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Are lower crude prices enough to bring aviation sector’s mojo back?

Pallavi Pengonda
Average ATF prices for domestic airlines at four metros have declined by nearly 20% compared to the average for the December quarter

Indian airlines got an apt New Year present: lower aviation turbine fuel (ATF) prices. According to Indian Oil Corp. Ltd, average ATF prices for domestic airlines at four metros have declined by nearly 20% compared to the average for the December quarter. These are the lowest monthly prices in this fiscal year.

This brings much-needed respite on the costs front for the industry. It also encourages airlines to reduce fares, which can potentially boost demand. But the big question is if demand will rise in line with the huge increase in capacity by market leader InterGlobe Aviation Ltd, which runs IndiGo.

Note that domestic passenger traffic growth hasn't been upbeat lately. Traffic growth for November stood at 11% on a year-on-year basis, according to the Directorate General of Civil Aviation. Growth stood at 19% over January-November.

Domestic aggregate passenger growth has been a record ~900 basis points lower than capacity growth (measured in available seat kilometre or ASK) during November, pointed out ICICI Securities Ltd in a report on 2 January. A basis point is one-hundredth of a percentage point. According to the brokerage firm, lower passenger growth was led by decline in travellers on key metro routes. “The decline in passenger number in top routes could be due to fare hikes taken by airlines,” added ICICI Securities.

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Shannon Attari, an aviation restructuring expert and partner at Attari Capital, says: “If metro routes are price sensitive then shouldn't we expect greater sensitivity on regional routes?” In other words, airlines are finding it difficult to increase fares without affecting demand. This is a worrying trend. Even as the industry hasn't yet figured out a way to sort this conundrum and be profitable, lower fuel prices help. According to Attari, assuming airlines pass on the decline in fuel prices to consumers, fares would decline and there should be a catch-up to the previous passenger growth rates.

But with capacity growing at a brisk pace, the all-important question is if fuel prices have fallen enough to ensure load factors remain high. InterGlobe has guided for capacity addition, measured in ASK, to grow by 35% in the second half of FY19.

While the trends on demand and load factors are yet to play out, the redeeming factor is that ATF prices have come back to levels where low-cost airlines generated decent profits.

In the year-ago March quarter, when ATF prices averaged around ₹62 per litre, IndiGo reported a net profit of ₹117.64 crore. Besides, spreads (RASK less CASK) stood at ₹0.10. In the preceding quarter, when fuel prices were about 9% lower, the spread was far higher at ₹0.66.

RASK is revenue per available seat km, and CASK is costs per available seat km. Both are unit measurements for airlines.

It's little wonder IndiGo's share price has climbed back to where it was a year ago. But it's worth noting that the lower fuel price environment is not necessarily a permanent feature. There is always the risk that prices will inch higher. This is why, before optimism flies too high, it would be prudent for investors to curb their excitement. Especially so, given that the industry capacity now is much higher than it was last year.