Here's Another Reason Why Airline is a lousy business?

Tue, 30 May Pre-Open

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The noises about Air India's impending privatization have grown louder. Finance minister Arun Jaitley, in an interview, favored disinvestment of the state run airline, and that it would pave the way for growth in the aviation sector.

Chief Economic Advisor Arvind Subramanian, had also recommended that government should privatise Air India in the Economic Survey released this year.

Recently, union civil aviation minister Ashok Gajapathi Raju, indicated that the government is looking at all options for the ailing national carrier, including disinvestment.

He said that despite the Rs 300 billion bailout package approved for Air India in 2012, the national carrier remained a debt trap and the government cannot commit the taxpayers' money for an eternity to revive the ailing company.

Mired in debt for years, the state-owned airline has been staying afloat on taxpayers money and it seems the government is finally ready to offload the national carrier and has decided that it is not worth spending more funds on its revival.

At the end of FY16, the airline's debt stood at around Rs 460 billion, with about Rs 280 billion in working capital debt, and Rs 40 billion in interest burden alone. The acquired debt is the root of all problems as the airline is unable to modernize or improve its operations because of the high debt.

This has led to the national carrier consistently losing market share to private players.

Air India's market share in domestic market has fallen to 14% in 10 years from 35% a decade ago, placing it third in the national ranking, behind Indigo, which commands about 40% of Indian skies, and Jet Airways, which has about 16% of the share. Air India also flies overseas, and commands 17% of the international traffic from and into India.

A privatized Air India could not possibly be worse, and likely will be much better. And, most importantly, it will cease to be a drain on the exchequer.

With privatization on the anvil, can Air India throw up opportunities for individual investors?

We don't think so.

Firstly, the airline is overburdened with a massive debt which will weigh down on the operations and profitability, regardless of ownership. A large restructuring exercise would need to take place to reduce and normalize the debt.

Secondly, aviation sector isn't exactly known for its wealth generation ability for shareholders. And India's aviation sector is no different.

As Rahul Shah writes in a recent edition of the 5 Minute Wrapup:

While Buffett has taken a fancy to US airline stocks, their Indian counterparts aren't exactly setting the bourses on fire. All the listed airline companies in India have underperformed the benchmark index over the last one year. In fact, only one stock, Interglobe Aviation, has been able to give a positive return.

It can of course be argued that the very fact that these stocks have underperformed could now turn them into potential future winners. After all, things revert to the mean, don't they?

Of course they do. But the principle is applicable to companies that are efficiently run, have strong balance sheets and are only victims of an economic downturn or the downturn in the industry. But when companies have negative networth like Air India, and private players Jet and SpiceJet do and also have balance sheets loaded with debt, it is usually a good idea to stay away from such companies rather than invest in the hope that things will indeed turn around one day.

Thus, while privatization may be positive for Air India, one must not get carried away if the national carrier is listed on the bourses.

The question to be asked is whether the company has what it takes to consistently become profitable and improve the return on capital for its shareholders and curtail its massive debt going forward.

For information on how to pick stocks that have the potential to deliver big returns, download our special report now!

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