Indian aviation: Flying in calm skies

Anand Kalyanaraman BL Research Bureau | Updated on January 06, 2011 Published on January 06, 2011


Pruning debt necessary to realise potential

Circa 2008 and 2009: The aviation sector in India, under attack from a recession-induced demand crawl and major capacity oversupply, was on its knees. The humungous leverage of the big boys in the game turned the knives in the wounds, and the sector as a whole made huge losses. The survival strategies in an acutely price sensitive environment included aggressive cost-cutting and a forced embrace of the low-fare model by the full-service carriers.

Cut to 2010: The thaw in the economy gave way to a significant revival in air traffic demand in 2010 (up around 20 per cent over the previous year). Add calibrated supply increases to the concoction and load factors for the beleaguered industry perked up.

Airlines started digging themselves out of the hole, posting profits (however minor) or, at least, paring losses. Debt restructuring processes were put on the fast track, with the Government lending a helpful nod. The bourses took notice and the listed players (Jet, Kingfisher and SpiceJet), earlier subject to heavy punishment, saw their stock go up between 40 and 50 per cent in the latter half of the year.

With demand reaching record levels in the latest December quarter, the airlines tried to make the most of their pricing power, only to find that the free market is not so free after all. Agitated consumers and an alarmed Government forced the airlines to back off (at least a wee bit).

In other interesting side-shows, a new owner took charge at SpiceJet. Also, in perhaps a sign of things to come, ‘the old gave way to the new' with the other low-cost major, Indigo, moving up the pecking order as far as market share is concerned. It dislodged national carrier Air India from bronze position last November. Ambitions also soared beyond the domestic skies with eligible low-cost carriers going or poised to go international.

Crystal ball 2011

The drivers that propelled the sector in 2010 seem set to continue in 2011. Demand is expected to grow strongly (at least in the mid-teens), supply should be lower than demand (with significant additions expected only from the low-cost players) and balance-sheet repair, which is underway, should ease some pressure off the FSCs. The planned push into the smaller towns and cities should also create new and promising demand pockets. Yet, the sector still has a considerable distance to traverse before it moves into the safe zone.

The overall debt level remains precarious (in excess of Rs 60,000 crore). This, even as accumulated losses over previous years has shrunk the equity base of most players and eroded the net worth of two of the three full-service carriers.

While the much-needed restructuring and planned equity infusions are a good first step, it will take quite some time for Air India and Kingfisher Airlines to shrug off the debt albatross and show profitability at the net level. Also, while Jet has been turning in profits for some quarters now, its debt burden remains huge, and a thinning of flab is a must if the full potential of the improved demand-supply dynamics needs to be realised by the airline at the net level.

The low-cost carriers with limited leverage, better operating metrics and aggressive expansion plans, seem to be in a better position to capitalise on the opportunities being thrown up by a growing economy.

Not surprisingly, unlisted players in this category, such as Indigo and GoAir, are reported to be planning to go public in 2011.

Despite an improvement in the fundamentals and sentiment over the past year, the sector still faces headwinds. The immediate among these are escalating costs due to crude oil prices riding up in the past few months.

Also, increased Government directives and activism may put a cap on top-line and bottom-line growth. Besides, the sector needs to keep a close watch on aggressive capacity expansion plans which, if uncontrolled, could lead to an undesirable encore. From a valuation perspective, the three listed stocks in the space currently look fairly priced or even a tad expensive. SpiceJet and Jet Airways are trading at an EV/EBITDA multiple of more than 10 times, while for Kingfisher, the multiple is much higher at around 25.

Of the lot, SpiceJet seems to be the best-positioned. However, the sharp run-up in its price coupled with the substantial equity dilution after the entry of the new promoter may limit per share earnings and market upside from current levels. Also, increasing competitive pressure in the low-cost space warrants caution.

Besides, the new public issues could set revised valuation benchmarks for the incumbents.

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Published on January 06, 2011
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