Monday, April 5, 2010

SpiceJet Covered in Today's ET Investor's Guide...

More Headwinds Ahead

The financial condition of the aviation sector remains precarious with most airlines saddled with huge debt and soaring interest burden. However, SpiceJet offers a good bet


A PROFITABLE third quarter, high doubledigit growth in passenger traffic and low and stable crude oil prices have brought a renewed optimism in the aviation sector. The rising optimism is reinforced with the full-service carrier Jet Airways reporting a strong growth in its passenger traffic for the fifth consecutive month in February this year. So how long would this good time continue and is this the right time for investors to start accumulating aviation stocks?

Taking a dispassionate view of the sector, it would naïve to assume that times ahead for the sector would be good. The financial condition of the sector continues to be precarious with most airlines saddled with huge debt and soaring interest burden. Though the passenger growth has surged enabling airlines to improve the load factor and their factor productivity, profitability is still inadequate to pay-off the debt and liabilities accumulated during the excesses of 2006-09. Total outstanding debt of Jet Airways, Kingfisher Airlines and Air India together is estimated at more than Rs 50,000 crore, according to the Centre for Asia Pacific Aviation (CAPA). It will take many years of strong and copious earnings growth for the industry to get rid of this huge debt.

Another concern for the airlines is low realisations. Realisation means the revenue per kilometre per passenger an airline makes on a route, also called RPKM in the industry parlance. For most airline companies, realisations have been dwindling, despite increasing load factor. For instance, Jet Airways India saw a double-digit dip in its realisations in the December 2009 quarter despite a sharp increase in its seat load factor. Its blended realisations in the domestic sector fell to Rs 3.35 per RPKM from Rs 4.58 a year ago. This shows that it is the price war that is hindering its realisation growth. Of two choices available — engaging in price war or cutting down the capacity — airline companies are choosing the former.

More so, with the Union Budget imposing a 5% custom duty on crude oil, companies fuel cost has gone up proportionately making their profitability even more vulnerable to the price war. The concern has been heightened due to the niggling fear of a further rise in crude oil prices in the international market. Currently, crude oil is trading around $84 per barrel and once it breaches the $90 mark, it will be tough for airlines to sustain the growth momentum. Fuel costs sill form the largest component of airlines operating expenditure and any upward movement in aviation turbine fuel will rapidly eat into their profit margins. In the case of Jet Airways, fuel cost accounted for 37% of its expenditure in the quarter ended December 2009. In fact, such dependence on crude oil prices has been the prime reason for investors to stay away from airline stocks.

In the bourses, however, the aviation stocks have been high fliers with stock prices of airlines tripling or quadrupling in the past 12-months. This has raised industry’s valuations to historic highs and minimising the chances of a further upside. Quite unexpectedly, airline stocks had attracted attention of traders (rather than investors) in October last year. It was observed that all the listed entities, Jet Airways, Kingfisher and SpiceJet saw increase in trading volumes. This resulted in appreciation of these companies’ stock prices, which continued till January this year.

Now, these stocks are trading below their peaks in the December-January period. For instance, Jet Airways’ stock price had been at a peak of Rs 598 in December last year, while currently it is trading at Rs 480, a fall of around 20%. This decline is due to lack of any big trigger for airline companies.

Those who are looking at investing in airline stocks can consider SpiceJet as the company has just got the government approval to fly aboard. Besides, there is a fair chance of it being acquired by a prospective domestic investors or a foreign airline if and when government policy allows it. Besides, SpiceJet’s balance sheet is least leveraged among all. Long-term investors are advised to accumulate the stock at the current level.

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