Hazy weather

With airline stocks reeling under rising crude and falling rupee, it could just be a long-term opportunity

Soumik Kar

At the beginning of 2018 — one of India’s biggest airlines — Jet Airways, was flying high. Despite a drop in yield and crude price moving up, investors were bullish with the stock hitting a 52-week high at Rs.884 on January 5. With passenger traffic growth on the rise, stocks of other listed players like IndiGo and SpiceJet were trading at Rs.1,202 and Rs.146 as of January 1 this year compared to Rs.824 and Rs.59 on January 1, 2017.

But post-June as Brent crude started hovering around the $80 mark, rising operating cost adversely impacted margins. Adding to the airlines’ woes, even the rupee started depreciating, and yields also dropped. Consequently, investors began to steer clear of aviation stocks. As of October 3, most aviation stocks are trading at their 52-week low with IndiGo at Rs.770, Jet Airways at Rs.175 and SpiceJet at Rs.63.

Turbulent times

For Jet Airways, macro headwind isn’t the sole reason for concern. Its mountain of debt has also impacted profitability as interest cost soared. A double blow has hit the company – its revenue available per seat kilometre (RASK) dropped by 4%, and at the same time, fuel cost available per seat kilometre (CASK) rose 37%. Hence, the earnings before interest, taxes, depreciation, amortisation, and rentals (EBITDAR) dropped by 98% YoY in Q1FY19, despite 4% passenger volume growth and 1% decline in non-fuel CASK.

In addition, Jet Airways’ total expenditure grew by 26.40% (year-on-year) in June quarter led by 53.03% rise in power and fuel cost. Operating expense also grew by 12.52% to Rs.22.80 billion. With expenses continuing to mount, the airline reported a net loss of Rs.13.23 billion in the June quarter.

It’s not just Jet, but also its peers who are bearing the brunt of rising fuel prices. For instance, IndiGo, which has been an investor’s favourite for the past two years, reported a drop in standalone net profit of a whopping 96.57% to Rs.278 million in June 2018 compared to Rs.8.11 billion in June 2017. The significant underperformance was driven by lower yields, higher fuel costs and elevated dollar-denominated maintenance charges.  Power and fuel cost rose by 54.37% to Rs.27.16 billion in June 2018 from Rs.18.60 billion in June 2017.

“The depreciating rupee hits airlines’ maintenance expenses. Beyond that there is lease expense which is dollar-denominated,” says Madhukar Ladha, senior analyst, HDFC securities. While the airlines are marginally passing on the price rise, he adds that increasing the ticket price substantially isn’t an option for beleaguered airlines. “If you start increasing prices then occupancy and load factor suffers. It is a tough scenario for airlines,” asserts Ladha.

While other airlines are reeling under cost pressure, SpiceJet has been an outlier. The company’s yield expanded 4% year-on-year in Q1FY19 to Rs.41.84 billion. SpiceJet is the only airline that has reported yield growth of 4-8% year-on-year in the past two quarters.

Yet, the positive growth numbers were offset by rising aircraft maintenance expenses, which stood at Rs.0.66/seat-km, higher than normal expenses by Rs.0.10/seat-km as observed in thepast. According to a recent report by Elara Securities, this was primarily due to rising fleet age. Passenger RASK growth and passenger volume growth was partly nullified by fuel CASK rise of 33% (year-on-year).

Waiting for revival

Ladha opines that SpiceJet is better equipped to weather the macro headwind. “Among the three, SpiceJet’s route deployment is a lot smarter. It’s a lot more agile in that respect and profit-oriented,” he explains. Analysts also believe that Jet Airways has the potential to script a turnaround. “Theoretically speaking, Jet Airways has the best business model. In a rising crude falling rupee environment, when you have revenue coming in from international business, or revenue flow coming in various foreign currencies, you have a better hedge against depreciating rupee and rising crude,” says Mahantesh Sabarad, head, retail research, SBICap Securities.  

As fuel prices continue to inch up and yield showing no sign of improvement, growth for the next two quarters is expected to remain subdued as fuel and dollar-denominated costs eat into almost 60% of revenue. The drop in profitability coupled with waning investor interest mean that currently, Jet Airways, IndiGo and SpiceJet are trading at 10x, 22x and 32x, respectively on a one-year forward basis.  With two airline stocks (Jet Airways and IndiGo) trading close to their all-time low, this could be just the opportunity for long-term investors to buy airline stocks.