Weak fundamentals, high valuation: Is it time to sell IndiGo, SpiceJet?

It has mostly been a one-way street over the past one month for aviation stocks such as SpiceJet and InterGlobe Aviation (IndiGo) as a gush of liquidity drove investors towards equities. That apart, some investors have been lapping up these stocks in the hope that the government's 'unlock' of the economy and the possibility of a vaccine over the next few months will push people to travel more.

The stock of SpiceJet, for instance, has soared 80 per cent in the past month, from a level of Rs 49.6 apiece on the BSE (on closing basis) to Rs 89.3 on December 4. The stock extended its rally and gained another 5 per cent to hit a high of Rs 94.15 per share on the BSE on Monday.

IndiGo, which hit a fresh 52-week high of Rs 1,768 on the BSE in the intra-day deals today, has gained 33 per cent. In comparison, the S&P BSE Sensex has advanced around 14 per cent during the period.

Other aviation stocks such as Global Vectra, Hindustan Aeronautics, Jet Airways, and Taneja Aerospace are up in the range of 7 per cent and 25 per cent during the period, ACE Equity data show.  

The party in the aviation space began early November, when US-based Pfizer Inc said its experimental Covid-19 vaccine was more than 90 per cent effective based on initial trial results, giving hopes that global economies may soon return to normalcy. Soon after, Moderna Inc, AxtraZeneca-Oxford, and Sputnik V released efficacy data, each claiming over 90 per cent efficacy rate.

"After cost-cutting and sufficient liquidity, both IndiGo and SpiceJet are better placed to benefit from the complete unlock and resumption of flights. As long as we don't have a resurgence of Covid and consequent lockdown, the situation should improve quickly and materially," says Vinit Bolinjkar, head of research at Ventura Securities.

Ajit Mishra, VP- research at Reliage Broking, meanwhile, says that the upcoming holiday season (Nov-Dec) may boost leisure travel, even as demand and revenue would be lower as compared to last year. All these factors, he says, are helping the aviation stocks to inch higher.

Fundamentals cracking?

Ambareesh Baliga, an independent market analyst, too, believes that the short-term sentiment has turned positive, which is driving these stocks. That said, he does caution against the overall market valuation and especially of these aviation stocks.

"Fundamentally, airlines aren't doing well. Costs have gone up on account of capped fares, high crude oil prices, and limited capacity. That apart, Covid-19 related restrictions or mandatory coronavirus tests before flying has hit the passenger traffic. Therefore, while the stocks are soaring due to the overall momentum, the valuations are extremely expensive," Baliga said.

A recent report by ICRA pegged airlines' losses at Rs 21,000 crore in fiscal 2020-21 (FY21) as against a net loss of Rs 12,700 crore reported in FY20, impacted by lower revenue and higher costs.

"FIIs are pumped in nearly Rs 18,005 crore so far in December. This comes after a record flow of Rs 62,782 crore in November… In effect, valuations are now distorted for aviation stocks and it is time for the investors to be cautious," G Chokkalingam, founder and chief investment officer of Equinomics Research says.

Time to exit?

Given the steep rally and no fresh triggers, analysts suggest investors book profits as markets are entering overbought territory.

Baliga, for instance, suggests new investors avoid buying aviation stocks, while long-term investors should book profits as prices have risen sharply.

Foreign research and brokerage Citi recently downgraded IndiGo to 'Sell', as it feels the stock’s rally adequately prices in the gradual improvement in domestic air traffic but ignores the competitors’ ramp-up (albeit slow), weak pricing environment, and uncertainty about the sustainability of strong Q2 drivers.

"Stocks of IndiGo and SpiceJet have seen a considerable run-up in the last month owing to the positive development on the vaccine front and easing restrictions on capacity. Further, pick up in passenger traffic has also been positive for the industry. Nonetheless, we feel the risk-reward isn't favorable for investors and valuations are expensive, and the sector itself is highly cyclical and has a huge dependence on crude oil prices. We thus would recommend avoiding fresh buying at current levels and wait for some correction. Existing investors may book partial profits and reenter once we see some moderation in the stock prices," says Mishra of Religare Broking.