Despite rebound, airline stocks to underperform; investors advised caution

Even as costs are lower, demand weakness likely to keep airlines in the red for most of FY21

Aviation stocks SpiceJet and InterGlobe Aviation (IndiGo) have rebounded 8-23 per cent since their lows in March. The gains came on the back of a market rally, expectations of a relief package by the government, falling crude oil prices, and renegotiation of lease rentals. Investors, however, should be cautious, given a weak outlook for FY21 and higher fixed-cost structure of the airline industry. 

Recently, global aviation consultant CAPA indicated that domestic passenger volume could fall by 40 per cent in FY21 to 80-90 million, with a similar fall in international passenger traffic to 35-40 million. The consultancy also expects load factors to be at 50-60 per cent, given social distancing norms, empty middle seats, and an aversion to flying. Normalcy is not expected to return till the March quarter of FY21. 

While social distancing norms and half-empty planes will make it difficult for airlines, the sharply lower crude oil prices, deferrals of lease rentals for 3-6 months, lower maintenance and marketing costs (13 per cent of operating cost) could help in achieving break-even. 

 

 

Analysts at Credit Suisse say crude oil prices have lowered the variable cost of flying, and airlines can aim to fly with a 50 per cent load factor and start making a contribution towards covering its fixed costs at 10 per cent lower fares than in FY20. Given lower demand, the ability of airlines to maintain pricing discipline needs to be monitored. Further, given the limitation on seats that can be occupied and social distancing norms, smaller planes connecting regional routes may not be unviable, which could impact SpiceJet more than other airlines. 

Most brokerages believe that IndiGo is in a better position than SpiceJet. They expect aircraft lessors to give favourable terms to better-funded airlines. Further, IndiGo could gain market share if there is further consolidation, while benefiting from the pricing discipline that is likely, given the weak balance sheets of competitors. 

While lower costs help, the revival of demand is key for the financial health of the sector. Even for IndiGo, Credit Suisse expects losses at the profit before tax level till the third quarter of FY21 and minor profit in Q4FY21. Investors should await clarity on the resumption of travel and demand trends before considering an investment.