Airbus' (NASDAQOTH:EADSY) mammoth order win from a leading Southeast Asian low-cost carrier (LCC), IndiGo, for 250 A320neos has on the one hand taken the aircraft maker's backlog to dizzy heights, but on the other, it has stoked fears of deferrals and cancellations. Let's dig deep into the reasons for concern and the order itself.
The present situation of the Asian airlines
The Southeast Asian LCC's attempts to expand their fleets are hurting their yields, and in order to tackle their dropping profits, the carriers are being forced to cancel or defer deliveries. For a sense of scale, AirAsia's second quarter yields fell 6% and Tigerair's fell 15%, while both experienced 15% capacity growth.
In February of this year, Malaysian carrier AirAsia, which used to be Airbus' largest customer but has now been pushed to No. 2 by IndiGo, deferred deliveries of 19 A320s. The planes were slated to be handed over through 2015. Even Indonesia's Tigerair cancelled deliveries of nine A320s in March.
According to a Bloomberg Intelligence report, "Southeast Asian airlines have seen persistently falling yields for the past year, with a number of airlines deferring aircraft. This may continue as analysis of the number of aircraft per dollar of GDP indicates the fleet and order books may be too large."
These cancellations and deferrals are making it difficult for the aircraft makers to convert their bookings into billings. For both Boeing and Airbus, continuation of the trend could actually put the backlog at risk with chances of the figures being trimmed, particularly for Asia, which accounts for almost 28% of total combined backlogs. With the addition of the latest 250 jets, Airbus' backlog for the A320 family comes to 4,998 jets.
There are reasons to believe this order might be for good
The 250-jet order, the largest that Airbus has ever received for its sheer number, adds to the 180 A320neos IndiGo had ordered in 2011. These two deals combined are valued at $40 billion, for a total of 430 aircraft, at catalogue prices. IndiGo is India's largest domestic airline by market share.
IndiGo looks safe: IndiGo is an exception to the general trend of falling airlines' profits in India. While Indian carriers such as Jet, SpiceJet, and Air India have been deep in the red and are struggling big time, privately-held IndiGo has consistently made profits since 2009. In fiscal year ending March 2013, the company had posted earnings of $130 million on sales of $1.6 billion. Even in the tough times of the following year, IndiGo is said to have registered $100 million profit. In 2014 through September, IndiGo's market share stands at 31%, carrying 15.243 million passengers. In second place, SpiceJet, is a far cry with 18.7% share. IndiGo has become the leader in less than a decade, having commenced operation in 2006.
What's fueling IndiGo's growth is its absolute commitment to basics. With an impeccable on-time record, it doesn't compromise on quality. President Aditya Ghosh says, "Low cost does not mean low quality." In 2014 through September, its on-time performance at the four metro airports of India is the highest at 89.9%, and passenger complaints are the lowest.
Another major reason behind its success is its sale-and-lease-back model, the first ever airline to follow this in India. Under the arrangement, new planes are sold to leasing companies and are simultaneously leased back. The selling price of the aircraft is generally higher than the price at which it was purchased from aircraft makers. IndiGo then retires the plane in six years, helping it maintain a new fleet -- a practice much appreciated by passengers -- and keep costs low.
Airbus is an integral part of IndiGo: IndiGo is slowly inching toward its goal of having a fleet of 1,000 jets. Airbus is an essential part of this growth as the carrier keeps things simple by sticking to a single class with a single model -- A320. Even before IndiGo started operations, it had signed a deal for 100 A320s in 2005, an order that will be completed by November. Deliveries for the 2011 order for 180 A320 are expected to start by the end of 2015. And delivery of the 250 A320neos will begin from 2018. IndiGo's Airbus-exclusive fleet as of now stands at 83.
Through its fleet expansion, IndiGo is trying to grab an even bigger share of the growing market. "We believe India is a highly underpenetrated market. Some of these (new planes) will go to replacement ... but a lot will be for growth," said Ghosh. According to Airbus' estimates, the rising air traffic in India will create demand for 1,290 new planes ($190 billion) in 20 years. Another estimate says that the 60 million people that traveled by air in India will triple in the coming 10 years.
Though nothing can be seen as completely foolproof, this order might be for good for Airbus. Investors need to keep in mind that with newer players, such as Tata Sons and AirAsia's joint venture AirAsia India, joining the fray, things could become challenging for IndiGo. Inability to control costs has seen some of the leading airlines (read: Jet) plummet. But IndiGo's tight check on costs through strategies like paid meals, no-frills service, and a high load factor of above 80% hold it in good stead. Its excellent track record and sound future planning are also comforting.
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