Airlines regain pricing power on supply squeeze

After five quarters of losses, low-cost carrier SpiceJet and full-service carrier Jet Airways veered back into profits in June.
This, say analysts, signals the worst may be over for airlines in the country and that pricing power will not desert them for at least a few quarters to come.

Anand Kumar, analyst with BofA Merrill Lynch Global Research, on Monday upgraded both SpiceJet and Jet Airways to ‘buy’, mainly on expectation of better pricing power, higher yields and route rationalisation.

Pricing power has improved, led by slower-than-anticipated increase in supply, Kumar noted.

In the past few months, overall supply growth in aviation has been restrained as Kingfisher Airlines significantly cut down capacity. According to analysts, the airline is currently flying only 10 aircraft — down from 64 in early 2011 — and even these are not fully utilised.

True, most of the low-cost carriers have added capacity over the same period. But, it’s not enough to offset Kingfisher’s capacity withdrawal.

Kumar thus expects pricing power to remain with the airlines in the quarters to come. “Domestic yields (are likely) to rise sharply this year. Compared to our earlier estimates of 10% YoY increase, we expect a much stronger 15% expansion in yields for the industry this year. This is despite the economic weakness and solely led by slower supply growth of 5-6% vs our earlier forecast of ~10-12% growth and better pricing discipline among financially weak carriers,” he noted.

Sharan Lillaney, analyst, Angel Broking, agrees. “The capacity reduction has led to increase in pricing power, which would remain with the airlines for the remaining part of the year.”

Jet Airways also believes that ticket prices will sustain at current levels. “There is a stronger possibility the price increase will hold. The price hike already in place may hold or probably also increase,” a top official told analysts on an earnings call on Monday.

A top official of a global aviation research firm, in fact, expects airlines to continue to hike fares. “I expect airlines to continue to keep fares high. The only hitch would be if there is a regulatory interference,” he said, but cautioned that the positive trend could derail in case airlines take fares prices and thus impact demand.
To be sure, the price hike during the June quarter had impacted demand growth in June.
In fact, India was the only country to show degrowth in demand that month.

“India’s domestic travel fell by 0.7% in June even as capacity expanded by 4.5%. This is the second month of weak year-on-year growth, and the trend in growth continues to be flat since the start of 2012,” said an IATA report on passenger growth trends.

Jet Airways’ top management is confident that demand growth will remain in the 10-15% range, no matter what. It estimates industry capacity addition for this fiscal at less than 5%.
However, other experts remain sceptical.

“The Indian economy is going downwards and the airlines are adding capacities. It will be tough for the airlines to stick to similar pricing or increase the prices. Air traffic has degrown in June and airlines will be forced to reduce the ticket costs in order to maintain the market share. SpiceJet has been offering attractive ticket rates and Jet Airways too will have to bring down the costs going ahead,” said an analyst from a domestic brokerage firm who did not wish to be named.

“Sustaining pricing power looks difficult for the coming quarters,” the analyst maintained.