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Increase in fuel prices passed on. Jet Airways, Kingfisher and Air India which together
account for 62.4% of total capacity in the domestic segment, have increased ticket
prices by Rs100 for distances less than 750 kms and Rs200 for distances above 750 kms
(effective from Jan’11). This has been done to neutralize the impact of higher fuel
prices. We see these moves as positive for the sector, reflecting some amount of pricing
power on account of the demand-supply balance. We retain our BUY rating on Spicejet
and Jet Airways with target prices of Rs114 (Rs120 previously) and Rs1,220,
respectively.
Higher fuel prices passed on to the market
The effective increase in the average ticket prices on account of increase in fuel surcharge would
be ~Rs150 per ticket. To put in perspective, the average gross fare (domestic) of Jet airways in
2QFY11 was Rs4,495 per ticket. The current increase implies ~3.3% increase in the average ticket
price which would be sufficient to cover ~10.5% increase in fuel costs (Exhibit 1). The average jet
fuel price has increased by 13.6% qoq in 3QFY11 (Exhibit 2). The current increase in ticket prices
would effectively take care of ~80% of the increase in fuel price.
Higher PLF and higher yields would cushion profits in spite of higher fuel prices
We illustrate our point with a scenario analysis on Jet Airways. For Jet Airways, the EBITDA margins
in 4QFY11E versus 2QFY11 would be positively impacted by three factors: (1) Higher fuel
surcharge (+3.5% impact on EBITDA) of Rs150 per ticket, (2) higher PLF (+4%) of 75% versus
71% in 2QFY11, and (3) higher average ticket price (+4%) of Rs4670 versus Rs4,495 in 2QFY11.
There would be a negative impact of -6.2% on account of a 20% increase in the jet fuel prices as
we are assuming this will remain constant at the current levels (US$104/bbl versus US$86.8/bbl in
2QFY11) in 4QFY11E. On the whole, a ~5.3% positive impact on EBITDA (net of increase in fuel
price) margins should allow airlines to improve profitability and still absorb the impact of higher
fuel prices (up 20% from 2QFY11).
LCCs have not followed the lead – we expect them to hold prices as of now
Spicejet, Indigo and Go Air have kept their fares static as of now. We expect status quo to
continue on account of: (1) The qoq improvement in PLF (3QFY11 versus 2QFY11) in case of LCCs
would be much more than FSCs which would allow them to absorb higher fuel expenses and still
post significantly higher EBITDAR margins qoq in 3QFY11E (Exhibit 3). We expect some part of this
gain in PLF to sustain in 4QFY11E (seasonally weak qoq), and (2) The discount between the
average fares of LCCs and FSCs has narrowed down from historical levels (Exhibit 4).With the
current price increase announced by FSCs, we expect the discount (LCC versus FSC) to move
towards the historical mean. We expect LCCs to follow FSCs in case there is another increase in
fuel surcharge in the event of crude oil prices trending even higher in future.
Changed estimates for Spicejet – continue to like the sector
We have made changes in the earnings model for Spicejet to include addition of new aircrafts
(Q-400s from Bombardier).Retain BUY on Spicejet and Jet Airways with target price of Rs114
(previously Rs120) and Rs1220, respectively.
Airlines could show higher profits in 4QFY11E after absorbing higher fuel prices
We illustrate our thesis with a comparison between 2QFY11 and 4QFY11E of Jet’s domestic
business. We have made the following assumptions:
` Average fare in 3QFY11E would be 6% higher qoq.
` Average fare in 4QFY11E would be 2% lower qoq in line with the trends observed in
FY2010.
` PLF in 4QFY11E would drop 2% qoq in line with the past trends.
` Fuel price to remain at US$104/bbl for 4QFY11E which is 20% higher than average level
of US$86.6/bbl in 2QFY11. As the fuel cost is ~32% of sales (as per 2QFY11), a 20% rise
in fuel costs would have a -6.2% impact on the EBITDA margins.
LCCs to absorb the impact without increasing ticket prices
We expect higher improvement in PLF in 3QFY11E for Spicejet as compared to Jet Airways.
Assuming PLF will improve at least 100 bps mom in the month of December (seasonal trend),
we expect Spicejet to report a PLF of 86.8% (versus 73.6% in 2QFY11) in 3QFY11 as
compared to 76% (versus 71% in Q2FY11) of Jet. We note that this gives Spicejet additional
room as compared to Jet (~7% on the top line; without incremental costs) to manage
higher fuel costs and still improve operating performance qoq. We expect that LCCs would
follow FSCs in the second round of price increases if at all they happen in the future. Right
now, the high PLFs give them more than sufficient cushion to maintain the status quo on
pricing.
Changing estimates for Spicejet
We have made changes to our model for Spicejet to account for the addition of new
aircrafts (Q-400s from Bombardier) from July ’11. We are modeling period end fleet of 9 Q-
400s aircraft in FY2012E and 22 by FY2013E. We retain our BUY rating with a target price
of Rs114 (previously Rs120).
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