Delay in Neo delivery to hurt IndiGo

Market worry pushes stock down nearly 6% on concern about future earnings, margins

The induction of A320 Neos into the fast expanding fleet of IndiGo is seen as a game changer for India’s largest commercial airliner. With the company now stating the induction has been delayed because of ‘industrial reasons’, it has left markets worried. Given the gains the Neos are supposed to bring to the company, it is little surprise that the market is worried. IndiGo scrip was down 5.6 per cent on Monday at Rs 1,079.25 a share on the BSE following the company’s statement to stock exchanges on Saturday.

The company’s statement said, “On December 17 (Thursday) after close of business hours, we received an official notification from Airbus that the A320 Neo aircraft, the first of which was to be delivered on December 30 has been delayed due to ‘industrial reasons’.” What has added to the worry is the uncertainty on delivery timelines. “At this time, IndiGo does not have a clear visibility of its future delivery schedule and the potential for additional delays,” the company said. The only solace is that IndiGo’s management is looking at mitigating the potential shortfall in capacity through other options.

It is surprising this information was shared only on Saturday, even as this was known to the company on Thursday and given the financial implications for it.

IndiGo stock, which closed between Rs 1,184.5 and Rs 1,190.5 on Tuesday, Wednesday and Thursday, fell to Rs 1,142.5 on Friday. Over two days (December 18 and 21), the stock has lost nine per cent.

The market’s worry is justified, even as some analysts are finding it difficult to estimate the potential impact in the absence of a timeline. In August this year, IndiGo had placed an order for 250 Neos with Airbus, a deal estimated at $25 billion (Rs 1.65 lakh crore).

A recent report by Motilal Oswal Securities (MOSL) dated December 10, nevertheless, gives a good indication of the possible implications.

IndiGo already has the lowest fuel costs among Indian airliners. With the A320 Neo (new engine option), this advantage was expected to widen. These aircraft are about 15 per cent more fuel efficient, and can carry 186 passengers compared to 180 in case of A320s.

In their report, Harshad Borawake and Rajat Agarwal of MOSL had said, “IndiGo is one of the early launch customers for A320 Neo and will start getting deliveries in the current financial year. We estimate the A320 Neo’s share to reach 33 per cent by financial year 2018 and give a significant lead over its competitors as lower fuel cost will help it keep ticket prices lower.”

They said, typically, fuel is the largest cost element of an airline, 40-50 per cent of total costs. IndiGo already has among the lowest fuel costs in India. Induction of A320 Neos in its fleet will result in a further 10-15 per cent in fuel cost savings.

Additionally, A320 Neos have similar sub-systems as A320s, a major part of IndiGo’s fleet of around 100 aircraft. This would help keep a tab on maintenance costs, as the company will not have to deploy different maintenance providers or maintain spare parts inventories. With Boeing and Airbus’ order books full until 2020, IndiGo’s competitors will not be able to enjoy the same advantages by ordering new aircraft, said analysts.

According to MOSL estimates, IndiGo, which had 94 A320s in FY15, was expected to see its fleet size increase to 111 in FY16, of which nine would be A320 Neos. However, in FY17, out of the fleet of 134, there would be 32 Neos (some other analysts had pegged it at 25-26) increasing to 52 in FY18 in a fleet size of 154. The improvement in fuel consumption was pegged at one per cent for FY16, rising to four per cent in FY17, and to five per cent in FY18.

The delay in Neos’ induction is likely to impact revenue per aircraft and simultaneously mean higher costs to achieve similar growth rates (assuming Neos were inducted).

While the impact for FY16 might not be significant in terms of potential loss in cost savings (assuming IndiGo is able to lease out required capacity, enabling it to sustain growth rates), there could be a visible impact for FY17 and FY18. An analyst with a domestic brokerage said the impact on top line growth would be about two percentage points, whereas it would be 200-300 basis points on the earnings before interest, taxes, depreciation and amortisation. All this assumes that IndiGo will be able to induct aircraft as good as its existing fleet of A320s, which analysts believe will be difficult.