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Aviation
India
No respite. Domestic airlines have not been able to pass on higher costs on account of
fuel prices. Major reasons include (1) price discounting by Air India, and (2) lower PLF
(yoy) on account of capacity additions which are higher than the growth in passenger
numbers YTD. We are hopeful of a turnaround from 3QFY12E as the industry enters
into a seasonally strong quarter. Also, there are indications of Air India reversing its
pricing strategy.
Fuel costs continue to be high
Despite concerns about a slowdown in the global economy, fuel prices have not corrected
meaningfully. Jet fuel prices have averaged US$127 per bbl (QTD) against an average price of
US$131 per bbl in 1QFY12. Taking into account depreciation (~5%) in Rupee, the price is broadly
static versus 1QFY12 in Rupee terms.
Airlines have been unable to increase fares to pass on higher fuel expenses
In 1HFY12, airlines have been unable to increase fares to pass on higher fuel costs. The reasons are:
(1) Air India reduced fares dramatically from mid-January 2011. From a point where the company
was selling tickets at a premium to full-service carriers, it moved the pricing to a slight
discount/parity to the low-cost carriers. We have been highlighting this in our various updates on
the sector, and (2) capacity of the industry has increased by ~17% in the first six months of the
calendar year versus a growth of ~15% in the number of passengers in the same duration, which
has led to slightly lower PLFs in 2QFY12 versus last year. This has reduced pricing power and is in
contrast to FY2011 when growth in capacity of the industry was lagging passenger growth.
Average fares down ~8% qoq (QTD); Air India has increased prices; possible recovery in 3QFY12E
Our index for one week forward fares is down ~8% qoq (QTD). Combined with the low PLFs in a
seasonally weak quarter (2QFY12), it means losses in 2QFY12 would be significantly higher than
1QFY12 in the domestic business. Air India has increased ticket prices in the past two weeks. News
reports suggest a change in strategy, though we are not sure at this point of time. Also, with
3QFY12 being the seasonally strongest quarter, we expect yields to show significant improvement
qoq which could reverse the trend of sustained losses in the past few quarters.
Deterioration in operating metrics has been much severe for Indian airlines versus global peers
Global airlines have done much better operationally than Indian airlines in the background of rising
fuel prices. In 2QCY11, our sample of 33 airlines from across the globe managed to report profits
(though they were down 60% yoy) in stark contrast to the domestic carriers which have posted
large losses in 1QFY12 (versus profitable operations in 1QFY11). In light of the fact that PLF of
domestic airlines was better than most of the global peers, the performance seems even more
stark. In our view, weak pricing environment in the domestic market due to price discounting by
Air India is the major reason for such a dichotomy.
Changing our estimates; retain BUY on Spicejet and Jet Airways
We have reduced our earning estimates to take into account sustained high fuel prices and
inability of the industry to pass on the same. We are modeling jet fuel at US$120 (versus US$115
per bbl earlier), US$122 and US$125 for FY2012E, FY2013E and FY2014E, respectively. We retain
our BUY rating with a target price of Rs50 (Rs65 earlier) and Rs500 (Rs650 earlier), based on 8X
FY2013E EBITDAR, for Spicejet and Jet Airways, respectively.
Reversal of Air India’s strategy of discounting the market would be a major
turning point for the sector
One of the major reasons for the inability of domestic airlines to pass on higher costs has
been the move by Air India (mid-January 2011 onwards) to price its fares at much lower
levels versus competition. Given the large market share of the national carrier (17.5% as of
August 2011), competition had to follow. Any reversal of the current stance by Air India
would lead to a turnaround in the sector as the airlines would be able to increase prices to
pass on higher costs, even if partially.
Air India has increased fares in the past two weeks. The tickets are now priced at a premium
to low-cost carriers versus parity/discount earlier. As of now, we are not able to comment on
whether it is a change in the earlier strategy (discount pricing) or not. Some of the recent
news reports suggest that the national carrier is relooking at its strategy as it is not
sustainable in the long term. We present an excerpt from the same:
”In the past few months, AI was offering very low fares and there has to be a correction as
the airline needs a strong cash flow to survive. As oil companies have put us off the cashand-
carry list, we now have a flexibility of Rs225 crore every month, from which we’ll pay
salaries,” said a senior official.
Times of India, September 15, 2011
PLF of the industry has declined marginally in 2QFY12 on capacity additions
Capacity of the industry has increased by ~17% in the first six months of the calendar year
versus a growth of ~15% in the number of passengers in the same duration, which has led
to slightly lower PLFs in 2QFY12 versus last year. This is in contrast to FY2011 when the
growth in capacity of the industry was lagging passenger growth. Capacity additions in the
industry has taken place in a back-ended manner in FY2011 and hence the impact on PLFs.
In our view, capacity of the industry would increase by ~15% in FY2012E, which would be
more or less in line with increase in the number of passengers. The number of passengers
has increased by ~13% yoy in the first four months of the fiscal year.
Deterioration in operating metrics has been more severe for Indian airlines
versus global peers
Global airlines have done much better operationally than Indian airlines in the background
of rising fuel prices. In 2QCY11, our sample of 33 airlines from across the globe managed to
report profits (though they were down 60% yoy) in stark contrast to the domestic carriers
which have posted large losses in 1QFY12 (versus profitable operations in 1QFY11). In light
of the fact that PLF of domestic airlines was better than most of the global peers, the
performance seems even more stark. In our view, weak pricing environment in the domestic
market due to price discounting by Air India is the major reason for such a dichotomy.
Change in estimates
We have reduced our earning estimates to factor in sustained high price of jet fuel. We now
factor in a recovery only from FY2013E onwards. We are modeling jet fuel at US$120
(versus US$115 per bbl earlier), US$122 and US$125 per bbl for FY2012E, FY2013E and
FY2014E, respectively. We retain our BUY rating with a target price of Rs50 (Rs65 earlier)
and Rs500 (Rs650 earlier), based on 8X FY2013E EBITDAR, for Spicejet and Jet Airways,
respectively.
Valuation
We value Spicejet at Rs50 per share
Valuation table for Spicejet, March fiscal year-ends (Rs mn)
EBITDAR 10,939
EV EBITDAR multiple (X) 8.0
EV 87,508
Aircraft rentals capitalised at 7X (50,512)
Cash 442
Net Debt (a) (17,082)
Implied equity value 20,356
Value per share (Rs) 51
Note: (a) Debt has been taken only for 15 Q-400 aircrafts.
Source: Company, Kotak Institutional Equities
We value Jet at Rs500 per share
Valuation table for Jet Airways, March fiscal year-ends (Rs mn)
EBITDAR 32,024
EV/EBITDAR multiple (X) 8.0
EV 256,191
Aircraft lease rentals capitalised at 7X (97,048)
Net Debt (114,463)
Value of the equity 44,680
Value per share 518
Source: Company, Kotak Institutional Equities
