Aviation - Light at the end of the tunnel; sector update:: Edelweiss,

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The exit of Kingfisher Airlines (KFA) from certain routes has augured well for the industry demand-supply equilibrium, forcing fares to go up 20% this month. We believe the growth in industry supply could remain under pressure given the worsening balance sheet position of key players. While a sharp rise in fares would be unsustainable as it may impact demand growth, a modest rise in yields looks imminent. We believe Jet Airways (JAL) is best placed to benefit from an improvement in industry dynamics. 

Balance sheet strain forces supply cuts

KFA, having 16% of the industry capacity, has already exited certain routes and might cut down further given the state of its balance sheet and operating losses, in our view. As a result, we estimate the industry supply growth to limit to 5%-11% CAGR over FY12-14 under various scenarios. If the demand growth sustains at 10%-15% annually from here on (which will push industry load factor over 80%), it would bode well for yields.

Yields moving up, but sustained high fares may dent demand

JAL and other carriers have increased fares by about 20% in November, egged on by supply cuts by KFA in a busy season. Demand, however, has remained strong so far, growing at nearly 18%-20% YoY over April-October 2011. We note that price elasticity is high and a sustained rise in fares can damage demand. We believe that hiking fares beyond ~5% in FY13 would be improvident if demand growth is to be sustained in high double-digits.

Cost rationalization to help, oil prices remain key

Industry players including JAL are taking cost cutting initiatives including staff rationalization to tide over the crisis. One of the key cost elements (excluding fuel) is the pilot cost which should be contained now with the exit of pilots from KFA (100 pilots have resigned as per media reports in the last few months), easing the shortage. Possible policy initiatives from the government such as a cut in sales tax on ATF could potentially act as a big positive. Since fuel cost comprises ~45% of sales, every 1% fall in ATF will improve JAL’s EBIDTAR by 1.5%. 

Jet Airways: Best positioned to benefit

JAL has a dominant market share among corporate travelers, a low price elastic segment. With KFA (the only other alternative apart from the national carrier) announcing a series of flight cancellations, Jet has seen an influx of corporate bookings. Further, a 20% rise in fares in November augurs well for the profitability in Q3. We have built in a 5% YoY fall in oil prices and a 5% rise in yields in FY13 for JAL. With these assumptions, we arrive at a target price of INR400 based on 7.25x FY13 EV/EBIDTAR.