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Aviation
India
Concerns overblown. Aviation stocks under our coverage (Jet Airways and Spicejet)
have corrected by 5-12% over the past two weeks on account of: (1) Perceived risk of
government intervention on account of high spot fares, and (2) weakness in the
broader market. We think the concerns are overblown and would advise investors to
take advantage of the recent correction to take/increase exposure to the sector. We
maintain our BUY rating on Spicejet and Jet Airways with target price of Rs120 and
Rs1,220, respectively.
High spot fares reduced
Airlines have reduced spot fares after the Minister of Civil Aviation warned of an action where
high spot fares were not brought down to reasonable levels. According to media reports, Indigo
and Spicejet have reduced the average spot fares by 20-25% after their meeting with the DGCA
(Director General of Civil Aviation). The spot fares on the Mumbai-Delhi sector are in the range of
Rs10,000-Rs12,000 vs Rs17,000-Rs19,000 earlier. Going forward, the airlines are required to
publish the monthly bucket-wise fares at the beginning of each month. As per the fare structure
published by Spicejet, the maximum fare that can be charged for the Mumbai-Delhi sector is
Rs11,599 per ticket (fuel surcharge variable; UDF and service tax not included) vs ~Rs19,000 per
ticket earlier. We would view the current developments as positive from a long-term perspective:
` No risk to our earning estimates. For our earning estimates, we have assumed the domestic
yields (revenue per RPKM) to increase by 6% in FY2011E and 2% thereafter in FY2012E and
FY2013E and revenue per ASKM to increase by 7.5% in FY2011E and 2% thereafter in
FY2012E and FY2013E. Our yield assumptions are conservative even if we assume the current
fare structures with lower spot fares were to continue in the future. We note that the increase
in yields for Spicejet for 1HFY11 is higher than our assumptions for FY2011E (Exhibit 1) and the
key point is that there were no high spot fares in the 1HFY11. We note that revenue per ASKM
has increased by 15% in 1HFY11, even after adjusting for higher cost per ASKM (up 7% yoy).
` Risk of incremental regulation reduces. We believe that it would be in the long-term interest
of the sector if the companies are able to continue with above-average profitability for longer
period of time rather than going for super-normal profitability in the short term and risk
government intervention in terms of new regulations to limit air fares. There have been
instances in the past in the power and cement sectors where the government had taken action
on high prices by way of:
ƒ Limiting the maximum price that could be charged. In the power sector, the maximum price
that could be charged in the spot market was limited to Rs8 per unit for a brief duration of
~2 months to tame the spot prices which had gone above levels of Rs10/unit.
ƒ Incremental taxes: In the cement sector, dual rate of excise was introduced in which the
companies had to pay higher excise (Rs250 per bag extra) in case they charged higher than
specified price (Rs190) per bag.
` Super-normal profitability could initiate faster-than-expected supply response. The
aviation business is particularly vulnerable to a swift supply response as capacity could be
increased in a short period of time by leasing aircraft (6-9 months). Very high profitability could
encourage airlines to bring in capacity much faster than our assumptions.
No signs of cartelization or predatory pricing, contrary to media reports
The knee-jerk reaction of the media has been to put the blame on the ‘cartelization’ in the
industry which is a bit pre-mature in our opinion on account of:
` The high spot fares (Rs17,000-25,000) were charged only for 4-5 tickets per flight. Any
passenger who wanted to book the same ticket only one week in advance would have
been charged a reasonable price of Rs4,500-5,000 per ticket
` The high fare buckets always existed but never really came into play as the PLFs have
never been so strong in the sector till date. These fares are part of the fare bucket which
represents the last 4-5 seats in the flight.
Same level of profitability could be achieved in a different manner
We believe that demand-supply dynamics in the market would be final arbitrator of the
revenue realized by the airlines per flight. Airlines could realize the same revenue (with high
spot fares) per flight by changing their fare structures:
` By reducing the number of tickets in the lower fare buckets
We believe that with the PLFs running at very high levels (>86% in November according to
our estimates), there is some amount of pricing power in the sector for the companies to
start exploring alternate fare structures as suggested above. We note that this has not
started happening as of now.
` By increasing the average price of the ticket by ~Rs300
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