Jet Airways: Stopping to re-fuel

Jet has lagged behind the Sensex since its listing on the bourses. With the battle for the skies having begun, the going may only get tougher.

With over 40 per cent marketshare and a fleet of over 50 aircraft, Jet Airways has been a high flier in the Indian aviation space. Of all the players that crowded the Indian skies post deregulation in 1994, Jet was one of the two survivors.

Positioning itself as the businessman's airline, it re-wrote the rules for air travel in the country. In an industry that needs access to capital, Jet has managed to build up a fleet with 42 aircrafts. Not surprising then that the company commanded a price/earnings (PE) multiple of 24 times estimated FY05 earnings when it went public in February this year.

The stock got off to a flying start as it listed at Rs 1300 levels, translating into a multiple of 29. Since then, however, its been a bit of a bumpy flight for investors - the stock dropped to Rs 1185 before rallying back to Rs 1373 and then retreated all the way back to Rs 1054, below the IPO price. Today it trades at Rs 1079.

The reason: the arrival of a slew of new airlines, either low cost carriers (LCC) or value airlines. Dropping fares to unheard of levels, these carriers are tempting Indians to fly like never before.

While Air Deccan, Spice Jet and Kingfisher have all taken off, there are couple of others such Go Air, waiting in the wings. For Jet, used to a near-oligopoly, this means having to keep its fares competitive, its costs under control and at the same time not letting its service standards slip.

Jet recently started flights on international routes and has drawn up aggressive expansion plans. With regulations for international flights likely to be relaxed though, other players too could enter the fray.

Thus, in the near-term Jet could hit some air pockets as domestic competition intensifies, international operations take time to stabilise and costs escalate. At Rs 1079, the stock trades at a forward multiple of 15 times estimated FY06 earnings and 12.7 times estimated FY07 earnings.

That is way below what it commanded at the time of the IPO. Though the stock is not expensive, valuations are not also compelling, given that the battle for the skies has just begun.

More fliers ....but more seats too
With passenger traffic tipped to grow by a compounded 18-20 per cent between now and 2010 - the growth in FY05 was 25 per cent - the opportunity for airlines is huge. But there is also enough capacity coming up - estimates of 20,000 seats daily are being talked of by year-end.

Assuming a 60 per cent loading, this would work out to 5 million additional seats annually while a 20 per cent growth in passenger traffic in FY06 implies an incremental demand for 4 million seats.

Air Deccan plans to have 30 aircraft by year-end, while Jet will have 58 aircraft by the end of FY06. So, the arrival of Air Deccan, Kingfisher and Spicejet, as also a recharged, profitable Indian Airlines could mean stagnant or even a marginal loss of market share for Jet. In FY05, for instance, the market is estimated to have grown by 25 per cent, while Jet carried 18 per cent more passengers.

"We did not have enough capacity last year," says Saroj Datta, executive director, Jet Airways, adding that "we will maintain market share since we are targetting primarily business traffic."

But even as the passenger pie grows, the share of business traffic is becoming smaller. Earlier approximately 80 per cent of the traffic was estimated to have been driven by business travellers with the remainder being accounted for by leisure traffic. Datta believes that now a larger share of nearly 40 per cent of the traffic comes from the holiday travel segment.

Lower fares could push down yields....
With the other airlines flaunting lower fares at times 40 to 50 per cent lower than those of full service carriers and some that even match 3rd AC train fares, Jet will have little choice but to try and remain competitive. In any case there is no room to increase ticket prices as that would surely mean a loss of marketshare.

This means that if it lowers fares, its revenue per passenger comes down. "Yields will obviously be under pressure, but the higher volumes will compensate for that," admits Datta.

However, with value airlines taking off on the lucrative Category-1 routes, which are where Jet earns a big chunk of its revenues, they could well lure customers away with cheaper fares. Also while LCCs may be trying to persuade holidayers to travel by plane rather than train, there could be a fair number of business travelers from smaller enterprises who would want to cash in on lower fares especially if the LCCs are able to maintain time schedules.

And if for some reason demand does not materialise as anticipated, players would start undercutting in a bid to achieve higher loads. While that may be an extreme situation, new entrants, and there are any number of them, will play the price card in the initial phase. So while loads for Jet, on domestic routes are currently 70 per cent plus - in Q1FY06 they were 74 per cent - they may not go up very much despite the general growth in passenger traffic.

....while keeping costs down remains a challenge
As fares drop, cost control will be a key differentiator. Rising aviation turbine fuel (ATF) costs are a source of concern for airlines since it will be difficult for them to continuously pass on the higher costs in the face of keen competition.

Fuel costs now account for 40 per cent of total expenses for airlines compared with 36-37 per cent some time back. "We took a 12 per cent hike in April and another 10 per cent hike recently, so we are now in a comfortable position, because the 12 per cent hike was more than needed," says Datta.

Moreover selling and distribution costs for Jet are between 9-11 per cent, which analysts believe is high. It pays a three per cent commission on all passenger sales and 2.5 per cent on cargo sales, over and above other commissions to Jetair, a promoter group company.
 

FINANCIALS
(In Rs crore)	FY05	FY06E	FY07E
Revenues	4338.00	5339.00	5677.00
EBITDA	1214.00	1235.00	1510.00
EBITDA margin	27.90	23.13	26.60
PAT	392.00	617.00	731.00
EV/EBITDA	9.40	7.70	6.90
EPS (Rs)	45.40	71.50	84.50
P/E @ Rs 1075	25.40	16.20	13.60
Source: Analysts estimates

Air Deccan's selling and distribution costs too are about nine per cent. Around 50 per cent of its sales are through agents and airports, while 25 per cent comes from call centres and 25 per cent through the Internet. This too is high but could moderate with increasing scale.

Flying abroad
Jet is now looking to grow its business overseas and currently operates six flights on global routes - a second flight to London will start soon. According to Datta, the loads on the London and Kuala Lumpur routes have been above 70 per cent while for Singapore they have been lower at around 60 per cent.

Datta says it is too soon to talk about yields on these routes since the airline is offering substantially low fares than the competition as introductory offers. He claims that the London route has broken even adding that "we will break even within 12 months of operation on any route."

Jet definitely has an advantage over international airlines in that the employee costs in India are lower at around 8-10 per cent of revenues compared with around 15-30 per cent for international peers. Despite the competition, analysts believe that revenues from international operations could show good growth and estimate that by FY08, 25 per cent of the airline's revenues could come from international operations.

Given its track record, Jet should be able to gain marketshare. However, there has been talk of relaxing rules for airlines operating on overseas routes. If that were to happen, other airlines would take advantage and start international flights.

Big plans... but slowdown in earnings likely
Jet has mapped out big expansion plans. In FY05 Jet added just one aircraft to its fleet but it now has plans to buy or lease 30 new aircraft by FY09. The average age of the Jet fleet currently is a young 4.5 years and the management says it would remain thereabouts in the future too.

The estimated expenditure for the 30 new aircraft is Rs 10,000 crore and according to Datta it will be funded entirely by debt though the company would take care to see that the debt -equity ratio would be restricted to 2.5.

FY05 was an excellent year for Jet as it saw a 140 per cent growth in earnings thanks to a huge increase in demand. FY06 too should be good with an earnings growth of over 50 per cent. However, analysts believe that in FY07, the earnings growth could be muted.

While there is every reason to believe that the demand for air seats will only grow, it must be remembered that airlines is a cyclical industry and one in which fixed costs are high. Any downturn can be extremely damaging to a company's financials - in fact, Jet notched up losses of Rs 24.50 crore in FY03 over a loss of Rs 13.40 in FY02, despite a 14 per cent increase in revenues.