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It has not been a flying start for airlines in 2021.
For India’s largest airline – InterGlobe Aviation Ltd. – not only soaring valuation in a challenging macro environment and without fundamental support was a concern, but a double whammy of rising crude prices and mounting Covid-19 cases also added to its woes.
In November 2020, we wrote about the rising share prices of IndiGo and the downsides that were overlooked by investors. [What’s the Story with IndiGo Valuations Flying High?]
Since then, its shares have fallen 5%.
In this post, we discuss the recent trends related to passenger traffic and ticket prices in the airline industry and their impact on IndiGo.
The aviation industry which was on its way to recovery with rising month-on-month passenger traffic just got hit by a roadblock on account of Covid-19 resurgence. With this, the path to recovery just got a bit longer and turbulent for IndiGo as it now also has to deal with rising crude prices.
Average aviation turbine fuel prices across four metros have been recently increased by 21%. Of course, this doesn’t bode well considering that fuel costs form a big proportion of operating costs for airlines and, therefore, can weigh on profit margins. For instance, in FY20, fuel costs as a percentage of revenues stood at close to 35% for InterGlobe Aviation.
Rising crude prices wouldn’t have been a problem, had it not been for subdued demand recovery.
The average daily passenger traffic in February stood at 2,76,175. However, March has turned out to be rather slow.
The air traffic had peaked in the month of February 2021 with an average passenger load factor of 67%. In March, though the capacity was increased, air traffic failed to pick up. Average passenger load factor – capacity utilisation – slipped to 60%.
Because of the subdued air traffic, the airlines are finding it difficult to fully pass on the rise in fuel cost to customers. Ticket prices on 20 major routes in India have fallen in the month of March, after reporting a growth in the last two months. This is despite the fact that the Indian Government has increased the lower and upper limits on domestic airfares by 15-30 %, in the last month, due to rising ATF prices.
While announcing a resumption of scheduled domestic flights in May last year, the Aviation Ministry had placed limits on airfares through seven bands classified on the basis of flight duration. This was done to ensure that the financially hit airlines are able to survive as well as passengers are not charged exorbitantly.
Nevertheless, the ticket prices are still lower compared to last year.
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. However, a fresh spurt in Covid-19 cases and travel restrictions by some states has derailed the fragile recovery of the domestic civil aviation sector – one of the worst hit by the pandemic.
Several states have made a negative covid test report mandatory for those flying from regions facing a recurrence of coronavirus. For instance, air travelers from Maharashtra, Kerala, Chhattisgarh, Madhya Pradesh, and Punjab have to submit negative RT-PCR test reports before entering Delhi. Karnataka, Uttarakhand, West Bengal have taken almost similar steps.
The covid tests mandated by some states have had a negative impact on air ticket bookings.
Weak pricing, low utilisation, and rise in ATF price will put pressure on IndiGo’s margins. A $1 move in the price of crude oil per barrel generally impacts IndiGo’s EPS by ₹ 2.5-3, in the absence of any price hikes. In the past three months or so, the price of crude has moved up by over $10 per barrel, which would require at least 5% price hike in ticket prices, for it to be fully passed on. The pricing environment is not conducive due to weak volumes and low utilisation levels. Hence, it would be difficult to raise prices, implying pressure on near-term margins.
Indigo has been gaining 3-4 percentage points in market-share per annum over the years. So far, in FY21, there has been a spike in IndiGo’s market share due to the curtailment of operations by competition. Smaller players – Vistara, AirAsia, and GoAir – are flying less in an effort to conserve cash. Thus, this shift in market share could well likely be temporary.
Because of this temporary shift in market share, IndiGo has been able to capture more air traffic. But it has come at a cost of its capacity utilisation. IndiGo has been constantly reporting a lower passenger load factor compared to its nearest peer – SpiceJet. In the month of February, IndiGo’s passenger load factor was also lower than that of Air India and GoAir.
India has currently capped the flying capacity at 80% of pre-Covid levels and plans to open the industry 100% when passenger traffic crosses 3.5 lakh (in 2019 on an average 3.95 lakh passengers flew daily) on three occasions in a month.
With no consolidation in the airline industry so far, as and when the cap on flying capacity is removed, a fare war looks imminent, as players would look to grab market share. This would make the situation much more precarious. Along with this, the competition might just get tougher, with GoAir IPO and Air India stake sale gaining momentum.
According to media reports, the Wadia group-owned GoAir plans to come out with a Rs 2,500 crore-initial share sale early next fiscal. The no-frills airline has been working on expansion plans and an IPO will help in raising funds. While for Air India, the government is aiming to complete the divestment by August 2021.
Now share prices of IndiGo have come off from their high. However, even at current levels, the valuations fail to factor in the fact that the path to recovery just got a bit longer and turbulent for IndiGo. While positive news flow on vaccination would help, it may not be enough for aviation stocks to take off.
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