Against the backdrop of a cyclical industry with business cycles, crude oil price and currency (INR/USD) impacting earnings, InterGlobe has built a strong business model enabling it to protect downside during downturns and generate strong returns in favourable operating environments. With crude at historic lows, we expect InterGlobe’s near-term earnings to be strong and peak in early FY17 but, with its valuations rich, we initiate coverage at Equal Weight (EW) with a 12-month price target of Rs 1,203.
Competitive strengths: InterGlobe’s large order-book for aircraft (430) should afford its visibility on deliveries at good pricing until 2026, ensuring that it benefits from capital and operating efficiency (eg, low fleet age). Its focus on a single fleet type offers InterGlobe operational flexibility and reduces its maintenance costs. Its large order book also ensures that cash flow support comes in from sale and lease back gains, protecting downside during tough years. The company’s continuous cost control efforts, good record in ontime performance, appropriate selection and loading of routes, and improving ancillary revenues (11% of revenue) are other positives.
Macro looks conducive: India’s growing middle class and improving affordability are key structural trends driving an increase in travellers in the country, while continued bottlenecks in rail infrastructure, limited progress on high-speed rail and improving airport infrastructure are specifically driving air passenger traffic growth. Air passenger traffic growth in FY15 was strong at 16% y-o-y compared with -2% for rail. Given its competitive strengths, we expect InterGlobe to sustain its current market share (at c37%) and load factors (c80% levels). The cost environment is also supportive with the crude oil price having declined significantly over the past 12 months.
Initiate at EW: We forecast an earnings CAGR of 23% for FY15-18e but a -4% CAGR for FY16e-18e. While we forecast a 17.6% revenue CAGR in FY16e-18e, the low earnings CAGR in that period is driven by our expectation of a crude price increase. With InterGlobe’s EV/Ebitdar (enterprise value/earnings before interest, taxes, depreciation, amortisation, and restructuring) at a premium to its low-cost-carrier (LCC) peers, risk/reward does not appear favourable. We initiate at EW with a price target of R1,203 (10x FY18e EV/Ebitdar).
Risks: Key risks to the upside are crude prices remaining weak and currency remaining steady, along with reduced competitive threats, while downside risks include higher crude prices and a delay in delivery of its aircraft, in addition to cyclical factors.
IndiGo has been able to increase its market share
Domestic air traffic in India has seen a strong growth rate of 20% for the first seven months of FY16, but InterGlobe’s IndiGo airline has seen an even stronger rate of traffic growth at 39% y-o-y. This has led to its market share rising from 32% last year to c37% as of October 2015. Its strong passenger traffic growth has ensured high passenger load factors for IndiGo despite the increase in its fleet size over the past year.
Long-term visibility on aircraft
Although IndiGo’s fleet size is smaller than those of Air India and Jet Airways, its average seat kilometres growth of 183% for the past four years has been significantly higher than any other low-cost carrier in India, as well as any LCC globally. The longer-term visibility on IndiGo’s fleet expansion is high as it has an order book of 430 aircraft, which is significantly higher than all other LCCs globally and all other Indian airlines.
However, near-term risk would stem from any delay in aircraft deliveries.
Delivery of A320neo aircraft, which was scheduled to commence from 30 December 2015, has been delayed by Airbus due to “industrial reasons”. Airbus has not provided clear visibility on the delivery of the aircraft and IndiGo’s management highlighted that there is potential for additional delays as well.
Strong depth of network
At end-August 2015, IndiGo had scheduled services to 33 airports with a maximum of 603 flights in a day. Although the number of cities served by IndiGo is significantly less than other large companies (such as Air India and Jet Airways), IndiGo’s market share is significantly higher, indicating its focus on depth and economies of scale in terms of airport operations.
Supply and demand dynamics
The growth in ASK (available seat kilometres) in India was only 6% over FY09-15, owing to the weak macro environment and issues with various airlines (eg, Kingfisher, which was shut down; Spicejet and Jet Airways had profitability issues). With new competitors such as Vistara and Air Asia launching services in India, we expect faster growth in industry ASK over FY15-18.
IndiGo has the largest fleet visibility in its peer group in India. Of the LCC carriers in India, Spice Jet may also book 250 aircraft to increase its longer-term visibility of deliveries, according to a Wall Street Journal report (12 October 2015). Booking orders in advance helps airlines to negotiate better pricing terms, in our view, vs. attempting to make last minute leasing arrangements.
In terms of competition, order books for most airlines are currently low. In addition, key competitors such as Jet Airways have a stated plan of keeping their fleet sizes similar to current levels until FY18, while Air India doesn’t have a large enough order book. New competitors such Vistara and Air Asia do not appear to be a threat in the next few years given limited capacity addition plans, which is also the case with Go Air. As for Spice Jet, while its current order book of 42 aircraft is not large, if it were able to sign long term agreements for 250 aircraft as reported, it could be a threat after the FY20 timeframe when the deliveries of these aircraft commences.
Earnings momentum appears strong in near term, valuations fair
We believe that with crude prices having declined sharply over the past 12 months, earnings momentum for InterGlobe airlines will remain strong in FY16. However, we note that earnings momentum should peak some time in FY17, as we are building in crude prices to increase in FY17 (Barclays global teams forecast Crude Brent to be at US$60 in FY17 vs. US$38 currently) and Indian rupee to depreciate. While we forecast revenue growth CAGR at 17.7% for FY15-18e and 17.6% from FY16-18e, we expect its earnings CAGR to be c23% in FY15-18e and -4% CAGR in FY16-18e. With current valuations at 18x FY18e P/E and EV/Ebitdar at 10x FY18e (at a premium to global LCCs, which are trading at an average 11x FY18E P/E and 6.5x FY18E EV/Ebitdar) we see limited room for outperformance and set our price target at R1,203. Hence, we initiate coverage with an EW rating.