The Big Story. Aviation sector: Betting high

The sector is known to make millionaires of billionaires, and Warren Buffett famously shuns it. But investors who had the gumption to bet on Indian aviation stocks in the dreary days of late 2014 would be pleased as punch.

The SpiceJet stock has more than quadrupled while the Jet Airways stock has nearly tripled since then, despite losing ground in recent months. Investors in the IndiGo Airlines IPO in October 2015 would be sitting on gains of about 35 per cent — lower than the 75 per cent plus gains at the beginning of the year but still quite neat. Investors may soon have another stock to bet on; reports indicate that GoAir may hit the market in 2016-17.

The strong appetite for aviation stocks over the past year or so has not been without reason. Sharply lower fuel cost and high passenger growth have enabled many airlines to post strong profits after a long hiatus. From being on the verge of shutdown in late 2014, SpiceJet’s fortunes revived with the change in management in early 2015, which coincided well with favourable flying dynamics. The airline posted profit of ₹334 crore in the nine months ended December 2015, compared with a loss of over ₹700 crore in the April-December 2014 period.

Jet Airways too swung to profit of ₹776 crore in the April-December 2015 period from loss of about ₹85 crore in the year-ago period. IndiGo nearly doubled its profit year-on-year to more than ₹1,400 crore for the nine months ending December 2015. The recent December quarter has, in fact, been the best for all these airlines with record quarterly profit. The March quarter is expected to be quite healthy too.

While the stock rallies have been spectacular, it may be time for a pause. One, the key driver of the sector’s turnaround — cheap fuel — needs to be watched. With crude oil price inching up over the past few months, ATF price has risen about 20 per cent since February.

Higher excise duty on ATF in the Budget has also played a part. If passed on to customers, traffic and revenue growth could slow down, and if absorbed by airlines, their margins could be dented. A further rally in crude oil prices, though unlikely given the global tepid demand and oversupply conditions, could queer the pitch for airlines.

Next, after the run-up, the valuations of the stocks are not cheap. The pull-back in the stocks since January suggests caution. There are company-specific factors to consider too. For instance, while SpiceJet’s financial growth metrics should be above industry average, there could be a fairly large stock and earnings dilution on allotment of shares against warrants to the erstwhile promoters.

If a long-term bet on the Indian aviation sector is what you seek, IndiGo Airlines seems the better choice, at least for now. This is despite its premium valuation compared with peers. With the delivery of the fuel-efficient A320neos having commenced, a major overhang on the stock has been removed. The airline’s consistent profitability, market leadership, massive capacity addition plans and track record in running a tight ship also provide comfort.

The company’s track record is not without blemish though — its huge dividend payout to promoters before the IPO turned its net worth negative. Also, IndiGo’s September 2015 quarter profit was much lower than what was expected on the basis of the positive comments by the management before the IPO.

COMMENT NOW