Shares of Jet Airways (India) Ltd and SpiceJet Ltd took off sharply on Wednesday for no particular reason. The two stocks rose by 9% and 7%, respectively. The Directorate General of Civil Aviation released passenger traffic data for October on Tuesday that showed that traffic fell 15.7% on a year-on-year basis.
It must be noted here that October 2011 represented a relatively high base, since the festival of Diwali fell during that month. But it’s far-fetched to say that passenger traffic was impressive adjusted for that. Investors appear to be increasingly embracing the notion that in the Indian aviation sector, less is more.
It’s a well-known fact that tariffs and yields have remained strong of late. The sharp jump in airline shares suggests an assumption that the rise in tariffs will more than offset the drop in passenger traffic. Investors are now pricing in decent earnings in the October-December period, which has traditionally been a strong season for airline companies.
Even so, the valuations of both Jet and SpiceJet have reached levels where earnings growth will have to be sustained for many quarters ahead. According to an analyst with a domestic brokerage, who did not want to be quoted, on an EV/Ebitdar basis, Jet and SpiceJet now trade at 8.5 times and 8.7 times estimated earnings, respectively, for financial year 2012-13. EV stands for enterprise value and Ebitdar for earnings before interest, tax, depreciation, amortization and lease rentals. JP Morgan has price targets of Rs.245 and Rs.30, respectively, for the two stocks—considerably lower than their current traded price of Rs.451.5 and Rs.37.4 on BSE.
Since late last year, these companies have benefited from a reduction in industry capacity, owing to the sharp drop in Kingfisher Airlines Ltd’s flights. This, coupled with the fact that fresh capacity addition has been low, has helped them raise fares to take advantage of the demand-supply mismatch. In the September quarter, Jet’s revenue per RPKM (revenue passenger kilometre) rose by as much as 29.9% on a year-on-year basis. This was the main reason, apart from a drop in costs, why its break-even seat factor fell from over 90% a year ago to 77% last quarter. In this backdrop, a drop in passenger traffic hardly hurts. Government policy has also been favourable, with direct import of fuel being allowed and foreign direct investment permitted. Airline companies have also controlled costs on distribution and have been tapping new revenue streams.
But, as pointed out earlier, all this and more is now captured in their valuations. Investors may be in for a crash landing.