Aviation stock: Cost pressures continue to take a toll on profitability

Cost pressures in competitive environment continue to take a toll on profitability

Aviation stocks were among key gainers on Monday on expectations that falling crude oil prices and strengthening rupee will improve profitability. While SpiceJet gained nearly 20 per cent, Jet Airways and InterGlobe Aviation were up 7.7 per cent and 2.4 per cent, respectively. 

While fuel accounts for about 35 per cent of sales, a stronger rupee in addition to lower fuel costs helps bring down costs related to maintenance and rentals. 

Analysts say a 10 per cent increase in crude oil prices has a 3.5 per cent impact on profitability, both at the operating profit and profit before tax levels. 

The effect of the rupee is much more - a 10 per cent appreciation has a 5 per cent impact on profitability. 

The other trigger for the stocks’ better performance is bringing aviation turbine fuel under the goods and services tax (GST) regime. While currently, excise duty of 14-15 per cent, state value added tax of 20-25 per cent take the total to over 35 per cent, the highest rate of GST is 28 per cent.

Lower tariffs on transition to GST could be beneficial. 

Strong demand continues to be a major positive for the sector. 

Passenger growth for April and for the period between January and April was up 24-26 per cent year-on-year and analysts expect this momentum to continue. 

The summer schedule for airlines causes supply increase of 20 per cent.

 

Load factors, which have been 85-90 per cent on an average for major quarters in December and March quarters, are expected to be in the similar range going ahead. 

In fact, barring the September quarter, load factors have been on an upward trend for seven quarters in a row. 

The key worry, however, is over yields and the pricing discipline of operators. 

While yields were down for Jet Airways and Indigo, SpiceJet showed an improvement, considering the higher share of the more profitable regional routes. 

While most brokerages are bullish on the prospects of the sector against the backdrop of demands and efforts of operators to cut costs, investors should await clear trends on currency as well as crude oil prices before taking a position in this sector.