Airline Stocks Fly High in a Sweet Spot

AIBM

October - December 2017

Backed by strong fundamentals, the Indian aviation stocks are soaring high and are likely to attain greater heights as key players open their war chests in pursuit of a bigger slice of the growing market pie.

The Indian aviation sector is witnessing a new horizon underneath the blazing skies, with a renewed thrust on the crucial sector by the Modi Government for the last three years. As a result, the aviation sector in India is undergoing a transformation. India is the ninth largest aviation market in the world, with a size of around USD 16 billion and is poised to be the third biggest by 2020, and the largest by 2030. The Indian aviation industry promises huge growth potential on account of the large and growing middle-class population, rapid economic growth, higher disposable incomes, rising aspirations of the middle class and overall low penetration levels.

After having remained the fastest growing domestic aviation market in the world for almost 22 straight months, India lost the top slot to its neighbouring giant, China, in July, according to global airlines’ body, the International Air Transport Association (IATA). “China tops the domestic chart for the second time in 28 months, but the upward trend in India has picked up,” IATA said on September 6, adding that passenger demand remains on course, growing steadily this year, as a whole. In July, India clocked a growth of 12.5 pc, while the Chinese market grew 15 pc during the same period.

As the market has grown dramatically, the stocks of Indian carriers have also hit record highs, boosted by the low fuel prices, which account for a large chunk of all costs for the airlines.

On a steady course

These airline stocks include IndiGo, a low-cost airline headquartered in Gurugram, Haryana. It is the largest airline in India in terms of passengers carried and fleet size, with a 38.7 pc market share as of July, 2017. The airline operates to 46 destinations, both domestic and international. Founded as a private company, in 2006, by Rahul Bhatia of Inter Globe Enterprises, and Rakesh Gangwal, a United States-based expatriate Indian, Indigo went public in 2015.

InterGlobe Aviation said it reported the highest quarterly profit ever. Interglobe’s EBITDAR (earnings before finance income and cost, tax, depreciation, amortisation and aircraft and engine rentals) rose 26.3 pc to INR 196.18 billion in Q1 June, 2017 over Q1 June, 2016.

SpiceJet, another Gurugram headquartered low-cost airline is the third largest airline in India by a number of domestic passengers carried, with a market share of 14.2 pc as of July, 2017. It operates 312 daily flights to 55 destinations, including 45 Indian and 10 international destinations from its hubs at Delhi, Kolkata and Hyderabad.

SpiceJet reported a quarterly profit of INR 416 million for the three months ended March 31, 2017, making it the ninth successive profitable quarter for the airline.

The net profit for 2017 stood at INR 4.31 billion, making this the second successive year of profitable growth. According to the airline, the operating revenues were at INR 16.26 billion for the fourth quarter of 2017 and INR 61.91 billion for the fiscal, 2017.

SpiceJet’s strong operational performance comes despite significant headwinds. Demonetisation resulted in a substantial decline in yield in Q3 and Q4. Increase in fuel cost was at 46 per cent in Q4 eroding approx. INR 1.60 billion in profits.

These headwinds have subsided and SpiceJet is bullish about its future prospects. “Two successive profitable years, a record aircraft order and emerging as India’s largest regional operator are testament to the fact that SpiceJet remains firmly on track, with regard to its long-term growth strategy,” observed Ajay Singh, Chairman and Managing Director of SpiceJet, who had recently returned to take charge of the airline that he had founded to save it from going bankrupt. “SpiceJet continues to invest aggressively in creating capacity in line with forecasts. We overcame a complete operational shutdown and placed the biggest order for 205 aircrafts in our history,” he adds.

Mumbai-headquartered Jet Airways is the second largest airline in India, with an 18.2 per cent passenger market share. It operates over 300 flights daily to 68 destinations worldwide.

As Jet Airways is adopting the Indian Accounting Standards (Ind AS) from the financial year 2017–18 the company may submit its financial results for the quarter ended June 30, 2017 to the stock exchanges by mid-September, Jet Airways had said in a regulatory filing earlier this month. Jet Airways group had reported a net profit of INR 4.38 billion for the financial year ended March 31, 2017 on total revenues of INR 226.93 billion.

Sweet run on strong fundamentals

Of the three stocks which have made the most at the capital market is SpiceJet. The stock is up 124 pc in 2017. It has gained more than 800 pc since December 2014 when it was about to wind up, giving SpiceJet a market value of USD 1.2 billion. Its market capitalisation stands at INR 82.78 billion in September this year— double of what it commanded last year Similarly, Indigo whose stocks are traded by the name of InterGlobe Aviation has a market capitalisation of about INR 450 billion, significantly up from last year. Jet Airways’ market capitalisation stood at INR 64.72 billion, compared to INR 52.42 billion last September.

There are more than half a dozen reasons as to why airline stocks are doing well. Some are specific to the conditions of the civil aviation market in India and around the world, while some are linked to the performance of the broader stock markets in India, which have been hitting record highs, despite the lackadiascal performance of the Indian economy and the numerous shocks that it has had to suffer in the last few months.

As many as 14 stocks, in the Bombay Stock Exchange-500 list, soared to more than 100 pc returns in the first half of 2017.

Harsh Vardhan, former MD, Vayudoot traces the success of aviation stocks to this massive bull run. “There are multiple factors. First, the Indian capital market is doing well. Secondly, the aviation industry is also gaining due to lower crude prices. But in India, prices are fairly high,” he told the AIBM. After the implementation of the Goods and Services Tax from July 1, Harsh Vardhan points out that taxation in India has gone up, despite this, “the aviation industry has been able to maintain its margins.”

The main reason behind their steady performance is the low fuel price. For over three years now, crude oil prices have stayed below or around USD 50 a barrel, a sharp fall from the levels of USD 120-150 in the years 2012-13. As airlines spend anywhere between 40 to 60 pc on fuel, this has proven to be an unprecedented bounty. Even though the oil prices have firmed up a little, the outlook on crude remains positive. “Aviation Turbine Fuel (ATF) prices are at lower levels, and increased air ticket prices in domestic markets and rupee appreciation are likely to boost the profitability of aviation companies,” noted Mumbai-based Indian Diversified Financial Services Company (IIFL) in one of its reports recently.

As the rupee has also has stayed pretty much steady, the crude oil prices, denominated in USD, have not suffered on account of forein exchange fluctuations. SpiceJet and IndiGo, together control 54 pc market share of the domestic market. As lowcost carriers, they operate point-to point destinations and are best placed to benefit from the current growth in the total number of travellers.

In 2015–16, the number of domestic passengers grew almost 22 pc, recording traffic of 131 million passengers. The Centre for Aviation (CAPA) in its latest report on India’s outlook expected domestic air traffic to grow 25 pc and cross the 130 million mark in 2018. Nevertheless, the aviation market is still untapped with many airports lying either unserved or underserved and only a fraction of Indian population taking to the aircraft.

Out of a 1.3 billion people, just 70 million Indians fly on domestic routes in a year. Kapil Kaul, regional head-CAPA estimates air travel in India will continue to show double digit growth for the next 10 to 15 years.

The government seems to be doing its bit in promoting flying through subsidy schemes that offer upto 50 pc subsidy to airlines that aim to connect tier II and III cities, route monopoly for three years and a host of other concessions at landing airports. It expects the airlines to cap fares at INR 2,500 a seat an hour, on regional flights. The preference for air travel by Indians is on account of poor services by the railways, lack of incremental capacity and introduction of dynamic pricing that makes train travel costlier.

With the current crude oil prices expected to hover between the USD 50 to 55 a barrel, and with Ude Desh Ka Aam Nagrik (UDAN) schemes that aim to fly new 300 million domestic passengers annually by 2022 and 500 million by 2027, Indian aviation stocks seem to be in a sweet spot.