The September quarter has traditionally been weak for aviation passenger traffic in the country, and the sluggish economy made matters worse. So, despite costs rising sharply, airlines could not pass them on.
On the contrary, offers to woo travellers meant that yields declined for some airlines. All these resulted in record losses - of Rs 894 crore for Jet Airways and Rs 559 crore for SpiceJet – in the September quarter. To put this in perspective, the quarter’s losses exceed, by a wide margin, the airlines’ full year losses in FY13 and are between 60 and 90 per cent of the losses in FY12, which is considered to be the worst year so far for Indian aviation.
This September quarter shock has caused severe damage to the already stressed balance sheets of the two airlines. The market was unforgiving and the stocks of Jet Airways and SpiceJet are down 50-60 per cent over the last seven months.
The recent slippage in financials has prompted us to revise our earlier ‘Buy’ call on SpiceJet. Investors can cut losses on the stock while holding on to Jet Airways in the expectation that its financial position will improve with a strong strategic partner in Etihad.
More problems
In a landmark deal in late April, Etihad agreed to pay Jet Rs 2,060 crore for a 24 per cent stake. This was a 31.5 per cent premium over the then prevailing market price of the stock.
Also, the sale of majority stake in its frequent flier programme got Jet around Rs 800 crore from Etihad. The fund infusion was expected to help Jet pare its huge debt and repair its balance sheet. But the optimism dissipated due to the long delay in closing the deal and the Jet stock ceded the gains it had made. It was only in November that the last of the approvals was received.
There was hope that the impetus provided by the Jet-Etihad deal announcement would also enable SpiceJet forge a deal, that too, on better terms - since its financials were in better shape. But despite several reports of the company being in negotiations with foreign airlines, no deal has materialised so far. This also contributed to the run-up in the SpiceJet stock reversing.
Meanwhile, the competitive landscape in the Indian aviation sector changed significantly with the deep-pocketed Tata Group entering the fray in collaboration with Singapore Airlines. The Tatas are also partners in Air Asia’s proposed low-cost venture in the country. Both these new airlines are expected to start flying early next calendar. What could also queer the pitch for incumbent airlines is the Government’s reported plan to ease rules for airlines to fly international. Currently, only airlines with at least 20 aircraft and 5 years of operations in the domestic market are allowed to venture into foreign destinations. If this restriction is removed, the new players will soon compete on the international routes too, which are more profitable and provide some hedge against the difficult operating conditions in the domestic market.
Missed chance
There are some silver linings though. The December quarter, a traditionally strong one, holds promise. Passenger traffic has picked up, fares have been raised, and with the rupee recouping from levels of 68 to the US dollar to 62–63 now, fuel costs should ease somewhat.
Should investors in SpiceJet and Jet Airways sell off, hold on, or be brave and buy the beaten down stocks?
The enterprise value (EV) of the SpiceJet stock is around seven times its annualised operating profits (based on the relatively better June quarter EBITDA), while that of Jet Airways is close to 29 times. Airlines in the Asia region currently command an EV/EBITDA of around 10 times.
While the SpiceJet stock trades relatively cheap to peers, the deep damage caused in the September quarter warrants caution. Despite a modest profit of Rs 51 crore in the June quarter and despite periodic fund infusions by the promoters, the company’s net worth has seen sharp erosion.
It stood at a negative Rs 603 crore as on September from a negative Rs 224 crore as on March. Debt at Rs 1,645 crore is also a concern. Equity fund infusion is key and there are limits to the amount promoters can chip in with.
In hindsight, not tying up with an investor soon after the Jet-Etihad deal may have been a mistake. Now, with a considerably weaker financial situation and intensifying competition, SpiceJet’s ability to negotiate a favourable deal may be compromised.
This may increase the company’s reliance on debt to keep the show running, in the process raising finance costs. Investors can consider selling the SpiceJet stock.
Good timing
Jet Airways did well to clinch the agreement with Etihad before the September quarter. And with approvals now in place, the deal provides it the much needed equity funds.
But Jet’s financials still remain precarious. Its standalone net worth eroded further this year and was a negative Rs 1,735 crore as on September, compared with a negative Rs 343 crore as on March.
Even assuming that the entire proceeds from the Etihad deal are used to pare debt, standalone borrowings will still remain formidable at around Rs 6,200 crore.
Etihad may provide Jet cheap funds to tide over the difficult times. The many changes in Jet’s management team over the past few months suggest that Etihad now firmly shares the driver’s seat in the company.
So, funding may not be as big a worry as it was earlier. Also, with the sharp increase in the number of seats between India and the UAE (Etihad’s hub), Jet should be able to hold its own on key international routes, especially to West Asia.
This should help improve its financial performance and moderate valuations. Investors can hold on to their Jet stock. But given its current high valuation, fresh exposure should be avoided.
Source: HinduBusinessLine
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