Jet Airways: Shedding flab to compete

Cost reduction is positive and could translate into higher margins

The Jet Airways stock has gained 47 per cent over the past month and a half on expectations that the profit focus of the airline industry, cost savings programme outlined by the company, and international tie-ups would help improve revenues and profits. Though the September quarter (Q2) results were below expectations, brokerages such as Edelweiss Securities and ICICI Securities have upgraded the stock as they expect the cost management measures to improve margins.

The key trigger is the secular trend of high volume growth, which helped the sector grow at 20 per cent over the past four years and this is expected to continue. Analysts at HSBC forecast traffic growth at 14.5 per cent annually over the next four years. They expect this to be faster than capacity growth of 13.5 per cent, thus helping firm up airline yields of the sector. With improvement in yields, analysts at JP Morgan said crude oil risks, if prices remain around $60 a barrel, are manageable.

With its international operations underperforming due to demand and pricing pressures in the Gulf market, Jet is looking at augmenting its domestic fleet with the fuel-efficient Boeing 737-Max, starting June 2018. The company expects to get 25 deliveries by March 2020. This could be the right strategy as even in Q2, domestic passenger revenues increased 26 per cent, per unit revenues increased 2.6 per cent, but international revenues fell 1.5 per cent while unit revenues were down 8.4 per cent. In addition to a strategic partnership with Etihad Airways, enhanced code share with Air France-KLM would potentially lead to market share gain on international routes and improve international passenger load factors, said analysts at Edelweiss Securities. 

The other trigger is cost efficiencies from lower maintenance expenses, reduction in cost of sales and marketing and productivity improvements. The company, whose unit costs are 53 per cent higher than Indigo and 26 per cent more than SpiceJet, expects to reduce unit costs, excluding fuel, by 12-15 per cent from the current levels. The company expects to save up to Rs 3,000 crore over the next two years, which it will use to pare down part of its net debt of about Rs 8,000 crore. Operating margins before rental costs are expected to improve by 100 basis points to about 17 per cent in FY19.

While the steps are in the right direction, analysts at IDFC Securities say the firm’s leverage at 6.4 times net debt to operating profit is high with cash generation over FY18 and FY19 likely to fall short of scheduled debt repayments. Investors should await progress on the operational and debt reduction fronts before taking exposure to the stock.