Airline stocks heading for higher altitude

Robust passenger growth traffic in Feb, weakening dollar and lower crude oil prices are reasons

Aviation stocks shot up between 4.5 per cent and11 per cent on Thursday on tailwinds that include robust passenger growth traffic in February month, a weakening dollar and lower crude oil prices. Fuel, maintenance, lease costs are dollar denominated and any weakness in the greenback versus the rupee benefits airlines. The benign cost environment, according to ICICI Securities, has received fresh impetus with crude oil and dollar declining by 10 per cent and 4 per cent, respectively so far in 2017.

Ansuman Deb of ICICI Securities believes that currency is the biggest variable in earnings sensitivity for airlines and sustained strengthening of the rupee will lead to earnings upgrades in this space. The favourable impact would be visible in the March quarter results which is expected to come in better than initial estimates. Mayur Milak of Anand Rathi Research believes that with yields (average fare paid per mile by passengers) improving and declining crude oil prices (on rupee strength), March quarter earnings is expected to exceed the traditionally stronger third quarter.

While lower costs are important, the key parameter for the sector is passenger growth. For February, this grew by 15.8 per cent year-on-year but adjusted for the leap year in February 2016, the adjusted traffic growth would be about 19.2 per cent. Though this is lower than 20 per cent plus growth recorded over the last few quarters, it still denotes strong passenger demand. Moreover, supply of new aircraft continues to lag behind demand now for nine consecutive months. What could add to the demand for airlines is the plan by Indian Railways to extend its dynamic pricing system (about 40 per cent higher than rail base fares) to all routes in the railway network. Analysts at Kotak Institutional Equities believe that widespread use of dynamic pricing by railways could be a tailwind for airlines as they gain from higher yields or from a shift of rail passengers to air, depending on competition.

Given the positive signals, most analysts continue to keep market leader Indigo as their top pick as lower costs and higher yields are expected to rub off favourably on the company's earnings. Brokerages have a target price between Rs 1,000 and Rs 1,400 while the target set for SpiceJet is as high as Rs 150. Given the run up in both the stocks, investors could await a good entry point. Most analysts are neutral on Jet.