IndiGo and the habit of consistently making money

Travelling on IndiGo is a smoother experience than observing its handling of its IPO in the past fortnight has been, notes Rahul Jacob

A few years ago at the air show in Hyderabad, Rahul Bhatia, one of the two principal shareholders of  Interglobe Aviation, was spotted alighting at one of the hospitality lounges from the kind of large golf buggies used by the public.

An observer recalls complimenting Mr Bhatia for his down-to earth manner in an industry often defined by the flamboyance of a Vijay Mallya or a Richard Branson.

Mr Bhatia reportedly replied, “I’m not running a lifestyle business. I am running an airline.”

In an interview with Business Standard last week, Mr Bhatia was equally direct about the Indian government’s convoluted rules that forbid Indian airlines from managing their own ground handling services.

“The regulations say that (for) anything that touches the plane, only employees can do the handling but, as soon as that person leaves the plane and starts walking towards the terminal, he becomes a security risk,” Mr Bhatia said, adding that he had heard that the government might review this. 

“The reason you become a security threat is because. . . that’s where all the money is.”

The two comments encapsulate the promise and the challenge for IndiGo.

It has kept an accountant’s eye on costs to become the most profitable airline in India despite being hemmed in by the strange rules that have long bedevilled this sector.

As IndiGo’s market share hit 37 per cent this year -- including a staggering more than 50 per cent share in smaller cities that make up non-metro to non-metro traffic -- the big question is how much further the government will allow IndiGo to grow before it runs into regulatory rules to constrain it, Ambit observed in a report ahead of Interglobe Aviation’s initial public offering, which closes Thursday.

IndiGo is arguably more a financial services company than airline.

From when it started nine years ago, IndiGo has made a practice of making huge orders for aircraft from Airbus, thus deriving hefty discounts in incentives.

The company’s first order was for 100 airplanes.

The company receives these incentives in cash as per the industry practice and that money goes towards funding working capital.

Interglobe does not actually own aircraft, smartly choosing operating leases and finance leases instead.

“This is the key reason why the company has been able to manage operations without any working capital borrowings,” Ambit said, estimating that Airbus’s aircraft cost the company some 56 per cent less in fiscal 2014 than the list price of A320s in calendar 2013.

This is nice financial engineering work if you can get it, but if there was a slump in the global demand for aircraft, IndiGo would not look as clever as it does today.

As its prospectus notes, 'If we are unable to assign our right to purchase under our purchase agreements with Airbus to a third-party lessor . . .we may have to incur a significant amount of debt'.

Even though it is much smaller than the renowned Southwest Airlines in the US, whose management style has been closely followed by IndiGo, IndiGo’s order book stands at 430 to 267 for Southwest. IndiGo currently operates under 100 aircraft, versus 676 planes for Southwest.

What IndiGo demonstrates is a habit of consistently making money.

Its obsession with keeping costs down by owning only one type of aircraft or having flight attendants collect passengers’ newspapers before a plane lands, reduces the turnaround time on the ground and maintenance costs.

Southwest’s founder Herb Kelleher used both strategies to perfection and kept passengers and staff smiling by even getting staff to start sing-alongs.

IndiGo, too, has a reputation for being a happy place to work. Flight attendants don’t sing, but are well trained and appear unfazed by the company’s dress code that does not allow stewardesses to wear their hair long, even while wearing “Girl Power” buttons.

(CEO Aditya Ghosh said last week the rules are being relaxed.)

Despite finding such regimentation and rote recitals heralding the most clichéd delicacies in the city you are landing in off-putting, I am a repeat customer — if the fare is right.

This is because of IndiGo’s superb on-time record and young fleet -- the average plane is just 3.2 years old.

This is a low-cost carrier that does not, food aside, feel like a low-cost carrier -- unlike, say, RyanAir in Europe, which feels as if you were on a crowded school bus. This record of good service at a discount likely means IndiGo will make it very difficult for swank Vistara to make money.

IndiGo, meanwhile, has seen earnings before interest, taxes, depreciation, amortisation and rentals increase at an annual compounded rate of 35 per cent since fiscal 2011.

Travelling on IndiGo is a smoother experience than observing its handling of its initial public offer in the past fortnight has been.

The promoters’ decision to take a huge helping of dividends before the company went public, leaving it briefly with a negative net worth, looked bad.

Also questionable is an indemnity the company is providing Rakesh Gangwal, a non-resident Indian who ran US Airways and is the other leading shareholder of the company. It only comes into effect if India’s infamously whimsical revenue officials slap a retrospective tax on gains by the investment company, Caelum, and the Chinkerpoo family trust -- both controlled by him -- but still seems strange.

As Mr Gangwal and Mr Bhatia will still own more than three-quarters of the company after the IPO, foreign institutional investors seem untroubled.

With a day to go, the institutional tranche of the offering has been oversubscribed 4.5 times.

Like so many passengers, institutional investors have uncomplainingly piled in for a ride in the world’s fastest growing aviation market with one of the world’s three most efficient low-cost airlines.