InterGlobe stock to catch up: Premium valuation to continue, say analysts

Despite capacity issues and premium valuation, Street is postive on Indigo given its lower costs and strong balance sheet

The stock of InterGlobe Aviation, which operates the IndoGo airline, after lagging peers in the past, has gained 13 per cent in the last one month and  been hitting new 52-week highs recently. This is on expectation of strong double-digit growth in passenger traffic, gradual pick-up in capacity and improving yields, in line with the performance seen in the December 2017 quarter.

While demand is expected to be strong, the key factor for the Street is clarity on the resolution of the Pratt & Whitney (P&W) engine issues for the A320neo aircraft InterGlobe had procured; more of these are due for delivery. Delay in deliveries and the grounding of some of the existing A320neos was the key reason the stock underperformed peers over the past year. While Jet Airways and SpiceJet doubled, share price of InterGlobe grew 56 per cent.

While P&W has not given a timeline for resolution of the engine issue, Airbus has indicated its 2018 aircraft delivery target of 800 units remains on schedule. The uncertainty, however means deliveries could get delayed. Analysts at Kotak Institutional Equities, though, do not expect this issue to take long to resolve; they assume deliveries would resume over the next few months. They estimate IndiGo’s capacity growth at 21.7 per cent for FY19, on the back of stable deliveries of the Neo. Coupled with leased aircraft, this would make up for the shortfall in capacity addition during FY18. If the capacity addition comes through, the company can tap the ongoing strong demand growth more effeciently.

Traffic growth

Passenger traffic in January was up 20 per cent from a year before. This metric has grown in double-digit for 42 months. Passenger load factors (indicates capacity utilisation) have hit 89 per cent for the sector; InterGlobe’s is 89.7 per cent. As the strong growth trend is expected to continue, IndiGo, with a market share of just under 40 per cent, will look to again hit its peak of 43 per cent, achieved in October 2016. 

This uptick in demand should help the company and the sector improve its pricing and, thus, yields — a function of pricing and passenger traffic. In the December quarter, for example, yields were up six per cent and operating profit before rentals jumped 34 per cent over the year-ago period. This is despite the rise in crude oil prices, which puts pressure on unit costs.

Should investors buy?

While these are positive signs, should investors pay a premium for owning the InterGlobe Aviation stock? InterGlobe trades at a 10-15 per cent premium to Jet Airways and SpiceJet (based on FY19 estimates) and its market capitalisation at ~515 billion is thrice the combined one of the other two. Analysts justify some of the premium, given that InterGlobe’s unit costs are 15-26 per cent lower than listed players. This, they say, will be a major advantage if crude oil prices go through the roof. Given the competitive nature of the business, InterGlobe could be the last man standing. Also, high debt on others’ balance sheet (especially for Jet) means they would not have the flexibility to resort to aggressive pricing, says an analyst. 

The other factor that helps InterGlobe is its cash and cash equivalent of over ~100 billion, a fifth of it’s market cap. This will help tide over adverse periods. And, in periods of high growth, its capacity, which is more than thrice SpiceJet’s, should help reap the demand upside.

Given the 10-year record on profit, a strong balance sheet and a cost structure that is difficult to replicate any time soon by competitors, analysts expect the premium valuation to continue and the stock to outperform.