A long way to break even
Deccan Aviation (DAL) operates Air Deccan, a no-frills, low cost, scheduled commercial passenger airline in India, and Deccan Aviation, a private helicopter and airplane chartering service in India. Air Deccan follows a two aircraft-type fleet strategy with the business model based on a point-to-point route system, single class seats, low fares, and simple operations and cost reduction. It mainly targets customers using other means of transport and selects routes not catered to or underserviced by other airlines.
On 31 March 2006, Air Deccan had a fleet size of 29 aircraft: 11 Airbus A320 (180 seats) and 18 ATR Turbo props (48 and 72 seats), 26 on operating lease and three on hire purchase. It has a schedule of 226 flights daily, flying on 85 routes to 52 destinations and held a market share of 14.2%. Deccan Aviation, the charter service division, had a fleet size of 10 helicopters and two fixed-wing aircraft: nine owned and three on operating lease.
DAL has placed orders for 96 aircraft, scheduled for delivery by December 2012. It has entered into operating lease agreements for 11 aircrafts and hire-purchase arrangements for four aircraft. As per the schedule, 19 aircraft are to be received in FY 2007, 13 in FY 2008, 15 in FY 2009, 18 in FY 2010, 21 in FY 2011, 10 in FY 2012 and nine in FY 2013. The company has loan agreements with SREI Infrastructure Finance for financing the purchase of two helicopters.
On 22 April 2006, DAL entered into an agreement with Bennett, Coleman and Company to advertise in the group's print properties for four years for Rs 22.5 crore with an option to spend up to 11% of the annual advertising commitment in its non-print media.
The funds from the issue are proposed to finance the setting up of a training center at Bangalore, a hangar facility for basic and medium-level maintenance checks at Chennai, infrastructure at airports, market development initiatives, and debt repayment.
Strengths
- The domestic air travel grew at a compounded annual growth rate (CAGR) of 15.67% from FY 2002 to FY 2005 and 23.7% up to January 2006. Air Deccan, currently holding a 16% market share, will benefit from the addition of 96 aircrafts by 2012, with 19 additions in FY 2007. With the use of ATRs, it can explore more airports, seizing the first mover advantage. With a single class, the company is able to offer more seats.
- Currently, the maintenance of ATRs is carried at a leased hangar in Hosur, and major checks on Airbus are done at overseas facilities. Once the hangar at Chennai is completed by December 2007, DAL will be able to reduce its maintenance cost.
- The distribution of Air Deccan tickets is through the internet-based CRS system, which is much cheaper than the GDS system used by major players.
- The turbo prop ATR attracts lower sales tax on the turbine fuel against other types of aircraft. It also enjoys lower navigation fees. No landing fees are payable for aircraft with fewer than 80 seats at domestic airports controlled by the National Airport Division of the Airport Authority of India (AAI).
- DAL is selling advertising space on the exterior as well as the interior of aircraft including storage bins, headrests, and tray tables, which yields additional revenue.
Weaknesses
- In the period ended 30 November 2005, DAL had a negative operating margin of 11.8%, resulting in an operating loss before lease rent of Rs 56.38 crore and an adjusted bottom line loss of Rs 117.94 crore. The losses have been increasing over the past couple of years.
- DAL is focusing on penetrating into smaller airports where no other player has entered. But the infrastructure problems at these airports are obstacles to smooth operations.
- The on time service record of Air Deccan is poor. In FY 2006, 92% of its flights actually flown arrived or departed up to one hour of their scheduled time. The industry standard is much better. The cancellation figures are also higher.
- With all airlines increasing their fleet size, the demand for pilots and other technical staff will increase, leading to higher attrition levels as well as higher employee costs.
- Competition is increasing with players like Spicejet, GoAir, Paramount Airways, Indian, and Jet Airways ramping up their fleet size.
- Fuel expenses account for more than 35% of the costs of an aircraft and the incessant rise in oil and air turbine fuel (ATF) prices are not only forcing companies to hike fuel surcharge affecting demand, but have to also absorb part of the rise affecting the margin.
Valuation
The market capitalisation to sales ratio of DAL is about 1.93 times (approximately taking average price band) as against Jet Airways, which is 1.89 times and SpiceJet's 3.28 times.
DAL will take a couple of years to report net profit. However, revenue will grow fast, capitalising on the favourable industry scenario and expansion in the fleet size. But investors at the offer price of Rs 150- Rs 175 in a loss-making airline will be more vulnerable to negative triggers such as terrorist attacks, accidents, fuel price rise, litigations, and economic slowdown.
There is another angle to this company. Core promoters (Capt. G R Gopinath and associates) will hold only around 22.5% of the equity after the issue. Currently aviation industry is highly fragmented, with a couple of heavy-weight ambitious players sniffing around. Foreign carriers are also interested to enter the Indian market, if government permits. If any of these players start taking an interest in Air Deccan, shareholders may not have to wait for profits to see their scrips taking wings.