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Airlines – Please fasten your seat belts

Aviation stocks in India have taken off, virtually. What with the way the stock prices have returned in the recent past: Jet Airways up 100% in the last 6 months, SpiceJet  up 400% in the last 9 months & Interglobe Aviation posting huge listing gains over the last 2 months (up 80% at the peak)!!!

So what exactly led to these huge stock gains in the last couple of months? Was this move envisaged by ‘smart investors’ (I’m taking the liberty to tag institutional investors, as a whole, as smart investors)? The huge fall in crude price over the last couple of months and a rise in passenger traffic are primary reasons cited for the gain in stock prices; the logic being – a sharp fall in crude price eases input costs (aviation turbine fuel) for these carriers thereby expanding margins. Point taken. But, is this the 1st time that input costs have eased? Did airlines make money historically during a soft crude regime?

Air traffic has been consistently growing in India. So I don’t see much merit in that argument. Hereunder are 2 charts that plot ATF prices (IOC prices, ex Mumbai, in US$ terms) and OPMs of the 2 Indian carriers that have a history of listing. While ATF prices and margins tend to exhibit some correlation, it lacks consistency in any direct and proportionate correlation.

To check if a fall in crude price determines the direction of stock prices, we plot the 2 (as hereunder). A look at these charts indicate that stock prices have crashed in a declining ATF regime as well and vice versa in the previous cycle. So no direct indication here as well.

If no direct and proportional correlation was observed historically on the above parameters, then what exactly has changed (for the better) for the stocks to return so handsomely?

Nothing, except sentiments…in my assessment. An impending over-hyped IPO befitting the definition of an IPO (It’s Probably Overpriced J), lack of new ‘exciting themes’ in the market & stock purchases by some very respected names may have triggered this sentiment change. Everyone seems to be happy, at least for now. 🙂

However, I personally fail to see structural changes in the industry that merit these stocks to find a place in a core investment portfolio. Hence I see these stocks purely as ‘trades’. Here’s why:

  • Lack of customer loyalty – the Indian consumer continues to be highly price sensitive and is brand agnostic. A slightly lower price point entices a consumer to shift loyalties. This also implies a lack of pricing power with airlines.
  • Competitive intensity – relatively low, as implied currently with the exit of Kingfisher, Air Sahara, Air Deccan etc. But newer players like Air Vistara and AirAsia India have marked their entry. The Indian consumer has witnessed the demise of many an airline (Damania Airways, East West Airlines, Paramount, ModiLuft etc) in the past, temporarily easing competitive pressures. Strangely enuf, surviving players have failed to demonstrate any consistent track record of reporting profitability.
  • Bargaining power with stakeholders – Low. Regulatory bodies (airport charges, not in airline control), aircraft providers (duopoly market and timely delivery not in airline control), fuel suppliers (not in airline control), customers (lack loyalty) & employees are some of the key stake holders’ airlines need to deal with and lack sufficient bargaining power with.

Last but not the least, a look at shareholding pattern in both the stocks over the last 3 quarters don’t reveal any significant pointers. As seen in the stock charts over the last one year, most of the stock spike occurred post Oct ’15 with a serious increase in traded volumes. However, this was not followed by any meaningful change in the shares held by the ‘smart investors’ (institutional holders)!

 

All of the above, backed by the fact that crude trades at a 10 yr low (sub $30 per bbl) as I write this update make me cautious on this sector. The best ‘could’ be behind us, who knows. I had come across enough reports predicting crude spikes beyond $200 per bbl earlier (2008), citing logical reasoning behind their predictions. Likewise we are now flooded with predictions of crude plunging sub $20/$30 per bbl, obviously having their own rationale to justify their call. Like with most commodities, forecasters can only be reactive with their explanations to justify the move. While I am no expert myself to give any predictions on crude, I am inclined to believe that crude prices could revert to the mean sooner than later. When exactly, I have NO clue. Like any other commodity, it has tendencies to build excesses in both the directions, up or down. So, what happens IF crude prices start reverting to the mean? Explanations could surface later, but stocks could start correcting first…and fast.

So dance hard till the party is on. But, be prepared to step out the moment music stops.

These is my personal opinion. Happy to hear from you and learn.

Cheers!!!

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