InterGlobe Aviation: Turbulent times

Factors that led to the dismal March quarter results could continue to cast a shadow

A lot can happen over a week in Indian aviation. Or so it seems from the sharp dip in fortunes of market leader InterGlobe Aviation (IndiGo Airlines) and its stock on the bourses. From peak levels of ₹1,500 on April 26, the stock is down about 27 per cent. This follows unexpected bad news — first, the exit of top executive Aditya Ghosh and, next, the dismal results posted by the company in the March 2018 quarter with profits crashing about 73 per cent y-o-y. Reports about a probe by SEBI into delay in disclosing the resignation of Aditya Ghosh may also have taken a toll.

Does the steep fall in the stock present a buying opportunity for investors? Not quite. One, valuations remain on the high side, thanks to the stock’s sharp rally over the past year and half (more than 80 per cent before the recent fall).

 

At ₹1,182 now, the stock trades at about 20 times its trailing 12-month earnings. While lower than the peak levels of 25 times or so, it is still higher than the average 19 times since the stock’s initial public offer in late 2015.

Next, the earnings outlook seems weak. IndiGo has the bandwidth to overcome the uncertainty caused by the management churn. But challenges such as high costs and low yields that impacted the March quarter results could continue pulling down its financial performance, offsetting positives such as high passenger growth and load factors. A high base effect and step-up in capacity addition could also be a drag on earnings. Investors can sell the InterGlobe Aviation stock.

Summer blues

The washout in the March 2018 quarter is disconcerting for a few reasons. One, the March 2017 quarter was also a weak one, impacted by demonetisation, rising costs and low fares — profit then fell 25 per cent y-o-y to ₹440 crore. On this low base, the 73 per cent y-o-y dip in the March 2018 quarter has pushed down profit to ₹118 crore — the lowest quarterly profit since the 2015 public offer. But for ‘other income’, the airline would have ended in the red.

Next, the results signal a reversal in the turnaround seen in the first three quarters of 2017-18 after a dismal 2016-17. In the nine months ended December 2017, IndiGo’s profit had grown 74 per cent y-o-y to ₹2,125 crore. Now, due to the weak March quarter results, the full-year 2017-18 profit (₹2,242 crore) is up 35 per cent y-o-y — healthy, but much slower than what the trend earlier suggested.

Importantly, the factors that have tripped IndiGo badly in recent times could cast a shadow in the coming quarters too. Fuel costs increased about 33 per cent y-o-y in the March quarter and remain a concern. Global oil prices have risen sharply to about $75 a barrel now; this will translate into higher cost of aviation turbine fuel (ATF).

The ongoing weakness in the rupee (now about 67 to a US dollar), if it continues, will add to the cost. In the recent March quarter, the airline’s cost per available seat kilometre (CASK) rose 7.4 per cent y-o-y. Even excluding fuel, the CASK increased 5.3 per cent y-o-y.

Pricing pressure

On the other hand, pricing power that seemed to have returned in the first nine months of 2017-18 has again gone missing. Intense competition saw IndiGo’s yield (passenger ticket revenue/revenue passenger kilometre) fall 5.6 per cent y-o-y in the March 2018 quarter. A factor that aided fares and yields in the sector in the previous few quarters was engine trouble that kept IndiGo’s capacity (available seat kilometres) growth under check — about 15 per cent y-o-y.

But the airline’s capacity growth picked up to 21 per cent in the March 2018 quarter. With the engine troubles expected to ease in the coming year, IndiGo expects a capacity increase of about 25 per cent in 2018-19. Being the largest player in the domestic skies with about 40 per cent market share, IndiGo’s capacity addition has a bearing on fares not only for itself but the entire sector. Other airlines such as SpiceJet and GoAir too are adding to their fleet size. This could keep fares under check and prevent pass-through of cost hikes.

 

 

Sure, passenger traffic continues to grow at a healthy pace (in the high-teens or more) and load factors are healthy for the sector and most airlines. IndiGo’s revenue has also grown smartly — sales rose about 24 per cent in 2017-18 and about 20 per cent y-o-y in the March 2018 quarter. But what really matters for investors is for the traffic and sales growth to translate into profit growth — something sorely missing in the March 2018 quarter. The risk of a repeat of this unhealthy scenario in 2018-19 is high with high costs and low pricing power arising from step-up in capacity growth.

Transition risks

Meanwhile, besides the management transition, the airline is in the midst of other key changes. It has broken away from one of the key tenets of low-cost carriers — having a single fleet type. From flying only the A320 (including the neo variant) aircraft, it now also has some ATR turboprops in its fleet to cater to its foray into the regional connectivity scheme (UDAN).

Besides adding more of both these aircraft, IndiGo is also evaluating wide-bodied aircraft to start long-haul international operations. While it has withdrawn its plans to bid for Air India, IndiGo has ambitious international expansion plans — 15 per cent of its capacity is now on international routes.

The airline also plans to buy more aircraft in a shift away from its earlier predominant sale-and-leaseback model. These moves come with risks such as higher maintenance costs and operational complexities.

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