India Can Become the World’s Third Largest Aviation Market
Initially liberalised in 1994, the airline sector in India has seen annual passenger air traffic grow from c.7.5mn domestic passengers in 1993 to c.60mn domestic passengers in 2011 – an 8x increase.
In comparison, the primary alternative for long-distance travel – the Railways -transports 23mn passengers every day or 7200m passengers per year.1 Despite the enormous time saving, the rail is prioritized over air travel because of affordability.
Over the next few years, a step-change in (i) the affordability of air travel and (ii) the access to air travel, is expected to result in 270mn air passengers by 2020, making India the third largest aviation market globally2 (behind the US and China)
The Big Question
In 2000, it cost c.Rs.14 to make a local mobile phone call in India. In a country of 1.1bn people, there were 32m fixed telephone lines and 3.6m mobile connections. The “telecom revolution” triggered by the National Telecommunications Policy introduced in 1994, led to increased competition amongst mobile operators, a drop in the average tariff to c.Rs. 0.50 currently, and exponential growth in total mobile connections. Total mobile connections reached 893m in 2011, making the country one of the world’s largest telecom markets; and creating multi-billion dollar Indian telecom companies in the process. A hitherto “elitist” service used by a few rich consumers was transformed into a tool of common, daily use by all citizens. Is the airline industry capable of transforming itself from serving a tiny fraction of the population to becoming the mode of choice for long-distance passenger and freight travel for the entire country?
The Indian aviation sector is poised for significant growth, driven by increasing affordability of air travel, a multi-fold increase in air connectivity and the strengthening of viable domestic airlines, especially low-cost carriers. The nature of regulatory oversight and policy-making by the government poses an opportunity as well as risk; and will determine the speed at which the industry matures.
Affordability of Air Travel
The average cost of a low-cost carrier, one-way ticket between New Delhi and Mumbai, two of India’s largest cities, is Rs.8000 or US$160. The journey lasts approximately two hours (air time). The same distance is covered by train in 16 hours at a cost of Rs.2000 or US$405. The passenger “choosing” rail travel over air travel is saving Rs.6000 or US$120 in return for spending 14 incremental hours in transit. In other words, the saving per hour is c.US$9. For a consumer earning US$760 (India’s median per capita personal income), or US$0.36 per hour who is travelling with a family of four, the choice of rail travel is the “rational choice” because the total savings exceed the amount of income which could be earned in that time.
Given the recent and forecast trends in per capita disposable income in India, the number of people for whom air travel will become the rational choice will increase materially over the next few years. This consumer affordability will complement the increasing preference of business travellers who already represent a significant proportion of air travellers.
An important reason that rail travel trumps air travel in India is coverage. The Indian railway system is one of the world’s largest railway networks comprising 115,000 km of track, carrying 7,500 million passengers and reaching 7,500 rail stations. Dating back to colonial times, the rail network is vast and covers most parts of rural and urban India. In comparison, the air network is at an early stage of development; and it is only in the last two decades that the increasing prevalence of air travel has resulted in an expansion and upgrade of airport infrastructure.As of June-2012, the 6 largest international airports account for 52% of India’s air traffic7. Over the next 10 years, over 35 additional airports are expected to be upgraded in capacity as well as quality. The template for this has already been laid with new airports built in recent years in Delhi, Bangalore and Hyderabad and new terminals coming up in Kolkata and Chennai. The connectivity of new cities and the availability of more landing slots at existing airports will, in turn, drive traffic as new demand centers open up.
Strengthening of Domestic Airlines and Low Cost Carriers (“LCC”)
Under India’s Foreign Direct Investment laws, foreign ownership of airlines is restricted to 49%. As a result, since the liberalization of the sector, a number of domestic firms – established corporate houses but often start-ups – have launched airline businesses. Like in other parts of the world, running airlines profitably in India is a challenge and not all ventures have survived. However, over two decades of competition has resulted in some clear leaders that have operating standards and business strength comparable to international peers.Indian airlines clearly see the coming explosion in demand. In aggregate, Indian airline companies have placed significant orders for aircraft to be delivered to increase the total fleet size to 1,030 in 2020, against 397 aircraft in operation today.Of the major airlines operating in India, 59% market share belongs to low-cost carriers. Like in other countries , the emergence of LCCs in 2005 spurred an adoption of air travel driven by lower prices.
Unlike certain other infrastructure sectors, aviation has progressed well over the last ten years with tangible results to show for it – new airports, a radical change in airport and air travel quality and 16% passenger growth8. However, there are certain risks to the development of the aviation sector. Two factors, in particular, will have a big impact on the development path of the industry: (i) the quality of government intervention and (ii) the fuel costs of airlinesGiven its history as a 100% government controlled sector, the government still continues to play a major operating and policy making role in aviation. It operates a large (loss-making) airline; it runs the national Air Traffic Control system (“ATC”), it regulates the airlines (in terms of safety, quality standards etc); it auctions (or not) the right to build new airports; its fuel tax and surcharge policies determine ticket prices and its regulatory bodies can amend policy direction. Notwithstanding the success to-date, a number of recent initiatives have been stalled or mired in controversy. No new public-private partnership opportunities for airport modernisation or development opportunities have come out since 2008; foreign investors in the Delhi airport project have publicly expressed dissatisfaction at the government’s regulatory oversight; new ground handling regulations which have been legislated in 2009 for have not been implemented yet, the runway capacity in many key cities is limited, and the ability of the ATC to cope with increasing demand is in question. As described in the previous section, the growth of aviation in India is predicated partly on an increase in supply to hitherto unserved or underserved destinations. If the pace at which new, quality infrastructure is built and deployed is slowed down for policy or implementation reasons, the overall growth of the sector will suffer.The second significant factor likely to influence the growth of domestic passenger demand is the cost structure of airlines. Approximately one third of an international airline’s cost structure is fuel cost; in India, that percentage is as high as 45%9 because of high taxes on aviation turbine fuel. If global fuel costs increase materially due to a rise in the price of crude, airlines will have no choice but to pass these costs on to consumers. In comparison, the alternative to air travel i.e. rail runs on electricity and diesel both of which are deeply subsidized by the Indian government; and passenger fares are controlled by the government, with excess costs being absorbed by the government.
The Indian Aviation Opportunity
India’s economic growth and rising disposable income of the middle class is expected to create significant demand for passenger air travel. The increase in supply of aviation infrastructure to meet this demand will create new revenue streams in the sector. Key amongst these will be:
- Airport development opportunities
- Scheduled and charter air transport services and airlines
- Ground Handling Service providers
- Air Freight providers and handlers
- Terminal management operators – food & beverage, duty free, retail and advertising
- Management, Repair and Operations organisations
- Aviation Training and manpower development companies
- Construction and equipment suppliers to the industry
The economic potential of each opportunity is of course different.
There are a number of constructs for industry players, which are relevant for investors, to consider:
- Leveraging skills from operating at airports or servicing airlines to create a broad platform of aviation-related services that benefit from long-term traffic growth trends
- Financing airport growth: Airport build-out financing under Public-Private Partnership models that link the tier-two and smaller cities within India
- Conceptualising and executing the establishment of a regional hub in India which becomes the preferred transit and routing point for travel to and from Asia
Long-term capital is likely to be attracted to business models that have two key features: (i) models that have a reasonable reliability of generating profits insofar as severe competitive intensity does not destroy industry profitability; (ii) models where government policy is clearly articulated and successful implementation does not require navigating a labyrinth of bureaucratic complexity
The first wave of the Indian aviation story is nearing completion – transforming the sector from a niche elitist service operated by a government monopoly to a widely used, vibrant and competitive sector which has allowed millions of Indians to benefit from air travel. The next wave of the opportunity – where the industry scales by providing access and affordability to a billion Indians – is just beginning.
For further information contact Akshaya Prasad at firstname.lastname@example.org.
Akshaya co-heads the Indian office of the firm. Previously, Akshaya spent nine years at Goldman Sachs in London and Mumbai. Most recently, he set up Goldman’s infrastructure investment business in India and was part of the senior team managing Goldman Sachs’ US$6.5bn Infrastructure Fund. Previously, Akshaya was an Executive Director in Goldman Sachs’ Investment Banking team based in London. In that role, he executed a number of large and complex international transactions across various industry sectors. Akshaya started his career as a strategy consultant in London.