Airlines – stocks to continue losing altitude?

This is a follow up our previous post on this industry (as hereunder)

After a quick take off, getting investors excited, airline stocks suddenly seem to have hit an air pocket! What with airline stocks correcting over the last 6 months; SpiceJet down by a whopping 33%, InterGlobe Aviation (Indigo) down by 15% & Jet down by 14%. And this is at a time when the NIFTY has returned ~20%! Wow.

Aha! ‘changing sector dynamics’ apparently is being blamed for this southward journey. Initial arguments of sustained margin benefits stoked by low crude prices seems to have been challenged. Slowly, but steadily, views have started to change about the sector prospects.

InterGlobe RecoSpieJet Reco

The number of analysts recommending a hold/sell on InterGlobe Aviation has increased from 6 to 9 in the last 30 days. And this number has gone up from 1 to 3 in the case of SpiceJet, in the last 3 months.

Traffic growth continues to be healthy, no doubt (as acknowledged in my note). However, aggressive capacity addition and increasing crude prices pose a threat for margins.

Look at what some of the analysts tracking InterGlobe Aviation have to say:

JP Morgan – While passenger traffic growth is healthy (at 20%), competitive pressures are affecting profitability as the EBITDAR margins fell by 400bp y/y in the recent quarter. As load factors declined for Indigo in June (to 77.9%), management highlighted that it would reconsider its pricing strategy. We thus believe that the weaker pricing environment is likely to continue in the near term, which would partially offset the benefits from healthy air traffic growth. We are lowering our earnings estimates by ~15% over FY17/18 to factor in the rising pressure on profitability. We set a revised Mar-17 PT of Rs900 as we now value the business at 8.5x EV/ EBITDAR (compared to 9x earlier) to factor in the changing sector dynamics.

Morgan Stanley – In F1Q17 IndiGo posted 20% passenger growth with 83% PLF, yet its yield vs. cost spread narrowed – thus reflecting that pricing is weakening. IndiGo added 25% ASKM (available seat kilometers, measure of capacity) growth in F1Q17 and intends to add 37% in remaining three quarters of F17. Such aggressive capacity additions would further put pressure on yields. Overall, we view record-high margins as less sustainable now. Aggressive capacity addition and rising crude prices (jet fuel prices are up 9% for July + August 2016 vs. F1Q17) pose downside risk to margins. We broadly maintain earnings estimates, lowering EBITDAR margin assumptions but also lowering lease costs. Our price target goes down 22% to a Street-low (according to Bloomberg) as we lower our target EV/EBITDAR multiple to 7x for F18e (from 8x).

Motilal Oswal – We are disappointed by the yield pressure in the backdrop of continued high industry load factors. RASK decline of INR 0.54 YoY is more than fuel cost per ASK decline of INR 0.25 YoY, implying competitive pressure. Though Indigo continues to be the most cost efficient low-cost player, consistent fleet induction could further suppress load factors and yields, in our view, in the near term. We cut our FY17 / FY18 EPS by ~7% primarily led by ~2% cut in our yield assumptions as we believe that Indigo’s new stance to respond actively to competitor’s pricing could result in sacrificing profitability in the near term.

Whether aviation stocks are merely hitting air pockets or will continue to lose altitude, only time will tell. I fail to see structural changes in the industry that merit these stocks to find a place in a core investment portfolio, as yet.

Happy to hear your views.


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