Smooth landing?

SPECIAL REPORT

Although the aviation industry is looking up post-consolidation, investors should either adopt a wait and watch approach or invest keeping a minimum three year perspective.

If you are an air traveller, then brace yourself up to pay more for the air fares as they are expected to rise, thanks to the recent spate of consolidation moves with the most recent one being the buy-out of Air Deccan's majority stake by Kingfisher Airlines.

But if you invest in the stock market too, then sooner than later you may recoup much more than the incremental ticket cost by profiting from aviation stocks. The sector is looking up, finally. Some analysts feel that companies, which have been bleeding for a long time, will start making profits.

Says Rajiv Anand, head of investments, Standard Chartered Mutual Fund, "Consolidation in the aviation industry is positive as this will bring forward the break-even period of companies which are expanding their fleet." However investors need to take at least a three year perspective as companies are unlikely to give phenomenal returns in the short term. 

LOSS TO PROFIT
	Jet Airways  (March ending)			Spicejet  (March ending)			Deccan Aviation (June ending)
Rs crore	TTM*	FY08E	FY09E	TTM#	FY08E	FY09E	TTM@	FY08E	FY09E
Net sales	6822	11289.5	13481	719	1813.5	2725	1669	2738.5	3750
OP	263	1072.9	1434	-157	-23	-81	-660	-312	-275
Net profit	-200.4	165	277.5	-116	84.2	140	-356.4	-163.15	15
Source: Brokerage reports * Trailing 12 month ended December 2006; # Trailing 12 month ended February 2007;  @ Trailing 12 month ended March 2007

The flight of players
In less than three months, the Indian aviation industry has seen a rapid transition in the number of players. From being a fragmented industry with ten players competing neck-to-neck with each other, now the industry is left with only three big players.

While the long awaited merger of Air India and Indian Airlines has been given a green signal, consolidation has spread out to cover even private players. After the Jet-Sahara merger, the recent one to join the bandwagon is Kingfisher Airlines, which bought a 26 per cent stake in the biggest domestic low cost carrier Air Deccan (for more details, refer to box: Safe exit). Paramount Airways, a smaller regional player, is also said to be interested in buying out the Wadia-owned Go Air, which too is a national low-cost carrier.

This consolidation was much needed. Says Captain Gopinath, now the executive chairman, Deccan Aviation, "For the aviation sector the only way forward is by making profit, for which the key is consolidation."

Till date, not only the low cost carriers but also full service airlines were facing a double whammy of declining realisations (read reduced air ticket prices) initiated by Air Deccan on the one hand and increasing prices of air turbine fuel (ATF) on the other. As a result, companies' financials were deep in the red.

For example, Air Deccan made a huge loss of Rs 356 crore for the trailing 12-month period ended March 2007. Even as smaller player like Spicejet made losses of whopping Rs 116 crore. The only exception has been Jet Airways which has made some profits, thanks to its international operations.

Soon, things are likely to change for the better. According to the spokesperson for a leading domestic air carrier, air fares are expected to rise as companies cannot afford to bleed anymore. Adds Sidharth Agrawal, analyst, IL&FS Investmart, "Air tickets are set to rise an average 5-7 per cent over the next few months excluding the effect of monsoon when prices tend to be low because of off-season."

Although, ATF price is stable at around $37-38 a litre, it is higher compared to international prices of about $22. But if the government's proposal of allowing imports of ATF directly holds true, this will be a big boon to the industry. Moreover, the overall costs will come down due to better synergies in operations and infrastructure.

Though there are some concerns that continuing fleet additions by most players may lead to a situation of supply outstripping demand -- supply is expected to grow at 22-25 per cent while passenger traffic is expected to grow at 20 per cent -- with fewer players in the fray, competition will be healthier.

So far, the low cost carriers have been offering prices much below their operating cost and in the process losing about Rs 250 per ticket on an average. Now there is a strong possibility that the key players will get together and raise prices.

For example, Air Deccan has already re-introduced Rs 150 per passenger congestion surcharge from June 5. Besides, the average load factor in the industry is currently about 72-75 per cent but is expected to decline marginally in the short term because of new route additions. Again, this is not worrying because the seats are likely to get absorbed sooner than later.

Do all these guarantee profits? Probably not. Not all the companies will come back to black in the short term. For example, Sachin Neema, head of research, India Infoline is adopting a wait and watch approach as he fears that the three-way competition will still continue.

So, will stocks take off?
If one looks beyond six months, the outlook is positive as airlines will not be fighting as intensely as earlier and their yields are expected to improve too. However they are unlikely to give phenomenal returns in the short term. A leading broking firm expects one year return of over 20 per cent and 40 per cent on Jet Airways and Spicejet respectively over its current market price. Deccan Aviation is likely to perform in line with the market. 

SKY IS THE LIMIT
Fleet expansion plan	FY07	FY08E	FY09E	FY10	FY11	CAGR
Jet Airways*	61	79	86	92	97	12.3
Deccan aviation	40	51	64	75	85	20.7
Spicejet	11	19	23	27	30	28.5
Pass trafiic (mn)	33	39.6	47.52	57.02	68.42	20
*Excluding  Sahara Source: Company and Industry

After being beaten down heavily by the market due to the negative sentiment surrounding the aviation sector and the outpriced Air Sahara buy-out deal particularly, Jet Airways is on the radar of analysts once again.

The improving domestic scenario and its successful international operations are the main reasons. Jet's overall domestic yields are expected to improve with the inclusion of Sahara's low cost carriers and cost savings due to the latter's infrastructural rights and other facilities. The company's success at its international operations provides a key trigger to the stock price as it spreads its wings to other routes. 

THE BIG DEALS
Acquirer	Acquired	Date	Number of Air crafts	Deal value (Rs Cr)	% stake
Indian Airlines	Air India	Mar-07	112	"�	"�
Jet Airways	Air sahara	Apr-07	80	1450	100
Kingfisher Airlines	Air Deccan	Jun-07	71	546	26*
* Open offer for another 20 per cent due

Analysts expect over 30 per cent growth in revenues over the next two years and profits are expected to jump manifold from a trailing 12-month loss of Rs 200 crore in FY07 to an estimated profit of Rs 165 crore and Rs 277 crore in FY08 and FY09 respectively. The stock trades at about 50 times FY08 estimated earnings which may look high, however, on FY09 basis, it trades at an attractive valuation of 18 times.

As for the low cost carrier Spicejet, analysts expect the company to break-even in FY08 itself due to improving yields and better load factor. The airline operates at a load factor of over 80 per cent, one of the highest in the industry, thanks to its adherence to the typical low cost carrier model and standardised fleet having low engineering, maintenance, inventory and crew costs. The company trades at a reasonable valuation of about 12 times FY09 estimated earnings. While revenues are expected to grow over 50 per cent, the company is expected to report profits in FY08.

Says Agrawal of IL&FS, "Investors should invest in these stocks with a minimum three years perspective as every fledgling industry like aviation in India takes time to mature." He believes that over the next four-five years, Indian aviation sector is likely to replicate the phenomenal metamorphosis witnessed in the telecom sector.

Safe exit

The Deccan Aviation stock has gained nearly 30 per cent over the past one month largely owing to the buzz over rival Vijay Mallya's Kingfisher Airline acquiring a controlling stake. After buying a 26 per cent stake in the country's largest low cost carrier for Rs 546 crore, Mallya-owned UB Holdings is readying to launch an open offer to acquire an additional 20 per cent stake in the company at Rs 155.

The marriage seems ideal because Deccan Aviation was in dire need for cash while Kingfisher Airlines was eyeing to partner a low-cost carrier to take on its key competitor Jet Airways which is expected to re-launch Sahara Airlines, acquired a couple of months ago, as a low cost carrier called JetLite. While this acquisition is bound to spark head-on collisions in the sky, Deccan can hope to fund its expansion quite comfortably.

However, "the recent run-up in Deccan's the stock price lacks fundamental support," says Agrawal of IL&FS. Considering the recent rise in the stock price which is currently trading at a nine per cent discount to the open offer price, it may be a good idea to grab the open offer.

Fuelled by its aggressive pricing strategy, Deccan has achieved ferocious growth to become the second largest domestic airline in the country but this has come at the cost of profits. Over the past year, the airline recorded 32 per cent growth in the number of passengers flown and 40 per cent increase in number of flights to 350 flights a day.

Currently, it operates at a load factor (the number of seats an airline as to sell in order to cover operating expenses) of 85 per cent, but it does not have the power to pass on its rising costs on various fronts to passengers without fearing a fall in the number of travellers.

The going should be good going forward with Kingfisher-Air Deccan combine expected to save around Rs 300 crore in the first year of operation. "There would be savings from route rationalisation, maintenance and sharing of resources such as manpower, parking bays and ground handling facilities," claims Agrawal.

Air Deccan's fares are also expected to rise, owing to the consolidation in the industry. "But the turnaround may take a year to show results, and profits are expected to flow in only from FY09," says Surbhi Chawla of Angel Broking. For now, it appears wise to make an exit from the counter at Rs 155 and buy at a lower level when the market corrects.

Deccan's open offer commences on July 25 and closes on August 13.

Niren Shah