IndiGo's $33B Airbus deal: A few questions to ponder on

IndiGo's order of 300 A320neo family aircraft is astonishing in many parts.

Just this one order is worth $33 billion, or the equivalent of Rs 2.3 lakh crore, much higher than the Rs 92,000 crore that the Supreme Court had asked telecom companies to pay, raising questions on the survival of some of them.

The order size is equally numbing. At 300 planes, it's nearly half of the combined fleet size of all the Indian airlines. And guess what, of the 641 total aircraft flying in the country, IndiGo already has one-third.

This will take IndiGo’s total number of A320neo family aircraft orders to 730. That is again a number unseen in the Indian aviation industry. Globally, IndiGo is now counted among the larger airlines in terms of fleet. The largest is American Airlines, with nearly 1,000 planes.

A deal that was needed
SBI Cap Securities' Santosh Hiredesai and Chalasani Teja point out that it was "imperative that IndiGo place an order of this magnitude sooner than later to support growth beyond FY25."

In a note to investors after the IndiGo-Airbus deal, the two analysts said the airline needed to add up to 400 aircraft on its existing base to deliver around 20 percent CAGR in volume terms.

At present, 46 percent of IndiGo's fleet is older than six years, and 44 aircraft are older than 10 years. This is much higher than its average fleet age of 3.7 years during its 2015 IPO.

"Thus, IndiGo will need capacity to support growth as well as significant capacity (around 150 aircraft) over the next three years should the company consider replenishing its fleet (let go of any capacity over six years of age) to rein in its cost structure as under its earlier model," said Hiredesai and Teja.

A few questionsBeyond the big numbers, a few questions, including the delivery schedule and engine make, remain.

After the recent problems with Pratt & Whitney engines, IndiGo had signed a deal in June for LEAP-1A engines with the US-based CFM International. While there could be a repeat, the final decision on engines may happen much closer to the delivery of the planes.

The biggest question is on the purchase model that IndiGo would have for the multi-billion dollar deal, especially after the change in accounting standards.

When it made that first, famous deal with Airbus for 100 aircraft just before the airline began operations in 2005, IndiGo had used the sale and leaseback model. Under this, once an airline gets delivery from the manufacturer -- say Airbus -- it sells the plane to a leasing company and then leases back the aircraft from the lessor.

This model helped IndiGo save money, including on maintenance costs, and also kept it asset-light.

But from January, a change in accounting standard meant that the lease rental cost was now counted as debt. This would mean that the company would also have to account for depreciation and interest costs, denting margin.

"This is a big shift from previously when rentals were accounted for as an expense," says Nitin Sarin, Managing Partner of Sarin & Co, which specialises in aviation law.

While the change doesn't mean that the airline will now have to forego more cash, the new accounting standard does make its financial numbers less attractive.

At present, IndiGo operates most of its fleet on the sale and leaseback (SLB) model. It's only a part of its ATR aircraft fleet that IndiGo directly owns.

Going forward, industry pundits feel the airline may opt for a mix of models. It may outright purchase a few, put some on SLB, or third, have a finance lease. In a finance lease, the airline takes ownership of the aircraft, unlike in the SLB model, where the lessor retains the planes.

The purchase model becomes a crucial part of the deal, given the recent subdued numbers that the airline reported. IndiGo's losses in the second quarter widened to Rs 1,062 crore, and CEO Ronojoy Dutta indicated that rest of the year would be as challenging. Thus, he would want to lower the impact of the new Airbus order, on IndiGo's income statement.