Why Indigo proves once again its IPO will have many takers

Indigo could not have wished for a better timing for its phenomenal performance. The company is planning to tap the primary markets to raise money for its future growth capital, and its record profit just made that job easier.

In FY15, the company posted a profit of Rs 1,304 crore - a growth of 2.8 times as per the company’s filling in its offer document. The sharp jump in profit has been despite its revenue growing by only 22% to Rs 13,925 crore. Profit before tax rose to Rs 1,847 crore from Rs 471 crore in the previous year.

Low fuel prices contributed largely to a higher bottom line jump in profits for Indigo. But low fuel was an advantage that was available to all airline companies. Yet, Indigo is the only one to post profits.

Against revenues of Rs 20,965 crore Jet Airways posted a loss of Rs 2,097 crore while SpiceJet on revenue of Rs 5,201 crore reported losses of Rs 687 crore. Although the two airlines managed to lower their losses, neither of them is anywhere close to posting profits. SpiceJet, however, deserves a longer rope as the company went through a change in management during the year and has posted profits in the last two quarters.

What differentiates Indigo from the rest in the sector is that the company is a quintessential low-cost carrier (LCC). It is one of the lowest cost carriers in the world and has been a trend setter in cutting cost and bringing in simple cost-cutting measures.

In an interview, Aditya Ghosh, President and Chief Executive Officer of Indigo said that rather than chasing a billion dollar idea, the company believes in chasing a billion $1 ideas. Small but effective ideas like having boarding ramps, lighter seats to burn lesser fuel among others have all contributed to the company being one of the lowest carrier in the world.

Its financial muscle power and growth visibility helps it negotiate better deals with its vendors. After adding 17 Airbus during FY15, the company presently has a fleet of 96 A320s, and now it plans to add 430 aircraft more. Visibility of future business helps the company in extracting lower cost deals which is not possible for other airlines whose financials do not give comfort to the vendors on their sustainability.

Indigo entered into a contract with the original equipment manufacturers (OEM) on a power-by-the-hour basis. Here, the company pays the OEM based on its usage on a per hour basis. Since Indigo sweats its assets, OEMs are also assured to regular business while the airline pays for it only when the equipment is actually being used.

It is cost-control measures like these that give the company a steady margin. Going forward, as the company increases in size, it would get the benefit of economies of scale on its side to improve its margins further.

But is the premium that the company seeks in its IPO justified?

Reports say the company is looking to raise money at a valuation of about Rs 17,000 crore. The FY15's profit of Rs 1,304 crore gives the company a valuation of about 13 times which is not too expensive when compared to its track record and future visibility. However, one may say that this year was a good year as fuel prices were lower.

Although its valuations look cheap based on FY15 numbers, it does not when one compares it with its peers. While both Jet Airways and SpiceJet are not profit making on an annual basis, valuation comparison based on profits will not be right. But if we look at the market capitalisation to sales, Indigo does look expensive.

Jet Airways enjoys a market cap of Rs 3,705 crore and a sales of Rs 21,561 crore taking a market cap to sales ratio to 0.17 times. SpiceJet, on the other hand, enjoys a market cap of Rs 1,453 crore but has a revenue of Rs 6,304 crore, giving it a market cap to sales ratio of 0.23 times. Indigo has a market cap to sales ratio of 1.22 times (valuation of Rs 17,000 crore and sales of Rs 13,925 crore).

However, markets give valuations on the company’s track record and future numbers. This is what Indigo is banking on in its IPO. The company’s track record will give comfort to the investor that the company can manage a four-fold increase in its fleet in the coming years, which cannot be said about Jet Airways. Indigo is a clear leader and will deserve the premium it is asking.