Aviation stocks: Riding the re-rating wave

Scrips are getting higher valuations as demand stays strong while fuel costs continue downward trend

With crude oil prices falling below $35 to the barrel, aviation scrips were in demand ending with gains of 5-8.5 per cent on Tuesday. While the stock of InterGlobe Aviation and Jet Airways touched their 52-week highs, SpiceJet made smart gains. Aviation stocks are the first to move up as aviation turbine fuel costs account for 40-50 per cent of revenues. With fuel costs falling and passenger numbers gaining strength, analysts have re-rated the sector and given higher multiples for listed stocks.

Motilal Oswal Securities in a recent report attributed a fair value of Rs 1,478 to the Indigo stock, valuing it at a one-year forward multiple of 9.7 times its FY17 EV/Ebitda. The stock has been continuously re-rated since the time of its initial public offering (IPO). While the stock was valued at 7.6 times FY16 EV/Ebitda at that time of the IPO, analysts put a higher number of eight times its FY17 estimates given the strong passenger growth numbers in the past two months and falling oil prices. Expectations of an attractive dividend yield upwards of five per cent (Rs 60 a share) is adding to the Street's interest.

For SpiceJet, the re-rating is on the back of traffic growth. Aggressive pricing coupled with strong demand has led to record occupancies with SpiceJet achieving 90 per cent plus load factors for six months in a row.

Is the re-rating justified and should investors buy at these levels given that stocks such as Indigo are up 54 per cent from issue price of Rs 765? The Street's view is mixed.

Some analysts feel the Indigo stock is fairly valued and might not correct below Rs 1,100, but others are sceptical. Santosh Hiredesai of Edelweiss Securities in a note last month said the company's premium valuations were justified given its market leadership position. Going ahead, Indigo's structural cost advantage and expansion strategy will help it register stronger growth than peers. While SpiceJet trades at a discount to Indigo, analysts say the discount will narrow only if the company manages to post consistent net profits.

Others such as Daljeet Kohli of IndiaNivesh say looking at valuations when the sector is going through its best period might not be the right way to judge future prospects. Given the sensitivity to fuel prices, profit projections could go awry if crude oil prices move up. A sector so dependent on external factors should not get premium valuations and that applies to Indigo as well, Kohli adds.