InterGlobe Aviation: Flying into an airpocket

Low fares have depressed profits despite passenger growth. This is likely to continue

IndiGo Airlines, the market leader in domestic aviation, has been struggling over the past year. While it has been growing capacity and passenger traffic rapidly, the airline’s finances have been hit by high costs and weak ticket prices.

The stock, staying largely subdued over the last calendar, has rallied nearly 30 per cent since January, thanks to a dip in oil prices and a stronger rupee that could cut fuel costs.

At ₹1,093, the IndiGo stock now trades at about 22 times its trailing 12-month earnings, higher than the average of about 17 times since listing in late 2015, and is costlier than its peer SpiceJet (16 times). Investors can sell the IndiGo stock.

The company’s performance could remain under pressure with high capacity addition keeping fares in check. Also, while air passenger growth remains strong, it has slowed somewhat in recent months — from over 23 per cent y-o-y last calendar to 18.6 per cent in the recent March quarter. Growth moderation could continue with a higher passenger base and airport infrastructure constraints in big cities, at least in the near term.

The crude oil price has dipped to about $50 a barrel recently but may stay in the $45-60 range, given global demand-supply dynamics. The rupee too, though stronger at about 64 a dollar in recent months, is hard to predict, and could move in the 60-70 range, as seen in the past few years. IndiGo plans to fly regional routes under the government’s recently launched UDAN scheme and has placed an order for ATR turboprop aircraft for this foray. This could open up growth opportunities but comes with risks — increased maintenance costs and uncertain demand.

Weak show

IndiGo has had a difficult 2016-17. The company saw its bottom-line take a knock in three of the four quarters last year, including the recent March 2017 quarter, when profit fell about 25 per cent y-o-y. Consequently, profit for the full year 2016-17 was down over 16 per cent to ₹1,659 crore. This is in sharp contrast to the more than 50 per cent increase in profit in 2015-16.

The poor show last year is a paradox, given the rapid growth in carrying capacity and passenger traffic. Expansion in fleet and network saw the airline’s capacity, measured in available seat km (ASK), grow more than 27 per cent. Also, IndiGo flew more than 4.16 crore passengers in 2016-17, 32 per cent higher than in 2015-16, entrenching its position as the domestic market leader, boasting a near 40 per cent traffic share.

The decline in profit, despite these healthy metrics, was due to higher costs, especially fuel, and lower ticket prices. With crude oil price rising from its lows last year, IndiGo’s fuel cost, its largest expense, rose by nearly a third. As a percentage of sales, the airline spent about 5 percentage points more on fuel in 2016-17. Overall costs rose by about a quarter.

But rather than increase ticket prices to offset the impact, the airline took sharp cuts. Intense competition in the domestic skies and fare wars saw IndiGo’s yield (average fares) dip more than 10 per cent in 2016-17, resulting in revenue growth of just about 18 per cent.

Demonetisation compounded the problem in the December 2016 quarter, with airlines slashing fares to woo passengers. Overall, in 2016-17, IndiGo’s revenue per ASK slipped more than 9 per cent, while cost per ASK fell by a much lower 2.5 per cent.

The airline’s EBITDAR (operating profit before aircraft rent) margin fell to about 29 per cent in 2016-17 from 35 per cent in 2015-16, while net margin fell to 9 per cent from 12 per cent.

Fare pressure

The dip in oil price and the rally in the rupee in recent months should provide some relief to airlines including IndiGo on the cost front. But it remains to be seen whether airlines adopt rational pricing and rake in benefits.

Big fleet expansion plans across the sector could dampen yields.

Last year, IndiGo's huge capacity expansion resulted in it taking among the sharpest fare cuts. The airline’s fleet increased to 131 aircraft as on March 2017 from 107 a year ago.

This helped capacity and passenger growth, but not financial performance. IndiGo continues to add aggressively to its fleet and expects to increase it to 170 (excluding the recent ATR aircraft order) by March 2018.

Most other airlines, including SpiceJet, GoAir, Vistara and Air Asia too, have big expansion plans. If new airlines such as Qatar Airways make an entry into the Indian market as planned, capacity could grow faster. Seen in conjunction with moderating passenger growth, this could add to the pressure on fares. IndiGo has indicated that there was improvement in fares in February and March. Indeed, the dip in yields in the March quarter (about 4 per cent y-o-y) was lower than in earlier quarters. But whether this will sustain is moot.

Inducting ATRs

IndiGo has decided to throw its hat into the regional ring and participate in the regional connectivity scheme — Ude Desh Ka Aam Nagrik (UDAN) — launched by the government. For this, it has signed a term sheet for 50 ATR turboprop aircraft worth $1.3 billion (about ₹8,500 crore) at list prices.

Doing this, the airline is breaking away from one of the key tenets of low-cost carriers — having a single fleet type. So far, the airline has been flying only the A320 (including the neo variant) aircraft. Operations with the smaller ATR aircraft, that seem more suited for regional routes, are expected to commence by the end of calendar 2017. IndiGo expects to have seven of these aircraft by March 2018 and 20 by December 2018. The airline plans a separate division to handle turboprop operations.

The UDAN scheme is expected to open up Tier II and Tier III centres to air traffic and could be a growth opportunity for airlines. SpiceJet has stolen a march, winning some routes in the first auction, thanks to the smaller Bombardier Q400 aircraft in its fleet. IndiGo will likely jump into the fray in future auctions after the delivery of ATR aircraft commences.

The move to diversify the fleet type is not without risks, though. It will increase maintenance costs. Also, if the selected regional routes do not deliver good traffic growth, the new aircraft could become a burden.

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