68 Rs. Per available seat kilometer, but much of that revenue growth was driven by Rupee depreciation.

Ultimately, the signal for Jet that things had gotten out of hand was the 41.8% decline in the net international result to a Rs. 1,051 Crore net loss from Rs. 741 Crore a year prior. Pruning the most unprofitable routes then had to be a concern for Jet. These routes (unsurprisingly) had very good loads.

In fact during the 4th quarter analyst’s call, Jet released the following load factor figures for Q4.

UK routes were 91.7%
ASEAN routes were 85.7%
Gulf routes were 86.0%
SAARC routes were 76.8%
Africa route was 78.2%
Italy route was 83.7%

But even ceteris paribus (all else equal), these loads would not be good enough in the face of cost increases. In particular, Bangalore Aviation’s sources say that the Johannesburg route had very low fares which led to large losses in the face of steadily rising costs. Meanwhile the Gulf routes are under severe pricing pressure from both Air India (Express and mainline) and the slew of LCCs while business class passengers mostly elect to take the Etihad/Qatar/Emirates triumvirate. The added costs and A330-200 returns meant as well, that Delhi-Singapore could no longer support a widebody service.

The critical point to remember here is that these changes are good, even cathartic for Jet Airways. They represent a re-balancing of international capacity towards Jet’s Mumbai stronghold, which is a good idea as Jet can now try to improve and streamline the quasi-hub they have there at the moment. They also represent smart business strategy, the first occurrence in a 6-8 month stretch which has seen a confused, conflicting strategy from Jet on domestic operations, JetLite/Konnect combination and the like. As Mr. Sudheer Raghavan, Jet’s chief commercial officer put it, “We [Jet Airways] are focusing on network rationalization, selectively adding flights to profit making markets such as Gulf & Middle East and ASEAN routes and pulling out of loss making routes… We have taken a call on pulling out of some of the routes which are loss making. To name some of them, the Johannesburg route is one of them. The Delhi-Colombo route is one another route that we are announcing to get out of. As well as one or two other routes in to Dubai from the south of India.”

Widebody fleet plans to have an uncertain effect on Jet’s finances

The next few quarters will see a moderate shift in Jet Airways’ widebody fleet. The total fleet will grow from the current 16 to 18-20 aircraft, but the composition will change. Currently, Jet Airways operates 5 Boeing 777-300ER, and 11 Airbus A330-200 aircraft. They also have on order 5 Airbus A330-300 (to be leased from Intrepid Aviation Group), and 10 Boeing 787-8 ordered directly from Boeing.
Over the next year, Jet will induct 2 A330-300s to replace 2 A330-200s that are being returned to lessors, as well as 1-2 A330-300s for growth. Additionally, 2 more Boeing 777-300ERs will be returned from Thai Airways International.

Jet Airways is reportedly considering converting (only these two aircraft at first) the 777-300ER economy class into 10-abreast 3-4-3 configuration (as Emirates and numerous other airlines do). Additionally, they are looking at various A330-300 configurations, including a 268 seat one (38J/230Y). As for the first plan, it is a good move, though it would have been better had Jet also withdrawn its first class “pods” that are so heavy that they cause severe performance issues for Jet’s 777-300ERs (cutting hundreds of miles off of these aircraft’s range). Meanwhile a 268 seat configuration in 2 classes for the A330-300 is also disappointing because it does not take advantage of the full cost potential of the A330-300. US operators Delta Air Lines and US Airways both get more than 290 seats in 2 class seating into their A330-300s (Delta even includes a premium economy cabin in its 298 seat configuration).
However, despite these plans, a broader question exists… Can Jet Airways even profitably induct the limited number of widebodies it is taking on? The 777-300ERs have been widely recognized as a failure, ostensibly because they are too big for Jet’s origin and destination (O&D) traffic driven route network. Yet when the A330-300s are inducted, they too will be bigger than the A330-200s that have been Jet Airways’ most successful (in relative terms) aircraft. There are certain routes on which the lower CASK of the A330-300 will help no doubt, but are these markets numerous enough to support a fleet of 5 aircraft?

Longer term the best strategy for Jet is to replace all of its 777-300ERs with A330-300s (the latter can be stretched to 290 seats or so) converting to a 3-class configuration with premium economy (removing first class) and growing to a fleet of around 10 frames or so. As Jet’s route network stands currently, there is not a single route that cannot be performed with either an A330-200 or an A330-300 and it is likely to remain as such for the foreseeable future unless Jet is planning nonstop flights to the US and/or to Australia. Additionally, Jet should take delivery of all 5 remaining A330-200s on order bringing them to a fleet of 14 of the type. Then Jet should place an order for 15 787-9s as well as 6-8 additional 787-8s and replace the A330-300 with the 787-9 and the A330-200 with the 787-8 by 2020. This type of fleet plan will allow Jet to streamline its fleet around one aircraft type (except in the interim period of replacement), while providing the correct blend of low costs and right-sized capacity in the Indian market.

Ancillary revenue is a potential goldmine but fraught with risk

One particularly interesting shift in the business model of Jet Airways is that the carrier is giving signals that it will in fact begin to shift its service offering towards the a-la-carte model (a.k.a. charging for everything or “nickel and diming” the passenger) currently in favor amongst the profitable US airlines. The model, the most visible example of which can be found at European low cost carrier Ryanair, chiefly involves unbundling the various services an airline provides to its passengers (checked baggage, onboard refreshments, et. al) from the standard ticket price. A variant on this model can be found at full service US carriers, where non-elite economy class passengers can get access to some of the perks offered to their counterparts traveling in business or first class (such as expedited boarding, expedited security, et. al).

During Jet’s quarterly conference call, Mr. Raghavan had this to say about Jet’s ancillary revenue efforts:
“So, there are some very compelling reasons for us to say that we really need to start changing our model and start selling optional services and from a consumer perspective, I think it is a meaningful thing to do rather than charging all sundry the same fare. The concept of allowing people to pay for what will enrich their travel experience is increasingly becoming more sensible thing to do.”
When asked what specific programs Jet would implement, he further clarified:
“I think, there is buy on board food; there is preferred selection of seats, lounge facilities, preferred check-in. There is a potential to sell miles to companies who want to revert their good customer. So, the list is endless. In fact, I have seen more and more airlines getting very creative at building new sources of ancillary revenue.”
There is no question that ancillary revenues could be huge for Jet Airways, especially in counteracting some of the economy class pricing pressure coming from the low cost carriers. The top US carriers routinely score more than 20% of their ticket prices in additional fees, and if Jet Airways can replicate this figure, then it would take a big step towards profitability. At the same time, one has to question just what the tolerance level is amongst Indian passengers for this type of pricing model. While buy-on-board food has become commonplace with LCCs IndiGo and SpiceJet and the remaining services mentioned by Mr. Raghavan largely fall into the category of upgrading the travel experience (as opposed to unbundling). But in all honesty (outside of selling frequent flyer miles, which could be big business), there’s no real money in these services at a macro level, at least not to the degree (20% of the average ticket price or Rs. 1500 for Jet ~ Rs. 1000 on the domestic network) that Jet is talking about.

Ultimately, scoring such large revenue gains from ancillary services will come down to charging for checked bags (something like Rs. 250 a bag would be an ideal level) or charging high fees whenever a customer changes his or her reservation. And Bangalore Aviation feels that these particular fees are not going to fly at the moment with Indian travelers. Jet also has to be very careful that it does not dent its good customer service reputation. Indian travelers today are extremely price conscious, and as such Jet must strike a balance between charging extra for whatever possible and not losing passengers to poor service.

2013 Outlook Mixed – Fuel and Kingfisher withdrawal to help premium and international segments, domestic view uncertain with new entrants and SpiceJet growth

So following a dismal 2012, how will Jet Airways perform financially in Fiscal Year 2013? The correct answer is that things are very fluid. There is no question that the recent down-slide in fuel prices towards a likely stabilization in oil prices between $70 and $90 per barrel (West Texas Intermediate or WTI measure – likely to occur because of rising US oil production and the return of Libyan oil) will benefit Jet Airways substantially – the ultimate trend in Jet’s finances is that they make money when oil prices are low and lose money when they are high. So a push towards stability in the oil market is a very good thing for Jet, though it’s too bad that they cannot “hedge” (buy some form of oil futures now, then pocket the gains to offset fuel price increases if oil spikes).

image courtesy of Air Insight

On the other side, the recent trend of rising fares in the domestic market and abroad will be helped by Kingfisher’s diminished service; which will prop up premium fares domestically and international fares to a lesser degree. Capacity as a whole in the Indian market has been much more flat in the past couple of months which should help the bottom line. Jet will also see boosted profitability on the international front, as it sheds the most unprofitable routes in its network and benefits from a hopefully stabilizing rupee.

On the flip side, the domestic market might be further destabilized if all of the proposed new entrants actually take flight. The combination of Pegasus, Volk Airlines, and Air Costa, all of whom plan to operate 70-90 seat aircraft could be a big destabilizing force in the domestic market. Remember these aircraft do not pay full amounts of fuel sales tax and airport charges, thus allowing operators to lower prices (artificially some would say). Considering that they are all-new carriers, these airlines would likely be very eager to regain lost market share, which would throw pricing in the domestic market off completely. Of course there are still many steps to take before these carriers are fully certified, but the downside risk from new entrants is there.

A more quantifiable risk can be found in LCC SpiceJet’s continually growing Bombardier Q400 operation. The airline, which operates a total of 15 Q400s, recently took delivery of 5 new aircraft, and immediately used them to establish a regional base at Delhi. These aircraft will now be used to target high fare regional routes where Air India and Jet Airways once shared a duopoly (the latter using ATR 72-500 aircraft). While our sources say that SpiceJet will not be ordering more Q400s right now due to equity limitations, the combination of new markets added out of Delhi, and the continued maturation of SpiceJet’s southern Q400 operations will put increased pricing pressure on Jet’s regional routes, which are some of their most profitable ones domestically. Jet has re-adjusted to this reality and stopped taking delivery of new ATRs, but regional operations are likely to trend downwards financially.

Jet Airways unlikely to order Airbus A320neo

Earlier this year, a major hubbub was raised when the Sydney based aviation consultancy the Center for Asia Pacific Aviation (CAPA) said that Jet Airways was likely to purchase 100 Airbus A320neo aircraft in the coming fiscal year. While Jet Airways is likely talking to Airbus about the neo, at least to drive down the price on Boeing’s offering if nothing else, we feel that they will in all likelihood order the Boeing 737 MAX, though the timeline on this order is at least 9 months away. Jet too is suffering from a dearth of cash at the moment, and as such is in no position to order 100 aircraft. As for the rationale for the MAX over the neo, Jet is currently a very happy 737NG operator (recently converting some of their 777-300ER orders into 737s) and the advantages of commonality (with regards to training, procedures, and the like) are likely to outweigh whatever minimal operating cost advantage the neo might have.

In conclusion, fiscal year 2013 is an uncertain one for Jet Airways. On one hand, they will undoubtedly benefit from stabilization of yields, capacity, and oil prices both within India and abroad. At the same time, there is significant downside risk from new entrants and SpiceJet’s regional operations. The most likely result is that Jet will perform better financially, but not yet at an adequate level of profitability. Like the suddenly shaky Indian economy, Jet might be on a path to simply muddle through in 2013.

About Vinay Bhaskara

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