Is Jet a good bet?

One can invest in Jet Airways confidently if one has the right answers to three questions. Is the aviation sector set for explosive growth in India?

How much of this explosive growth will be captured by Jet, which is currently not positioned on the value-for-money platform? And three, what is the value one must subtract from Jet Airways for certain management-related risks that the IPO prospectus spells out clearly?

Jet's public offer is for 1.73 crore shares of the face value Rs 10, of which 1.42 crore are through a fresh issue, the rest being an offer for sale by the promoter company. The price band is set at Rs 950 to Rs 1,125 per share.

Post-issue, the company will have an equity capital of 8.63 crore shares, 80 per cent of which will be held by the promoter. Based on the price band, the issue size is around Rs 1,640-1,942 crore.

Of this, around Rs 1,350-1,600 crore will enter the company's books in lieu of fresh equity. The company will have a market-cap of Rs 8,201-9,712 crore.

Of the total money garnered, the company will repay debt totalling to Rs 792 crore and spend Rs 460 crore on creating capital assets. The rest is to be used for general corporate purposes.

Will aviation see explosive growth?
Right now, India seems an under-penetrated market with an average air travel of 0.014 trips per person per year as compared to an average 2.02 trips per person in the United States. Growth in the recent past has been steady but nothing extraordinary.

Between FY02 and FY04, the domestic aviation sector saw an annual growth of 8.9 per cent. The total number of passengers carried by scheduled domestic airlines in India was 15.25 million in FY04 and 8.80 million in the first six months for FY05.

Till now, the growth in demand has been matched by the growth in domestic capacity. The potential for growth in the future looks high.

One, a fast growing economy will mean more business travellers. Two, as income levels rise, domestic travel and tourism will be on the rise, pushing up demand for air travel.

Third, a whole new segment of people who currently travel by road or rail now could start flying, maybe even flying frequently, if air fares are more affordable.

This third category is what could drive explosive growth in the sector. For the record, in FY04, the Indian Railways carried around 52 million passengers in its premium class products - that is, air-conditioned and first-class coaches.

The concept of low-cost carriers(LCC) is gaining popularity across the globe. In India, the first no-frills airline was launched by Air Deccan in August 2003. Other business houses, including the Bombay Dyeing group and the UB group, are venturing into budget airlines.

Recently, Royal Airways (earlier, ModiLuft) announced plans to start a budget airline. The Royal Airways scrip which was languishing in single digits for so many years, thus, has run up from Rs 5 in September 2004 to Rs 66 on news that the company is getting back in business with its budget airline service called SpiceJet.

With no credentials to support(except the licenses), the company's market-cap stands at over Rs 900 crore.

Where does Jet stand?
Jet Airways is positioned as a full-service airline, with high focus on customer service and reliability. Started in 1993, Jet Airways is the No 1domestic airline in the country today.

Jet flies people across 42 destinations in India and two outside India and operates 1,924 flights weekly. The company has a market-share of 45 per cent.

In FY04, the airline flew 6.91 million fare-paying passengers on all flights (they are called revenues passengers in airline parlance). Jet's relatively young fleet, with average age of 4.5 years, consists of 42 aircraft, of which 34 are Boeing 737 and eight are ATR 72s.

Following the government's decision to allow Indian airline companies to foray into international skies, Jet will fly into foreign skies shortly.

Can Jet attract category three customers who will be the drivers of explosive growth? Currently, Jet derives 80 per cent of its revenues from business travellers.

This is good and bad. Good, because corporate customers are less sensitive to prices. They do not usually switch loyalty just because of lower rates.

So Jet may not lose out to lower cost competitors easily. But bad, because Jet's full-service positioning will mean that it may not be able to grab a substantial share in the large price-conscious customer segment without compromising on its profitability, though there is no doubt about its steady growth prospects.

For now, the management is confident of guarding its position. The threat of competition is not as serious in the near future. New entrants are likely to face a hindrance to growth due to shortage of parking bays and tight aircraft delivery schedules.

Jet is comfortable on this count. Currently, Jet enjoys a healthy utilisation rate (passenger load factor) of 68-70 per cent and should be able to hold on to its customers.

In fact, Jet's EBITDAR (earnings before interest, tax, depreciation, amortisation and aircraft rentals) margin of around 30 per cent is amongst the highest globally.

Singapore Airlines had an EBITDAR margin of 25 per cent in the nine months till December, 2004. In some cases, Jet enjoys higher margins than even low-cost carriers - Southwest Airlines, a low-cost carrier (LCC) that operates in the US, has margins of just 18 per cent.

(RyanAir, one of the most successful LCC stories, enjoys EBITDAR margins as high as 41 per cent.) But what's important is that Jet's margins are amongst the highest among comparable companies. 
 

Operational metrics
	2003	2004	Sep-04
Passengers carried (millions)	6.41	6.91	3.78
ASKMs (million)	8496	9162	4796
RPKMs (million)	5291	5852	3245
Passenger Load factor (%)	62.3	63.9	67.7
Aircraft utilisation (hours/day per aircraft)	9.41	9.46	9.84
ASKM: Average seat kilometres; represents the aircraft seating capacity multiplied by the number of kilometres the seats are flown. RPKM: Revenue passenger Kilometres; represents the number of kilometres flown by revenue passengers. Passenger load factor: Represents revenue passenger kilometres expressed as a percentage of available seat kilometres Aircraft utilisation: The average number of block hours operated per day per aircraft for the total aircraft fleet.  Figures are for six months

Also, operating efficiencies and economies of scale are now kicking in and have resulted in high earnings growth. In FY04, operating profit more than doubled, while the net profit in the nine months till December 2004 is already 60 per cent higher than the profit in the whole of FY04.

This is significant since FY05 results had the adverse impact of higher prices for fuel (25 per cent of sale).

The ownership issue
Jet Airways is owned by a company called Tail Winds, as Isle of Man company which is wholly owned by Naresh Goyal, the chairman of Jet Airways.

Post-issue, the promoters will have an 80 per cent stake in the company. According to the articles of association of the company, Naresh Goyal is the permanent chairman of the company and also the chairman of the board.

The prospectus clearly spells out that since the promoters have significant control, and have the ability to direct the company's business and affairs, "their interests may conflict with your interest as a shareholder."

Seen in this light, there are some points to be worried about. Firstly, the company does not currently own the Jet Airways name and trademark. The trademark or the brand is owned by Jet Enterprises Private Ltd, another company substantially owned by Naresh Goyal, and licensed to Jet Airways.

The management has said the company will effect transfer of ownership within the next six months for a certain consideration.

The catch, however, is the value of the brand. The higher the value of the brand, the more the money Jet Airways will have to shell out to buy it out.

In the case of Pidilite, for instance, the promoters held the brand but transferred the brand back to the company at Re 1. In the case of Nirma, however, the brand - held by promoter Karsanbhai Patel - was transferred to the company for a substantial consideration, hurting the company's minority shareholders.

Another cause for concern is that Jet Airways' general sales agent for India is Jetair Private Ltd which is again controlled by Naresh Goyal. According to the terms of the agreement, the company has to pay an overriding commission of 3 per cent on all passenger sales and 2.5 per cent on all cargo sales.

This commission is payable in addition to the sales commission that is payable to sales and travel agents. On top of this, the agreement with Jetair provides for a charge back of certain expenses.

"Our transaction with these promoter group companies may potentially involve conflicts of interest. There can be no assurance that in such circumstances, our promoters will not favour the interests of Jetair or other promoter group companies over our interests," the prospectus makes it clear.

So where does this leave valuations?
Based on rough estimates for FY05 earnings, the price band implies a valuation ranging from 21 to 25 times earnings, which again is not cheap. 

Financials
(Rs crore)	2003	2004	Dec-04
Operating revenues	2875.68	3447.42	3134.66
Non-operating revenues	66.42	118.32	62.91
EBITDAR	695.38	1090.76	1044.50
EBITDA	417.35	864.12	894.98
EBIT	-55.92	348.96	553.04
Net profit	-244.45	163.11	258.99
Figures are for nine months

Analysts point out that it makes more sense to look at the EV/EBITDAR ratio for airline companies, which is the enterprise value (market-value plus debt minus cash) as a multiple of earnings before interest, tax, depreciation, amortisation and aircraft rentals.

Based on its FY04 EBITDAR, Jet is valued between 9 and 10 times. Using FY05 estimates, the valuation is lower at between 7 and 8 times.

There isn't any strict comparison for Jet, which has a dominant position in a fast-growing market. Jet is the best available play in the Indian airline sector.

However, it does not compare well will other industries will similar growth prospects.

Also, what will make see the Jet IPO through is the insatiable demand from foreign investors. The FII limit in several large-sized good companies has been breached and that means Jet should get a good response.