Flight path turbulence

Retention of trained manpower will hit established airlines as no-frills rivals take wing

As if the negative impact of lower air fares wasn't enough, the entry of multiple low-cost carriers in the Indian aviation market has introduced another problem for established players like Jet Airways.

News reports suggest that there's an acute shortage of trained manpower in the industry, leading to a substantial increase in staff costs.

Staff costs currently account for around 9 per cent of operating revenues for Jet Airways, and assuming that the company has to hike salaries by say 30 per cent in order to keep off "poachers", margins would be hit by over 200 basis points.

It was earlier felt that Jet may not be affected much because of the entry of low-cost carriers (LCCs), since it has an advantage in areas like parking slots for its aircraft, and given its popularity with the business community which would likely not shift loyalty just because of lower fares.

Further, the cost base of a low-cost carrier in India is not expected to be much lower than that of full-service provider, unlike the west where the cost is about 50-55 per cent lower because of much higher utilisation, besides the benefits of high internet penetration and secondary airports which lower costs.

Yet, even if the economics of operating a low cost airline in India may not be sound, it seems that there could be an impact on the profitability of established players when LCCs alight on to the Indian aviation scene.

To add to Jet's woes, prices of fuel (25 per cent of sales) continue to be higher on a y-o-y basis. Of course, things appear much more bright on the revenue front, what with Jet set to start flights to Singapore from April.

Other international offerings would soon follow suit. Nevertheless, earnings growth is expected to be in sub-20 per cent levels in the next couple of years. In light of that, the FY06 PE of over 20 times seems rich.

Gammon India

The Gammon India stock has appreciated about 60 per cent over the last two months, despite the Sensex being more or less flat during the same period.

Even the share price of peer L&T has been flat lately. The reason the Gammon stock has done well is it's been able to manage rising input costs like steel better than most of its peers.

Gammon India reported a 47.1 per cent growth in its profit before tax in the nine months ended December 2004 compared with the same period in the previous year. Operating profit margin improved 118 basis points to 10.93 per cent.

In contrast, L&T had grown its OPM (excluding other income) by a mere 24 basis points to 3.92 per cent during the same period. It's not that Gammon was unaffected by rising steel prices. Raw material expenses jumped by over 900 basis points to 35.9 per cent of revenues.

Nevertheless, Gammon cut sub contract and other site expenses from 58.4 per cent of revenues to 46.88 per cent of revenues, resulting in a net gain in profitability. This is one of the reasons the Gammon India stock has outperformed the broader market and its peers lately.

Gammon has carved its niche in segments like constructing bridges and energy projects. Toll based projects like the Cochin Bridge Infrastructure Company have helped keep its sales buoyant.

Going forward, sales growth is expected to be robust what with the India Infrastructure Report estimating total infrastructure spending of around $130 billion in next 5 years. Meanwhile, despite the run up in the Gammon stock, it currently trades at only about 7 times estimated CY05 earnings.

Banks reduce investment in corporate paper

Rising interest rates have spoilt banks' appetite for corporate bonds, while even the rally in the equity markets has not tempted banks into putting their money in equities. That's the message that emerges from a look at the RBI data.

Over the three months between November 12 and February 18, banks' investments in corporate instruments such as bonds, debentures, shares as well as commercial paper fell from Rs 92,920 crore on November 12, 2004 to Rs 88,434 crore on February 18, 2005, a fall of Rs 4,486 crore.

The biggest fall was seen in bank investment in public sector bonds, which declined by Rs 4616 crore. Investment in private sector bonds increased by only Rs 787 crore over the three months, nothing to write home about.

Bank investment in equities fell from Rs 12,105 crore to Rs 11,936 crore between November 12 and February 18, indicating the reluctance of bank treasuries to dabble in the equity markets, despite the stellar returns from them in the last couple of years.

Banks' investment in commercial paper also declined by Rs 488 crore over the period. In contrast, banks' investments in government paper continue to be positive.

For instance, between December 10 and March 4, bank investments in gilts rose from Rs 6,70,954 crore (excluding the effect of IDBI being converted into a bank) to Rs 7,01,584 crore. With bank credit showing impressive growth, the data seem to indicate that banks prefer funding corporates directly through loans rather than take a market risk on their paper.

With contributions from Mobis Philipose and Amriteshwar Mathur