A CRISIL Research study shows profitability of domestic airlines is well below that of global peers because of poor PLF

and revenue per RPKM, and

high fuel cost -- and despite lower employee cost. On average, operating margins of domestic airlines have been negative in the last 5 years compared
with double digits for global airlines.

The study covered the financial performance of 16 airlines (10 global and 6 domestic) including low-cost and full-service global carriers such as
Singapore Airlines, Air Asia, Air China, Emirates, Southwest, Air Canada, Jet Blue, Ryan Air, Lufthansa and EasyJet, and Indian ones such as Jet
Airways, Air India, Indigo, Spice Jet, Go Air and Jet Lite (which together had about 99 per cent domestic market share -- based on RPKM ? in
2014-15).

For domestic airlines, employee costs considerably lower

This document is being provided for the exclusive use of SAI KIRAN GOGANA at Institute of Management Technology

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 Employee cost per available seat kilometre (ASKM) of domestic airlines is about half the global average for two reasons: one, global airlines have more
business-class passengers per aircraft which means a larger and better-paid crew for customised needs. Two, the salary of a pilot in a global airline is
almost twice that of a domestic-airline pilot. But this advantage has not translated into better operating margins of local airlines, which actually wallows
well below the global average.

Operating differentials

Note: PLF = RPKM/ASKM; ASKM = available seats x kilometres travelled; RPKM = passengers on board x kilometres travelled

Source: Annual report and presentations of various companies, CRISIL Research

Operating differentials

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 5 years average operating margins of global and Indian airline companies

Source: Annual report and presentations of various companies, CRISIL Research

Lower PLFs the biggest drag on profit

Among the factors pegging back industry profitability, lower PLFs ranks uppermost. India?s airlines have, over the last 5 years, operated at an average
PLF of 74.5%, which is about 600 basis points (bps) lower than the number for the global airlines assessed. The trend is similar be it low-cost or full-
service carriers. For instance, domestic low-cost carriers (LCC) operated at an average PLF of 78%, nearly 400 bps lower than their global peers. At
the same time, domestic full service carriers (FSC) reported an average PLF of 73%, 600 bps lower than global players. Such differences in PLF have
a considerable effect on operating margins; typically a 100 bps rise in PLFs translates into a 150 bps improvement in operating margins.

PLFs of global airlines have always outpaced that of Indian airlines

Source: Annual report and presentations of various companies, CRISIL Research

The reason for low PLFs is not hard to seek: Huge investments (made based on estimates of sector potential), high crude oil prices, falling rupee and
economic slowdown dealt a double whammy where fares couldn?t be lowered eventually impacting demand.

India?s aviation industry is also in early stages of development compared with peers in the US and Europe. This is reflected in low air-travel penetration
(measured as air trips per capita, per annum).

This document is being provided for the exclusive use of SAI KIRAN GOGANA at Institute of Management Technology

No part of this Report may be published/reproduced/distributed in any form without CRISIL's prior written approval
 PLFs have a direct relationship with air travel penetration

Source: IATA, Ministry of Civil Aviation, CRISIL Research

Huge investments are also inevitable considering the enormous potential in India ? reasons why AirAsia India, Vistara and Air Costa have made an
entry, intensifying competition. By contrast, the industry in the developed world is mature.

Another handicap for domestic airlines is a social obligation to fly on unviable routes. Guidelines by the Directorate General of Civil Aviation (DCGA)
mandate all scheduled Indian carriers to deploy at least 10 per cent of their Category I (largely includes metros) capacity on Category II routes (meant
to connect the north-east, Jammu & Kashmir, Andaman & Nicobar Islands, and Lakshadweep to key destinations).

Lower revenue per RPKM

On average, domestic airlines have had 25 per cent lower revenue per RPKM compared with global carriers over the last 5 years. That difference is
telling in the case of full-service carriers, where the number was 30-35 per cent lower. Airlines in matured markets benefit because the proportion of
high-priced business-class seats to total seats is significantly higher for global airlines.

Steep local taxes queer the pitch

India?s airline companies are also at a great disadvantage because fuel is dearer due to high taxes levied by states (4-30 per cent) on aviation turbine
fuel (ATF). Consequently, ATF prices in India are at least 30-35 per cent higher than in most countries.

Comparing retail ATF prices

Source: Industry publications, US Energy Information Administration

Domestic airlines were permitted to directly import ATF from February 2012, but most are yet to do so because of lack of infrastructure (landing,
warehousing and transportation facilities for fuel). Accordingly, fuel cost per ASKM for domestic players is around 8 per cent ? or 2.9 cents ? more than
This document is being provided for the exclusive use of SAI KIRAN GOGANA at Institute of Management Technology

No part of this Report may be published/reproduced/distributed in any form without CRISIL's prior written approval
 the global airlines assessed. Typically, a 100 bps reduction in ATF price leads to about 40-60 bps improvement in operating margin.

Local carriers are also hit by poor infrastructure. For example, frequent landing delays due to congestion at airports increases ATF consumption, while
aircraft handling and scheduling are very inefficient compared with developed countries. Additionally, major domestic airports are operating at high
utilisation rates. CRISIL Research estimates that airport infrastructure in India will need Rs 400-500 billion investments in the next 5 years just to be in
lockstep with traffic. Meeting longer-term demand will need even more investments.

For low-cost carriers in India, fuel cost per ASKM is 3 cents or 30 per cent more than for global peers. But for full-service carriers, fuel-cost per ASKM is
the same -- 3 cents ? in India and abroad because the proportion of business-class seats to total seats is significantly higher (almost 3x) for global
airlines. Since business-class configuration is luxurious offering more seat space, it leads to fewer seats in an aircraft and consequently lower ASKMs.

Other factors
Employee and fuel costs constitute about 60 per cent of airline operating costs. Excluding these, other costs per ASKM are lower for Indian airlines
despite high lease rentals paid by domestic carriers. Almost 85 per cent of the fleet with domestic carriers is leased compared with 40 per cent for the
global airlines assessed. This leads to higher lease rentals ? of about 10-15 per cent of net sales ? or two to three times that for global carriers.
Consequently, lease rentals per ASKM for domestic carriers are almost twice that for global carriers.

The key factor contributing to lower other costs has been landing, parking, navigation and overflying charges, which constitute about 10-15 per cent of
net sales. For Indian airlines, landing, parking, navigation and overflying charges per ASKM is about half of what airlines pay abroad. A study by
International Civil Aviation Organisation showed landing fees ? say for an A320 -- is lower in India compared with the UK, China, Australia and Canada.

PLFs set to improve, onus on government to ease ATF sales tax burden
It is clear that lower PLFs, lower revenue per RPKM and higher fuel costs have been why there is the yawning margin gap between domestic and
global carriers. Among these, PLF is vital as it has a direct bearing on operating margins. We believe there is vast scope to improve PLFs.

Despite the entry of new players, PLFs are estimated to have increased by 500-600 bps in 2014-15 compared with 2013-14 because of healthy
passenger traffic growth and well-thought-through capacity additions. Because of this, we expect PLFs to improve 100 bps in 2015-16 riding on an
estimated 15-17 per cent growth in passenger traffic. This will mean traffic growth would outpace capacity growth. As for new entrants, we believe they
will be cautious about ramping up capacities.

We believe lower revenue per RPKM for domestic carriers (because of low-proportion of business-class seats) is a structural issue linked to economic
development. In developing markets such as India, demand for economy-class seats will be far greater than for business-class seats. However, as
consumer spending picks up with the economy, the proportion of business-class seats will progressively increase.

Fuel, which constitutes 40-45 per cent of operating cost, is another important determinant of operating margin. High sales tax on fuel in India is another
structural challenge that diminishes the attractiveness of the sector. The draft civil aviation policy released in November 2014 has emphasised
rationalisation of tax on ATF. How the government moves on this front will remain a key monitorable for the sector.

This document is being provided for the exclusive use of SAI KIRAN GOGANA at Institute of Management Technology

No part of this Report may be published/reproduced/distributed in any form without CRISIL's prior written approval