James D. Parker, managing director (equity research), Raymond James & Associates

James D. Parker is one of the world’s foremost analysts for the low cost carriers (LCC) sector. He is the only analyst to have been recognised in The Wall Street Journal’s Best on the Street survey in all the 13 years that it has been compiled, and is one of only five analysts in the same magazine’s Analyst Hall of Fame. His firm Raymond James (he is currently managing director, equity research) has helped several leading airlines around the world list and raise money at US stock exchanges, with truly impressive valuations for some of them. Parker was in Mumbai last week to speak at the Centre for Asia Pacific Aviation (CAPA) summit. He spoke to Businessworld’s Anjuli Bhargava on the risks, threats and challenges for the nascent Indian low cost carrier industry as he sees it. Excerpts:

How does the present stage of the Indian market compare with the US, when the low cost airline revolution started there?
India is in a high growth phase and there is a rush to expand air services within the country. There is also a particular emphasis on low cost carriers starting up as they have been very successful in the rest of the world, and because it is low cost carriers that can stimulate air travel for the middle classes. The potential demand for air travel at fares that the public can afford is immense. There is a very large growth opportunity for airlines that have a cost structure that will enable them to offer such fares.

In the US, the air travel market was dominated by the legacy carriers for most of its history. These started up after World War I and II, and the corporate culture of these airlines was generally elitist: the pilots were war heroes, the flight attendants were required by law to be nurses and the passengers wore suits because only the very affluent could afford to fly. This prevailed until the 1970s — the industry in the US was deregulated in 1978 — but in the state of Texas it was deregulated in 1971, and the first low cost carrier, Southwest Airlines, was set up to serve the masses. It charged $26 as a fare primarily between three large markets — Dallas, Houston and San Antonio. It was the first visiting friends and relatives airline (VFR) in the world. It catered to a market that was either driving or taking buses between these destinations (we don’t have much of a rail system) and people who were simply not taking trips. This was the beginning of the airlines system for the masses in the US. Now, airlines is the mass transportation system of the US. I believe that a similar situation may evolve in India.

India, however, does have a fairly well developed railway system…
Yes, but look at the distances and time taken. Although India does have a fairly well developed rail system, how long does it take you by train from Mumbai to Delhi? 12 hours? 14 hours? To many destinations, it could be over 24 hours. Who wants to do that? So, there is huge market that can be stimulated if the fares can be kept as low as or even lower than trains.

What do Indian LCCs need to do to make the model work here?
The most important thing in the airline business is to have low costs. If you have low costs, you can have the lowest fares. This is a commodity business. In its 34th year, Southwest remains the lowest cost producer in spite of having the highest labour costs in the industry. In fact, American legacy carriers have been unable to bring down their costs to Southwest’s levels even in bankruptcy. Moreover, their attempts to establish low cost carriers have all failed.

In Europe, Ryanair has the lowest unit cost at euro 30.24 per seat for fiscal 2005, which is around 43 per cent lower than easyJet, one of its biggest competitors and the next lowest cost producer.

The second most important thing is to have a large bank account — cash — both for offensive and defensive reasons. Cash is important because if you go into a high-density market, there is going to be an incumbent carrier already there. It may have higher costs but it may also have more money. That carrier — even though it may lose money trying to compete with the new entrant — has more money to lose so it will ultimately win. So, it’s critical you have a very nice bank account.

Then, if an airline is serving a particular market and a new entrant comes to compete, you want to have the cash so that you can keep the new entrant from getting started. This is the nature of the airline business.

Then, airlines can try and improve bottomlines and shore up revenues through ancillary activities. Most airlines see themselves as being only in the business of carrying passengers. If that changes, an airline can make the most of what is virtually a captive audience.

For instance?
Airlines like Ryanair have not only sold seats and done that very well (it’s the lowest cost carrier in Europe), it also markets other services, mostly travel related, to its passengers. So, it derives almost 15 per cent of its sales and 25 per cent of its earnings from selling services and merchandise other than seats. It books hotels, cars, credit cards, train tickets and bus tickets; it sells food, soft drinks and liquor; and it does mortgages, and sells scratch cards and game cards on its airplanes. Soon, they will introduce gambling on the airplane. One of the main reasons they can do that is that if you want a book a Ryanair ticket, you have no choice but to get onto the website. Passengers can only get this low fare on the website; when you do that, Ryanair offers you all the services you may need to travel and make your travel more comfortable. On the website, the airline gets 15 million unique visitors per month and not all of them are booking seats. This is something unique to Ryanair; easyJet is trying it now but Southwest, for example, does not do it.

As an analyst of this sector, what do you see as some of the risks and threats faced by Indian LCCs?
There are three particular risks in India that stand out. One is growing too fast. This puts upward pressure on costs, often causes customer service to be poor and could jeopardise safety. Safety is very important for all airlines, but it’s a particularly sensitive issue for new low fare airlines because the public perception is that if you have low fares, perhaps you are skimping on safety.

Are there examples of airlines that went bust because they grew too fast?
Many. Take, for instance, ValueJet in 1996. An accident destroyed ValueJet in the US, which was a very good airline with low costs, and which grew very fast. The accident wasn’t its fault but the airline was destroyed.

When the industry was deregulated in the US, the airline that ran out and got the maximum new markets was an airline called Braniff. Have you ever heard of it? The reason you haven’t is that it promptly went bankrupt because it grew way too fast.

Look at the example of JetBlue. Again, it has grown too fast. When JetBlue launched (February 2000), it came out with a much better product than everyone else. It had live TV, low fares and a real nice product. It did very well for around four years but then the competition began to intensify. Delta started an airline called Song, which was like JetBlue. It was a dumb idea and didn’t last but Delta threw money at it. Delta lost its money but it had an impact on JetBlue. Secondly, they started growing just too fast. The airline accelerated its growth from 15 aircraft to around 35 a year and, for whatever reasons, JetBlue now has one of the poorest service records in the industry. Its reputation is tarnished. And now it is trying to defer the growth. It is now losing money. From having pre-tax margins of 17-20 per cent, it now has negative margins.

Another risk is growing faster than the airport infrastructure because that leads to poor customer service in terms of on-time performance and completion. It’s clear that the development of infrastructure at India’s airports is not likely to keep pace with the growth of its airlines.

One of the other risks is the huge amount of money that investors are throwing at airlines here. There will ultimately be a shakeout. There will be attractive investment values to be found in the survivors, but not all will survive.

As things stand in India, Indian carriers appear to be in a race to grow as fast as possible, aiming to add at least one aircraft per month. What do you think is sustainable growth in a market like this?
If you only have 5 or 10 aircraft and you add one per month, do you know what that is? It’s ridiculous. If you have unlimited resources and are just looking to spend your money, that’s fine. But ultimately, you have to focus on costs.

Growth that’s sustainable depends on your existing size. If you have one airplane and you add another, that’s 100 per cent growth, but that’s okay. But if you have 50 airplanes and you add 30, that is pretty rapid growth. Or if you have 10 aircraft and in one year you go up to 20, that, in my view, is again way too fast. You see, if you add 10 airplanes, you have to add at least 1,000 people; 30 airplanes and you probably need to add 3,000. That kind of growth is not conducive for low costs and it’s really not conducive to having a high level of customer service.

Which are some of the carriers that have successfully built an LCC, apart from those in the US and Europe?
One of the great examples of the way to build a LCC airline is GOL, Brazil. It started in February 2001 and now has 45 aircraft in its fifth year. It took the Southwest low cost, low fare model and tried it in Brazil, which is much like India (except it’s a smaller market). It grew at a deliberate pace and kept costs low — it is one of the lower cost producers in the world (AirAsia is the lowest). GOL was able to take away almost 30 per cent of the market from the high cost, high fare flag carrier. In June 2004, GOL raised money in the US market, and its stock has appreciated 227 per cent since. Its current market value is $7 billion with just 45 aircraft. Its 2004 EPS was 26 per cent higher when calculated by US GAAP compared to Brazilian GAAP.

Listing the airline and listing in the right market is important too. Valuations of JetBlue, Ryanair, AirTran, Southwest and GOL are generally higher than for similar carriers without a US listing (see ‘The US Advantage’). You need to look at Ryanair to see how well this can work (see ‘How Ryanair Fared’).