Airline Sector Initiating Coverage

March 26, 2010

ICICIdirect.com | Equity Research

Initiating Coverage

Ready to take off… The airline sector has witnessed a significant upturn in Q3FY10 (domestic pax traffic growth of 28% YoY) after experiencing a severe contraction throughout the major part of FY09. Growth is driven by optimism about the future, market share gains by low fare carriers (LFCs) and stable crude oil prices. LFCs are likely to benefit from the moderate growth of crude oil prices in FY11E-12E, contributing to higher pax growth and load factors for the sector. We are initiating coverage on airline sector with a STRONG BUY rating on Spicejet and REDUCE rating on Jet Airways.

Improved macroeconomic environment to boost pax growth

With the economy gaining momentum (GDP grew 7.9% in Q2FY10) and upward revision of FY10 growth forecasts by the RBI (7.5% from 6% earlier), we expect business and consumer confidence to improve contributing to growth of domestic pax (CAGR of 12.8% during FY10E-12E). Our forecasts are based on a pax growth multiple of 1.5x GDP growth (ex-agriculture). As the economy comes out of the slowdown, consumers will increasingly prefer low cost travel, benefiting LFCs (market share of 43.7% in Q4FY12E vs. 34.1% in FY09). Furthermore, the moderate growth of crude oil prices expected in FY11E-12E (average of US$83.9 per barrel in FY12E vs. US$76.9 in Q3FY10) will limit growth of passenger fares, further boosting demand for LFCs (due to high co-relation between ticket prices and crude oil prices).

Higher load factors to drive earnings

We believe the capacity rationalisation undertaken by airlines was a positive move, with domestic sector capacity decreasing by 2.4% YoY in FY09. As the current industry capacity is more in line with demand, domestic load factors have steadily improved (78.1% in Q3FY10 vs. the bottom of 62.2% in Q3FY09). We expect the sector’s profitability to expand with continued growth of domestic load factor (75.6% in FY12E vs. 63.7% in FY09). However, yields will continue to remain under pressure due to increased competition in the LFC segment.

Key risks Include

• Premature withdrawal of the economic stimulus package by the government

• External shocks in the global economy can derail GDP growth

momentum, which may, in turn, decelerate pax traffic growth • Additionally, the rise in competition among operators or

significant rise in fuel prices from current levels may dent operators’ margins and adversely impact pax traffic growth of LFCs (higher proportion of fuel costs in total operating costs)

Indian Airlines Sector Comparative Returns (%) Stock Returns (%) 1M 3M 6M 12MJet Airways 5.1 -10.5 48.4 276.9SpiceJet 3.6 17.8 73.2 336.9Kingfisher -0.1 -10.3 -4.0 91.8 Stock Metrics Jet Airways REDUCECMP Rs 473.0TP Rs 444.8Upside % -6.0Market Cap Cr 4,083.4

FY10E FY11E FY12ERevenue Rs cr 12,121 13,852 15,663EBITDA Rs cr 1,012 1,244 1,928EBITDAM % 8.4 9.0 12.3PAT Rs cr -568 31 696PATM % -4.7 0.2 4.4EPS Rs -53.6 2.9 65.6

SpiceJet STRONG BUYCMP Rs 58.0TP Rs 72.0Upside % 24.1Market Cap Rs Cr 1,398.0

FY10E FY11E FY12ERevenue Rs cr 2,202 2,681 3,216EBITDA Rs cr 74 216 335EBITDAM % 3.4 8.1 10.4PAT Rs cr 105 244 324PATM % 4.8 9.1 10.1EPS Rs 4.4 8.0 10.6

Stock Price movement

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Sector Summary In crore FY09 FY10E FY11E FY12EDomestic pax-traffic 3.9 4.5 5.0 5.7International pax-traffic 1.0 1.0 1.1 1.2Domestic RPKM 3,770.3 4,332.5 4,803.9 5,537.4International RPKM 4,074.0 3,857.9 3,742.2 4,041.3Domestic ASKM 5,915.9 5,952.6 6,443.5 7,342.6International ASKM 6,217.0 4,874.5 5,526.6 5,558.3Domestic Load factor (%) 63.7 72.8 74.6 75.4 International Load factor (%) 65.5 79.1 67.7 72.7

Analyst’s name Rashesh Shah [email protected]

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Indian Airlines Sector

ICICIdirect.com | Equity Research Page 2

Recommendations The Indian airline sector is witnessing a significant change in its operational structure with major full service carriers (FSCs) such as Jet Airways and Kingfisher rapidly converting a majority of their capacities into low cost. The passenger preference has also tilted towards LFCs as the preferred mode of travel primarily due to the economic slowdown and high fuel prices in the past few quarters. SpiceJet, a pure-play LFC, has witnessed a rise in its market share to 12.5% in Q3FY10 from 10.5% in Q3FY09. Although the topline of airlines is still under pressure due to decline in yields, the improved pax traffic in Q3FY10 (29.9% YoY) and stable crude oil prices (average of US$76.9 in Q3FY10 vs. US$58.3 in Q3FY09) has raised hope for a bright future ahead. We believe an improvement in the macroeconomic environment, stable crude oil prices and improvement in load factors due to strong capacity rationalisation plans will help the airlines to improve their EBITDA margin. Our rating rationale is based on EV/EBITDA. We prefer SpiceJet due to its strong fundamentals and increasing brand preference in the fast growing low cost air travel.





Indian airlines sector Rebound of domestic pax growth in Q3FY10

Domestic passenger (pax) growth witnessed an upturn in Q3FY10 (28% YoY) driven by the improved macroeconomic performance (GDP growth of 7.9% in Q2FY10 vs. 6.1% in Q1FY10) and lower airline fares (yields have declined as a result of lower fuel prices and focus on the LFC model by airlines). As a result of the capacity rationalisation by operators (return of aircraft to lessor and leasing self-owned aircraft) and solid growth of pax traffic, domestic load factors significantly improved to 78.1% in Q3FY10 (vs. 62.2% in Q3FY09), allowing airlines to sustain low yields. With pax traffic growth scaling new all-time highs in December 2009 (44.5 lakh) despite the recent rise in crude oil prices (US$76.9 per barrel in Q3FY10 vs. US$59.5 in Q1FY10), we believe this is the beginning of a new growth phase for the industry. It has witnessed severe contraction throughout FY09 (pax traffic declined by 11% YoY).

For Q4FY10, we expect a continuance of the recent uptrend as a robust booking window has been observed in January 2010 (as per industry sources), with operators under our coverage hinting at peak load factor as high as 80%. In our view, the buoyancy in demand is driven by the improved business and consumer confidence (upward revision of FY10E GDP forecasts to 7.5% from 6.0% earlier) and optimism about the future.

Exhibit 1: Monthly domestic pax* traffic

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Domestic Passenger - Lakh (LHS) YoY Growth % (RHS)

Source: Source: DGCA, MOPSI, ICICIdirect.com Research, * Pax=Passenger

Challenges for the airline sector first appeared at the end of FY08 with crude oil prices crossing US$100 per barrel resulting in significant margin erosion for operators. As a result, airlines were forced to raise ticket prices (gross yields increased by an average of 20% in FY09), resulting in lower pax traffic. Despite average crude oil prices declining to US$58.3 per barrel in Q3FY09 (vs. US$118.1 per barrel in Q2FY09), pax traffic growth continued to remain under pressure due to the global economic slowdown. The sector woes were further aggravated by the load factor falling to 63.7% in FY09 (from 68.9% in FY08) as the sector was flooded with excess capacity due to the robust demand in the boom period of FY05-08 (pax traffic grew at a CAGR of 31.7%).

Beginning of new phase of sector growth in Q3FY10

Pax traffic contracted by 11% in FY09 due to high crude oil prices and global economic slowdown





Exhibit 2: Annual domestic pax traffic

137.1 128.5 139.5 156.8194.5

252.0

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Source: DGCA, ICICIdirect.com Research

High crude oil prices during Q4FY08-Q2FY09 led to load factors crashing to 60.4% in August 2008. Further, load factor bottomed at 55.3% in September 2008 due to the global economic crisis.

Exhibit 3: Historical load factor of all airline operators

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Passenger Load Factor - % (LHS) Crude oil prices - USD per barrel (RHS)

Source: DGCA, MOPSI, ICICIdirect.com Research

Exhibit 4: International crude oil and jet fuel prices ( forecasted by EIA)

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Crude Oil (USD per Barrel) Jet Fuel (Cent per Litre)

Source: Energy Information Administration(USA)

Moderate growth expected for crude oil prices during FY11E-12E





Low penetration of air travel in India

Despite the robust growth of pax traffic witnessed over the past few years, we believe significant growth opportunities exist for the aviation sector in India due to the current low penetration of air travel. As per our estimates, domestic pax per head in India (i.e. 43 per 1000 population) is significantly lower than China and the US. We expect strong growth in penetration of air travel to be driven by the sustained growth of per capita income (CAGR of 6.0% to Rs 36,876 during FY10E-12E), increased affordability accorded by LFCs and potential upgrading by the vast user base of Indian Railways.

We believe a substantial upgrade is only possible if airlines continue to keep ticket prices low, which is contingent on movement of crude oil price. As per estimates of the Energy International Administration (EIA), average crude oil prices will increase to US$83.9 per barrel by FY12E as the global economy recovers (3.0% in FY11E and 3.5% in FY12E). In our view, the moderate growth expected for crude oil prices will drive growth of pax traffic, leading to increased penetration of air travel in the country.

Exhibit 5: Air pax per head (2009)

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Source: Economic Intelligence Unit (EIU),USA, ICICIdirect.com Research

Substantial growth potential due to the current low penetration of air transport in India





Domestic pax to grow 1.5x GDP (ex agriculture)

We estimate that domestic pax traffic will grow at a CAGR of 12.8% during FY10-12E driven by sustained growth of the economy, improved airport infrastructure, moderate growth of crude oil prices (average price of US$83.9 per barrel in FY12 vs. 76.9 per barrel in Q3FY10) and gain in market share by LFCs.

Our growth forecasts are based on the assumption of 1.5x growth of domestic pax vis-à-vis GDP growth (ex agriculture) in FY11 and FY12. Pax growth averaged at 1.5x GDP in FY01-09. As per our analysis, a strong relationship exists between growth of domestic pax traffic and growth of GDP (ex-agriculture); correlation of 0.91 in FY04-09 with an R-square of 0.82.

Key risks to our forecasts include a higher-than-expected rise in crude oil prices that may compel operators to hike ticket prices, consequently slowing down pax traffic growth. Further, the impact of an external shock in the global economy or urgency in withdrawal of stimulus package by the government may adversely impact domestic demand.

Exhibit 6: Forecasted domestic pax

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Exhibit 7: Strong correlation between GDP (ex agri) and pax traffic (FY04-09)

GDP (ex-Agri) Industrial GDP Services GDP Agri GDP

Correlation 0.91 0.90 0.85 0.39

R-Squared (Regression) 0.82 0.81 0.72 0.15


Rapidly improving infrastructure provides an upside to pax growth

We believe the rapidly improving air transport infrastructure in India provides a further upside to our pax traffic growth forecasts. In the Eleventh Five Year Plan (2007-12), the government has earmarked Rs 49,200 crore to upgrade infrastructure, improve connectivity and improve affordability of air transport. As a part of the plan, the Airport Authority of India (AAI) plans to modernise all the metro airports and upgrade 35 non-metro airports.

Total Rs 49,200 crore earmarked for improvement in air transport infrastructure

Domestic pax traffic estimated to grow at a CAGR of 12.8% during FY10E-12E

Domestic pax traffic assumed to grow at 1.5x GDP (ex-agriculture) growth rate in FY11-12E





Exhibit 8: Airport development plans of AAI

City Activity Timeline

Kolkata Modernisation/Expansion Project awarded in October 2008

Chennai Modernisation/Expansion Project awarded in August 2008

Bangalore Expansion/New Terminal Completion by 2014

Delhi New Integrated Terminal Completion by July 2010

Mumbai New Domestic Terminal Completion by March 2011

Mumbai Integrated Passenger Terminal Completion in 2012 Source: Planning Commission, ICICIdirect.com Research

Budget airlines expected to benefit from demand pickup A new business model has emerged with Jet Airways launching a ‘no frills brand’ Jet Airways Konnect (JAK) in May 2009, further widening the scope for budget travel in India (in addition to LFCs). JetKonnect was launched by the operator to deal with the economic slowdown. By Q3FY10, Jet Airways had converted nearly 70% of its capacity to Jet Airways Konnect (a mid-segment between the FSC, Jet Airways and LFC, Jet Lite), leading to market share gains. Similarly, Kingfisher Airline has also shifted a significant portion of its domestic capacity to its economy brand ‘Kingfisher Red’.

In our view, budget airlines will benefit from the pax traffic growth in FY11E due to the increased price elasticity of demand (consumers are likely to opt for low cost travel as the economy comes out of the slowdown). Further, we expect muted growth of pax fares in FY11E-12E due to the moderate growth expected for crude oil prices, benefitting LFCs. Ticket prices of LFCs have a higher elasticity to changes in crude oil prices vis-à-vis FSCs as fuel costs account for 45-50% of total operating costs of LFCs vs. 35-40% for FSCs.

Budget FY10E-11E has proposed to include economy class travel under the purview of service tax of 10% (earlier applicable to business class and above). This will lead to increase in ticket prices in the future. However, we feel that revision of individual tax slabs will increase the disposable income in the customer’s hands, thus minimising the negative impact of the introduction of service tax for air travellers. Consequently, we believe that major LFCs (JetLite, Indigo, Spice Jet and Go Air) will be able to increase their market share to 43.7% by Q4FY12E (vs. 40.4% in Q3FY10 and 32.4% in Q4FY08) primarily due to visible preference of customers towards low cost travel as the economy comes out of a slowdown. Exhibit 9: Domestic market share – LFCs vs. FSCs

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Source: DGCA, ICICIdirect.com Research, LFCs- Indigo, SpiceJet, Jet Lite and Go Air, FSCs - Jet Airways and Kingfisher, Others private players includes Air Deccan, Paramount and MDLR

LFCs to gain market share in FY11E-12E due to increased customer preference as economy comes out of slowdown





Benign crude oil prices to boost load factor of LFCs

Majority of FSCs have shelved their fleet acquisition plans for the next two or three years. However, LFCs are likely to take delivery of aircraft in FY11E-12E that were ordered in the past.

Domestic capacity, as measured by ASKMs, witnessed growth at a CAGR of 29.7% during the boom period of FY05-08. However, as a result of economic slowdown and consequent contraction in demand, airline operators undertook capacity rationalisation (capacity declined by 2.4% in FY09). Despite this, domestic capacity of LFCs increased by 14.1% in FY09 as this segment has been successful in maintaining an optimum capacity level due to prudent capacity addition during the growth phase of FY05-08. As a result, we estimate that fleet size of LFCs will continue to increase during FY10E-12E with the revival of demand. SpiceJet (+26.3% to 24), Indigo (+25.0% to 30) Go Air (+66.7% to 10), etc. Among FSCs, we expect NACIL to acquire new aircraft during the period FY10E-12E. However, the majority of the new aircraft will replace the old fleet, thus reducing the maintenance costs. Air India placed orders for 111 aircraft in 2007, primarily to Boeing and Airbus. All of these are expected to be delivered during 2007-2012.

Consequently, we expect the load factor, a key determinant of utilisation, to increase for LFCs in FY09-12E (77.6% in FY12E vs. 67.8% in FY09). Further, the moderate growth expected for crude prices in FY11-12E will drive pax growth for LFCs, contributing to higher load factor. However, we expect a steeper rise in load factor of FSCs (77.5% in FY12E vs. 65% in FY09) due to capacity rationalisation (and no new capacity in FY10E-12E) and conversion of majority of capacity into the low cost model in the last few quarters.

LFC’s load factor fell below FSCs in Q4FY08 (70.0% for LFCs vs. 71.5% for FSCs) due to high crude oil prices as LFCs’ passengers downgraded to alternative means of transport (e.g. railways) with airlines raising ticket prices.

Exhibit 10: Load Factors (%) – LFCs vs.. FSCs

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Source: DGCA, ICICIdirect.com Research, LFCs- Indigo, SpiceJet, Jet Lite and Go Air, FSCs - Jet Airways and Kingfisher

Load factor of LFCs estimated to improve to 77.6% in FY12E (vs 67.8% in FY09) driven by the sustained demand for low cost travel and benign fuel prices





Yields still under pressure

Yields, as measured by revenue per RPKM, have declined significantly due to the shift to the LCF model, with the yield of Jet Airways declining by 29.3% and 11.6% each for JetLite and SpiceJet, between Q3FY09 and Q3FY10. As airlines continue to focus on the LFC model over the next few quarters (and expected increase in competition in the space) combined with the moderate increase expected for crude oil prices, we estimate that yields will continue to remain under pressure.

Out of our coverage companies, we expect the yield of Jet Airways to remain highest due to conversion of its idle capacities to JetKonnect (ticket prices typically 10-15% higher than pure-play LFCs).

Exhibit 11: Domestic net yields (Rs.)

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Jet Airways - Domestic Jet Lite SpiceJet

Source: DGCA, ICICIdirect.com Research

Stretched balance sheet In our view, the over-leveraged balance sheet due to the aggressive fleet addition in the past is the biggest challenge faced by airlines in India. In FY09, the debt/equity ratio of Jet Airways was 7.6x, while the net worth of Kingfisher and NACIL was negative. The combined debt was Rs 36,000 crore for Jet Airways, Kingfisher and NACIL.

Despite the pickup of pax traffic and stabilisation of yields, we expect airlines to find it tough to pay back debt and service the significant interest expenses. As a result, airlines are raising equity to improve their liquidity position (and payout borrowings, primarily aircraft loans).

Exhibit 12: Equity raising plans of select airlines

Operator Fund requirement Status

Air India

Government will provide a bailout pakage of Rs 2000 crore in the next 2-3 years

Rs 800 crore to be received by end of FY10

Jet Airways

Permission from government to raise nearly USD 400 mn (Rs 18,600 crore) through the QIPs route

USD 200 mn (Rs 9,300 crore) to be raised by the end of FY10

Kingfisher

In discussion with PE firms to raise capital worth USD 350-400 million (Rs 16,275-18,600 crore) No funds raised till Q3FY10

Source: Company, ICICIdirect.com Research

Access to funding a key challenge facing airlines

Limited upside to yields due to focus on LFC model by airlines and moderate increase in fuel prices





Exhibit 13: Interest coverage ratio

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Jet Airways - Consolidated Kingfisher SpiceJet


In our view, the government’s restrictive FDI policy is a major hurdle for the sector’s growth. At present, foreign airlines are not allowed to invest in the domestic sector, even though FDI limit in the sector has been capped at 49%. We believe a relaxation of the norms will allow the cash starved carriers to raise the much needed funds and benefit from technical expertise of the foreign partner. However, there has been no indication from the government towards this. We do not expect things to move rapidly on this front. Exhibit 14: Foreign ownership limits in sector

Segment Foreign ownership limit

Passenger airlines 49% FDI and 100% investment by NRI

Non schedule airlines, chartered airlines, and cargo airlines 74% FDI and 100% investment by NRI

Ground handling services 74% FDI and 100% investment by NRI

Maintenance and repair organisations, Training institutes 100% FDI Source: Govt filings,, ICICIdirect.com Research





Risks and Concerns Significant increase in crude oil prices

As the global economy recovers, international crude oil prices have already increased by 29.3% during 9MFY10 to US$77 per barrel. A higher-than-expected rise in crude oil prices during FY11-12E due to a stronger-than-expected recovery of the global economy and speculative activities can result in pax traffic growth coming under presure, especially for LCFs where fuel costs account for a higher proportion of total operating costs (compared to FSCs). Pax traffic and, consequently, the load factor declined significant in FY09 with crude oil prices scaling new highs (US$124 per barrel in Q1FY09 and US$118 per barrel in Q2FY09).

Urgency in withdrawal of stimulus packages

The IMF recently raised its 2010 global GDP forecasts to 3.9% (from 3.1%) driven by improved economic performance during the last six months. However, substantial credit for the global economic recovery goes to increased spending by governments across the globe. A premature withdrawal of fiscal stimulus by governments may adversely impact the global economic recovery. Consequently, this may slow down India’s economic growth, resulting in a likely decline in domestic pax traffic growth. In particular, the Indian government has gone ahead with partial withdrawal of fiscal stimulus. Budget-2010 has proposed an increase in central excise duty (10% vs. 8% earlier), MAT (18% vs. 15% earlier), custom duty on crude petroleum (by 5%).

Excess capacity

As domestic pax traffic growth gains momentum with improving business confidence, airline operators may place large orders for new aircraft in anticipation of sustenance of buoyancy in demand. An oversupply situation is possible in case there is a slowdown of pax traffic (due to lower-than-expected economic growth or increase in crude oil prices), contributing to margin contraction for operators.

Inability to raise funding In our view, access to funding is a key challenge facing the aviation sector. Large operators continue to grapple with significant debt on their balance sheets due to aggressive fleet addition in the past, consequently adversely impacting their liquidity conditions. Further, restriction on foreign ownership in the sector by the government remains an inhibitor for domestic operators looking to raise the much needed capital. We believe operators will be unable to take advantage of the expected buoyancy in pax traffic in FY12E if they are unable to raise the required funding.





Valuations

The Indian airline sector is witnessing a significant change in its operational structure with major FSCs such as Jet Airways and Kingfisher rapidly converting a majority of their capacities into low cost. The passenger preference has also tilted towards LFCs as the preferred mode of travel primarily due to the economic slowdown and high fuel prices in the past few quarters. SpiceJet, a pure-play LFC has witnessed a rise in its market share to 12.5% in Q3FY10 from 10.5% in Q3FY09. Although the topline of the airlines is still under pressure due to a decline in yields, the improved pax traffic in Q3FY10 (29.9% YoY) and stable crude oil prices (average of US$76.9 in Q3FY10 vs. US$58.3 in Q3FY09) has raised hopes for a bright future ahead. We believe an improvement in the macroeconomic environment, stable crude oil prices and improvement in load factors due to strong capacity rationalisation plans will help the airlines to improve their EBITDA margin.

Our rating rationale is based on EV/EBITDA. We prefer SpiceJet ahead of Jet Airways due to its strong fundamentals and increasing brand preference in the fast growing low cost air travel (due to increasing preference of customers). We believe that other multiples such as EV/EBITDAR (including lease rentals) cannot provide good indicator as enterprise value (EV) of players owning an aircraft always remains higher compared to players operating a majority of its fleet size under lease resulting in higher EV/EBITDAR multiples for players operating owned fleets. We have compared Jet Airways with major South-East Asian airlines that have a strong domestic market share and also have a sizable international presence (similar to Jet Airways). For SpiceJet, we have looked at the long-term EV/EBITDA band chart to derive the valuations.

Exhibit 15: Comparative Valuation

Company EPS P/E (x) EV/Sales (x) EV/EBITDA (x) ROCE (%)

FY09 FY10E FY11E FY09 FY10E FY11E FY09 FY10E FY11E FY09 FY10E FY11E FY09 FY10E FY11E

Jet Airways -111.4 -53.6 2.9 NA NA 162.6 1.5 1.5 1.2 NA 17.5 13.6 -10.0 0.2 1.4

SpiceJet -14.0 4.4 8.0 NA 13.1 7.1 0.9 0.7 0.6 NA 19.7 7.4 -137.8 62.6 71.1 Source: Company, ICICIdirect.com Research

Exhibit 16: Global Valuation matrix

EV P/E EV/Revenue EV/EBITDA EV/EBIT P/BV

LC mn TTM FY10E FY11E TTM FY10E FY11E TTM FY10E FY11E TTM FY10E FY11E TTM FY10E FY11E

Air China 303,682 NA 37.9x 43.6x 5.9x 5.8x 5.0x 77.6x 28.9x 22.4x NA 136.0x 56.4x 7.2x 5.9x 5.2x

China Eastern Airlines Co. 61,798 NA 117.0x 52.2x 1.6x 1.4x 1.1x NA 15.7x 7.4x NA NA 19.3x 2.7x NA 18.5x

China Southern Airlines Co. 82,492 NA 120.0x 41.7x 1.5x 1.4x 1.3x NA 11.0x 7.4x NA 166.0x 33.3x 6.5x 5.1x 4.4x

EVA Airways 116,690 NA NA 17.5x 1.4x 1.6x 1.3x 71.8x 12.2x 10.3x NA NA 57.1x NA 1.5x 1.4x

Cathay Pacific 98,227 NA 22.1x 24.2x 1.1x 1.5x 1.3x NA 10.1x 8.8x NA 22.7x 22.5x 1.6x 1.5x 1.5x

Korean Air 12,559,972 NA 127.2x 15.7x 1.2x 1.3x 1.2x 19.5x 12.2x 8.9x NA 55.1x 22.5x 2.0x 1.6x 1.5x

Malaysia Airlines 3,375 NA NA NA 0.2x 0.3x 0.3x NA NA 7.6x NA NA 15.2x NA 0.9x 1.0x

Singapore Airlines 16,457 17.3x 774.0x 20.9x 1.0x 1.4x 1.2x 6.2x 9.3x 6.0x 18.2x 341.4x 19.6x 1.3x 1.4x 1.3x

Thai Airways International 173,502 NA 19.7x 13.0x 0.9x 1.0x 1.0x 34.6x 6.4x 5.7x NA 23.0x 19.3x 0.9x 0.9x 0.9x

Median 107,459 17.3x 117.0x 22.5x 1.3x 1.4x 1.2x 34.6x 12.2x 8.2x 18.2x 136.0x 22.5x 2.3x 1.5x 1.5x

Mean 1,359,594 17.3x 174.0x 28.6x 1.6x 1.7x 1.5x 42.0x 13.7x 9.8x 18.2x 178.2x 34.1x 3.1x 2.3x 3.8x

Adjusted Mean** 129,074 17.3x 84.8x 27.3x 1.3x 1.4x 1.2x 42.0x 12.6x 8.7x 18.2x 144.3x 31.3x 2.8x 2.0x 2.3x

**Adjusted mean is used to remove extreme values, either minimum or maximum.

LC - Local Currency

Source: Reuters, ICICIdirect.com REsearch

We prefer SpiceJet on the back of its strong fundamentals and increasing brand presence



March 26, 2010


Initiating Coverage

Valuation concerns… Jet Airways (JAL) is the largest domestic airline operator in India with a market share of 26.9% (Q3FY10). We believe the company would benefit from the recent upturn in domestic pax traffic (29.9% YoY in Q3FY10) due to its strong market position and focus on the budget segment. However, it is also prone to major key risks that include slowdown of economic growth, steeper-than-expected increase in crude oil prices, leading to lower load factor and consequently profitability. We are also concerned with the adverse liquidity situation of the company (i.e. debt-to-equity ratio of 5.7). Hence, we are initiating coverage on the stock with a REDUCE rating and a price target of Rs 444.

Revival of sector to drive topline

With the introduction of ‘all-economy’ Jet Airways Konnect (JAK) services, we estimate strong domestic pax growth for JAL (CAGR of 14.3% during FY10E-12E) as consumers will increasingly prefer low cost travel with the economy coming out of the slowdown. JAL is expected to benefit from the revival of pax traffic in the domestic market (CAGR of 12.8% in FY10E-12E). As a result, we estimate JAL’s revenues will grow at a CAGR of 15% to Rs 15,991 crore during FY10E-12E. Continued strong performance of international operations is also expected to contribute to the topline growth (load factor of 81.5% in FY12E vs. 68.2% in FY09).

Slow recovery in margin in FY10E and FY11E

Despite the expectation of higher load factor and stable crude oil prices, we estimate that the net margin will remain negative in FY10E (-6.1%) due to high interest costs (debt-to-equity ratio of 5.7 at the end of Q3FY10). Margins are expected to improve slowly in the next two years (2.4% in FY11E and 6.7% in FY12E) due to increased competition from LFCs (yields under pressure).

Valuations At the CMP of Rs 465, the stock is currently trading at 1.3x FY11E EV/sales and 13.6x its EV/EBITDA. The rebound in tourist traffic has improved the outlook of the company. However, we continue to remain cautious on the liquidity situation of the company as the fresh capital expected to be raised by the management (~Rs 930 crore/US$200 million) falls short of the total payment obligation (~Rs 1,500 crore/US$330 million) of the company at the end of Q4FY10. Hence, we have valued JAL at a FY11E EV/EBITDA of 12.8x, at a discount to its current valuation multiple, computing a target price of Rs 444. We are initiating coverage on the stock with a REDUCE rating, downside risk of 4.5%. Exhibit 1: Consolidated Financial summary Rs. Crore FY08 FY09 FY10E FY11E FY12ENet Sales 10,246 13,078 12,121 13,852 15,663EBITDA -163 -859 1,012 1,244 1,928Net Profit -654 -961 -568 31 696EPS (Rs) -75.7 -111.4 -53.6 2.9 65.6P/E (x) -6.2 -4.2 -8.8 162.6 7.2RoCE (%) -7.8 -10.0 0.2 1.4 4.7RoNW(%) -20.5 -30.3 -23.9 1.2 23.7


Jet Airways (JETAIR) Rs 465

Rating Matrix Rating : Reduce

Target : Rs 444

Target Period : 12 months

Potential Upside : -5%

YoY Growth (%)

FY09 FY10E FY11E FY12ENet Sales 27.6 -7.3 14.3 13.1EBITDA 426.9 -217.9 22.9 54.9Net Profit NA NA LP NAEPS NA NA LP NA Stock Metrics Bloomberg/Reuters Code JETIN:IN /JET:BOSensex 17,578Average volumes 431,980.8Market cap (Rs crore) 4,08352 week H/L 598.2/154.5Equity Capital (Rs crore) 86Promoters Stake (%) 80.0FII Holding (%) 7.7DII Holding (%) 8.2

Valuation matrix FY09 FY10E FY11E FY12E

Target PE -4.0 -8.3 152.9 6.8EV/EBITDA -22.1 17.2 13.6 7.9EV/Sales 1.5 1.5 1.2 1.0Price/BV 1.9 2.0 1.9 1.5

Stock Price movement (Stock vs. Nifty)

0100200300400500600700

3/25

/200

9

5/25

/200

9

7/25

/200

9

9/25

/200

9

11/2

5/20

09

1/25

/201

0

3/25

/201

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Rs.

0

1000

2000

3000

4000

5000

6000

Jet Airways (LHS) NIFTY (RHS)




Jet Airways (JETAIR)


Company Background Jet Airways (India) Ltd (JAL), India’s largest private sector airline with a domestic market share of 26.9% in Q3FY10, began its operation in May 1993. The company strengthened its position in the aviation sector by acquiring Air Sahara (rechristened as JetLite, the all-economy, no-frills service) in April 2007. At present, JAL operates 112 aircraft, which flies to more than 61 destinations in India and abroad. In May 2009, JAL launched Jet Airways Konnect (JAK), an all-economy service, by utilising the idle business class capacity of the parent company, Jet Airways (JA). Out of the total fleet size of 89 aircraft, 27 aircraft are operated for JAK. JetLite operates predominantly on the domestic routes with a fleet size of 23 aircraft. In addition to the domestic operations, JA also provides international flight services to several destinations including Gulf, Saarc countries, Asia-Pacific, North America and Europe. In FY09, international operations contributed 52.5% of JA’s revenues. In 2005, the company raised Rs 1,899 crore through an IPO of 1.72 crore shares at a price of Rs 1,100 per share to fund its domestic and international capacity addition. Despite the Indian aviation sector witnessing a significant contraction in FY09 (domestic pax traffic declined by 11.1% YoY), the consolidated revenues of the company increased by 27% YoY to Rs 13,078 crore driven by higher pax yields (high fuel prices contributed to increase in fuel surcharges). During FY05-08, JAL witnessed robust revenue growth (CAGR of 32.3%). This was fuelled by solid growth of domestic pax traffic (CAGR of 31.7%), which was supported by the booming economy (GDP grew at an average annual rate of 8.9%).

JAL, headquartered in Mumbai, has staff strength of 11,400 employees (December 2009).

Exhibit 2: Domestic market share (Dec ‘09)

Jet A irw ay

s19%

Jet L ite 7%

K ingf isher

22%NA CIL 18%

Indigo15%

Spice Jet

13%

G o A ir 5%

O thers 1%


Exhibit 3: Domestic pax traffic (in lakh)

0

6

12

18

24

30

Q1FY

08

Q3FY

08

Q1FY

09

Q3FY

09

Q1FY

10

Q3FY

10

JA - Domestic JA - International JetLite






Investment Rationale Jet Airways (India) Ltd (JAL) has emerged as the largest player in the domestic aviation sector with a market share of 26.9% at the end of Q3FY10. JA, the parent company, is the first FSC that has capitalised well on the increasing customer preference towards low cost travel by utilising about 70% of its total capacity for budget travellers. We expect the domestic pax traffic of JAL to grow at a CAGR of 14.3% (12.8% for the sector) during FY10E-12E due to its strong brand presence and focus on the budget segment. However, we are concerned about the liquidity situation of the company due to high debt on its books (debt-to-equity ratio of 5.7 at the end of Q3FY10). We are initiating coverage on the stock with REDUCE rating and a price target of Rs 440.

Domestic business Aviation sector to witness robust pax traffic growth

We believe the Indian aviation sector will witness strong growth over the next two or three years after the significant contraction reported in FY09 (pax traffic declined by 11% YoY). Growth of pax traffic will be driven by improved economic environment (GDP expected to grow at a CAGR of 7.5% in FY10E-12E vs. 5.4% in FY09), stable crude oil prices and rapid growth of demand for low cost travel. As a result, we estimate the domestic pax traffic will grow at a CAGR of 12.8% during our forecast period FY10E-12E (1.5x the GDP-ex agri growth rate).

In our view, JAL will be the primary beneficiary of the upturn in domestic pax growth due to its strong market position (market share of 26.9% in Q3 FY10), solid brand name, capacity rationalisation undertaken during the last few quarters and emphasis on the budget segment. Nearly 1/3 of the parent company’s capacity shifted to the all-economy brand, JAK by Q3FY10. As a result, we estimate JAL’s domestic pax traffic will grow at a CAGR of 14.3% in FY10E-12E with improvement expected in load factor (80.3% in FY12E vs. 67.1% in FY09). Further, JAL’s revenue passenger per kilometre (RPKM), a measure of demand, is expected to grow at a CAGR of 13.3% in FY10E-12E. As a consequence, we expect JAL to maintain its market share in FY12E (26.9%) despite the expected increase in competition from the LFCs. Exhibit 4: Domestic pax traffic (in lakh) – Sector vs. JAL*

252

358

444395

445502

566

152135117111129128119

0

100

200

300

400

500

600

FY06 FY07 FY08 FY09 FY10E FY11E FY12E

05101520253035404550

Sector - LHS JAL (Domestic) - LHS JAL market share (%) - RHS

Source: Company, ICICIdirect.com Research, * Includes pax numbers for domestic operation of JA and JetLite

We expect the domestic pax traffic of India to grow at a CAGR of 12.8% during FY10E-12E driven by strong macroeconomic growth, increase in demand for low cost travel and expectation of stable crude oil prices





Exhibit 5: RPKM (in lakh) – JA (domestic) and JetLite

68,840 71,04784,096

97,22985,650

43,57140,30838,82138,56040,090

0

20,000

40,000

60,000

80,000

100,000

120,000

FY08 FY09 FY10E FY11E FY12E

-25-20-15-10-50510152025

JA RPKM (Dom) - LHS JetLite RPKM - LHS

JA (Dom) YoY% - RHS JetLite YoY% - RHS

Source: Company, ICICIdirect.com Research,* potential upgradation to low cost air travel from premium rail travel

Introduction of Jet Airways Konnect – a positive move

With the economy gaining momentum and preference of consumers for low cost travel, we believe the management’s strategy to shift substantial capacity to JAK was a positive move (JAL’s market share increased to 26.9% in Q3FY010 compared to 24.3% in Q1FY10). JAK carried about 15.7 lakh pax, 65.4% of the total pax carried by JA during Q3FY10.

JAK was launched in May 2009 by JA to utilise its domestic business class capacity that was left idle as a consequence of the economic slowdown. In a normal economic environment, business class pax accounts for 50-60% of the total traffic for FSCs in India.

Consolidated domestic load factor to improve to 81.3% in FY12E

JAL’s domestic load factor deteriorated significantly in FY09 (66.9% vs. 70.9% in FY08) as a result of domestic pax contraction (down by 11.1% YoY in FY09). This was further aggravated by the strong capacity expansion undertaken during FY05-08 (fleet size grew at a CAGR of 18.3% to 106 aircraft). As a consequence, the management undertook an aggressive capacity rationalisation programme in FY09-10E, including leasing of idle aircraft to foreign airlines and return of some aircraft to the lessor. Further, according to the management, there are no plans to acquire new aircraft for the next 12-18 months.

We believe JAL’s present capacity is more in line with the current demand. Therefore, we expect a firm load factor in Q4FY10E (the company reported load factor of 73.6% in January 2010 and 75% in February 2010). Also, the booking window of March 2010 has indicated a load factor in the high 70s for domestic operations. We estimate that the load factor for JA’s domestic operations and JetLite will increase to 78.9% and 83.7%, respectively, in FY12E driven by the expected growth of domestic pax traffic.

JA’s load factor increased to 75.4% in Q3FY10 despite an increase in capacity (13.3% YoY and 17.9% QoQ). This was primarily due to the introduction of JAK service. The final phase of conversion of about 1/3 of the capacity to JAK was completed in October 2009.

Introduction of ‘all-economy’ JAK service to target low cost customers led to increase in market share in Q3 FY10

Load factor will improve on the back of increasing domestic pax traffic and continuing capacity rationalisation in our forecast period





Exhibit 6: ASKM (in lakh) and load factor (%) – JA (domestic) and JetLite

0

30,000

60,000

90,000

120,000

150,000

FY07 FY08 FY09 FY10E FY11E FY12E

50

60

70

80

90

100

JA ASKM (Dom) - LHS JetLite ASKM - LHS

JA (Dom) load factor (%) - RHS JetLite load factor (%) - RHS


Moderate growth expected in pax yields

In our view, the yields of JA, measured by revenue per RPKM, will grow by 7.6% YoY to Rs 5.8 in FY11E due to its focus on the budget segment (introduction of JAK service) and deferral of new aircraft addition (leading to improvement in load factor). Also, we expect capacity addition in the sector to remain muted due to balance sheet concerns of major players (including JAL). The strong growth in pax traffic and low capacity addition will help JA to improve its yields marginally.

However, JA’s yield is expected to be lower than the high witnessed in FY09 (Rs 6.8) primarily due to high price elasticity of consumers as the economy comes out of the slowdown, stable fuel prices, conversion of aircraft from FSCs to LFCs and increasing competition from pure-play low cost carriers (SpiceJet, Indigo and Go Air).

Exhibit 7: Annual yields (Rs) – Jet Airways (domestic) and JetLite

5.7 5.8

6.8

5.45.8 5.9

4.6

3.43.9

3.5 3.7 3.8

0

2

4

6

8


Rs.

JA - Dom JetLite


Focus on low-cost consumers expected to keep yields under pressure





International Business Growth momentum of international business to continue During the last few quarters, the international operations have been more profitable for JA compared to its domestic operations due to higher load factor (82.5% for international operations in Q3Y10 vs. 75.4% for domestic operations) and route rationalisation undertaken by the company (discontinuing non-profitable international routes such as London-Amritsar, Mumbai-US via Shanghai etc ). As a result, the international segment contributed 51.3% of the total revenues of the consolidated business (vs. 43% in FY09) in Q3FY10. Also, all major international routes operated by JA were profitable during the quarter, with load factors ranging between 80 and 89% (excluding Gulf routes). In our view, the high load factor of international operations was driven by:

• Strong capacity rationalisation in the international segment (ASKM reduced by an average of 15.1% YoY during Q1-Q3FY10 vs. 7.2% YoY for domestic operations) by leasing out excess aircraft

• Introduction of several short-haul routes by JA that led to

improved connectivity with Saarc countries. Some of the profitable routes that witnessed strong load factor in Q3FY10 were Mumbai–Kathmandu, Mumbai-Dhaka, Delhi–Hong Kong, and Delhi–Bangkok via Varanasi.

• Improved aircraft utilisation as domestic aircraft were utilised on

international routes during the night time, primarily to Gulf and Saarc countries

Exhibit 8: JA load factor (%) – Domestic vs. international

78.3 78.768.0 67.5 68.2

80.672.766.970.970.2

81.579.3

0

25

50

75

100


JA (Domestic) JA (International)


The profitability of JA’s international operation is also dependent on its lower cost of operation (cost per ASKM in domestic operation was higher by 61.1% in Q3FY10 as compared to international operation). Further, the fuel costs in India are about 29.7% higher than international destinations, leading to improved margins for international operations for the company (According to the management, average fuel prices for domestic

We expect high load factor in the international segment to continue due to strong capacity rationalisation and introduction of new short-haul routes





operations were about Rs 41.5 per litre in Q3FY10 vs. Rs 32 per litre for international operations). Exhibit 9: Cost per ASKM – Domestic vs. international

5.34.8 4.7

3.83.9 3.73.3

2.52.72.2 2.2 2.3

1.91.5 1.8 1.7

0

2

4

6

FY09 Q1FY10 Q2FY10 Q3FY10(R

s.)

Cost/ASKM - Dom* Cost/ASKM w/o fuel - Dom

Cost/ASKM - Intl# Cost/ASKM w/o fuel - Intl

Source: Company, ICICIdirect.com Research, * Domestic, # International

Exhibit 10: JA EBITDA margin (%) – Domestic vs. international

-17.0

-10.4

2.6 4.0

-1.9

-24.7

7.7

18.314.9

18.415.7

18.6

-9.7-11.2

-30-25-20-15-10-505

10152025

Q1FY09 Q2FY09 Q3FY09 Q4FY09 Q1FY10 Q2FY10 Q3FY10

JA (Domestic) JA (International)


Although we believe the improved economic environment will translate into higher business and leisure travel in the next few years, the incremental growth in international traffic will be contingent on JA’s ability to maintain its market share in major routes such as Saarc, Asean and Gulf. We are conservative on the growth of international pax traffic and expect it to grow at a CAGR of 10.5% during FY10E-12E (lower than the growth of domestic pax traffic). However, we believe the management’s plan to defer addition of incremental capacity in the international segment during the next three to four quarters will contribute to the improved load factor for international operations. Consequently, we expect the international load factor to increase to 81.5% in FY12E (compared to 78.9% in domestic operation).





Margins

Cost cutting measures bearing fruit

After witnessing a severe margin contraction in FY09 (EBITDA margin of -6.6% vs. -1.6% in FY08) and slight improvement in H110 (average of 1.7%), JAL reported a strong upturn in margins in Q3FY10 (15.4%). The margin expansion was driven by:

• Higher load factor in domestic operations (75.4% in Q3FY10 vs. 62.4% in Q3FY09) as well as international operations (82.5% in Q3FY10 vs. 67.8% in Q3FY09)

• Lower crude oil prices (average price of US$76.9 per barrel in Q3FY10) compared to the highs witnessed in H109 (average price of US$121 per barrel)

• Staff rationalisation leading to lower employee costs; headcount reduced to 11,700 at the end December 2009 as compared to 13,400 in January 2009

• Increased synergy between JA and JetLite employees leading to further cost savings

According to the management, cost per ASKM is expected to decrease by 5-10% YoY during the next few quarters. Accordingly, we estimate that the EBITDA margin will expand to 8.4% in FY10E and further to 9.0% in FY11E and 12.3% in FY12E. Margin expansions will be driven by stable jet fuel prices, continuance of cost saving initiatives and higher load factor.

Exhibit 11: JAL EBITDA margin (%)

5.1

-1.6

-6.6

8.4 9.0

12.3

-10

-5

0

5

10

15


EBITDA Margin - JAL


Stable crude oil prices to benefit JAL

In our view, JAL will benefit from the expected stability of crude oil prices primarily due to the conversion of majority of its capacity to JAK. Budget carriers are able to price their tickets more competitively in a low fuel price environment. Our expectation of low crude oil prices are further supported by the Energy International Administration (EIA) of US, that forecasts crude oil prices at an average of US$70.1 per barrel in FY10E, US$80.3 per barrel in FY11E and US$83.9 per barrel in FY12E. Accordingly, we forecast that JAL’s cost per ASKM will remain lower in our forecast period (Rs 3.7 in FY12E) as compared to the high witnessed in FY09 (Rs 4.0)

EBITDA margins will improve to 12.3% in FY12E due to continuance of cost saving initiatives and expectation of a stable fuel price environment

JAK service to benefit from stable fuel price during FY10E-12E





Exhibit 12: Consolidated cost per ASKM (Rs) – with fuel and without fuel

3.0

3.74.0

3.5 3.6 3.7

2.4 2.4 2.4 2.42.4

2.0

0

1

2

3

4

5


Rs.

Cost/ASKM - LHS Cost/ASKM (w/o Fuel) - LHS


Fuel costs account for about 30-35% of the total operating costs of JAL, which makes the company’s earnings highly susceptible to the movement in fuel prices. The sensitivity chart below presents the risk of fuel price movement to JAL’s bottomline (we have assumed average jet fuel prices of 50.2 cents per litre (CEP), 59.7 CEP, 63.1 CEP in FY10E, FY11E and FY12E, respectively, based on our crude oil forecasts).

Exhibit 13: Sensitivity of JAL’s EPS with jet fuel prices

Change in average jet fuel prices (%) EPS (Rs)

FY10E FY11E EPS - FY12E

10 -64.2 -41.2 19.2

Base case -53.6 2.9 65.6

-10 -42.9 47.0 112.0 Source: EIA, ICICIdirect.com Research





Balance sheet concerns

Balance sheet severely stretched

JA’s balance sheet is severely stretched with total borrowings of Rs 14,708 crore at the end of Q3FY10 (debt-to-equity ratio of 5.7x). As a result, we believe the bottomline will continue to remain under pressure during FY10E due to high interest expenses (interest coverage ratio of -0.1% in FY10E and 0.3% in FY11E), despite an improvement in operating results in Q3FY10. JAL has received permission from the government to raise equity worth ~Rs 1,860 crore (US$400 million) through the QIP route. Although, we have assumed that the company will be able to raise ~Rs 930 crore (US$200 million) in the next three or four months (as indicated by the management), the amount is still less than the payment obligation of about Rs 1,500 crore (outstanding creditors, loans for aircraft and payment obligation due to legal dispute with Sahara over JetLite) at the end of Q3FY10.

JAL is also exploring the sale and lease back option for its assets (primarily aircraft) to use the proceeds to pay down its debt. However, we are cautious on this front as the company cannot sell JetLite assets without permission from the court (the JAL-Air Sahara dispute is sub judice at present). Exhibit 14: Debt-to-equity ratio – Consolidated

2.7 2.9

7.6

5.75.3

0

2

4

6

8

FY07 FY08 FY09 FY10E FY11E

x

Debt to Equity


Despite an improvement in operational results, net profits will remain negative in FY10E due to high interest costs





Risks and Concerns Rise in fuel prices

Since fuel costs constitute about 30-35% of the total operating costs of the company, a significant rise in fuel prices will negatively impact the profitability. Further, as airlines are forced to raise ticket prices in a rising fuel price environment, a significant rise in fuel prices will lead to a slowdown in pax traffic.

Delay in recovery of domestic economy from slowdown

The pax traffic in India is highly sensitive to the performance of the real economy. With the government talking about the withdrawal of the fiscal stimulus in order to bring down the high fiscal deficit in India, the full recovery of the domestic economy may be delayed, leading to a decline in pax traffic as passenger will shift to cheaper modes of transport such as railways.

Strong capacity addition by LFCs may lead to over-supply situation

Pure-play LFCs such as SpiceJet, Indigo and Go air are planning to increase their fleet size during the period FY10-12. In case of a less-than-expected recovery in pax traffic, there is fair chance of an over-supply situation in the sector. This will negatively impact the load factor.

Inability to raise money in international market A slower than expected recovery in the international market may derail JAL’s plan to raise ~Rs 1,860 crore through the QIP route. JAL wants to raise fresh capital of ~Rs 930 crore (US$200 million) within three to four months in order to partially payback its debt, which stood at Rs 14,708 crore at the end of Q3FY10.





Financials

Consolidated revenue growth to pick-up from Q4FY10E

We expect the consolidated revenue sales of JAL to grow at 23.8% YoY to Rs 3,428 crore in Q4FY10 after witnessing an average de-growth of -15.6% YoY during the past three quarters. The growth is expected to be driven by the revival of domestic as well as international pax traffic on the back of a strong macroeconomic performance and stable fuel prices. With an improvement in yields, both domestic and international, we expect the topline of JAL to grow at a CAGR of 13.7% during FY10E-12E (as compared to 32.3% during FY06-09).

The international business, which contributed 51.3% to the consolidated revenues in Q3FY10, is expected to maintain its share in the topline driven by the increased focus of the company to improve its share on international routes such as Asean, Saarc and Gulf routes.

Exhibit 15: Consolidated revenues estimated to grow at a CAGR of 13.7% during FY10E-12E

9,05410,300

13,078 12,12113,852

15,663

-4000

0

4000

8000

12000

16000

20000


Rs. c

rore

-20

0

20

40

60

80

JAL - LHS Growth YoY (%) - RHS






Positive EBITDA expected in FY10E

After reporting negative EBITDA in the last two years (due to high fuel prices and a slowdown in the domestic market), we expect JAL to report a positive EBITDA of Rs 1,012 crore in FY10E on the back of the strong performance in Q3FY10 (EBITDA of Rs 510 crore). With the revival of the demand environment, ongoing cost cutting measures and stable fuel prices, we expect JAL’s EBITDA to grow at a CAGR of 38% to Rs 1,944 crore during FY10E-12E.

Exhibit 16: Consolidated EBITDA to improve during FY10E-12E

362

(163)

1,0121,244

1,928

(859)-1250

-625

0

625

1250

1875

2500


Rs. c

rore

-700

-450

-200

50

300

EBITDA - LHS Growth YoY% - RHS


Margin to recover slowly

In our view, the EBITDA margin of the company will improve to 12.3% in FY12E on the back of improved domestic and international operations. In Q3FY10, the international operations of the company reported higher EBITDA margin (18.6%) as compared to domestic operations (15.7%). This was primarily due to high load factor, leading to better realisations. Although we believe the growing domestic demand, stable fuel prices, and low interest costs (due to slowdown in capacity addition) will help the company to improve its bottomline, the margin will still be lower than the high witnessed in FY05-06. Exhibit 17: Slow recovery in margin during FY10E-12E

27.9

16.4

5.18.4 9.0

12.3

-6.4 -4.7-6.6

-1.6

4.40.2

-7.4

0.4

8.09.0

-12

-6

0

6

12

18

24

30

FY05 FY06 FY07 FY08 FY09 FY10E FY11E FY12E

(%)

EBITDA Margin PAT Margin






Return ratio to gain in FY11E and FY12E

JAL operates about 50% of its aircraft on a lease basis while the other half is through a sale and lease back basis. This model got severely impacted in the slowdown (FY09 and H1FY10) due to high fixed costs. However, due to high operating leverage, we expect this to drive a big upturn in returns on the back of expected improvement in the pax traffic. Further, the deferral of capacity expansion by the company is also expected to lower the interest costs for the company, leading to an improvement in return ratios in our forecast period.

Exhibit 18: RoCE (%) and RONW (%)

4.7

23.7

-10.0

1.4

0.2

-7.8

1.2

-23.9

-30.3-20.5

-40

-30

-20

-10

0

10

20

30


ROCE ROE






Valuations

JAL is the largest domestic airline operator in India with a market share of 26.9% in Q3FY10. We believe the company will be the prime beneficiary of the recent upturn of domestic pax traffic (28% YoY in Q3FY10) due to its strong market position, focus on the budget segment and capacity rationalisation undertaken in FY09. As the economy comes out of the slowdown, we expect increased demand for JA’s ‘all-economy’ service JAK, contributing to higher load factors. Further, the margin is expected to improve driven by the expected increase in load factor and stable crude oil prices.

Key risks include slowdown of economic growth and a steeper-than-expected increase in crude oil prices, leading to lower load factor and consequently profitability. Further, a significant debt on the balance sheet (Rs 14,708 crore in Q3FY10 and debt-to-equity ratio of 5.7) poses additional risk to our earning forecasts as a contraction in operating results may lead to worsening of the liquidity situation for the company. At the CMP of Rs 465, the stock is currently trading at 1.3x FY11E EV/sales and 13.6x its EV/EBITDA. The rebound in tourist traffic has improved the outlook of the company. However, we continue to remain cautious on the liquidity situation of the company as the fresh capital expected to be raised by the management (~Rs 930 crore/US$200 million) falls short of the total payment obligation (~Rs 1,500 crore/US$330 million) of the company at the end of Q4FY10. Hence, we have valued JAL at a FY11E EV/EBITDA of 12.8x, at a discount to its current valuation multiple, computing a target price of Rs 444. We are initiating coverage on the stock with a REDUCE rating, downside risk of 4.5%.

Exhibit 19: Asean peer’s valuation matrix

P/E EV/Revenue EV/EBITDA P/BV

TTM FY10E FY11E TTM FY10E FY11E TTM FY10E FY11E TTM FY10E FY11E

Jet Airways NA NA 162.6x 1.4x 1.5x 1.3x NA 17.5x 13.6x 2.8x 2.0x 1.9x

Air China NA 37.9x 43.6x 5.9x 5.8x 5.0x 77.6x 28.9x 22.4x 7.2x 5.9x 5.2x

China Eastern Airlines Co. NA 117.0x 52.2x 1.6x 1.4x 1.1x NA 15.7x 7.4x 2.7x NA 18.5x

China Southern Airlines Co. NA 120.0x 41.7x 1.5x 1.4x 1.3x NA 11.0x 7.4x 6.5x 5.1x 4.4x

EVA Airways NA NA 17.5x 1.4x 1.6x 1.3x 71.8x 12.2x 10.3x NA 1.5x 1.4x

Cathay Pacific NA 22.1x 24.2x 1.1x 1.5x 1.3x NA 10.1x 8.8x 1.6x 1.5x 1.5x

Korean Air NA 127.2x 15.7x 1.2x 1.3x 1.2x 19.5x 12.2x 8.9x 2.0x 1.6x 1.5x

Malaysia Airlines NA NA NA 0.2x 0.3x 0.3x NA NA 7.6x NA 0.9x 1.0x

Singapore Airlines 17.3x 774.0x 20.9x 1.0x 1.4x 1.2x 6.2x 9.3x 6.0x 1.3x 1.4x 1.3x

Thai Airways International NA 19.7x 13.0x 0.9x 1.0x 1.0x 34.6x 6.4x 5.7x 0.9x 0.9x 0.9x

Median 17.3x 117.0x 22.5x 1.3x 1.4x 1.2x 34.6x 12.2x 8.2x 2.3x 1.5x 1.5x

Mean 17.3x 174.0x 28.6x 1.6x 1.7x 1.5x 42.0x 13.7x 9.8x 3.1x 2.3x 3.8x

Adjusted Mean** 17.3x 84.8x 27.3x 1.3x 1.4x 1.2x 42.0x 12.6x 8.7x 2.8x 2.0x 2.3x Source: Company, ICICIdirect.com Research

JAL valued at 1.3x FY11E EV/Sales, at a premium to its Asian peers but valuation concern remains





Table and Ratios Profit and loss statement

(Rs Crore)(Year-end March) FY08 FY09 FY10E FY11E FY12ENet Sales 10,246 13,078 12,121 13,852 15,663% Growth 45.2 27.6 -7.3 14.3 13.1

Fuel Expenses 4,070 5,854 3,900 4,682 4,925% of Sales 39.7 44.8 32.2 33.8 31.4Personal Cost 1,389 1,584 1,373 1,407 1,520% of Sales 13.6 12.1 11.3 10.2 9.7Other Operating Expenses 4,950 6,499 5,836 6,519 7,290% of Sales 48.3 49.7 48.1 47.1 46.5Total Expenditure 10,409 13,937 11,109 12,608 13,736% Growth 55.5 33.9 -20.3 13.5 8.9

Operating Profit -163 -859 1,012 1,244 1,928% Growth NA NA LP 22.9 54.9Other Income 0 0 0 0 0Depreciation 802 902 976 1,008 1,167EBIT -965 -1,761 36 236 760% Growth NA NA 102.0 -560.7 222.1

Interest 522 802 946 690 613Non-operation income 676 1,536 343 485 548Profit before Tax -812 -1,027 -568 31 696% Growth NA NA NA LP NATaxation -158 -66 0 0 0

Net Profit -654 -961 -568 31 696





Balance Sheet (Rs Crore)

(Year-end March) FY08 FY09 FY10E FY11E FY12ELiabilities Equity Share Capital 86 86 106 106 106Reserves & Surplus 4,065 2,111 2,457 2,487 3,183Secured Loans 1,753 5,036 3,136 2,136 1,136Unsecured Loans 10,452 11,598 11,584 11,625 11,677Current Liab. & Prov. 4,523 4,113 5,103 5,130 5,222Others 573 275 275 275 275Total Liabilities 21,452 23,219 22,661 21,760 21,600

Assets Gross Block 16,669 18,845 18,845 18,845 18,845Less: Acc. Depreciation 2,556 2,550 3,527 4,535 5,702Net Block 14,113 16,295 15,318 14,310 13,143Capital WIP 1,303 657 657 657 657Net Fixed Assets 15,415 16,952 15,975 14,967 13,800

Loans & Advances 1,192 1,324 1,389 1,556 1,764Cash 958 1,466 2,053 1,880 2,515Trade Receivables 1,399 808 847 949 1,076Inventory 604 696 425 435 472Investments 10 100 100 100 100Total Current Assets 4,164 4,394 4,813 4,921 5,927

Others - Goodwill 1,872 1,872 1,872 1,872 1,872Total Assets 21,452 23,219 22,661 21,760 21,600





Cash Flow statement (Rs Crore)

(Year-end March) FY08 FY09 FY10E FY11E FY12EProfit before Tax -812 -1,027 -568 31 696Depreciation 802 902 976 1,008 1,167Other Non Cash expenses 2,567 -838 0 0 0Diect Tax Paid 13 15 0 0 0Interest Income 0 0 0 0 0Others 1,683 -294 -633 -205 -64Cash Flow before WC Changes 862 -684 1,041 1,244 1,928

Net Increase in Current Liabilities 2,200 -631 990 27 92Net Increase in Current Assets 928 -367 -168 280 371Cash Flow after WC Changes 2,134 -948 2,200 991 1,648

Purchase of Fixed Assets -8,263 -1,531 0 0 0(Inc.)/Dec. in Investment 804 281 313 485 548CF from Investing -7,459 -1,250 313 485 548

Inc/(Dec) in Loan Funds 6,149 4,429 -1,913 -959 -949Inc/(Dec) in Net Worth 0 0 934 0 0Others -522 -802 -946 -690 -613Casf Flow from Financing Actv 5,627 3,626 -1,926 -1,649 -1,561

Op. Cash & Cash equivalents 1,097 958 1,466 2,053 1,880Cl. Cash & Cash equivalents 958 1,466 2,053 1,880 2,515





Ratios (Year-end March) FY08 FY09 FY10E FY11E FY12EPer share data (Rs)EPS -75.7 -111.4 -53.6 2.9 65.6Cash EPS 17.1 -6.9 38.5 98.0 175.7Book Value 480.8 254.5 241.6 244.5 310.1Operating Profit Per Share -18.9 -99.5 95.4 117.3 181.7

Operating RatiosOperating Margin -1.6 -6.6 8.4 9.0 12.3Net Profit Margin -6.4 -7.4 -4.7 0.2 4.4

Return RatiosRoNW -20.5 -30.3 -23.9 1.2 23.7ROCE -7.8 -10.0 0.2 1.4 4.7

Valuation Ratios EV/EBITDA -94.1 -22.4 17.5 13.6 7.9PE -6.2 -4.2 -8.8 162.6 7.2EV/Sales 1.5 1.5 1.5 1.2 1.0Sales to Equity 2.5 6.0 4.7 5.3 4.8Market Cap to Sales 0.4 0.3 0.3 0.3 0.3Price to Book Value 1.0 1.9 2.0 1.9 1.5

Turnover Ratios Fixed Asset Turnover Ratio 549.2 473.1 481.1 394.4 321.6Debtor turnover 49.8 22.5 25.5 25.0 25.1Creditor turnover 72.5 49.5 32.6 29.2 28.0Cash to abs. Liab. 0.2 0.4 0.4 0.4 0.5

Solvency Ratios Debt/Equity 2.9 7.6 5.7 5.3 3.9Current Ratio 0.9 1.1 0.9 1.0 1.1Quick ratio 0.8 0.9 0.9 0.9 1.0



March 26, 2010


Initiating Coverage

Riding high on improving macros… SpiceJet is India’s second-largest low fare carrier (LFC) with a market share of 12.8% (Q3FY10). The company has grown faster than the sector in April-December 2009 (pax traffic growth of 46.3% YoY vs. 11.5% for the sector) due to the preference of consumers towards low cost travel and higher capacity (average growth of 28.2% YoY). We believe the company will benefit in FY10-12E from the strong revival in domestic pax-traffic and stable crude oil prices. We are initiating coverage on the stock with a STRONG BUY rating with a target price of Rs 72.

Strong topline growth in FY10E-12E

We expect SpiceJet’s topline to grow strongly in FY10E-12E (CAGR of 20.8% to Rs 3,215.8 crore) driven by the preference of consumers towards low cost travel as the economy comes out of the slowdown and higher capacity (fleet size of 24 in FY12E vs. 19 in FY09). Consequently, SpiceJet’s market share is estimated to increase to 13.9% in FY12E (from 12.8% in Q3FY10). The recent upward revision of the FY10 GDP growth forecast by RBI (7.5% vs. 6% earlier) is likely to boost consumer and business confidence, leading to robust growth of the sector’s pax traffic (12.8% CAGR in FY10-12E).

Margin expansion imminent

Driven by higher load factor (75.7% in FY10E vs. 66.1% in FY09) and stable crude oil prices (average of US$70.1 per barrel in FY10E vs. US$121 per barrel in H1FY09), we expect SpiceJet to turn profitable in FY10E (EBITDA margin of 3.4% vs. -24.8% in FY09) for the first time since it commenced operations. The operational performance improved significantly in 9MFY10 (EBITDA margin of 0.7% vs. -24.8% in FY09). This is likely to contribute to positive PAT margins in FY10E (lower interest expenses of Rs 8.6 crore vs. Rs 16 crore in FY09).

Valuations At the CMP of Rs 58.0, the stock is trading at 7.4x FY11E EV/EBITDA against its global peer’s average mean FY11E EV/EBITDA of 8.8x. We believe the stock is currently undervalued considering its improving operational performance on account of the improving macroeconomic outlook. The company has a sound financial position and is also foraying into the profitable international market. As a result, we value the stock at 9.0x FY11E EV/EBITDA (i.e. at a premium to its global players). We are initiating coverage on the stock with target price of Rs 72 and a STRONG BUY rating, offering an upside of 24%. Exhibit 1: Financial Summary Rs. Crore FY08 FY09 FY10E FY11E FY12ENet Sales 1,295 1,689 2,202 2,681 3,216EBITDA -252 -419 74 216 335Net Profit -132 -340 105 244 324EPS (Rs) -5.5 -14.1 4.4 8.0 10.6EV/EBITDA (x) -5.3 -3.8 20.0 7.4 5.4RoCE (%) -44.2 -137.8 62.6 71.0 54.7RoNW(%) -124.6 169.6 -27.8 -198.1 132.7


Spicejet Ltd (MODLUF) Rs 58.0

Rating Matrix Rating : Strong Buy

Target : Rs 72

Target Period : 12 months

Potential Upside : 24 %

YoY Growth (%)

FY09 FY10E FY11E FY12ENet Sales 30.5 30.3 21.8 19.9EBITDA 66.3 -117.7 192.5 54.9Net Profit 159.4 -131.2 131.6 33.0EPS 159.0 -131.2 83.1 33.0

Stock Metrics Bloomberg Code SJET:IN Reuters Code SPJT:BOFace value (Rs) 10.0Promoters Holding 12.9Market cap (Rs crore) 1,397.952 week H/L 64.4/13.1Sensex 17,558.0Average volumes 3,774,376.5

Valuation matrix FY09 FY10E FY11E FY12E

Target PE -5.2 16.9 9.2 6.9EV/EBITDA -4.7 25.1 7.4 5.4EV/Sales 1.2 0.8 0.8 0.6Price/BV -4.1 -5.4 27.3 5.5

Stock Price movement (Stock vs. Nifty)

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-09

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Jul-0

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Prices - LHS Sensex - RHS




Spicejet Ltd (MODLUF)


Company Background SpiceJet commenced its operation in May 2005 as a budget airline with a strong focus on the domestic market. The company has emerged as the second largest LFC after Indigo, with a market share of 12.8% at the end of Q3FY10. The company operates 19 aircraft, which fly to 18 different cities in India.

SpiceJet is planning to add five aircraft by 2012 (24 aircraft) in order to boost its domestic capacity and start international operations. The airline has recently received permission from the government to fly on international routes.

Spice Jet’s revenues witnessed a growth of 30.5% YoY to Rs 1,689 crore in FY09 despite the significant contraction witnessed in the pax traffic (growth of 0.12% in FY09 vs. 57.6% in FY08). The strong growth in topline was primarily due to high fuel prices, leading to high yields during the year. During FY06-08, SpiceJet witnessed robust revenue growth (CAGR of 75.7%) driven by booming pax traffic in the domestic market.

SpiceJet is listed on the BSE and is headquartered in Gurgaon, Haryana. Exhibit 2: Evolution of SpiceJet


Exhibit 3: Domestic pax traffic (in lakh) and market share (%)

9.1 8.611.7 11.6 12.0

7.210.0

11.913.6 13.6

15.5

8.2 8.210.1 10.3 10.5

8.1

10.512.2 12.8 13.0 12.8

0

6

12

18

Q1FY

08

Q2FY

08

Q3FY

08

Q4FY

08

Q1FY

09

Q2FY

09

Q3FY

09

Q4FY

09

Q1FY

10

Q2FY

10

Q3FY

10

0

5

10

15

Pax carried (In lakh) - LHS Market Share (%) - RHS


SpiceJet is planning to add five aircraft by 2012 (24 aircraft) in order to boost its domestic capacity and start international operations. The airline has recently received permission from the government to fly on international routes.

1984 – Incorporated as Genius Leasing

Finance Investment Company, promoted

by Modi Group companies

1996 – Ceased operations after

renaming again to ModiLuft Ltd

1993 – Renamed as MG Express, started providing air transportation

2000– Started operations as Royal

Airways

2005– Renamed SpiceJet, started

operation in domestic market

2006– Raised US$80 million through FCCBs to Istithmar and Goldman

Sachs

2008 – WL Ross & Co as new investor and

exit of Goldman Sachs from FCCB

investment





Investment Rationale

SpiceJet is the second-largest LFC operating in India with a market share of 12.8% in Q3FY10. We are positive on the growth prospects of the company driven by the following rationale:

• Strong macroeconomic growth (real GDP expected to grow at CAGR of 7.5% during FY10E-12E) to boost domestic pax traffic

• Low crude oil prices (average of US$78.1 per barrel during FY10E-12E vs. US$121 per barrel in H109) will benefit LFCs

• Rising income levels, with GDP per capita expected to grow at a CAGR of 6% during FY10E-12E to Rs 36,876, will push premium rail travellers towards low-cost air travel

• The improving operational performance of SpiceJet coupled with rising brand presence will improve the market share (13.9% in Q4FY12E)

Pax traffic growth in India is highly dependent on macroeconomic performance and fuel price movement. A premature withdrawal of the fiscal stimulus by the government and a higher-than-expected rise in fuel prices can impede the growth potential of the company.

Potential upgradation of premium rail pax to boost LFC

We believe low cost airlines (SpiceJet, Indigo, Go Air, Paramount and JetLite) will be the primary beneficiaries of the potential upgradation of premium rail travellers due to improving air traffic infrastructure and rising income levels in the country. In our view, the potential shift of about one-third of the premium rail travellers (about 50,000 passengers daily) can increase the air-pax traffic penetration to 5.3% in FY10E (vs. 3.8% in FY10E without the potential upgradation). Exhibit 4: Potential increase in domestic pax traffic

0

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In L

akh

0

2

4

6

8

Pax traffic (Normal) - LHS Pax traffic (Pot Upgrad*) - RHS

Penetration (Normal %) - RHS Penetration (Pot upgrd* %) - RHS

Source: Company, ICICIdirect.com Research,* potential upgradation to low cost air travel from premium rail travel

In our forecasts, we have assumed that railway’s premium travellers (constituting passengers travelling in the higher upper class) will grow at a CAGR of 12.5% during FY09-12E (vs. 12.2% during FY07-09). According to our analysis, the passengers who travel in AC I and AC II (constituting about one-third of the total AC travellers) and pay an average ticket price of Rs 2,350, have a greater chance of choosing low-cost air travel as compared to AC III passengers (The current AC III passengers are expected to upgrade themselves to AC I and AC II with rising income levels).

Potential upgradation of about one-third of premium rail traveller (primarily AC class travellers) can increase air-pax traffic penetration to 5.3% in FY10E

Strong macroeconomic growth and stable crude oil prices to improve the domestic pax-traffic





Exhibit 5: Railways ticket prices* on Delhi-Mumbai route

Delhi - Mumbai Class 1A Class 2A Class 3A

Mumbai Rajdhani 3,305 1,975 1,495

Golden Temple 2,586 1,532 1,120

Average Ticket Prices 2,946 1,754 1,308 Source: Indian Railways, ICICIdirect.com Research, * Air ticket prices for travel on March 19, 2010

Exhibit 6: SpiceJet ticket prices*

From Destination Avg Ticket Prices

New Delhi Mumbai 5,474

New Delhi Ahmedabad 4,229

Average ticket prices 4,852

Source: Indian Railways, ICICIDirect.com Research,* Air ticket prices for travel on March 19, 2010

However, any potential upgrade of premium rail traffic is constrained by a significant increase in crude oil prices as fuel expenses account for about 45-50% of the total operating expenses for LFCs. A rising fuel price environment forces LFCs to increase their ticket prices at a higher rate compared to full service carriers (FSCs), leading to reduced gap between the ticket prices of these carriers. Further, a slower-than-expected recovery of economic growth can force premium rail travellers to fall back on the cheaper railway services. Well positioned to increase market share

SpiceJet is the second-largest LFC in India with a market share of 12.8% at the end of Q3FY10 (Indigo is the only pure-play LFC ahead of SpiceJet with a market share of 14.4% in Q3FY10). The growing preference of passenger towards low cost travel, as the economy comes out of the slowdown, was evident from the fact that SpiceJet witnessed a robust pax traffic growth of 46.3% YoY during April-December 2009 (vs. 11.5% for the sector and -0.4% for market leader Jet Airways{JAL}). Growth was driven by:

• Lower ticket prices for SpiceJet during April-December 2009 (average passenger yields of Rs 2.97 vs. Rs 3.44 for JAL)

• Decline of 24.1% YoY in fuel expenses during April-December 2009 due to lower crude oil prices (average crude oil prices of US$68.2 per barrel vs. US$100.1 per barrel during April-December 2008)

• Increased aircraft utilisation as number of flights per day per aircraft increased to 6.4 in H1FY10 from 5.3 in FY09

• Capacity, as measured by available seat per kilometre (ASKM), grew at a monthly average of 28.4% YoY during April-December 2009 vs. 26.8% YoY during April-December 20008

• Improvement in load factor to an average of 75.8% during 9MFY10 (vs. 63.4% during 9MFY09)

We expect the market share of SpiceJet to grow to 13.9% in Q4FY12E driven by strong pax traffic growth (CAGR of 17.5% during FY10E-12E vs. 12.8% for the sector), improvement in capacity due to increase in fleet

SpiceJet’s market share is expected to increase to 13.9% in Q4FY12E vs. 12.8% in Q3FY10





size (24 in FY12E vs. 19 in FY09) and stable fuel prices (US$80.3 per barrel in FY11E and US$83.9 per barrel in FY12E).

Exhibit 7: Domestic pax traffic (in lakh)

12

710

1214 14

15 15 16 1619 18 19 18

22 20

0

8

15

23

30

Q1FY

09

Q2FY

09

Q3FY

09

Q4FY

09

Q1FY

10

Q2FY

10

Q3FY

10

Q4FY

10

Q1FY

11

Q2FY

11

Q3FY

11

Q4FY

11

Q1FY

12

Q2FY

12

Q3FY

12

Q4FY

12

-40

0

40

80

120

Passenger Traffic (LHS) Growth YoY% (RHS)


SpiceJet leads in aircraft utilisation

SpiceJet maintains a high aircraft utilisation rate of 12 hours primarily to spread its fixed costs (such as lease rentals, etc.). This translates into one additional flight a day. As a result, the company is able to lower its cost of operation, which translates into lower ticket prices for customers.

Load factor to improve despite capacity expansion

We estimate that SpiceJet’s capacity will grow at a CAGR of 15.4% during FY10E-12E driven by the induction of five new aircraft in its fleet (fleet strength of 24 in FY12E vs. 19 in FY09). According to the management, the fleet expansion is primarily aimed at boosting the airline’s presence in profitable domestic routes and the commencement of international operations from FY11E.

We expect SpiceJet’s load factor to improve (79.8% in FY12E vs. 66.1% in FY09) despite the capacity expansion plans of the company. Improvement in load factors will be driven by the revival of domestic pax traffic with a strong preference towards low cost travel; SpiceJet witnessed a robust load factor of 78.9% in Q3FY10 (vs. 65.5% in Q3FY09) despite 28.2% YoY growth in capacity addition. Further, load factor will be supported by the strong capacity rationalisation witnessed in the sector (domestic capacity declined by 2.4% in FY09 vs. growth of 24.4% in FY08). JAL and Kingfisher (with a combined domestic capacity of ~ 46.3% in FY09) have shelved their capacity expansion plans for the next 12-18 months, leading us to believe that supply will be well aligned with the demand situation in our forecast period.

SpiceJet’s load factor will improve to 79.8% in FY12E (vs. 66.1% in FY09) despite capacity expansion plans

High aircraft utilisation rate of 12 hours by SpiceJet translates into one additional flight a day





Exhibit 8: ASKM (in lakh) and load factors (%)

35,320

72,08060,130

88,860 101,259

118,376

0

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80,000

120,000

160,000


0

25

50

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100

ASKM - (LHS) Load Factor (%) - (RHS)


Yields to remain under pressure despite improvement in outlook

In our view, SpiceJet’s yields will remain under pressure (Rs 3.2 in FY12E) primarily due to increasing competition in the budget segment. Major FSCs such as JAL and Kingfisher have converted a majority of their capacities into low cost in order to improve their load factors. JAL has started a new service, Jet Airways Konnect (JAK), by converting about 1/3rd of the fleet size (excluding JetLite) into low-cost carriers.

Further, we expect crude oil prices to remain lower during our forecast period FY10E-12E (average of US$82.1 per barrel) as compared to the high witnessed in H1FY09 (average of US$121 per barrel). This will keep fuel surcharge at a comparatively low level, leading to stable yields for the company. In our view, the low fuel price environment will help SpiceJet to increase its focus on load factors while maintaining low-ticket prices during our forecast period.

Exhibit 9: Pax Yields (Revenue per RPKM)

2.2

2.8

3.33.0 3.1 3.2

0

1

2

3

4


Pax Yields (Rs.)


Marginal increase in yields due to increasing competition from FSCs ISIEmergingMarketsPDF in-mapegroup from 114.143.218.106 on 2011-07-20 10:22:12 EDT. DownloadPDF.




EBITDA margin to turn positive from FY11E

SpiceJet witnessed a robust EBITDA margin of 15.9% in Q3FY10 after reporting an average EBITDA margin of -10.4% in H1FY10. The margin improvement in Q3FY10 was driven by:

• Robust topline growth of 35.9% YoY to Rs 642.1 crore in Q3FY10

• Decline in crude oil prices during the last three quarters (average price of US$68 per barrel vs. US$121 per barrel witnessed in H109

• Significant improvement in load factors (78.9% in Q3FY10 vs. 65.5% in Q3FY09)

In our view, SpiceJet’s operating performance will remain strong during our forecast period primarily due to strong topline growth (CAGR of 20.8% during FY10E-12E) and expectation of lower crude oil prices (share of fuel expenses in total operating expenses is expected to decline to 39.4% in FY12E vs. 44.8% in FY09). As a consequence, we expect the EBITDA margin to improve to 8.1% in FY11E and 10.4% in FY12E. Further, the decline in fuel expenses during our forecast period is expected to lower the cost per ASKM of SpiceJet to Rs 2.4 in FY12E (Rs 2.9 in FY09).

Exhibit 10: EBITDA margin (%)

-25.0-19.5

-24.8

3.48.1 10.4

-30

-20

-10

0

10

20


EBITDA Margin (%)


Exhibit 11: Cost per ASKM (Rs) – with and without fuel

2.6

1.5

2.4

2.92.4 2.4

1.6 1.51.51.4

0

1

2

3

4


Rs.

0

25

50

75

100

%

Cost per ASKM Cost per ASKM - w/o Fuel

BE* load factor (%) BE* load factor (%) - w/o fuel

Source: Company, ICICIdirect.com Research,*Breakeven load factor

Strong growth in net sales and lower fuel expenses to improve EBITDA margins





Although we have forecasted lower crude oil prices during FY10E-12E (average prices of US$70.1 per barrel in FY10E, US$80.3 per barrel in FY11E and US$83.9 per barrel in FY12E), a higher-than-expected rise in crude oil prices poses a significant threat to the operation of SpiceJet. LFCs are more vulnerable to a rise in crude oil prices due to higher share of fuel expenses in total operating expenses as compared to FSCs.

To capture the impact of rising crude oil on the company’s bottomline, we have carried out a sensitivity analysis of the movement in crude oil prices on SpiceJet’s EPS. We have assumed average jet fuel prices of 50.2 cents per litre (CEP), 59.7 CEP, 63.1 CEP in FY10E, FY11E and FY12E, respectively, based on our crude oil forecasts. Exhibit 12: Sensitivity of SpiceJet’s EPS with jet fuel prices

Change in average jet fuel prices (%) Change in EPS (Rs)

FY10E FY11E FY12E

10 3.5 4.8 7.2

0 4.4 8.0 10.6

-10 5.3 11.2 14.1 Source: EIA, ICICIdirect.com Research

FCCBs conversion to strengthen balance sheet SpiceJet has foreign currency convertible bonds (FCCBs) worth US$78 million on its books due for redemption in December ‘10. Istithmar, a UAE-based investment house, holds FCCBs worth US$12 million while the rest is held by WL Ross & Co, a US-based investment company. SpiceJet has also issued warrants worth Rs 606.1 million (convertible to equity shares at Rs 25 per share) with a conversion date in June ‘10.

According to our analysis, we believe SpiceJet will proceed with full conversion of warrants and about 40% of FCCBs conversion into equity shares to increase its foreign shareholding to 48.4% in FY11E (when these warrants and FCCBs are due for redemption) from 27.5% at present. Foreign shareholding decreased to 27.5% in February ‘09 after Istithmar sold about 13.4% of its equity stake in SpiceJet to domestic investors in India. In our view, the full conversion of warrants and part-conversion of FCCBs will keep the foreign shareholding within the prescribed limit of 49% as mandated by the government.

We estimate that the conversion of FCCBs will help SpiceJet to reduce its debt (Rs 348.7 crore in FY12E from Rs 488.8 crore in FY09). This, in turn, will strengthen its balance sheet (positive net worth of Rs 81.4 crore in FY11E vs. negative net worth of Rs 429.4 crore in FY09).

Exhibit 13: Net worth to turn positive in FY11E

184.682.1

406.3

-328.2-429.4

28.0

-600-450-300-150

0150300450


-5

0

5

10

15

20

25

Networth (Rs crore) Debt-to-equity (x)


FCCB worth US$78 million due for redemption in December 2010





Risks and Concerns Increase in crude oil prices

LFCs, such as SpiceJet, are more vulnerable to rise in crude oil prices than FSCs as fuel expenses account for about 45-50% of the total operating expenses (vs. 30-35% for FSCs). In a rising fuel price environment, LFCs are forced to hike their ticket prices more rapidly than FSCs, thus narrowing the gap between ticket prices of these carriers.

Continuance in macroeconomic slowdown

SpiceJet primarily caters to the demand of typical low-cost travellers who have upgraded themselves from premium railways services and prefer personal or leisure travel. Given the dependence of air traffic on the economic performance, a slowdown in macroeconomic growth will hit the low cost travellers more than business travellers. This can negatively impact SpiceJet’s pax traffic growth.

Excessive capacity addition may lead to decline in utilisation levels

Our analysis suggests that the present demand situation in the sector is well aligned with the capacity situation and the sector can easily accommodate capacity growth of 7-8% in the next two or three years. However, LFCs such as SpiceJet, Indigo, Go Air and Paramount have strong capacity addition plans as 28 new aircraft are expected to be delivered to these airlines during FY10E-12E. Any slowdown in the demand situation during our forecast period will create an oversupply situation in the sector, leading to a decline in load factors.





Financials Total revenues to grow at a CAGR of 20.8% during FY10E-12E

SpiceJet’s total revenues witnessed a growth of 27.0% YoY during April-December ‘09 (vs. 42.1% YoY witnessed during April-December ‘08) primarily due to the high base effect. The growth was driven by a decline in fuel surcharges (average crude oil prices of US$68.2 per barrel during April-December 2009 vs. US$100.1 per barrel during April-December 2008). Consequently, we estimate that total revenues will grow at 30.3% YoY to Rs 2,202 crore in FY10E. In our view, SpiceJet’s revenues will grow at a CAGR of 20.8% to Rs 3,215.8 crore during FY10E-12E (higher than 15% growth for market leader JAL) driven by a revival of domestic pax demand and preference towards low cost travel. Exhibit 14: Net sales estimated to grow at a CAGR of 20.8% during FY10E-12E

643.8

1,295.01,689.4

2,202.02,681.3

3,215.8

0

700

1,400

2,100

2,800

3,500


Rs. c

rore

0

20

40

60

80

100

120

Net sales - LHS Growth YoY % - RHS


EBITDA to improve significantly during FY10E-12E

We estimate that the EBITDA of the company will improve significantly in FY10E (Rs 74 crore vs. Rs -419.2 crore in FY09) driven by strong growth in net sales and a decline in fuel expenses (11% YoY in FY10E). In our view, strong topline growth and stable crude oil prices expected during FY10E-12E will help SpiceJet to manage its expenses better than the past years. As a consequence, we expect positive EBITDA of Rs 216.5 crore during FY11E and Rs 335.4 crore during FY12E. Further, the EBITDA margin of the company is expected to grow to 10.4% in FY12E vs. -24.8% in FY09. Exhibit 15: EBITDA to improve during FY10E-12E

-160.8

335.4

74.0

-252.0-419.2

216.5

3.48.1

10.4

-25.0-19.5

-24.8-550

-400

-250

-100

50

200

350


Rs. c

rore

-30

-23

-15

-8

0

8

15

EBITDA - LHS EBITDA Margin (%) - RHS


SpiceJet’s revenues to grow at a CAGR of 20.8% to Rs 3,215.8 crore during FY10E-12E (higher than 15% growth for market leader JAL) driven by a revival of domestic pax demand and preference towards low cost travel.





Full year profit expected in FY10E

We expect SpiceJet to report a net profit of Rs 101.3 crore in FY10E (after witnessing losses during the past five years). In addition to a strong improvement in the margin, we estimate lower interest payment of Rs 8.6 crore in F10E (vs. Rs 16 crore in FY09) due to repayment of secured loans scheduled during the year. Further, we believe that the company will proceed with the part-conversion of FCCBs (which is due on December 20009) into equity shares, leading to a decrease in interest payment obligations during FY11E-12E. As a result, we expect the net margin to expand to 10.8% in FY12E. Exhibit 16: Net margin to improve during FY10E-12E

-133.5

-352.6

101.3243.7

324.2

-80.1

-400

-200

0

200

400


Rs. c

rore

-20

-10

0

10

20

Net Profit - LHS Net Margin (%) - RHS


Net worth to turn positive in FY11E

With increased visibility in operating profit, we expect the net worth of the company to turn positive in FY11E. Exhibit 17: RoCE expected to improve in FY11E-12E

184.6

28.0

-328.2

82.1

406.3

-429.4-600

-450

-300

-150

0

150

300

450


-200

-150

-100

-50

0

50

100

Net Worth ROCE (%)


We expect company’s net margin to expand to 10.8% in FY12E.

Net worth of the company to turn positive in FY11E.





Valuations

SpiceJet has emerged as the second-largest LFC in India with a market share of 12.8% in Q3FY10. We believe that SpiceJet will be one of the prime beneficiaries of the preference of passengers towards low cost air travel (as the economy comes out of the slowdown) and potential shift of premium rail passengers towards air travel. As a consequence, we expect SpiceJet’s pax traffic growth (CAGR of 17.5% during FY10E-12E) to be higher than the sector (12.8%). Further, the lower fuel price expected during our forecast period (US$80.3 per barrel in FY11E and US$83.9 per barrel) will help the company to improve its EBITDA margin to 10.4% in FY12E (vs. -24.8% in FY09).

SpiceJet’s earnings are highly susceptible to the movement of crude oil prices as fuel expenses account for about 45-50% of the total operating expenses. Higher-than-expected crude oil prices can negatively impact the company’s operations. We are also concerned about the capacity addition by SpiceJet and other LFCs such as Indigo, Go Air and Paramount that can lead to an overcapacity situation in the sector in case demand growth remains muted. The sudden withdrawal of fiscal stimulus by the government can derail the economic growth momentum, leading to low pax traffic. At the CMP of Rs 58.0, the stock is trading at 7.4x FY11E EV/EBITDA against its global peer’s average mean FY11E EV/EBITDA of 8.8x. We believe the stock is currently undervalued considering its improving operational performance on account of the improving macroeconomic outlook. The company has a sound financial position and is also foraying into the profitable international market. As a result, we value the company at 9.0x FY11E EV/EBITDA (i.e. at a premium to its global players). We are initiating coverage on the stock with a target price of Rs.72 and a STRONG BUY rating, offering an upside of 24%.

Exhibit 18: Comparable Analysis

Company EV EV/Revenue EV/EBITDA EV/EBIT P/BVUSD m TTM FY10E FY11E TTM FY10E FY11E TTM FY10E FY11E TTM FY10E FY11E

Air China 4.6x 4.5x 3.9x 60.8x 22.6x 17.5x NA 106.5x 44.2x 5.3x 4.4x 3.9xChina Eastern Airlines Co. 1.4x 1.3x 1.0x NA 14.4x 6.7x NA NA 17.6x 2.3x NA 15.7xChina Southern Airlines Co. 1.4x 1.3x 1.1x NA 9.9x 6.7x NA 150.3x 30.2x 5.4x 4.2x 3.7xEVA Airways 1.3x 1.5x 1.3x 68.6x 11.7x 9.8x NA NA 54.6x NA 1.3x 1.3xCathay Pacific 1.1x 1.4x 1.2x NA 9.6x 8.3x NA 21.6x 21.4x 1.5x 1.4x 1.3xKorean Air 1.2x 1.2x 1.2x 18.4x 11.5x 8.4x NA 52.0x 21.2x 1.7x 1.4x 1.3xMalaysia Airlines 0.4x 0.4x 0.4x NA NA 11.7x NA NA 23.2x NA 1.3x 1.5xSingapore Airlines 0.9x 1.2x 1.0x 5.4x 8.0x 5.2x 15.7x 294.2x 16.9x 1.2x 1.2x 1.2xThai Airways International 0.8x 1.0x 0.9x 31.5x 5.9x 5.2x NA 21.0x 17.6x 0.6x 0.6x 0.6xMedian 1.2x 1.3x 1.1x 31.5x 10.7x 8.3x 15.7x 79.2x 21.4x 1.7x 1.4x 1.3xMean 1.5x 1.5x 1.3x 36.9x 11.7x 8.8x 15.7x 107.6x 27.4x 2.6x 2.0x 3.4xAdjusted Mean** 1.1x 1.2x 1.0x 36.9x 10.1x 7.8x 15.7x 70.3x 24.0x 2.7x 1.8x 3.7x


SpiceJet is valued at 9.6x FY11E EV/EBITDA , at Rs 72 per share.





Table and Ratios Profit and loss statement

(Rs Crore)(Year-end March) FY08 FY09 FY10E FY11E FY12ENet Sales 1,295 1,689 2,202 2,681 3,216% Growth 101.1 30.5 27.9 15.4 19.9

Fuel Expenses 703 945 820 980 1,134% of Sales 54.3 55.9 37.2 36.5 35.3Personal Cost 140 155 181 195 214% of Sales 10.8 9.2 8.2 7.3 6.6Other Operating Exps 704 1,008 1,127 1,290 1,532% of Sales 54.4 59.7 51.2 48.1 47.7Total Expenditure 1,547 2,109 2,128 2,465 2,880% Growth

Operating Profit -252 -419 74 216 335% Growth 56.8 66.3 -117.7 192.5 54.9Depreciation 8 7 9 13 13EBIT -260 -426 65 203 322% Growth 47.6 64.1 -115.2 213.2 58.5

Interest 14 16 9 13 13Non-operation income 144 105 49 54 64Profit before Tax -130 -337 105 244 374% Growth 71.5 159.4 -131.2 131.6 53.4Taxation 0 0 0 0 50

Net Profit -130 -337 105 244 324% Growth 71.5 159.4 -131.2 131.6 33.0





Balance Sheet (Rs Crore)

(Year-end March) FY08 FY09 FY10E FY11E FY12ELiabilities Equity Share Capital 241 241 241 305 305Preference capital 0 6 6 0 0Reserves & Surplus -213 -677 -575 -223 102Secured Loans 167 33 21 37 43Unsecured Loans 365 456 456 306 306Current Liab. & Prov. 791 691 730 751 768Others 0 0 0 0 0Total Liabilities 1,351 751 878 1,176 1,523

Assets Gross Block 86 96 96 96 96Less: Acc. Depreciation 21 28 41 54 67Net Block 65 68 55 42 29Capital WIP 499 185 185 360 360Net Fixed Assets 564 253 240 402 389

Loans & Advances 174 154 214 271 316Cash 600 308 399 472 783Trade Receivables 2 12 13 16 19Inventory 11 23 12 15 17Investments 0 0 0 0 0Total Current Assets 787 498 638 774 1,135

Total Assets 1,351 751 878 1,176 1,523





Cash Flow statement (Rs Crore)

(Year-end March) FY08 FY09 FY10E FY11E FY12EProfit after Tax -130 -337 105 244 374Depreciation 8 7 9 13 13Other Non Cash expenses 0 0 0 0 0Diect Tax Paid 2 3 0 0 50Interest Income 0 0 0 0 0Others 130 108 40 40 51Cash Flow before WC Changes -254 -441 74 216 286

Net Increase in Current Liabilities 35 -225 39 21 17Net Increase in Current Assets 58 3 49 63 50Cash Flow after WC Changes -278 -670 63 175 254

Purchase of Fixed Assets 171 304 0 0 0(Inc.)/Dec. in Investment 81 0 0 0 0CF from Investing 396 429 49 -121 -111

Increase/(Decrease) in Loan Funds 99 -43 -12 -134 6Increase/(Decrease) in Net Worth -26 -53 0 173 0Others -14 -10 -9 -19 -13Casf Flow from Financing Activities 60 -106 -21 19 -7

Op. Cash & Cash equivalents 351 600 308 399 472Cl. Cash & Cash equivalents 600 308 399 472 783





Ratios (Year-end March) FY08 FY09 FY10E FY11E FY12EPer share data (Rs)EPS -5.4 -14.0 4.4 8.0 10.6Cash EPS -5.1 -13.7 4.7 8.4 11.1Book Value 1.2 -17.8 -13.6 2.7 13.3Operating Profit Per Share -10.5 -17.4 3.1 7.1 11.0

Operating RatiosOperating Margin -19.5 -24.8 3.4 8.1 10.4Net Profit Margin -10.0 -20.0 4.8 9.1 10.1

Return RatiosRoNW -124.6 169.6 -27.8 -198.1 132.7ROCE -44.2 -137.8 62.6 71.0 54.7

Valuation Ratios EV/EBITDA NA NA 20.0 7.6 4.0PE -10.5 -4.1 13.3 7.3 5.5EV/Sales 1.0 0.9 0.67 0.61 0.41Sales to Equity 46.3 -3.9 -6.7 32.6 7.9Market Cap to Sales 1.1 0.8 0.6 0.5 0.4Price to Book Value 49.9 -3.3 -4.3 21.5 4.4

Turnover Ratios Fixed Asset Turnover Ratio 159.0 54.6 39.8 54.7 44.1Debtor turnover 0.5 2.7 2.1 2.2 2.1Creditor turnover 133.0 236.8 157.4 149.4 170.4Cash to abs. Liab. 0.8 0.4 0.5 0.6 1.0

Solvency Ratios Debt/Equity 19.0 -1.1 -1.5 4.2 0.9Current Ratio 1.0 0.7 0.9 1.0 1.5Quick ratio 1.0 0.7 0.9 1.0 1.5





RATING RATIONALE ICICIdirect.com endeavours to provide objective opinions and recommendations. ICICIdirect.com assigns ratings to its stocks according to their notional target price vs. current market price and then categorises them as Strong Buy, Buy, Add, Reduce, and Sell. The performance horizon is two years unless specified and the notional target price is defined as the analysts' valuation for a stock. Strong Buy: 20% or more; Buy: Between 10% and 20%; Add: Up to 10%; Reduce: Up to -10% Sell: -10% or more;

Pankaj Pandey Head – Research [email protected]

ICICIdirect.com Research Desk, ICICI Securities Limited, 7th Floor, Akruti Centre Point, MIDC Main Road, Marol Naka, Andheri (East) Mumbai – 400 093

[email protected]

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