Air India’s debt can remain a drag even after partial offloading

The government knows that if it has to get more suitors for Air India Ltd, it will have to offload a good portion of its gigantic debt. A report in The Economic Times on Monday said that of the airline’s total debt of Rs52,000 crore, about Rs33,000 crore will be transferred to a special purpose vehicle (SPV). The remaining debt, which is against aircraft purchases, will remain on its books, said the report.

If this does happen, the government is doing the right thing by moving out a substantial part of Air India’s debt, since it is a huge overhang on the airline’s privatisation plans. Even then, Rs19,000 crore of debt that remains is not small either.

Jet Airways (India) Ltd, an airline with similar revenues as Air India but comparatively better profitability, has an enterprise value, or EV (market capitalization plus net debt) of only Rs13,400 crore. Even if investors assign a small equity value to Air India, its EV would be about 50% more than that of Jet Airways.

Does Air India deserve such a significant premium over Jet Airways? A new owner may be able to pluck some low-hanging fruit that can help improve Air India’s financials. One area is making better use of the airline’s slots.

According to an analyst, Air India is better off on the slots front and could prove to be more profitable compared to Jet Airways, if managed well. If Air India reduces fares on the long-haul international routes, there could be more underlying demand, which in turn may boost load factors, says the analyst.

“The new operator will have to streamline other operating costs and improve on-time performance, dispatch reliability and service quality,” says Santosh Hiredesai, an analyst at SBICAP Securities Ltd. This should help improve brand perception and thereby loads/occupancy, he added.

But how these pan out remains to be seen and it can prove an uphill task. Sure, lower debt will offer relief on interest costs, which were as high as about Rs4,700 crore for fiscal year 2016 (FY16).

Even then, the remaining Rs19,000 crore of debt needs to be serviced. Moreover, the transfer of debt to the SPV may be accompanied by transfer of non-core assets as well.

Air India’s consolidated financials show that lower fuel costs aided operating profitability in FY16. For instance, it earned an Ebitda of Rs2,246 crore compared to an Ebitda loss worth Rs325 crore in FY15. However, higher interest costs ate into profits, with the company reporting a pre-tax and exceptional item loss of Rs4,321 crore on revenue of Rs23,302 crore. Ebitda is short for earnings before interest, tax, depreciation and amortization.

For comparison, Jet Airways’ consolidated revenues, Ebitda, and pre-tax and exceptional profit for FY16 were Rs22,207 crore, Rs2,236 crore and Rs1,054 crore, respectively.

Debt of Rs19,000 crore would mean annual interest costs worth Rs1,700 crore at a similar effective interest rate, which Air India’s FY16 Ebitda could cover. But note that Jet Airways’ Ebitda declined to Rs1,153 crore in FY17 primarily owing to higher fuel costs. Air India’s FY17 earnings are also likely to show similar trends.

With Air India’s financial performance on weak ground, it is likely to prove a challenge to get the right set of suitors unless the government effectively tackles its bloated debt.