Airline Industry Analysis
Submitted in Partial Fulfillment of the requirements of the
courseInvestment ManagementProject toProf. K.N. BadhaniOn30th
August 2014
ByGROUP 6 SECTION BDasi Prithvi Tej PGP13019Binita Kumari
PGP13081Rakesh Krishna V PGP13108Shital Kumar PGP13118Rohith
Votarikari PGP13129Post Graduate Diploma in ManagementIIM
Kashipur
MACROECONOMIC ANALYSISMacro-economic factors affecting the
Airlines Industry are: Recovery in the global economy As global
economy is expected to recover after 2014, growth of passenger
traffic is expected because of increase in foreign tourists as well
as NRIs. As Indian airlines is concentrating more on short haul
routes as well as heavy traffic destinations such as Middle east
and Europe, it is expected to grow significantly and become more
affordable. Proposed development of tourist circuits like
Sarnath-Gaya-Varanasi Buddhist Cicuit and five other tourist
circuits will help to boost airline traffic in longer run.
Electronic Travel Authorization (e-Visa) at nine airports It will
give a push to foreign arrivals and boost airline traffic over the
long term. Investment in Airport Infrastructure Investment of close
to Rs 310 Billion is expected to flow into airport infrastructure
between 2013-2014 to 2017-2018. It will boost the airlines industry
and improve the airport facilities. Grant of flying rights to
oversees destination An increase in flying rights between New Delhi
and Abu Dhabi to 36000 seats per week has been granted, similar
grants to high traffic international routes such as Middle East and
Europe will improve the air passenger traffic significantly. High
ATF costs, no control over the volatility Aviation Turbine
Fuel(ATF) prices are driven by the volatility in demand-supply of
global crude oil. Rising fuel costs forces to increase price of
ticket which eventually leads in the decline in airline traffic.
Higher sales tax in India In India, ATF prices are more because of
higher sales tax ranging from 4 to 30 per cent because of which
fuel cost escalate leading to operational inefficiencies. Facing
Inflation in operating costs, no comparable hike in prices aircraft
and other technical costs, employee costs, landing and parking
charges at airports have risen sharply, but prices are not
increasing in a commensurate manner leading to low RKPM and rising
expense per ASKM for airline companies. Increase in price leads to
decrease in air traffic. Besides that, airline companies have been
regularly giving heavy discounts to attract customers and fill
their capacity; any such discount without the actual increment in
passenger traffic will lead to further narrowing the operating
margin. Government allows FDI by Foreign carriers in Domestic
Airlines for the operators, FDI will provide the much needed
funding for highly leveraged carriers, while for consumers, opening
airlines to foreign players will ensure worlds best practices in
terms of better flying experience and improved technology and
safety systems. However, lack of required infrastructure and the
depreciating rupee, will create hurdles to have any material impact
on ATF costs. Exchange Rate operating costs for airline companies
include ATF costs, aircraft lease rental costs, staff costs,
selling costs, and administrative costs etc., close to 70 percent
of these costs are linked with US Dollar. Hence, fluctuations in
exchange rate directly impact the operating costs of the companies.
Acutely sensitive to global factors like wars, economic instability
and environmental regulations - the industry thrives on the growth
in disposable incomes of consumers; any economic downturn hit it
badly. War or terrorism has direct impact on this industry as can
be seen from the decline in air traffic after 9/11. Recent
accidents of international airlines have also impacted the air
traffic.
INDUSTRY ANALYSISEvolution of the industry and present
competitive landscape
2002-03: Moderately competitive landscapeIn 2002-03, competition
in the domestic airlines industry was low with 2 players dominating
the industry: Jet Airways and Indian airlines group (Air India,
Alliance Air & Indian Airlines) together had 88 per cent market
share. Sahara airlines also operated at this time and had a smaller
share of the overall domestic market. The players did not undercut
each other on ticket prices to grab market share and concentrated
on profitability.2006-07: Competition intensifies: Low-fare
carriers forayed into the industry, beginning with the launch of
Air Deccan in 2003-04. Subsequently, three more - Spice Jet, Go Air
and Indigo - began operations between 2005-06 and 2006-07. Two
full-service carriers - Kingfisher and Paramount - also entered the
market in 2005-06. Thus, the number of carriers in the domestic
airlines industry trebled from 3 in 2002-03 to 9 in 2006-07. LFCs
offered tickets at much lower prices as compared to FSCs and hence,
managed to capture 42 per cent of the domestic market share in
2006-07.
2007-08: Extremely competitive landscape: With competition
rising rapidly, the new entrants and incumbent players rapidly
expanded their fleet, in a bid to capture market share. The share
of LFCs rose to 47 per cent in 2007-08 from 42 per cent in 2006-07.
However, this expansion heavily eroded players profitability. Costs
incurred by airlines on ATF, manpower etc, rose sharply, but
companies were unable to hike fares due to intense competition.
This led to pressure on realizations, and profit margins of most
airlines slid into the red. The industry's combined losses amounted
to Rs. 49 billion in 2007-08. The capital structure of most
airlines deteriorated, while some carriers faced a liquidity crunch
and had to raise further debt to meet capital expenditure
requirements.The consolidation phase: Steadily increasing losses
eroded the net-worth of airline companies, forcing financially. The
consolidation phase weak companies to sell out or merge with
stronger companies. This led to consolidation in the industry,
wherein JetLite (Air Sahara) was acquired by Jet Airways, while
Kingfisher bought Air Deccan. The government decided to merge
Indian Airlines with Air India to form a new entity, National
Aviation Company of India Limited (NACIL). The move was taken due
to the steadily mounting losses of Air India and Indian Airlines.
As a result of such consolidation, the market share of the top
three players NACIL, Jet Airways group and Kingfisher airlines rose
to around 70 per cent at the end of 2008-09.2009-10: Growing market
share of LFCs: LFCs such as Go Air, Indigo and SpiceJet continued
to gain market share by expanding their fleet. As a result, the
share of the top three players (Jet Airways, Kingfisher and NACIL)
dropped to around 60 per cent in 2009-10. To sustain and expand
their market share, Jet Airways and Kingfisher introduced low-fare
operations under the Jet Konnect and Kingfisher Red brands,
respectively. Jet Airways converted two-thirds of its seating
capacity to Jet Konnect by the end of the second half of 2009-10.
Consequently, more airlines shifted to the LFC model from the FSC
model.2010-11: PLFs touch record highs: Entry of LFCs, higher
household income, strong economic growth, surging tourist inflow,
increased air cargo movement, sustained business growth and
supportive government policies were major drivers for the growth in
the domestic aviation industry in 2010-11. During the year, PLFs
reached record highs due to limited fleet addition and strong
demand from business and leisure travellers. Few efficient airlines
with better operating cost structure and financials turned
profitable. The market share of the top three players (Jet Airways+
Jetlite , Kingfisher and Indigo) in the industry was about 61 per
cent in 2010-11. PLFs increased to 77 per cent in 2010-11 from 72
per cent in 2009-10.2012-13: Pricing Discipline post kingfisher
exit: The period saw a marked decrease in passenger traffic due to
ongoing economic slowdown and high air fares. Kingfisher exited
domestic operations beginning in the 3rd quarter on account of its
financial woes, leading to about 13 per cent of total domestic
capacity going out of market. The remaining 6 players namely
Indigo, Air India, Jet Airways, Jetlite, Spicejet and Go air
registered marginally better PLFs of 77 per cent and higher
realizations post kingfisher's exit. Indigo, Jet Group (Jet
airways+ Jet Lite) and Spicejet together captured close to 73 per
cent of the domestic market.2013-14: Deals and Discounts: The year
saw discounting on ticket prices during the peak seasons too.
Overall, the both international and domestic realizations declined
during the year. Also, Abu Dhabi based Etihad Airways bought 24 per
cent minority stake in Jet Airways for Rs 20.6 billion during the
year. As a part of the deal, Jet also sold three of its flying
slots at London's Heathrow Airport for a sum of USD 70 million to
Etihad.The entry of AirAsia India, a three-way venture between the
Malaysia-based low-cost airline, the Tata Group and investment firm
Telestra Tradeplace, in June 2014 is expected to further increase
pricing competition among existing LFCs. Another joint venture
between Tata Group and Singapore Airlines awaits operating permit
which will further intensify the competition in the industry.
Player wise RPKM
Porter Five Forces:
Profitability:
Capital-intensive: The airlines industry is capital-intensive,
with high fixed costs for aircraft acquisition, leasing and
maintenance. The cost of maintaining aircrafts and complying with
aviation safety norms are high. Additional costs incurred on
training pilots, technical support staff and crew members are fixed
as well. Moreover, the airlines industry has had to contend with
higher security and insurance charges since the September 11, 2001
terror attacks in the US.
Fuel costs & higher sales tax:Fuel costs, the largest cost
component for airlines, are beyond carriers' control and
considerably impact their operating margins. Aviation turbine fuel
(ATF) prices are driven by the volatility in demand-supply of
global crude oil. Rising fuel costs would force carriers to
increase ticket prices. Increase in ticket prices can lead to dip
in demand and subsequently, decline in passenger load factors
(PLFs) of the carriers.
ATF prices in India are expensive as compared to the rest of the
world, owing to high local sales taxes which ranges from 4-30 per
cent. Consequently, airlines' fuel costs escalate, leading to
operational inefficiencies.Congestion: Congestion affects the
turnaround time of aircrafts and reduces average aircraft
utilisation rates. This leads to wastage of fuel and inefficient
use of aircrafts by airline companies. Congestion can also cause
inconvenience to passengers, as delays in flight take-offs will
unsettle their time schedules.Aggressive price strategy: Carriers
often employ aggressive pricing strategies in order to capture
higher market share and sell tickets at below breakeven levels.
This strategy reduces average yields and increases competition,
leading to losses for the entire industry as others will be forced
to follow suit and bring down their fares as well.Inflating costs
and deflating revenues: For airlines globally, aircraft and other
technical equipment costs, employee costs, landing and parking
charges at airports have risen significantly, with ticket prices
not increasing in a commensurate manner.
This has led to low revenues per passenger kilometre (RPKM) and
rising expense per available seats per kilometre (ASKM) for airline
companies. Also, domestic airline companies are unable to pass on
increased costs because of severe competition in the
industry.EBITDAR AND EBITDA margin
Longer recessions, shorter recoveries: New airline carriers
enter the industry during periods of high economic growth. These
forays lead to a price war among players, resulting in considerable
losses for the whole industry. The price war continues until weaker
players move out of the industry or merge with financially strong
companies.Strong influence of external factors: The airlines
industry is acutely sensitive to external events such as wars,
economic instability, government policies and environmental
regulations. The industry's PLFs declined significantly following
events such as the 9/11 terror attacks in the US and the outbreak
of the SARS syndrome in South-East Asia. The industry thrives on
growth in disposable incomes of consumers and the economic downturn
seen since 2008 has impacted the overall profit margins of the
industry on the whole.Technical AnalysisThe term technical analysis
is a complicated sounding name for a very basic approach to
investing. Simply put, technical analysis is the study of prices,
with charts being the primary tool. The roots of modern-day
technical analysis stem from the Dow Theory developed around 1900
by Charles Dow. Stemming either directly or indirectly from the Dow
Theory, these roots include such principles as the trending nature
of prices, prices discounting all known information, confirmation
and divergence, volume mirroring changes in price, and
support/resistance. And of course, the widely followed Dow Jones
Industrial Average is a direct offspring of the Dow Theory. Here we
mostly used Support/Resistance, MACD, SMAVG (50), SMAVG (100), and
SMAVG (200).Bar chartsA bar chart displays a security's open (if
available), high, low, and closing prices. Bar charts are the most
popular type of security chart. As illustrated in the bar chart in
below figure, the top of each vertical bar represents the highest
price that the security traded during the period, and the bottom of
the bar represents the lowest price that it traded. A closing tick
is displayed on the right side of the bar to designate the last
price that the security traded. If opening prices are available,
they are signified by a tick on the left side of the bar.
Moving AveragesMoving averages are one of the oldest and most
popular technical analysis tools. A moving average is the average
price of a security at a given time. When calculating a moving
average, you specify the time span to calculate the average price
(e.g., 25 days). A simple moving average is calculated by adding
the security's prices for the most recent n time periods and then
dividing by n. For example, adding the closing prices of a security
for most recent 25 days and then dividing by 25. The result is the
security's average price over the last 25 days. This calculation is
done for each period in the chart. Note that a moving average
cannot be calculated until you have n time periods of data. For
example, you cannot display a 25-day moving average until the 25th
day in a chart.
The classic interpretation of a moving average is to use it to
observe changes in prices. Investors typically buy when a
security's price rises above its moving average and sell when the
price falls below its moving average.
MACD
The MACD is calculated by subtracting a 26-day moving average of
a security's price from a 12-day moving average of its price. The
result is an indicator that oscillates above and below zero. When
the MACD is above zero, it means the 12-day moving average is
higher than the 26-day moving average. This is bullish as it shows
that current expectations (i.e., the 12-day moving average) are
more bullish than previous expectations (i.e., the 26-day average).
This implies a bullish, or upward, shift in the supply/demand
lines. When the MACD falls below zero, it means that the 12-day
moving average is less than the 26-day moving average, implying a
bearish shift in the supply/demand lines. A 9-day moving average of
the MACD (not of the security's price) is usually plotted on top of
the MACD indicator. This line is referred to as the "signal" line.
The signal line anticipates the convergence of the two moving
averages (i.e., the movement of the MACD toward the zero line). The
MACD is the difference between two moving averages of price. When
the shorter term moving average rises above the longer-term moving
average (i.e., the MACD rises above zero), it means that investor
expectations are becoming more bullish (i.e., there has been an
upward shift in the supply/demand lines). By plotting a 9-day
moving average of the MACD, we can see the changing of expectations
(i.e., the shifting of the supply/demand lines) as they occur.
Company wise Technical AnalysisMACDGlobal Vectra
Currently MACD goes on decreasing that is moving from positive
to negative side and it also running below the signal line, it
shows the condition of bearish and to sell out the stock. Whereas,
somewhere on February 14 and May 17 MACD moving from negative to
positive and running above the signal line , it shows the condition
of bullish and to buy.Jet Airways
Here on July 15 signal line cross over is negative, though the
difference between MACD and signal line is very less, it shows the
beginning of bear market and suggest to sell out the stock.
Whereas, in September and April the difference between MACD and
signal line is very high and positive, which shows a condition of
bullish market and suggest to buy stock.Jagson Airlines
Here also showing a condition of bear market, because the MACD
is moving from positive to negative and the gap between MACD and
signal line is also negative, so it suggests to sell out the stock
The arrow represents the upward and downward pressure on the stocks
at specific period.Kingfisher Airline
Again it shows a condition of bearish market, because the gap
between MACD and signal line is negative. In September the signal
line cross over is very high and positive, so it shows a condition
of bullish market. The arrow represents the upward and downward
pressure on the stocks at specific period.
Spice jet Airways
Here also after June 15 the MACD continually goes on decreasing
and showing negative signal line cross over, this indicates bearish
market.
Support & ResistanceGlobal Vectra
Here prices are running somewhere around 50, which shows that
there is no trend. Since past one year it doesnt come across the
support zone i.e. oversold territory. Whereas, Somewhere during
Feb, May and June, it was running under overbought territory i.e.
resistance Zone.Jet Airways
Price are moving below 50 which means that stock losses are
greater than gain. During April it was running under overbought
zone, whereas for sometimes in December and February it was running
under oversold zone.Jagson airline
Here Prices are running much lower than 50 which means that
stock losses are much more greater than gain, it can be considered
as bearish market and suggest to sell the stock.Kingfisher
Airline
Here also price is moving much more below than 50 and showing a
condition of bearish market which suggests selling out the stock.
During February and March it was continuously running under
oversold territory.
Spice Jet Airline
However prices are running below 50, but it started moving
upwards with expecting to increase in prices over a period of
time.
Company Valuations:
SpiceJetValuing Airlines industry is difficult as operating
profits itself are negative. We have tried to value company
Spicejet using discounted cash flow method FCFF and used following
assumptions
Assumptions of Valuation: Currently Spicejet is in growth phase
as we have observed it still makes significant amount of Capital
expenditure and also expanding its fleet every year. Terminal
growth for Spicejet is assumed after 10 years. High Growth phase
for Spicejet is considered for coming 5 years after which
transition period is considered from year 6 to year 10. Stable
growth rate rate is assumed at 5% which would be on par with GDP
rate. Instead of assuming overall growth rate in EBIT we have
assumed component wise growth rates as EBIT is negative for
SpiceJet. Beta in the stable growth phase will tend to one. WACC is
equal to return on Capital in stable growth phase. Tax rate for the
company is assumed to be zero due to previous years high net
operating loss
Values considered in Valuation:Risk Free Rate8.50%
Indian Equity risk Premium7.00%
Beta1.83
Cost of Debt10%
Cost of Equity21.3%
Perpetual growth rate5%
Individual Component Growth Assumptions for coming 10
years:YearGrowth Rate in RevenueEBITDA/RevenueGrowth Rate in
Capital SpendingGrowth Rate in DepreciationWorking Capital as % of
Revenue
127%-6%-50%15%2%
225%-4%-50%15%2%
322%-3%-50%15%2%
420%-1%-20%15%2%
515%0%-20%10%2%
615%1%-10%10%2%
712%2%-10%10%2%
812%3%5%5%2%
98%4%5%5%2%
106%5%5%5%2%
EBIT Calculation with consideration of past Net operating Losses
(NOL):YearRevenuesEBITDADepreciationEBITNOL at beginning of
YearTaxesEBIT(1-T)
171128.6106-4267.716636960.7675-5228.484136-7443.610-5228.4841
288910.76325-3556.430531104.882625-4661.313155-12672.094140-4661.3132
3108471.1312-3254.1339351270.615019-4524.748954-17333.407290-4524.749
4130165.3574-1301.6535741461.207272-2762.860846-21858.156240-2762.8608
5149690.16101607.327999-1607.327999-24621.017090-1607.328
6172143.68521721.4368521768.060799-46.623947-26228.345090-46.623947
7192800.92743856.0185481944.8668781911.151669-26274.9690401911.15167
8215937.03876478.111162042.1102224436.000938-24363.8173704436.00094
9233212.00189328.480072144.2157337184.264337-19927.8164307184.26434
Terminal
Year247204.721912360.236092251.4265210108.80957-12743.55209010108.8096
Expected free cash flows to the
firm1-5228.484136-3922.235960.767510875.35221-19065.30385
2-4661.313155-1961.11751104.882625355.643053-5873.191083
3-4524.748954-980.558751270.615019391.2073583-4625.900043
4-2762.860846-784.4471461.207272433.8845247-2519.985099
5-1607.327999-627.55761607.327999390.4960722-1018.053672
6-46.623947-564.801841768.060799449.070483707.5645286
71911.151669-508.3216561944.866878413.14484442934.552047
84436.000938-533.73773882042.110222462.72222575481.651195
97184.264337-560.42462572144.215733345.49926198422.556183
1010108.80957-588.4458572251.42652279.854402111491.93583
Current Cost of Capital Calculation:Total Debt in 201318022
Market Capitalization12908
Debt to Capital0.582672048
Equity to Capital0.417327952
WACC14.72%
Cost of Capital calculation with changing D/EYear1 to
5678910
Beta1.831.61.51.31.11
cost of equity21.31%19.70%19.00%17.60%16.20%15.50%
Debt Ratio58.27%58.27%58.27%58.27%58.27%58.27%
cost of capital14.72%14.05%13.76%13.17%12.59%12.30%
Reinvestment rate in Stable Growth phase and Terminal
value:Return on capital at perpetuity12.30%
Reinvestment rate in stable growth0.406504065
Terminal Value113299.2117
PV Calculation using FCFFYears012345678910
FCFF-19065.30385-5873.191083-4625.900043-2519.985099-1018.053672707.56452862934.552055481.65128422.55611491.94
Terminal FCFF113299.2
PV
Calculation13251.6202434315.3026545363.3300356830.1374567920.254178936.1550189317.6055898669.5401106184.337111127.7
Final Share PricePV of Equity5530.271537
Outstanding Shares535
Market Value when valuation is done18.2
Value of each share10.33695614
RecommendationSell
Current price of SpiceJet is Rs. 12.80 so our Sell
recommendation is correct.Relative ValuationsWe have used
Price/Sales multiple to relatively value all the companies. The
relative valuation results are as follows:CompanySalesShares
outstandingSales/Shares outstandingSales MultipleRelative
PriceMarket Price
Jet Airway176166.4113.591550.8970860.161299250.158148254.05
Jagson Airways20.1680.1612993.21
Kingfisher5013.828808.726.1997081810.1612991.000006732.9
Global Vectra3301.2614235.80428570.16129938.034995333.05
Spicejet 63042.33535117.83613080.16129919.0068518.2
Note: Couldnt find the Sales of Jagson Airlines for the year
2013-14
Relative valuation shows that JetAirways and Kingfisher are
overvalued and Global Vectra and SpiceJet are undervalued in the
industry when valued with Sales Multiple.
GlossaryASKM Available seats KilometreRPKM Revenue Passenger
KilometrePLF Passenger Load FactorATF Aviation Turbine FuelLFC Low
Fare CarriersDGCA Director General of Civil Aviation