Downgrading Indigo

Indigo, despite its apparent problems, is an India consumer play

Immediately after Indigo Airlines announced its fourth quarter results, there was a flurry of downgrades coming from brokers. The reasons are not far to seek. Higher oil prices were pushing up the costs and competition was pulling down their pricing power. Most brokers do not see any immediate respite for Indigo and that is what has driven these downgrades. Are these downgrades justified or do lower prices make a case for buying aviation stocks?

Financials weaken

For the quarter ended March 2018, Indigo saw some real pressure on financials. With Brent Crude at $74/bbl, there was pressure on the cost front as the price of Aviation Turbine Fuel (ATF) accounts for more than 60% of the operating cost of an airline. Then there is competition. Jet, Spice Jet, Go Air, Indigo and a resurgent Air India are fighting for the Indian aviation market. While the market has been growing at 18-20% annualized, the intense competition is surely putting pressure on the pricing power of aviation companies. That is also reflected in the fourth quarter results. Indigo’s PAT was down by 75% in the fourth quarter even as the Revenue per average seat kilometer (RASK) declined by 3.2%. In fact, the RASK came in at Rs.3.40 as against the consensus estimate of Rs.3.70. Despite the 25% rise in passenger traffic, losses for Indigo could continue to mount from the current levels.

Fuel and competition

This will be the two-factor model that will determine the performance of Indigo Airlines going ahead. Brent Crude at $74/bbl is already sharply higher over the last 1 year. At least, till the time the Saudi Aramco IPO is completed, it is estimated that crude prices will stay in the range of $70-$80/bbl. That means cost of ATF will also remain at elevated levels unless the US manages to flood the market with oil supplies. The bigger challenge is on the pricing front. While domestic aviation market is growing at 25%, there appears to be a loss-leader strategy among the participants to grab a larger chunk of the aviation market. That is evident from the way the RASK of Indigo has fallen in the recent quarter. The tightening spread between RASK and CASK is not good news.

Take a long term view

It may still be too early for the Cassandra to come calling. The oil market will still be oversupplied if the demand does not gather steam. The new normal in crude oil may still be around $60/bbl and that should suit aviation companies. The bigger advantage will be the vast potential for flying in India. It is an under-penetrated aviation market and could soon emerge as a lucrative consumer proposition for investors. Even valuations are now attractive. If you have a long term view, you could still find value! ©

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