Crude oil spike, weakening rupee cause turbulence for aviation stocks

This would offset the recovery in volumes from the lows in May

Since their lows in April, Aviation stocks InterGlobe Aviation (IndiGo) and SpiceJet have gained 18-32 per cent on expectations of improvement in passenger traffic and regulatory relief in the form of higher fares and expansion in capacity.

The government had increased the domestic fare by 5 per cent (at the lower band) from the start of April and further by 13-15 per cent in June. This follows an increase of 10-30 per cent in rise in the upper and lower bands in February this year. The hikes were prompted by the increase in aviation turbine fuel prices, which increased 81 per cent YoY in Q1FY22 (12 per cent QoQ) and a rise in brent crude oil prices by 13 per cent QoQ.

Ashish Shah and Vaibhav Shah of Centrum Research believe that the upward fare revisions will provide interim relief to airline companies amid falling traffic and rising crude environment. They expect ticket yields of IndiGo and SpiceJet to increase 7 per cent sequentially in the June (Q1FY22) quarter.

The other trigger for aviation stocks is the rise in passenger traffic. From its lows in May when the average daily passenger traffic stood at 63,000, traffic more than doubled to 150,000 for the week ended July 10. Similarly number of daily departures and number of flyers per flight also increased by 50-67 per cent over their lows in May. What could help airline comanies is the decision by the Ministry of Civil Aviation to increase flying capacity from 50 per cent to 65 per cent of pre-covid levels from July 5, 2021.

The shift of international leisure market from India to the domestic market could aid volumes of domestic players. Say Aditya Mongia and Teena Virmani of Kotak Institutional Equities, “Recovery in demand for Indian carriers can receive a major boost if international travelers swap prospects of international travel by domestic, as has happened in the case of China. Among Indian carriers, Indigo is the one that continues to add capacities and may have a disproportionate share in the swap volumes.” Given this shift in January and February, select base airports (Jammu, Chandigarh) for tourist destinations had breached pre-covid levels of demand.

While they are key triggers, the sector faces multiple headwinds in the form of rising crude oil prices and a depreciating rupee. From sub-$60 per barrel levels in March, crude oil prices are up 25 per cent and hovering at $75 per barrel. Similarly, the rupee has depreciated by 3 per cent against the dollar from its lows at the end of May to over Rs 74.5 currently.

While crude oil prices remain the single biggest cost, a weak rupee will increase maintenance and leasing costs. Losses at the operating profit level could thus continue despite the volume improvement. Analysts expect volumes to reach February 2021 levels only by the end of the current year.

Given the multiple headwinds, investors should avoid airline stocks for now unless there is a clear indication of pricing power, lower costs and stable profitability.