Stock corner: ‘Reduce’ Interglobe Aviation, earnings were stronger than estimated

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Published: June 4, 2019 12:46:17 AM

FY21e EPS up 2% and TP revised to `1,575; while positives are factored in at present price, risks are not; downgraded to ‘Reduce’

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Indigo reported stronger-than-expected 4QFY19 earnings driven by higher yields. 9% yoy yield increase was driven by Jet’s closure as well as internal productivity measures. We note that capacity addition by competitors has picked up steam, and may likely pressure yields 2QFY20 onwards. We tweak our FY2020E EPS as we factor in lower costs on account of A321neo aircraft, driving a revised fair value of `1,575. We believe positives are now in the price, downgrade to Reduce (from ADD).

Higher-than-expected yields drive profit outperformance
Indigo reported a healthy 9% yoy increase in yields driven by capacity cuts by competitors, increase in international fares as well as internal productivity improvement measures. This resulted in 11% outperformance in EBITDAR and 23% outperformance in EBITDA. Margins (RASK-CASK) turned positive for the first time in FY2019 on account of higher yields and lower fuel cost.

Capacity to increase at a healthy clip
Indigo’s 4QFY19 capacity increased at 29% yoy, lower than earlier guidance but still in line with expectations. We believe the miss was predominantly on account of pilot issues that the airline faced in February-March, which seem to have now been sorted. FY2020 capacity is expected to increase at 30% yoy with additions of A321neo, A320neo and ATRs. We believe the proportion of Neo aircraft is set to steadily increase in the overall fleet and can drive a further cost advantage.

Proportion of international routes on the rise
International routes now contribute 20% of capacity from 15% a year ago. Incrementally, 50% of fresh capacity added would be directed to international routes, in line with Indigo’s strategy of developing an international network fed by its large domestic network. We believe international should not be margin-dilutive and lower RASK should be made up by lower fuel CASK.

Margin improvement fully priced in
We believe the positive boost to yields may last for a shorter duration than earlier expected on account of steep capacity addition by peers (Spicejet, Vistara). We are particularly wary of yields coming off on the profitable metro routes. Our estimates already bake in a fair amount of optimism – our spread assumptions (RASK-CASK) are `0.21-0.27 over FY2020-21, sharply higher than the `0.11 reported in 4QFY19. The 2% EPS revision for FY2021 drives our revised fair value of `1,575, based on an unchanged 16X FY2021E P/E multiple.

We believe the stock price is baking in all positives including further yield improvement, but not factoring in risks on account of competition, thus driving a downgrade in our rating to Reduce (from ADD).

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