SpiceJet: Buy

Investors with a high-risk appetite and a long-term perspective can consider buying the stock of SpiceJet, the listed low-cost carrier. Along with other airline stocks, SpiceJet too has been battered on the bourses over the last six months, primarily over concerns of galloping crude oil prices putting the brakes on the nascent recovery in the sector. These concerns have been vindicated to some extent, as seen in the losses posted by Jet Airways in the recent March quarter, primarily due to a steep increase in the price of aviation turbine fuel (ATF). Fuel accounts for a chunk (around 40 per cent) of airline costs.

That said, the extent of the fall in the stock price seems to be overdone, at least in the case of SpiceJet. The company's much stronger financial position compared with its listed full-service carrier peers (Jet Airways and Kingfisher Airlines) should help it weather the tide much better. At its current price of Rs 41, the SpiceJet stock has lost close to 56 per cent since early November and trades at around 9 times its trailing 12-month earnings, down sharply from around 25 times in November. Also, on an EV/EBITDA basis, SpiceJet at around 5 times trades cheaper than Jet Airways (around 9 times). Increasing passenger traffic, a strong balance-sheet with room to increase leverage, expansion plans with an eye on high regional demand in Tier-II and Tier-III cities, and gradual price hikes to offset fuel cost increases buttress our recommendation.

Robust passenger growth

As against the industry growth of around 21 per cent, the number of passengers carried by SpiceJet in the domestic sector in the March quarter increased by around 39 per cent year-on-year to almost 2 million. Its load factor in the quarter (around 80 per cent) has also been above-the-industry average of around 77 per cent. In March 2011, the company's domestic market share was 13.5 per cent, up from 12.6 per cent in September 2010. The number of passengers on its international routes (Colombo and Kathmandu), which commenced in October 2010, have also improved to touch around 19,000 in March 2011, with average load factor of around 76 per cent. With improving economic growth, the aviation sector in India is set to grow at a healthy clip, with load factors likely to improve with rising demand.

With an eye on the increasing demand, SpiceJet has lined up significant expansion plans, the major focus of which is towards Tier-II and Tier-III cities where air traffic is expected to grow faster than bigger cities in the country. The company plans to expand its fleet size significantly, from around 29 currently to 70 over the next three years. The bulk of the new aircraft to be ordered by the company is the Q400 Bombardier jet. These 78-seater airplanes with a smaller seat capacity (less than 80 seats) enjoy a significant advantage in terms of much lower taxes on fuel and concessions on airport charges. This should aid the company's margins in the years ahead.

Strong balance-sheet

SpiceJet plans to raise debt to fund its expansion plans. This should not be a constraint, given that the company currently has negligible debt, having converted most of its debt to equity during the management change last year. A much better balance-sheet vis-à-vis other listed players puts SpiceJet in a position of strength to capitalise on the expected growth in the sector.

Lastly, most airline players, including SpiceJet, have been raising fares gradually to cope with increasing fuel cost pressure. However, given the trade-off between fares and load factors, they have refrained from passing on the entire cost hike. While this will have an impact on margins, healthy volume growth in the case of players such as SpiceJet should provide a good hedge, so long as crude remains at high levels. Also, there has been some softening of crude oil prices over the past month, which has translated into a mild moderation in ATF prices. This trend, if it continues, will benefit all airlines, including SpiceJet.

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