Aviation stocks: Clear skies, profitability still a question mark

Falling fuel costs and higher demand are huge positives but pricing indiscipline the biggest risk

Aviation stocks have been moving up on the back of a steep decline in crude oil prices, with Jet Airways gaining 50 per cent and SpiceJet gaining 27 in the last 10 trading sessions. With crude oil prices dropping 40 per cent from its peak and expected to be at these levels for some more time, aviation stocks, which are reeling from higher competition and operating losses, are expected to get some relief. Aviation turbine fuel (ATF) is the largest component of their cost basket, accounting for 39 per cent of Jet Airways sales and 54 per cent for SpiceJet in the September quarter. ATF prices were reduced by four per cent on November 30, 2014, taking the level of reduction of the fuel since August to 15 per cent.

Analysts believe a fall in fuel prices and aggressive promotions could lead to improving demand and higher load factors. This, coupled with lower fuel costs, should improve profitability. HSBC analysts believe a 10 per cent fall in fuel prices could not only improve demand but also earnings before interest, depreciation, amortisation and rentals by 12 per cent and 23 per cent for Jet Airways and SpiceJet, respectively, in FY16.

The other positive factor for the sector has been strong demand. Passenger volume growth has been healthy with nearly six million domestic passengers in October pushing up year-on-year growth to a strong 18 per cent. For the first 10 months of CY14, passenger growth is pegged at 8.6 per cent with average passengers flown per month being 5.5 million. This is poised to improve due to the ongoing busy season. The load factors, however, have seen a fall in October given the additional flights during the festive season.

However, the rupee, too, has to strengthen or at least stay around the current levels for the full benefit of the lower costs and higher demand to flow through to the companies. About 75 per cent of operating costs (fuel, rentals, maintenance, loans) are dollar-denominated and any weakness in the rupee will offset some of the gains from the fall in fuel prices.

While operational performance is likely to improve going ahead, most analysts are looking at improving metrics before upgrading the stocks and thus are in the wait-and-watch mode. The launch of services by new entrants, though, could act as an overhang.

Jet Airways

The stock is in demand thanks to falling fuel costs and a rating upgrade by ICRA on the company's Rs 3,210-crore loan facility. The company's turnaround strategy by FY17 is dependent on its ability to increase international presence and rationalise capacity. As part of the strategy, the firm has already discontinued Jetlite, its low-cost arm, and turned it into a complete full-service airline. While the company turned profitable in the September quarter owing to sale of frequent-flyer business, its operational performance, too, saw an improvement with revenue per passenger up six per cent and on lower costs, which were down five per cent. Lower interest costs (down 15 per cent year-on-year) added to its bottom line. Given the expectations that the share of higher-margin international operations will rise from 53 per cent to 60 per cent, how the company leverages its partnership with Etihad will hold key to improving metrics.

SpiceJet
The key concern for SpiceJet is funding of operations given its loan liability of Rs 1,500 crore and negative net worth of Rs 1,000 crore. While promoters have infused Rs 133 crore, it is inadequate given the Rs 400 crore of cash losses over the past six months. Rashesh Shah of ICICI Securities believes significant fund infusion is a must either through a strategic partner or through a promoter to take advantage of favourable operating environment. On the operational front, the firm managed to bring down its reported losses in the September 2014 quarter at Rs 310 crore by half, compared to the year-ago quarter. The year-on-year reduction in losses was aided by a 28 per cent rise in traffic and 10 per cent decrease in unit costs. However, the performance was below expectations as lower yields or revenue per passenger (down 10 per cent) offset some of the gains accruing to the company on account of lower fuel prices and strong rupee compared to last year.