Jet, Sahara, go

POUND WISE

The Air Sahara acquisition will strain the balance sheet of Jet Airways but its international operations should drive earnings.

The stock market is not flattered with the deal Jet Airways, India's number 1 private airline, has finally struck with competitor Air Sahara. But the Jet stock has not been hammered the way some analysts were predicting when talks of the deal going through first emerged on April 10.

The stock, which lost 5.57 per cent on April 11 on reports that the deal value would be closer to what Jet Airways had offered to acquire Air Sahara when it first bid for the company a year-and-a-half ago, gained 3.24 per cent when the final announcement was made on Thursday. The stock ended the week at Rs 629.90.

Jet currently flies 44 domestic and 6 international operations and has one of the youngest fleets globally boasting of an average age of less than five years. Apart from the domestic routes, Jet now flies to destinations like London, Singapore, Bangkok and Kuala Lumpur. The airline commands a 25 per cent market share in the domesic market.

While Jet claims that the deal comes 40 per cent cheaper than its earlier aborted attempt, there are hidden numbers which make the deal more expensive. Eitherway, analysts are divided on the stock.

Those bullish are relying on Jet's flourishing international operations and a more benign domestic climate to accelerate its earnings. The bears on the contrary fear that the Sahara buy-out will strain Jet's balance sheet unnecessarily.

Even though Sahara's 27 aircraft, parking bays, staff and other infrastructure apart from its ready eight per cent market-share will be a definite plus, the benefits do not seem to be commensurate with the price Jet is paying for it, they feel.

A leading foreign broking firm put a sell on the stock with a target price of Rs 390. But two other firms, which have been positive on the counter since January this year, reaffirmed their bullish stance with a target price of over Rs 720.

Apart from the Rs 500 crore that Jet paid as upfront payment for the aborted merger attempt, the company would pay Rs 400 crore by April 20 and another Rs 550 crore through four equated annual instalments between 2008-2011. One good part of the deal is that the staggered payment eases the cash flow burden somewhat and reduces the acquisition price going by the net present value of Rs 1250 crore.

The total cost to Jet Airways for control of the Air Sahara however comes to Rs 1950 crore considering the money Jet had spent on Sahara before the deal was called off in June last year and certain other liabilities.

The valuation seems high for a company whose losses have soared and market share halved since the first aborted merger attempt in January 2006. If the stock market has still forgiven the company for this, it is because analysts were expecting a dead loss of Rs 700 crore for Jet Airways considering the litigation would have worked against Jet in all probability.

With intense competition from Low Cost Carriers and price undercutting becoming the order of the day, Sahara's financials have only worsened since January 2006.

According to reliable sources, Air Sahara incurred a loss of Rs 300 crore on a revenue base of around Rs 1800 crore with accumulated losses totalling to Rs 700 crore. Jet has also seen its realisations fall in the past year and is estimated to close FY07 with a loss of Rs 120 crore.

"Though the current indicated deal size is lower than the amount Jet was ready to pay for Air Sahara, when the deal was first announced, since then the overall competitive environment hasn't improved. As on December 2006, Jet Airways and Air Sahara both reported running in losses and lost a significant market share after the deal was announced. At the current valuations, we believe the merger would strain the profitability and balance sheet of Jet Airways in the near to medium term, before the merger can fully realize the benefits arising out of the synergies" says Surbhi Chawla, Research Analyst, Angel Broking.

Already, Jet Airways financials look streched with a debt-equity ratio of more than 2. In all the company will need to raise in excess of Rs 5000 crore in order to fund the acquisition and avail of export credit to pay for the aircrafts it proposes to buy for its international operations over the next couple of years.

The company plans to add 20 wide-body aircrafts for its international fleet expansion. All this only means that the need for additional capital would entail equity dilution creating an overhang on the stock.

But there are a few critical positives as well. Given the acute shortage of trained airline staff especially pilots, Jet gets a ready pool of experienced staff from Sahara. Besides, access to Sahara's parking bays will come in handy as it increases its international fleet.

"The synergies that we see from the merger of two entities will arise from the commonality of fleet (B-737), reduction in spares, maintenance cost, infrastructure facilities," adds Chawla of Angel Broking.

Critical to the financial performance of Jet would be how the domestic environment pans out. For now the reality is that most domestic airlines are adding to their existing fleet and increasing capacity. Unless the fleet addition slows and price competition eases, domestic yields may continue to be under pressure. But there are analysts who feel that the worst may be over.

According to Nikhil Vora, research analyst, SSKI, fears of price wars, low load factors and oversupply seem to be a thing of the past. He estimates that gross yields which were hovering under Rs 6.0 till 2006 are expected to improve to Rs 6.6 (FY08E) and Rs 6.8 (FY09E). Average load factors are also expected to improve from 69 per cent to 74 per cent in FY09 even as the aviation industry growth at 20-25 per cent per annum, the domestic air travel is expected to touch 60 mn passengers by FY09.

Much would depend on how Jet utilises Sahara. The talk doing the rounds is that Jet would convert Sahara into a LCC and it would remain focussed on business travellers as a premium carrier. This should help Jet hold up both realisations and market share. Eventually, Jet should be able to extend its higher level of operational efficiency to Sahara and turn it around within the next eighteen months.

The biggest plus is that the acquisition of Sahara strengthens Jet Airways' international operations as Sahara has permit to operate in Gulf market and operations could commence in early 2008. International operations enjoy higher realisation, load factor and better margins.

And in just a few months since launch Jet has been able to achieve yields and load factor comparable to that of global peers like British Airways and Singapore Airlines. The commencement of India-US operations later this year and the Gulf route through Sahara will further boost business and margins.

"Profitability in the business will be driven by rapidly surging international operations," says Vora who has put an Outperformer on the stock. He estimates that international revenues will help Jet double its total revenues over the next couple of years.

Overall, analysts estimate that Jet could incur a loss close to Rs 170 crore in the current fiscal, as much as in FY07 (estimated). Estimated earnings for FY09, at roughly Rs 40 crore is half of what it would have been without the merger. Rise in crude prices also remains a key risk.

But with buoyant economy, driving demand for air travel up at 20 per cent per annum, and international operations on a par with the best in the world, Jet's business looks a good story to buy. But one will have to wait patiently for gains to trickle in.