Global aviation stocks have been flying high as positive news of Pfizer’s Covid-19 vaccine fuelled hopes of a rebound in air traffic. Among the top-10 listed airlines globally, IndiGo is leading the charge as one of two large airlines with higher market cap than this time last year.
Share prices of InterGlobe Aviation not only touched its 52-week high but is also comfortably trading above pre-Covid levels. We took a look to see what it means for current and potential investors.
Indigo (Interglobe Aviation) stock has gained the most since last year compared to global airlines. Indigo is followed by the European low-cost airline Ryanair.
The rally in share price is on the back of:
- peaking of the pandemic situation in India,
- improving trends in daily traffic,
- market share gains, and
- positive developments related to Covid vaccine
However, what investors are overlooking:
- Air traffic is still less than half of last year,
- Airfares are low,
- PLFs are still low,
- Competitive intensity is and will remain high,
- Covid cases rising at a lower rate, but still rising,
- Cut in corporate travel, and
- Macro environment remains challenging
Peaking Pandemic
India’s Covid-19 hit a record peak in the middle of September when it reported more than a million active cases. Since then the number of daily cases has been steadily declining. A group of India’s top scientists believes that the pandemic can be controlled by February next year. However, before that, there could be a second wave of infections if caution is thrown to the wind during the festival season.
All such models assume the obvious: people will wear masks, avoid large gatherings, maintain social distancing, and wash hands. The fear of boarding a cylindrical box packed with too many people is going to keep peak occupancy away till such time as a vaccine is administered to most of the population – which will take time.
Daily Air Traffic
According to the data provided on the DGCA website, air traffic in India has been on an increasing trend. The average number of daily passengers flying has jumped nearly three times in the last six months.
Vaccine Hopes
IndiGo’s share prices joined a global rally as vaccine results fuelled optimism of an exit from the pandemic. Indian shares rallied to a record in the ceremonial evening session to mark Diwali on the hopes of vaccine and as earnings of some of the country’s biggest companies bolstered optimism for a faster economic recovery.
India’s key equity indexes have risen about 10% since last Diwali even as consumption was quashed by the world’s biggest lockdown, aimed at quelling the virus.
Market Share Gains
According to the data from the Directorate General of Civil Aviation, there has been some shift in the airline market share in favour of IndiGo. This is because smaller players – Vistara, AirAsia, and GoAir – are flying less in an effort to conserve cash. Also, there is no pressure from airports for slots utilisation.
Overlooked Downsides
Though the air traffic in India is rising, it is still half of what it was last year. In November 2020, so far on average, the daily air traffic has been close to 1.9 lakh, as compared to 4.3 lakh last year.
IndiGo’s valuations seem to overlook this fact.
The recent rise in air traffic could be on the back of low-ticket prices, more capacity being deployed and the onset of the festive season in India. Air ticket prices in India over the last two months also reflect the structurally low demand. Ticket prices in 12 major routes in India have either remained unchanged or have fallen in the last month.
Even during the festive season, with more people flying, the ticket prices have remained largely unchanged.
The growth in air traffic is also led by more capacity being deployed. The number of departures per day has increased by 10% in November compared to last month, while the average number of fliers per departure has increased by 3%. Compared to June, average daily departures have jumped 2.4 times, while fliers per departure have increased by only 1.2 times.
This growth in air traffic led by more capacity being deployed has largely led to a fall in the passenger load factor – capacity utilisation – for airlines in India.
Thus, the industry dynamics, have changed from higher and/or stable utilisation and ticket prices and growing air traffic, to lower utilisation and ticket prices and growing air traffic. The downtrend of two out of three factors, which generally lead to a strong financial performance for an airline, is been overlooked by IndiGo’s current valuations.
At the start of the pandemic, the market was expecting consolidation in the aviation industry, due to the weak liquidity conditions of few airlines in India. However, nothing has changed even eight months into a pandemic. There has been some shift in market shares but that looks temporary.
It seems as if IndiGo’s investors have placed their bets on the possible benefit to IndiGo from consolidation in the industry. Smaller and weaker carriers have sustained the pandemic by implementing stringent cost-saving measures and by negotiations with suppliers for a reduction in rentals to preserve liquidity.
SpiceJet which seemed to be one of the most vulnerable airlines with an anaemic balance sheet has sustained by deferring vendor payments, cutting costs and focusing more on its cargo business where demand has been much stronger than usual. Going forward, the company is expected to get stronger as 737 Max returns to operations. SpiceJet should start getting incentives for every aircraft as part of the sales and leaseback agreement of its 737 Max aircraft order.
With potential compensation from Boeing and cash incentives with every aircraft, the company might get the required liquidity to stay afloat and to improve its balance sheet. The return of 737 Max would also improve its cost structure.
Among the other players, GoAir with its new leadership team is striving hard to get its pre-covid level of market share. The company has been able to grow its market share from 3.8% to 6.7% as of September.
The Air India Stake Sale
Air India on the other hand, has been running its operations smoothly with a 10% domestic market share, even as the Government of India is struggling to find a buyer for the same. A successful sale would turn fat into muscle, increasing competition for incumbents, while a ‘no-sale’ is most likely to mean continued government support, in line with other loss-making PSUs.
The government has been trying to sell Air India for the past few years. Previously, when the government tried to sell Air India, the terms and the shape in which the government wanted to sell Air India were not sufficiently attractive to any of the potential buyers. Hence the government has sweetened the deal this time and has decided to be more flexible with the terms.
Tata Group partially owns and runs two airlines – AirAsia and Vistara – in India. Both these airlines have been able to regain most of their market share. The Malaysian promoter of AirAsia has indicated that it could exit India owing to financial distress. However, the Tata Group is in discussions to buy the stake. On the other hand, Vistara – which is jointly owned by Tata and Singapore Airlines – is looking to expand its operations by possibly acquiring Air India, according to media reports.
This indicates that the consolidation event in the Indian aviation industry is unlikely. In fact the competitive intensity could rise if demand growth continues to lag the supply growth.
Again, the valuations of IndiGo seem to overlook this concern.
Risks to this Valuation
Covid-19 in India might have peaked, and the number of daily cases has been declining steadily, but the total number of cases and deaths have still been rising. This has restricted flyers from flying. Moreover, with the ongoing festive season, the number of infections could well rise to go ahead. Kerala, for instance, recorded a sharp uptick in cases in September following celebrations of Onam, a harvest festival.
Delhi has been witnessing a sudden spike in coronavirus disease cases since October 28 due to the festive season, the opening of essential services, and allowing the movement of people. This phenomenon, if witnessed across different states, could push the Indian Government towards a second lockdown.
Even globally, many nations have announced a second lockdown as a new wave of infections sweeps through their nations. This means that the uncertainty around normalcy of international travel still persists.
Along with this, commentary from corporates suggests that travel is one of the cost lines that may get cut on a sustainable basis. This implies that business travel – half of the total domestic travel – may take much longer to recover. Thus, the continued rise in Covid-19 cases makes it difficult to pinpoint when normalcy would return.
And these concerns to have been ignored by IndiGo’s current valuations.
There is no doubt that IndiGo is a well-run business and is one of the best-placed airlines in India. It has a 50%+ market share and a strong balance sheet. However, the question is does the fundamentals and the current challenging macro environment justify such expensive valuations.
The overall liquidity rush has driven up the share prices, but the fact remains the same that at current levels the stock is expensive as the path forward doesn’t look so smooth.
As such, investors would do well to exercise some caution.
This article is for information and should not be considered as a recommendation to buy or sell any stock.
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