Rising crude oil prices increase turbulence for airline stocks

Cost headwinds come amid improved Q3 showing, rising yields

For a sector having posted net profit after a gap of eight quarters, the cheer may be short-lived. Cost pressures as a consequence of a rise in crude oil prices and higher competition could offset the positives from yield improvement and growth revival expectations.

The stock price movement of the country’s largest airline, InterGlobe Aviation (IndiGo), in recent weeks reflects the same. A strong showing in the December quarter and an improvement in passenger traffic led to a 22 per cent surge in its stock price since the start of February, before shedding a third of it in the last five sessions.

In the near term, the movement of crude oil prices and aviation turbine fuel (ATF) will weigh on the profitability of IndiGo and SpiceJet.

Brent crude oil prices had recently surged to their seven-year highs and are hovering over $93 to a barrel mark.

“Indian airlines historically have found it difficult to maintain both volume expansion and elevated margins at crude oil prices above $70 per barrel,” according to Ashish Shah and Vaibhav Shah of Centrum Research.  

The price of ATF was hiked last week by 5 per cent and is now at record levels. Given that crude oil prices are expected to sustain at these levels in the near term, ATF price could see an upward trend. Fuel costs accounted for 35-42 per cent of sales in the December quarter for IndiGo and SpiceJet.

To overcome the cost factor, two key metrics - passenger volumes and pricing - have to remain favourable. After a 43 per cent month-on-month fall in average daily passenger traffic in January to 207,000 on account of the Omicron variant, volumes have started moving up.

The weekly average of daily fliers is around the 250,000-mark currently, which is 26 per cent higher than the number in the first week of February. This is expected to move up as corporate travel, which hit 70 per cent of pre-Covid levels in December before a sharp fall in the first half of January, returns. Further, with plans of opening up international flights, passenger traffic and utilisation levels are expected to improve.

The other positive for airlines is the improvement in yields in the December quarter. While SpiceJet reported a 4 per cent increase year-on-year in this metric, IndiGo’s yields rose 19 per cent over the same period.

Commenting on the difference in yields of IndiGo and SpiceJet, Kotak Institutional Equities’ Aditya Mongia and Teena Virmani say IndiGo’s yields are now at a big premium to its listed peer versus a deficit seen prior to Covid-19. They expect some part of the premium in yields to stick and boost the case for peak spreads (unit revenue minus costs) for IndiGo in 2023-24.

Higher revenue and lower unit costs/other expenses rubbed off on operating profit before rentals in the quarter.

SpiceJet reported a 24 per cent increase, while IndiGo’s number was twice that in the year-ago quarter. While this led to the bottom line moving into black after eight quarters, Centrum Research is sceptical.

“While traffic recovery is imminent, we remain concerned over the sustainability of present levels of unit profitability in a high crude price environment,” say the analysts at the brokerage.

Further, the sector is expected to become more competitive, given the entry of two new airlines — Akasa and Jet Airways — and a possible consolidation of Vistara, AirAsia, and Air India. This could put pressure on pricing as the new entrants try to grab market share.

Most brokerages favour IndiGo over SpiceJet, given the former’s cash balance of Rs 7,800 crore, efficient fleet (induction of fuel-efficient A320neos), and cost structure. The resignation by one of the founder promoters Rakesh Gangwal and his intention to gradually reduce his stake is a positive, as the overhang related to promoter tussle is coming to an end.

Analysts, led by Jal Irani of Edelweiss Research, have reduced their target price and operating profit estimates for SpiceJet, given the delay in 737 MAX deliveries, lack of transparency for investors, transfer of the cargo business, replacement of cheap Boeing planes, and a weak balance sheet.