IndiGo's runaway rally worries analysts; Citi downgrades stock to 'sell'

Shares of InterGlobe Aviation (IndiGo airline) slipped up to 4.2 per cent, to quote at Rs 1,522.7, on the BSE on Thursday after global brokerage firm Citi downgraded the stock to ‘Sell’ from ‘Neutral’. The firm, however, revised target price upwards to Rs 1,400 from Rs 1,300. 
 

The stock eventually settled 2.9 per cent lower at Rs 1,544 on the BSE, as against a per cent's gain in the S&P BSE Sensex. So far in November, stock of the low-cost airline has zoomed 21.5 per cent on the BSE compared to an 11-per cent rally in the benchmark Sensex index.
 

According to Citi, the stock's outperformance is reaching its zenith and may not sustain going ahead. 
 

"The stock rally in IndiGo adequately prices-in the gradual improvement in domestic air traffic and IndiGo’s market share gains. The rally ignores the competitors’ ramp-up (albeit slow), weak pricing environment, and uncertainty about the sustainability of strong Q2 drivers," the report said.
 

In the past six months, IndiGo has outperformed the Sensex index and has rallied 78.4 per cent on the BSE till Wednesday. In comparison, the S&P BSE Sensex is up 42.8 per cent, BSE data show. 
 

Analysts at Citi believe that the mammoth rally logged by IndiGo has been driven largely on expectation of consolidation in the industry, as airlines with weaker balance sheets grappled with negligible demand. “The airline’s market share, which peaked at 60 per cent in July 2020, could trend lower as peer firms ramp-up services,” it says.
 

As of October, the Gurugram-based airline’s market share stood at 55.5 per cent, down from 57.7 per cent seen in September, and 59.4 per cent in August, data by Directorate General of Civil Aviation (DGCA) show. In comparison, peer firm SpiceJet’s market share remained stable at 13.4 per cent in October on a monthly basis, and dipped marginally from 13.8 per cent seen in August.  
 

The second factor warranting the downgrade is lacklustre fares as festive fares have been weaker this year owing to dull demand and fare-cap restriction.
 

"With competitors ramping up, we don’t expect much improvement in pricing. Benign jet fuel prices offer scope to lower fares, but it is applicable across operators. That said, our yield expectations inch up 1-3 per cent as fares for non-scheduled flights are strong," Citi noted.
 

On the flip side, CAPA India, an independent aviation sector think-tank, recently said that yields are expected to remain soft during H2FY21 as the sector will remain structurally constrained with a return to pre-Covid level only after Q3FY22. 
 

The agency noted domestic passenger traffic plunged 84 per cent YoY and international 93 per cent during H1FY21. Further, it forecasts nearly 50 per cent YoY fall in domestic passenger traffic during H2FY21 and 65 per cent dip in FY21.
 

In a report dated November 23, Elara Capital lowered FY22 EBITDA estimates for IndiGo by 54 per cent on an anticipated delay in recovery of demand until FY23.
 

"IndiGo is trading near its historical high of 16.2 EV/EBITDA in FY22E, given strong balance sheet (Rs 15,600 crore net cash by end-Q2FY21) and market expectations of major capacity reduction by smaller competitors. Its market share already has increased from 48 per cent in January to 56 per cent in October, which implies competitors are more focused on saving cash at the expense of losing market share," said Gagan Dixit and Rachael Alva, research analysts at the brokerage, in their report. 
 

The analysts downgraded the stock to 'Accumulate’ from ‘Buy’ as valuation has mostly factored in benefits of recovery in demand and improving cash position, which is subject to control over the Covid-19 pandemic. Their revised target price on IndiGo is Rs 1,802 from Rs 1,107 based on 8.0x (from 6.0x) FY23E EV/EBITDA.   
 

Lastly, Citi observed that IndiGo’s September quarter performance was “much-ahead of the estimates” making it difficult to sustain the performance. 
 

"We don’t think non-scheduled flights can be revenue drivers for long-term. Also, some of the cost-cut during H1FY21 is likely to return as operations resume. Cargo growth could sustain though, but it is reflected in the price, in our view," it said.