India's underpenetrated aviation sector is set to take off. The country has a bigger population than China but less than one-third of its air traffic capacity. S&P Global Ratings believes India's airlines and airports will spend heavily on expanding capacity over the next five years.

In our view, most of this spending will be debt-financed. Key airlines are already seeing negative aggregate discretionary cash flows from ongoing capacity investments. Airports also, generally, use a higher debt funding mix to build or expand.

On the bright side, revenues are improving. And the timing is right to support higher borrowing. Rising passenger air traffic, relatively cheaper domestic financing rates, and conducive government policies on foreign ownership should boost funding prospects for the sector.

Strong Demand Growth As India Gets Richer

Much of India's travel growth potential will come from its rising middle class. Domestic passenger traffic may surge to 300 million annual passengers by 2030, from 152 million in 2023, while international travelers could jump to 160 million annually, from 65 million, over the same period.

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Aircraft orders are the biggest driver of spending

We estimate the aircraft pipeline will cost over Indian rupee (INR) 12 trillion (US$150 billion) through 2030, based on outstanding orders from Boeing and Airbus as of September 2024. This represents over 1,700 aircraft (excluding orders from Go First and Jet Airways Ltd. since both airlines have ceased operations amid insolvency proceedings), and will triple the fleet size of the country's largest five airlines. Air India Ltd. and InterGlobe Aviation Ltd. (Indigo) together account for more than 80% of the orders.

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As of fiscal 2024 (ended March 2024), we estimate total capital spending of Air India, Indigo and SpiceJet rose to INR256 billion. This is nearly a five-fold increase on the average annual spending since fiscal 2019.

The enlarged capacity could expand the aggregate EBITDA of the three Indian carriers to INR830 billion (US$10 billion) through 2030, up 5.0x from fiscal 2024, by our estimates.

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Nonetheless, a significant step-up in capital spending since fiscal 2024 has resulted in negative discretionary cash flows for the sector. As a result, Indian carriers will rely on additional debt to fund its capital spending.

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Burdens vary. Indigo's balance sheet and cash flows have strengthened in the post-lockdown years, with EBITDA margins close to 25% in fiscal 2024, compared with about 16% in fiscal 2020. This gives Indigo more scope to fund a higher proportion of capex needs with internally generated resources, relative to peers.

Air India and SpiceJet are still hampered by high costs and operational issues. Air India could also face restructuring costs with respect to its merger with Vistara. As such, we expect these airlines to be more reliant on external funding for any growth plans.

Airports spending could double over five years

India is adding new airports, another channel that will expand capacity for airlines. The government targets to have about 220 airports by 2030 then 300 by 2047, up from about 145 airports as of July 2024. This is alongside a push to expand existing airports.

Airport investment could double to about INR2 trillion (US$24 billion) over the next five years. Spending will include about 10 greenfield airports with in-principle approval, post commercialization of 11 greenfield airports. This follows a capital outlay of about INR910 billion (US$11 billion) in the airport sector over 2020-2025, as indicated by India's National Infrastructure Pipeline.

Close to INR720 billion (US$8.7 billion) has been spent as of fiscal 2024 and 67% of this was borne by airports operating under the public private partnership (PPP) model (see Appendix 1).

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Diverse Funding Options Will Help Smooth The Undertaking

In our view, both carriers and airports will rely heavily on debt to finance the aviation's sector US$170 billion expansion over the next five years to 2030. Relatively attractive onshore rates and multiple financing options should support this.

Banks are key providers of funding to the broader aviation sector

Domestic banks have significantly ramped up lending to the sector. According to data from the Reserve Bank of India (RBI), the total bank credit to the aviation industry surged 81% in fiscal 2024 from two years prior, when the sector was still recovering from the pandemic. We expect this trend to continue.

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For carriers, leasing should continue growing as a proportion of obligations

The total gross debt from major Indian airlines has been rising over the past five years. Close to 67% of the debt comprised lease liabilities as of fiscal 2024, an increase from 56% in fiscal 2020.

We expect Indian airlines' reliance on aircraft lessors to mount. Sales-and-leaseback transactions have typically been popular among the Indian carriers given the ability to free up their balance sheet and reallocate capital. Ongoing supply chain issues and aircraft delivery delays could also prompt airlines to lease more aircraft to pursue growth targets.

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The development of Gujarat International Finance Tec-City (GIFT City) has also encouraged, via tax benefits, more foreign aircraft lessors to set up a presence in the country. We expect this strategy to boost the volume of leasing transactions.

Still, given a history of challenges faced with Indian carriers on insolvency recovery proceedings, lessors could be inclined to impose a higher-risk premium on lease rentals to alleviate downside risks or potential costs.

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For airports, debt will likely be the mainstay of capex financing

Debt will continue to dominate the airport financing landscape. This is due to massive funding needs and the recoverability of the cost of debt under the tariff framework. Airports typically fund their capex in a debt-to-equity mix of 70:30 or 65:35.

Given the country's lofty expansion plans and the airport authority's (AAI) active involvement in developing new airports, onshore banks will remain key to debt financing. Domestic banks have lent to greenfield projects such as Navi Mumbai International Airport and Noida International Airport. AAI has largely relied on domestic banks such as State Bank of India to part-fund the expansion plans of state-owned airports.

Privatization will also be key (see Appendix 1) to expanding funding options. Public-private partnership (PPP) airports such as Delhi International Airport Ltd. and GMR Hyderabad International Airport Ltd. demonstrate this. They have relied on U.S.-dollar denominated bond issuances to fund past expansion plans, raising a total of US$2.4 billion over 2016-2020 when interest rates were lower. They recently tapped the domestic debenture market to take out some of their U.S. dollar bonds, given the cost of onshore debt has not increased as much as for offshore debt.

Private markets could provide an alternate source of funding amid tougher market and financing conditions. For example, Mumbai International Airport Ltd. issued a US$750 million private placement debt from Apollo-managed credit funds in 2022. Proceeds were used for refinancing of existing debt and for new capital spending.

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The Sector's Growth Potential Could Fuel Investments

We think the Indian aviation sector's growth potential will widen its net of fundraising options. The sector has been able to raise capital despite myriad of challenges--high costs, pilot shortages, engine and supply-chain issues.

SpiceJet, as one example, in September 2024 raised INR30 billion (US$360 million) through a share sale to foreign institutional investors. Shortly before that, the cash-strapped airline's aircraft lessor, Carlyle Aviation Partners had agreed to restructure up to US$50 million of the airline's dues into equity. The funds raised will alleviate SpiceJet's current financial woes and enable it to resume its fleet growth plans.

Beside demand, other positive factors include flexibility in foreign-ownership rules (see Appendix 2) and airline consolidation over the years. The likely sustained duopoly by Indigo and Air India could also fuel more investments. The less fragmented market could allow dominant players to raise prices without risking a material fall in demand. This is a positive for potential returns.

But Baggage Is Heavy

Still, credit burdens--and risks--linger in a market that saw three airlines go bankrupt over the past decade. While some airlines have sufficient liquidity or financial support from a strong parent, several smaller carriers are still struggling financially even with some improvements relative to the lockdown years. Airports on the other hand, continue to face untimely tariff resets that could create higher cash flow volatility.

As expansions ramp up for the sector over the next five years, debt growth will likely outpace earnings. This could weigh on the leverage trajectory of players and heighten dependence on financing conditions.

India aviation market holds immense growth potential. The demand trajectory on its own is a positive horizon. Yet, regulatory, financial and execution risks are key watchpoints.

APPENDIX 1: Privatization's Role In The Airport Sector

The vast majority of commercial airports are operated by the state-owned AAI, with only a few operating under the PPP model. Still, PPP airports account for close to 63% of the country's total traffic volumes given past privatization was largely concentrated to metro/gateway airports.

The privatization route has been effective in funding capital spending in the sector. It allows for transfer of funding and execution risks to private airport operators who have the expertise and financial capability to develop capital-intensive airport assets.

One example is GVK Airport Developers' divestment of its majority stake in Mumbai International Airport Ltd. (MIAL) to the Adani group over 2020-2021. High debt burden and dwindling cash flows caused by the pandemic resulted in financial stress for GVK and stalled construction of the Navi Mumbai greenfield airport. With the Adani group's takeover, MIAL's capital structure improved and construction for the greenfield project resumed.

In India's context, temporary ownership of the asset through a concession agreement is typically adopted. The PPP model generates leasing income for AAI and relieves some financing burden. According to the National Monetization Pipeline, about 25 airports currently managed by AAI are slated for privatization over 2022-2025. In our view, the pace of privatization could increase (for both brownfield and greenfield assets) to allow more private sector investment to plug the funding gap.

AAI last awarded concessions for six airports to the Adani group based on competitive bidding in 2019. These were done through the latest PPP model where the government replaced the traditional revenue-sharing arrangement with per passenger fee as concession fee paid to AAI, with inflation adjusted. The concession period is longer dated at 50 years compared with 30 years previously.

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Key private players are largely concentrated to GMR Airports Ltd. and Adani Airport Holdings Ltd. In our view, these players that have emerged from the pandemic are financially well positioned to tackle the growth pipeline.

Appendix 2: More Flexible Foreign-Investment Regulations

Foreign airline ownership in India-registered airlines is capped at 49%, but the ceiling can go up to 100% for non-airline investors. This provides an alternate funding source for Indian carriers. For instance, Singapore Airlines will hold 25% in the combined Air India group once the merger completes by the end of 2024, with the potential for higher stake if additional funds are required by the airline.

If Indigo and SpiceJet both need to raise capital, they can also continue to dilute their promoter-stakes (49% and 29%, respectively as of Sept. 2024).

For the airports, 100% foreign direct investment (FDI) is allowed under the automatic route for greenfield projects, without the need for prior government approval. While 100% FDI is allowed for brownfield projects, only up to 74% is allowed under the automatic route. This reflects the government's efforts to attract foreign investors into the sector.

Foreign investor presence in the airport space remains somewhat limited to date, with a recent minority stake sale (11%) by Malaysia Airports Holdings Bhd. in GMR Hyderabad International Airport Ltd. and a pending minority stake sale (10%) in Delhi International Airport by Fraport AG.

That said, foreign investor participation can include investments at the operating asset level (e.g., Zurich Airport International's 100% ownership in Noida International Airport) or at the airport operator level (e.g. France-based airport operator Groupe ADP's 32.3% stake in GMR Airports Ltd).

Editor: Cathy Holcombe

Digital design: Evy Cheung

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