Is Aviation a good bet?

Airlines, although being the fastest mode of transport and forming an integral part of modern life, is still struggling in the race towards sustainable and profitable growth. Right from 1991, when the Government de-regularized the civil aviation sector, the Airlines sector has struggled to stay in the green. Although, today India has the fastest growing aviation sector in Asia, clocking CAGR of 12% over FY06-17, most of the domestic airlines are bleeding. The sector finds itself engulfed in myriad of problems including inadequate infrastructure, lack of affordability, cut-throat competition, not to mention high crude oil prices and forex fluctuations, all of which have hampered the sector’s health since the last two decades.

Currently just 2% of India takes to the skies. The Government is taking steps to speed up the pace of infrastructure development in the country. Finance Minister Arun Jaitley announced the Government’s intent of increasing airport capacity by 5 times in the next few years.

Challenges faced by the aviation sector

  1. Fuel Cost and Foreign Exchange: The biggest hurdle in aviation sector is the high cost of aviation turbine fuel which constitutes 35-40% of the total operating cost of the airlines. ATF Prices in India are 60-70% higher as compared to global peers Further due to cut throat competition and consequent price sensitivity among the travellers, airlines are unable to pass the cost of ATF prices to the customers.  Since India is a mainly Fuel deficit country, foreign exchange fluctuations directly impact the operating costs of the airlines.
  2. Passenger load Factor: Aviation business being capital intensive in nature and having high fixed costs, the efficiency with which airlines utilise their assets is the key to generate adequate return on investments. Higher Passenger Load Factor (PLF) helps in increasing revenue and profitability. Airlines in India have thus focused majorly in tier 1 cities where the PLF has been approx. 80% as compared to tier 2 and 3 cities where it has been 50%. Due to high fixed costs, operating on low PLF routes is non viable for airlines and thus India is largely under penetrated by the aviation sector.
  3. Lack of adequate Infrastructure: India’s aviation sector needs a big push on the infrastructure front. All the major airports are severely congested with the situation to only worsen in next few years.  India’s domestic air traffic nearly doubled to 117 million passengers in 2017 with 100 flights taking off every hour compared with 67 in 2011. Besides these issues, airports lack sufficient flight slots and airport parking bays. Lack of significant thrust to infrastructure poses would derail the hyper growth (above 20%) that the Indian airline industry is currently experiencing.

Vision 2020

To tackle these challenges, the government is proactively working on schemes to revive this sector. They have emphasized on tier-2, tier-3 cities where the next round of growth would come from. India’s smaller cities have so far remained neglected with very little connectivity. Airports in small cities or towns like Kanpur in UP, Cooch Behar in Bengal, Nasik in Maharashtra, Mysuru in Karnataka along with Puducherry are only few among the list of airports that are currently out of country’s air-map.

UDAAN Scheme (Ude Desh ka Aam Nagrik)

This scheme, launched by the Government in 2016 aims to make flying accessible and flexible to millions of Indians in the tier-2 and tier-3 cities by promoting airlines to fly these virgin routes.

Under this scheme, airlines will have to sell some of their seats (9-50) at a cost no more than 2500 per hour of flying, for which they will be compensated by the government. This will also boost tourism and business travel.

In order to encourage the airlines, the to operate, the government provides for a three-year monetary support in the form of Value Gap Funding(VGF). The VGF will be used to bridge the gap between the cost of airline operations and expected revenue. Airline operators would be extended VGF estimated to be around Rs 205 crore per annum for the operators chosen in the first round of bidding. So far, 19 States and three union territories have signed a MoU for this purpose. Also, the states participating under this scheme

will be providing sufficient land available; ensure adequate security; and provide essential services at concessional rates for the airports or airlines as this is one of major cost travelling in smaller cities. The Centre and States will bear the VCF cost in the ratio of 80:20. A total of 109 airports and heliports around the country have been awarded to various airlines and helicopter operators under the second round of bidding under the UDAAN scheme.

Indian Investor Perspective

Imagine having invested Rs 100 each in March 2005 in the following:

Let’s discuss a couple of listed stock and their probable future outlook:

Interglobe Aviation – God of Aviation sector

  • Only airline in India to be profitable for the last nine years.
  • Market leader in one of the most under penetrated market (India) – 40% share.
  • Strategy of ordering bulk purchase order of single type of aircrafts helped in reducing ownership cost, cost of maintenance, staff training cost and capex cost. Also, new fleet of vehicles keeps fuel cost lower as compared to peers.
  • On-time performance ensured high passenger load factor.
  • With strong share in the market and cost leadership the stock seems to be good stock in the aviation sector. However, in the near term, we would watch out for (a) impact on profitability led by fare-war, (b) capacity addition by competition and (c) crude oil price trend.

SpiceJet – Turnaround story

  • From the verge of bankruptcy, SpiceJet has navigated well upward in the last two years.
  • Company was making losses since its acquisition by Sun group in 2010. It became worst when oil companies refused to refuel SpiceJet airlines due to payment issues.
  • The reason for the fall was that the company was flying fewer flights to large number of stations with no return flights on the same day and high cancellation of flights leading to customer dissatisfaction.
  • Turnaround
  • Company was on the verge of bankruptcy when Ajay Singh acquired the company in 2015 for just Rs 5.
  • He focused on the critical issues like managing cost, utilizing assets and managing cash flows.
  • His strategy was to follow the low-cost model and focused on becoming an affordable model thereby winning customer loyalty.
  • Company which was making a loss of Rs 687crores and had a negative net worth of Rs. 1265crores in FY15 turned into profit of Rs.430crores in FY17.
  • SpiceJet is also awarded with few sectors under- the Udaan scheme and is focusing to capture non-trunk areas. Also, they have ordered for 50 Bombardier Q400 aircrafts for the same. It is expected that the company will see 5-7% growth in topline with the aid of this scheme.
  • The stock has gained more than 8x since the change of company`s management. Looking at the turnaround, the company has the potential to match the level of Indigo. In the near term the stock looks attractive, however the volatility of fuel prices and short vision of Udaan scheme makes the stock risky in long term.

Aviation sector is ready to take off due to the NDA governments aggressive push and higher connectivity, but the sector faces a lot of systemic risk in India. It is our belief that in future and with Udaan schemes fares shall further fall. In short term though few stocks may look interesting, we don’t see any potential in the long term to invest in Aviation Stocks.

This report is for discussion purpose only and does not give any buy/ sell recommendation.

This report has been penned by Khushbu Gandhi, Investment Adviser, Moneybee Investment Advisors Private Limited. For more details you can contact her on +91 4030 2053

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