IndiGo scrapes the bottom of the barrel; investors fume
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The initial public offering (IPO) of InterGlobe Aviation Ltd, which owns India’s most profitable airline IndiGo, was supposed to be one of the most sought after in years. But its promoters’ decision to scrape the bottom of the barrel, just before the IPO, has left a sour taste.
InterGlobe paid an unusually high dividend to existing investors in June, leaving the company with a negative net worth of Rs.139.4 crore. As of end-March, it had a positive net worth of Rs.426 crore. One analyst lamented at one of the company’s IPO roadshows in Mumbai, “You are showing negative net worth and asking for money from investors. This is an insult to investors.”
That may be an overreaction, but summarises the fact that the company’s decision to more or less empty its coffers ahead of its IPO hasn’t gone down well with investors. The company has a fair response to the criticism—that while its net worth is negative as of 30 June 2015, it will soon be back to positive territory thanks to its regular profit accretion. In the June quarter, it made a profit of Rs.640 crore, which means net worth may well be back to positive territory at some point this financial year on the strength of profit generation alone. Besides, it is soon expected to raise more than Rs.1,272 crore through a fresh issue of shares. But as pointed out earlier, the company’s last-minute move has irked some investors.
Be that as it may, it doesn’t look like the company will struggle to get enough demand for its issue. What’s more, it may well succeed in getting its targeted pre-money valuation of between Rs.24,000 crore and Rs.26,300 crore, or about 80% higher than the earlier estimated valuation of around Rs.14,000 crore.
InterGlobe has the financials to back this up. In June, when it had filed its draft red herring prospectus, it reported a profit of Rs.720.8 crore for the nine months till December 2014, or an annualized profit of Rs.961 crore. When it filed its updated prospectus last week, it reported a net profit of Rs.1,296 crore for financial year 2014-15, and a profit as high as Rs.640 crore for the June quarter of this year alone. The first quarter has typically accounted for about a third of a year’s profit for Indian airlines, which means this year’s profit could well be Rs.2,000 crore. Of course, all this depends on oil prices staying as low as they have been in the recent past.
Hong Kong-based analysts at Citigroup Global Markets Asia said in a 15 October note to clients: “For traditional airlines, fuel cost has accounted for an average of ~35% of their operating costs. However, due to the savings on other operating costs, fuel costs typically account for a higher proportion of the overall costs of low-cost carriers (LCCs), ranging from 40-50% for various LCCs. (Therefore), fluctuations in oil prices have greater impact on their earnings. Thus a declining oil price environment actually will benefit LCCs more than traditional full-service carriers.”
The huge jump in IndiGo’s profit lately testifies to this. IndiGo’s Ebitdar (earnings before interest, tax, depreciation, amortization and lease rentals) jumped to 37.4% for the June quarter, compared with 27.5% for the last financial year.
But what about valuations? At the middle of the price band, IndiGo is asking for a valuation of 13 times its estimated earnings for this year. Trailing earnings are discounted by 19.4 times. Since Indian listed carriers are not exactly comparable, with their high debt and huge losses, it makes sense to compare this with the valuations of a few international LCCs.
According to Citi Research, Ryanair Ltd, an Irish low-cost airline, trades at 13.2 times one-year forward earnings; Southwest Airlines, a major US airline, trades at 10.65 times earnings; and major LCCs across the world get an average valuation of 12.8x one-year forward earnings. Prima facie, then, it looks as if that does not leave much on the table for investors in IndiGo’s IPO.
However, much depends on the stage of growth that LCCs are in. Citi’s analysts say that during its fast-growing stage, Ryanair’s shares traded at a relatively higher valuation of 25 times during 2000-2004 and 18 times during 2005-2008. Valuations have, however, fallen to around 13 times after the global financial crisis; but then, growth has also fallen. Since use of air travel on a per-capita basis is extremely low in India, it can be said that IndiGo still has some years of growth left. While competition is a likely threat, IndiGo’s low-cost structure and asset-light strategy should hold it in good stead.
But on the flip side, it must be noted that despite penetration being extremely low, growth rates have slipped at IndiGo in the past two years. The jump in profit in the June quarter is largely aided by low fuel costs. But given the dearth of quality paper, it’s quite likely that InterGlobe’s shares will be lapped up, especially by institutional investors.