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Equity Research
June 16, 2016
BSE Sensex: 26726

INDIA

Aviation
Flying high amid good times
Reason for Report: Sector thematic and initiating coverage

InterGlobe Aviation
(Rs1,011 – BUY)
Target price Rs1,268
SpiceJet
(Rs66 – HOLD)
Target price Rs64
Jet Airways
(Rs561 – ADD)
Target price Rs621

Research Analysts:

Ansuman Deb ansuman.deb@icicisecurities.com +91 22 6637 7312

India’s aviation sector is set to undergo a strong growth period, which should benefit all the incumbent players, particularly on a benign crude price outlook.
Our supply-demand model for domestic air traffic implies 14% growth in passengers as evidenced from firm aircraft orders and latest delivery schedules.
With yield management becoming the singular strategy lever for Indian Low-Cost
Carriers (LCCs), cost structures assume high importance and structural asymmetries will decide the competitive edge for the airlines. However, much of these asymmetries in cost structure are inherited from the fleet strategy adopted by various airlines, hence normally have a long-lasting impact on their balance sheets. High operating leverage proves fatal in a cyclical downturn where balance sheet strength is vital. At the comfort of hindsight, bulk orders have benefitted IndiGo with valuable incentives, which have given it the structural advantage of lower rentals, while single fleet focus and strong balance sheet have lent IndiGo asymmetrical advantages on maintenance costs, redelivery expenses and supplementary rentals. That the other airlines have missed the plot thus far is a given, but the current growth phase of domestic aviation and low crude price outlook provide opportunity for them to shore up their balance sheet.
Our domestic supply-demand model shows an implied annual growth rate of only 14%. This is the implied growth rate based on the capacity addition programs of domestic airlines. Our model accounts for all the operating airlines in India along with their planned capacity additions, hence reflects competition. We believe, barring an uneconomical way of short-term operating lease/wet lease, the capacity addition options are fairly limited. Another constraint will be that PLFs typically tend to be stable or modestly increasing at the aggregate level, thanks to the modern-day yield management practices. Therefore, when we arrive at an average industry growth of
14% with increasing PLFs and factoring all the capacity additions, it is but the implied growth rate of the system. This implied growth rate of 14% is low considering that the average annual growth rate of passenger-traffic in India has been more than
18-20%% since 2000 excluding the three periods of: 1) 2001-02 in the wake of terrorist attacks in the US (9/11) and the subsequent global crisis, 2) the great 2009 financial recession, and 3) 2012, when Kingfisher Airlines went bankrupt. Fare corrections on account of lower crude prices have already played out with ~5%/15% dip in fares in FY15/FY16 respectively. As such, we believe that the fares are likely to stabilise with increasing oil outlook. In the near term, there is still sufficient room left among the metro cities of (~45mn excess capacity remain) within the top airports which share 90% of the cumulative traffic among themselves.
Cost asymmetries and balance sheet are the defining stock selection parameters. There are cost asymmetries favourably disposed towards IndiGo in the form of incentives and maintenance costs which dictate our positive construct for
IndiGo. The advantage of the fleet of fuel efficient next generation aircraft will also accrue to this cost differential in times ahead. These have led to IndiGo having the strongest balance sheet among all the Indian airlines and it will continue to benefit from these structural advantages. Any kind of catching up by the peers will necessarily have to be a slow affair.
Valuation Summary
Mcap
CMP
(Rs bn) Reco
(Rs)
IndiGo
364
BUY
1,011
SpiceJet
40 HOLD
66
Jet Air
64
ADD
561
Source: Company, data I-Sec research
Company

TP
(Rs)
1,268
64
621

Revenue (Rs mn)
FY17E
FY18E
205,627
243,776
59,272
72,414
240,198
255,894

EBITDAR (Rs mn)
FY17E
FY18E
68,691
86,594
15,675
20,086
40,074
43,111

Please refer to important disclosures at the end of this report

EPS% CAGR
(FY16-18)
26.9
36.3
(16.3)

Aviation sector, June 16, 2016

ICICI Securities

TABLE OF CONTENTS
Oversupply –is it a pressing concern?.......................................................................... 3
Our supply model suggests otherwise ............................................................................ 3
Domestic seat capacity supply model implies passenger growth rate of 14% ............... 3
Airport capacity growth to lag demand............................................................................ 6
Route Map of domestic airlines- is there untapped cities left? ....................................... 9
Investment in airport infrastructure and look at certain key projects ............................ 10
Indian aviation remain one of the best growth stories .............................................. 12
Triggers favouring strong air traffic growth in India ....................................................... 14
Comparison of railways with airlines ............................................................................. 16
Cost structure assumes obvious importance in a price based industry ................. 19
Cost Comparison across competition-IndiGo has an edge .......................................... 19
Cost comparison across global airlines ........................................................................ 20
Aircraft market –next-gens like neo provide safe haven ........................................... 21
Why A320neo is one of the most popular aircraft and offers safe value to IndiGo....... 24
Ancillary revenues remain a growth lever................................................................... 27
Globally ancillary revenues have a higher share .......................................................... 27
Ancillarisation of passenger revenues, bundling and unbundling ................................. 28
Risk in an airline business ............................................................................................ 30
The New Aviation Policy aimed to boost the sector .................................................. 31
The Regional Connectivity Scheme (RCS) ................................................................... 32
5/20 rule converted to a 0/20 rule ................................................................................. 32
Maintenance, Repair and Overhaul (MRO) to be boosted ........................................... 32
Bilateral Traffic Rights to get incrementally liberalised ................................................. 33
New airlines will find it tough to gain ground from competition .............................. 35
Case study – AirAsia ..................................................................................................... 35
Case study – Vistara ..................................................................................................... 37
Annexure......................................................................................................................... 38
Fleet details of key Indian players................................................................................. 38
Airlines – a cyclical industry and the role of yield management ................................... 41
Effects of competition in aviation industry ..................................................................... 45
Tracking the key determinant forces of aviation ........................................................... 47
Aviation Turbine Fuel: Supply-side to keep prices on the leash ................................... 51
Increasing oil efficiency would remain a constant feature ............................................ 51
Index of Tables and Charts ........................................................................................... 55

COMPANIES
InterGlobe Aviation ........................................................................................................... 57
SpiceJet .......................................................................................................................... 101
Jet Airways ...................................................................................................................... 127
2

ICICI Securities

Aviation sector, June 16, 2016

Oversupply –is it a pressing concern?
Our supply model suggests otherwise
Due to yield management techniques prevalent among airlines across the world, the air traffic demand growth is best analysed through the prism of available ASKs which can be mapped through the upcoming orderbook of the individual airlines in India. We have projected the upcoming orderbook of all domestic airlines based on their orderbook, estimated retirements and company guidance.
The fear of oversupply is not well placed considering that in a market which has grown on an average of 18-20%
(barring three extraordinary years of
2001-02, 2009 and
2012); the supply side of booked aircraft order only can accommodate 14%
CAGR. The investment argument in such a scenario is thus favourable to the incumbent airlines.

We have made a supply model of the planned capacity additions of all domestic airlines in India over the next four years, factoring the orders placed, probable delays, replacements and resultant average domestic seats for the period between FY17FY20. We believe that yield management will ensure that most of the large airlines will operate along the 85% level of PLFs. However, some of the new and marginal airlines will not be able to garner such PLFs, simply due to the exorbitant high passenger growth required for them in order to achieve the same. The result of the exercise is the implied passenger growth of all airlines and also the total domestic passenger growth model. This implied passenger growth comes to 14% for FY17-20E.
In other words, only 14% passenger growth is required to manage PLFs of entire industry given the fleet addition plans.
This implied growth rate of 14% is low considering that the average annual growth rate of passenger-traffic in India has been more than 20% since 2000 excluding the three years of 2001-02 in the wake of terrorist attacks in the US
(9/11), 2009 financial recession, and 2012 when Kingfisher went bankrupt.

Domestic seat capacity supply model implies passenger growth rate of 14%
This is the implied growth rate based on the capacity addition programs of domestic airlines. This model accounts for all the operating airlines with their planned capacity additions, hence reflects competition. Barring a perilous way of short-term operating lease/wet lease, the capacity addition options should be largely in line with the airline’s plan. Additionally, PLFs typically tend to be stable or modestly increasing at an aggregate level, thanks to the aggressive yield management practices adopted by the airline industry. These boundary conditions of rational capacity addition, passenger growth and PLF levels are the bedrocks of our India domestic air traffic model.
Table 1: Domestic air traffic supply model
System
Passenger growth
Passengers carried
Avg km per passenger
RPK (mn)
Departure/plane
Effective seats (FY)
Avg km per seat
ASK (mn)
PLF (%)
Source: I-Sec research

FY16
85,197,675
950
80,938
1,980
56,044
881
97,761
82.8

FY17E
15.5
98,363,142
954
93,838
2,000
64,504
890
114,817
81.7

FY18E
13.0
111,189,886
956
106,298
2,030
70,043
885
125,836
84.5

FY19E
14.1
126,879,624
956
121,297
2,040
78,812
881
141,644
85.6

FY20E
14.7
145,505,253
956
139,103
2,050
90,916
881
164,199
84.7

3

ICICI Securities

Aviation sector, June 16, 2016


Based on respective supply order, IndiGo,
SpiceJet and Go Air will increase market share at the expense of Air India and Jet
Air. The new players are unlikely to cut through competition

Increase in IndiGo’s market share from 36.9% to 41.1% by FY20. This is largely driven by IndiGo’s capacity increase. However, the implied passenger growth is an average 18% for IndiGo between FY17-FY20. This is very much possible because, even then, IndiGo’s PLFs would remain in the 80-88% range.
Table 2: Indigo supply model
System
FY16
Passenger growth
Passengers carried
31,453,451
Market Share
36.9
Avg. km per passenger
1,028
RPK (mn)
32,318
Departure/plane
2,510
Effective seats (FY)
16,895
Avg. km per seat
906
ASK (mn)
38,420
PLF (%)
84.1
Source: Company Data, I-Sec research



FY17E
25.0
39,316,814
40.0
1,028
40,398
2,510
22,093
906
50,241
80.4

FY18E
15.0
45,214,336
40.7
1,028
46,458
2,510
24,043
906
54,674
85.0

FY19E
15.0
51,996,486
41.0
1,028
53,426
2,510
26,847
906
61,052
87.5

FY20E
15.0
59,795,959
41.1
1,028
61,440
2,510
30,609
906
69,607
88.3

New entrants would struggle; exits would lead to further consolidation. The combined market share of the new players would remain low. To give a perspective, the combined market share of Air India Express, Air Alliance, Vistara,
True Jet, Pegasus, Air Costa and Air Asia would only manage to increase only by
1% between FY17 and FY20E. Although Air India Express and Air Alliance are not new, we have clubbed them in the group considering their low market share. This is the maximum market share they are able to reach with a passenger growth at
20% CAGR between FY17E-FY20E. Their PLFs would remain low, but increase in line with the growth in traffic. Any exits by any of the players or weakening of position would further provide opportunity for consolidation of the industry. So, one wonders whether IndiGo has any such exits factored in with their big orderbook.
Table 3: Air Asia supply model
System
FY16
Passenger growth
Passengers carried
1,705,808
Market share
2.0
Avg. km per passenger
1,104
RPK (mn)
1,883
Departure/plane
2,500
Effective seats (FY)
899
Avg. km per seat
1,045
ASK (mn)
2,348
PLF (%)
80.2
Source: Company data, I-Sec research

FY17E
20.0
2,046,970
2.1
1,104
2,260
2,500
1,260
1,045
3,292
68.7

FY18E
20.0
2,456,364
2.2
1,104
2,712
2,500
1,440
1,045
3,762
72.1

FY19E
20.0
2,947,636
2.3
1,104
3,254
2,500
1,620
1,045
4,232
76.9

FY20E
20.0
3,537,163
2.4
1,104
3,905
2,500
1,980
1,045
5,172
75.5

FY17E
20.0
1,707,133
1.74
1,028
1,755
2,000
1,332
1,010
2,691
65.2

FY18E
20.0
2,048,560
1.84
1,028
2,106
2,000
1,406
1,010
2,840
74.1

FY19E
20.0
2,458,272
1.94
1,028
2,527
2,000
1,628
1,010
3,289
76.8

FY20E
20.0
2,949,926
2.03
1,028
3,033
2,000
1,998
1,010
4,036
75.1

Table 4: Vistara supply model
System
FY16
Passenger growth
Passengers carried
1,422,611
Market share
1.67
Avg. km per passenger
1,028
RPK (mn)
1,462
Departure/plane
2,350
Effective seats (FY)
888
Avg. km per seat
1,010
ASK (mn)
2,108
PLF (%)
69.4
Source: Company data, I-Sec research



4

Maximum decline in market share likely for Air India followed by Jet. A slower growth in capacity will drive this lower market share for ‘Air India and Jet.
This is a missed opportunity for Air India/Jet who has not been able to manage their fleet inventory with long delays in orders and a higher share of wide body

ICICI Securities

Aviation sector, June 16, 2016

aircraft. To give a sense, Jet has had to lease 10 aircraft to Turkish
Airways/Etihad. However, it is not the missed opportunity from a strategy point of view, but more from the poor financial condition of these carriers. These airlines are big enough to take significantly more time to turnaround and as such it is in their best interest to focus on deleveraging rather than capacity expansion.
Table 5: Air India supply model
System
FY16
Passenger growth
Passengers carried
12,742,163
Market share
15.0
Avg. km per passenger
961
RPK (mn)
12,245
Departure/plane
1,085
Effective seats (FY)
12,299
Avg. km per seat
1,159
ASK (mn)
15,470
PLF (%)
79.2
Source: Company data, I-Sec research

FY17E
3.0
13,124,428
13.3
961
12,613
1,085
12,430
1,159
15,634
80.7

FY18E
8.0
14,174,382
12.7
961
13,622
1,085
12,839
1,159
16,150
84.3

FY19E
5.0
14,883,101
11.7
961
14,303
1,085
13,437
1,159
16,902
84.6

FY20E
4.0
15,478,425
10.6
961
14,875
1,085
13,825
1,159
17,389
85.5

FY17E
8.0
17,238,213
17.5
864
14,885
1,825
13,412
728
17,819
83.5

FY18E
3.0
17,755,359
16.0
864
15,332
1,825
13,443
728
17,860
85.8

FY19E
12.0
19,886,002
15.7
864
17,172
1,825
15,268
728
20,286
84.6

FY20E
15.0
22,868,902
15.7
864
19,747
1,825
18,275
728
24,280
81.3

Table 6: Jet Airways supply model
System
FY16
Passenger growth
Passengers carried
15,961,308
Market share
18.7
Avg. km per passenger
864
RPK (mn)
13,783
Departure/plane
1,825
Effective seats (FY)
12,877
Avg. km per seat
728
ASK (mn)
17,109
PLF (%)
80.6
Source: Company data, I-Sec research



SpiceJet and GoAir to have modest growth in market share. These two airlines are likely to increase their fleet size on the back of orders made earlier, albeit on a small scale compared to IndiGo..

Table 7: SpiceJet growth model
System
FY16
Passenger growth
Passengers carried
10,670,866
Market share
12.5
Avg. km per passenger
874
RPK (mn)
9,326
Departure/plane
2,100
Effective seats (FY)
5,775
Avg. km per seat
836
ASK (mn)
10,139
PLF (%)
92.0
Source: Company data, I-Sec research

FY17E
15.0
12,271,496
12.5
874
10,725
2,100
6,567
836
11,530
93.0

FY18E
20.0
14,725,795
13.2
874
12,870
2,100
8,220
836
14,432
89.2

FY17E
16.0
8,305,819
8.4
945
7,849
2,500
3,960
946
9,365
83.8

FY18E
22.0
10,133,099
9.1
945
9,576
2,500
4,860
946
11,494
83.3

FY19E
20.0
17,670,954
13.9
874
15,444
2,100
10,160
836
17,837
86.6

FY20E
20.0
21,205,145
14.6
874
18,533
2,100
12,780
836
22,437
82.6

Table 8: GoAir’s growth trajectory
System
FY16
Passenger growth
Passengers carried
7,160,189
Market share
8.4
Avg. km per passenger
945
RPK (mn)
6,766
Departure/plane
2,500
Effective seats (FY)
3,420
Avg. km per seat
946
ASK (mn)
8,088
PLF (%)
83.7
Source: Company data, I-Sec research

FY19E
18.0
11,957,057
9.4
945
11,299
2,500
5,580
946
13,197
85.6

FY20E
18.0
14,109,328
9.7
945
13,333
2,500
6,660
946
15,751
84.7

5

ICICI Securities

Aviation sector, June 16, 2016

Airport capacity growth to lag demand
Congestion and much required capacity expansion are evident, particularly in metro airports. We have detailed the traffic-capacity status of major airports in India as per 2015. The capacity underlined is based on peak hour capacity status of these airports. Clearly, there is a sense of traffic overload in cities like Mumbai, Hyderabad,
Pune and Goa. However, the continuing growth if projected will not spare any major airports from acute capacity shortage. So, apparently, the growth will come in nonmetro routes in future.
While the growth in airports will lag demand, there is still available capacity in the system. Though the paucity in the top metros is a given, it also presents a strong possible price hike to accommodate the traffic growth.

Despite the fact that bulk of the future growth will come out from the non-metros, one must not forget that capacities do catch up in time. Additionally, in the near term, there is still sufficient room left among the metro cities of ~45mn within the top 90% cumulative traffic share cities of India as shown in table 15.
Yet, how to deal with capacity shortage? Herein lies the importance of the ubiquitous yield management of airlines which would have to come into picture to allay the traffic growth in congested airports. The tariffs at major airport has increased not only because of the organic growth in GDP per capita and the increasing number of air travelling demographics, but also because of significant low fares over the last two years. Needless to say, if at there is congestion and the demand for air travel exceeds the available air slots, the balancing act will be to increase the fares in metros. We believe that average fare hike is on the cards in metro routes. We have factored
~2-3% growth in average fares for airlines.
Table 9: Indian Airport Traffic growth history
Passenger (mn)
Int'l
Domestic
2007-08
30
87
2008-09
32
77
2009-10
34
89
2010-11
38
106
2011-12
41
122
2012-13
43
116
2013-14
47
122
2014-15
51
139
2015-16
55
169
Source: DGCA, I-Sec research
Year

Total
117
109
124
143
162
159
169
190
224

Passenger growth (%)
Int'l
Domestic
15.2
23.3
5.9
(11.2)
9.0
15.5
10.2
18.1
7.6
15.2
5.5
(4.2)
8.3
5.1
9.0
13.9
7.7
21.2

Total
21.1
(6.9)
13.6
15.9
13.2
(1.8)
6.0
12.5
17.6

Table 10: Traffic Profile of Bangalore Airports
Capacity is 20mn passengers per annum. The master plan envisages the construction of a new integrated passenger terminal, equipped with world-class technology to accommodate up to over 50mn pax per annum.
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15
(Mn)
Domestic
8.6
7.1
8.0
9.4
10.3
9.5
10.2
12.5
International
1.6
1.6
1.9
2.2
2.4
2.5
2.6
2.9
Total
Bangalore
10.1
8.8
9.9
11.6
12.7
12.0
12.9
15.4
Passengers
International
YoY (%)
24.9
(13.6)
13.5
16.6
9.6
-5.5
7.3
19.7
Airport
Limited –
Passenger Traffic Share in %
BIAL
Domestic
84.7
81.3
80.5
80.8
81.5
79.1
79.5
81.0
International
15.3
18.7
19.5
19.2
18.5
20.9
20.5
19.0
% of Passenger Traffic in comparison with all Airports
Domestic
9.9
9.2
8.9
8.9
8.5
8.2
8.4
9.0
International
5.2
5.2
5.6
5.9
5.8
5.8
5.7
5.8
Total
8.7
8.0
8.0
8.1
7.8
7.5
7.6
8.1
Source: Association of private airport operators, I-Sec research

6

FY16
15.6
3.4
19.0
23.1
82.3
17.7
9.2
6.1
8.5

ICICI Securities

Aviation sector, June 16, 2016
Table 11: Traffic Profile of Mumbai Airport
Capacity to handle 40 million passengers per annum and one million tons of cargo annually.
FY08
FY09
FY10
FY11
FY12
FY13
(Mn)
Domestic
17.9
15.3
17.4
20.0
21.0
20.3
International
8.0
8.1
8.2
9.1
9.7
9.9
Total
25.9
23.4
25.6
29.1
30.7
30.2
Passengers
Mumbai
% YoY chg
16.2
(9.4)
9.2
13.5
5.8
(1.7)
International
Aiport
Passenger Traffic Share in %
Limited
Domestic
69.1
65.4
67.8
68.8
68.4
67.1
International
30.9
34.6
32.2
31.2
31.6
32.9
% of Passenger Traffic in comparison with all Airports
Domestic
20.5
19.8
19.4
18.9
17.3
17.4
International
26.8
25.7
24.0
23.9
23.8
23.1
Total
22.1
21.5
20.7
20.3
18.9
19.0
Source: Association of private airport operators, I-Sec research

FY14
21.9
10.3

FY15
25.2
11.4

FY16
30.0
11.6

32.2

36.6

41.7

6.7

13.7

13.7

67.9
32.1

68.8
31.2

72.1
27.8

17.9
22.2
19.1

18.1
22.5
19.3

17.8
21.2
18.6

Table 12: Traffic Profile of Hyderabad

GMR
Hyderabad
International
Airport
Limited

Capacity is 12mn passengers per annum. The Project has the flexibility to increase capacity to accommodate over 40 MPPA and shall be developed in a phased manner.
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15
FY16
(mn)
Domestic
5.5
4.6
4.8
5.8
6.7
6.2
6.4
7.8
9.2
International
1.4
1.6
1.7
1.9
1.9
2.2
2.4
2.7
3.2
Total
7.0
6.2
6.5
7.6
8.6
8.3
8.7
10.5
12.4
Passengers
% YoY chg
21.5
(11.0)
4.8
17.2
12.7
(3.5)
5.2
20.4
19.1
Passenger Traffic Share in %
Domestic
79.3
74.8
73.7
75.4
77.9
74.1
72.8
74.0
74.4
International
20.7
25.2
26.3
24.6
22.1
25.9
27.2
26.0
25.6
% of Passenger Traffic in comparison with all Airports
Domestic

6.0
5.4
6.0
International
4.8
5.0
5.0
Total
6.0
5.7
5.3
Source: Association of private airport operators, I-Sec research

5.5

5.5

5.3

5.2

5.6

5.4

4.9
5.3

4.7
5.3

5.0
5.2

5.1
5.2

5.4
5.5

5.8
5.5

Table 13: Traffic Profile of Cochin
Capacity is 9 million passengers per annum (MPPA) (will increase to 13 million with new terminal on 2016-2017 and potential to increase to 20 million by 2020)
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15
FY16
(mn)
Domestic
1.6
1.4
1.7
2.0
2.1
2.0
2.1
2.7
3.1
International
1.8
2.0
2.2
2.4
2.6
2.9
3.3
3.8
4.7
Total
3.3
3.4
3.9
4.3
4.7
4.9
5.4
6.5
7.8
Passengers
Cochin
% YoY chg
30.3
0.7
17.3
10.1
8.7
3.3
10.4
19.7
21.0
International
Airport
Passenger Traffic Share in %
Domestic
47.0
40.2
43.4
45.7
45.2
40.2
39.3
41.7
39.9
International
53.0
59.8
56.6
54.3
54.8
59.8
60.7
58.3
60.0
% of Passenger Traffic in comparison with all Airports
Domestic
1.8
1.7
1.9
1.9
1.8
1.7
1.7
1.9
1.8
International
5.9
6.4
6.5
6.2
6.3
6.8
7.0
7.4
8.5
Total
2.9
3.1
3.2
3.0
2.9
3.1
3.2
3.4
3.5
Source: Association of private airport operators, I-Sec research

Table 14: Delhi Airport Traffic Profile
Capacity is 60 million passengers per annum (MPPA) (potential to increase to 100 million by 2020)
FY08
FY09
FY10
FY11
FY12
FY13
FY14
(mn)
Domestic
16.8
15.1
17.8
20.7
25.1
22.8
24.2
International
7.2
7.8
8.3
9.3
10.8
11.6
12.7
Total
24.0
22.9
26.1
29.9
35.9
34.4
36.9
Passengers
Delhi
% YoY chg
17.4
(4.6)
14.1
14.6
19.8
(4.2)
7.3
International
Passenger Traffic Share in %
Airport
Domestic
70.0
65.9
68.2
69.0
70.0
66.3
65.6
International
30.0
34.1
31.8
31.0
30.0
33.7
34.4
% of Passenger Traffic in comparison with all Airports
Domestic
19.3
19.5
19.9
19.6
20.7
19.6
19.8
International
24.2
24.7
24.2
24.5
26.3
26.9
27.2
Total
20.5
21.0
21.1
20.9
22.1
21.6
21.8
Source: Association of private airport operators, I-Sec research

FY15
27.5
13.5

FY16
34.3
14.2

41.0

48.4

11.1

18.1

67.0
33.0
19.7
26.6
21.6

70.9
29.2
20.3
25.9
21.6

7

ICICI Securities

Aviation sector, June 16, 2016
Table 15: Traffic versus capacity status of 90% traffic of Indian airports
Airport
Delhi
Mumbai
Bangalore
Chennai
Kolkata
Hyderabad
Cochin
Ahmedabad
Pune
Goa
Trivandrum
Lucknow
Jaipur
Guwahati
Srinagar
Calicut
Bhubaneswar
Visakhapatnam
Indore
Coimbatore
Mangalore
Nagpur
Source: DGCA, I-Sec research

Pax (mn)
48.40
41.67
18.96
15.22
12.42
12.36
7.75
6.48
5.42
5.38
3.47
3.24
2.89
2.78
2.31
2.31
1.89
1.80
1.69
1.69
1.67
1.60

Share (%)
21.6
18.6
8.5
6.8
5.6
5.5
3.5
2.9
2.4
2.4
1.6
1.4
1.3
1.2
1.0
1.0
0.8
0.8
0.8
0.8
0.7
0.7

Capacity
60.0
40.0
20.0
23.0
24.0
12.0
13.0
14.0
3.9
4.9
14.0
3.0
8.8
5.5
8.3
6.6
3.5
6.1
6.1
5.5
4.4
9.6

Post expansion 100
50
30
50
20
12
13
6

12
11

Current excess capacity 11.6
(1.7)
1.0
7.8
11.6
(0.4)
5.3
7.5
(1.5)
(0.5)
10.5
(0.2)
5.9
2.7
6.0
4.3
1.6
4.3
4.4
3.8
2.7
8.0

Cumulative
Share
21.6
40.3
48.8
55.6
61.1
66.6
70.1
73.0
75.4
77.8
79.4
80.8
82.1
83.4
84.4
85.4
86.3
87.1
87.8
88.6
89.4
90.1

14.0
12.0
10.0
8.0
6.0
4.0
2.0
0.0
(2.0)

Patna
Chandigarh
Varanasi
Trichy
Amritsar
Raipur
Jammu
Bagdogra
Vadodara
Agartala
Port Blair
Madurai
Imphal
Ranchi
Udaipur
Bhopal
Dehradun
Rajkot
Leh
Vijayawada
Tirupati
Dibrugarh
Jodhpur
Aurangabad
Rajahmundry
Silchar
Lengpui (Aizwal)
Juhu
Gaya
Jabalpur
Bhuj
Belgaum
Dimapur
Surat
Tuticorin
Jamnagar
Guggal (Kangra)
Khajuraho
Allahabad
Jorhat
Bhavnagar
Hubli
Agatti
Diu
Bhuntar
Others
Porbandar
Barapani (Shillong)
Gorkhpur
Agra
Gwalior
Pantnagar
Lakhimpur (Lilabari)
Mysore
Kanpur (Chakeri)

(mn)

Chart 1: Excess capacity in non-metro airports

Source: DGCA, I-Sec research

Supply side constraints can put upward pressure on yields
Airports which together constitute 90% of the domestic travellers’ currently operate at
70% capacity utilisation. Even from this perspective, the possible growth available from the infrastructure is at best ~14% for the next three years. This reiterates a strong underlining case for price hike in the future assuming continuous robust demand.
We build in 2%/3% increase in average fares over FY17/18E

8

ICICI Securities

Aviation sector, June 16, 2016

Route Map of domestic airlines- is there untapped cities left?
We have made a route map table for the major domestic airlines in India as shown in table 16. The yellow shaded cells indicate cities with more than 10,000 passengers per month (Based on March 16). While most of these cities are covered by Jet/Air India, there are several cities yet to be covered for IndiGo,
SpiceJet and GoAir. This is especially positive for IndiGo, which will tap these markets as it aggressively ramps up its capacity. We have also indicated the cities which are capable of handling an A320 (relevant for IndiGo and GoAir).
Airports which are big enough to host an A320 will also be capable to host a
B737 (relevant for SpiceJet and Jet Airways).
Table 16: Current domestic route map of Indian airlines
Destinations
Chandigarh
Bengaluru
Kochi
Goa
Srinagar
Jammu
Delhi
Jaipur
Ahmedabad
Lucknow
Bagdogra
Guwahati
Kolkata
Hyderabad
Chennai
Mumbai
Pune
Varanasi
Dehradun
Udaipur
Indore
Patna
Agartala
Vizag
Coimbatore
Trivandrum
Kozhikode
Nagpur
Port Blair
Bhubhaneswar
Leh
Amritsar
Baroda
Bhopal
Khajuraho
Imphal
Raipur
Vijaywada
Madurai
Mangalore
Aurangabad
Ranchi
Jodhpur
Bhuj
Rajkot
Silchar
Aizawl
Rajahmundry
Tiruchirapalli
Dharamsala
Allahabad
Tirupati
Surat

Jet Airways

Indigo

A320
A320
A320
A320

A320
A320
A320
A320
A320
A320
A320
A320
A320
A320

A320
A320

Spicejet

Go Air

Air India

Vistara

Air Asia

Monthly Traffic
159,138
1,380,333
280,739
449,877
191,332
101,945
3,274,512
244,888
502,893
238,786
108,934
270,479
1,004,200
867,021
978,593
2,613,920
486,621
150,999
61,628
85,074
138,973
153,546
81,573
163,048
135,720
113,244
31,478
134,060
84,896
175,873
23,431
94,142
80,586
51,782
8,780
79,673
101,443
39,196
60,225
77,597
25,141
66,925
24,972
12,105
30,942
16,301
13,090
19,448
11,915
8,360
3,516
36,778
12,467

9

ICICI Securities

Aviation sector, June 16, 2016
Destinations
Jet Airways
Indigo
Jabalpur
A320
Dimapur
Dibrugarh
Gorakhpur
Jorhat
A320
Belgaum
Hubli
Pondicherry
Tuticorin
Mysore
Agatti
Agra
Dammam
Diu
Durgapur
A320
Gaya
A320
Gwalior
A320
Jamnagar
A320
Kullu
Lilabari
Pantnagar
Shillong
Tezpur
Source: Company Data, I-Sec research

Spicejet

Go Air

Air India

Vistara

Air Asia

Monthly Traffic
10,949
9,530
26,674
5,105
4,342
8,913
3,255
8,264
1,814
1,382
2,717
1,414
6,901
1,204
6,698
1,704
738
1,010
1,105
172

Investment in airport infrastructure and look at certain key projects As per Industry estimates, Rs250-275bn will be invested in the airport sector over
2016-17 to 2020-21. Most investments are likely to be towards Greenfield projects where implementation is more challenging given land acquisition issues and challenges with regards to clearances. Investments are likely to pick up from end of
2017-18 as large Greenfield airports such as Navi Mumbai and Goa airport commence construction. Navi Mumbai Airport project has seen extreme delays. The Navi Mumbai airport project was announced in 1996. However, environmental clearances were granted in
2010. As the land allotted constituted mangroves, forest clearances and the high court's permission were essential, which were received in 2013. Moreover, the project was facing land acquisition issues until 2015 where two villages were to give their consent (of the total of 1,160 hectares for core airport area, about 25% was pending).
The land acquisition issues for Navi Mumbai airport have been addressed as of now.
City and Industrial Development Corporation (CIDCO) stated that the affected families have been entitled for compensation of an additional 10% developed land with 2.5 floor space index (FSI), over and above the 12.5% of developed land (at 1.5 FSI) initially offered. The plots are proposed in a new township situated in the vicinity of the airport. Navi Mumbai airport is proposed to be developed through PPP. A special purpose vehicle will be formed in which CIDCO and its nominees (including project affected persons) will hold 26% of paid-up equity and the rest will be held by private developer. The Ministry of Civil Aviation approved 30% 'shared till' for Navi Mumbai airport, which indicates 30% cross-subsidization of non-aeronautical revenues for computing aeronautical tariffs at airport.

10

ICICI Securities

Aviation sector, June 16, 2016

The project is steadily moving towards RFP stage, final selection of bidder is pending: Four companies and consortia which include GMR Delhi, GVK-led Mumbai
International Airport, the Zurich Airport with Hiranandani Developers, and MIA
Infrastructure of France along with Tata Realty had submitted their bids for the RFQ.
In June 2015, these four companies and consortia got selected for submission of bids for RFP. In February 2016, the consortium of Zurich Airport with Hiranandani
Developers was rejected by the Union Home Ministry on security grounds. Estimated commencement of construction is FY17. However, the project is likely to face cost overruns, which could impact financial returns.

The next big increase in airport capacity led by greenfield projects will happen in 202123

Second Pune Airport development is in suspension. The land is yet to be identified for a new airport in Pune. The earlier identified sites at Khed and Chakan in
Pune have been completely ruled out. The original site finalised in Chakan in 2008 met with opposition from farmers. Another site was explored at Khed, but this site too faced problems with over half of the land coming under special economic zone (SEZ).
Maharashtra Airport Development Company is in the process of preparing technical reports for alternative sites for a new airport in Pune. In October 2015, a long-pending proposal to expand the existing Pune airport received nod of the Defence Ministry, which has agreed to stretch it by 15 acres. Though the existing airport in Pune will get expanded post Defence Ministry's nod, it shall not serve as an alternative for building a new airport but acts only as a temporary relief.
Goa airport progressing towards RFP stage: Owing to the capacity constraint at the
Dabolim airport in Goa, a second airport was being planned in Mopa. The plans for establishing a new international airport at Mopa have been over a decade. In October
2014, RFQs were floated for Goa's Mopa airport. Five bidders for RFQ include AAI,
GVK, GMR, Essel Infra and Voluptas Developers. The airport is actively progressing towards the RFP stage.

Table 17: Status of major airport projects
Project
Navi Mumbai Airport
Pune Airport
Goa Airport
Hassan Airport
Dholera Airport
Ankleshwar Airport
Dwarka Airport
Aranmula airport
Kannur Airport
Nagpur Airport
Chennai Airport
Nedumbassery Airport
Bengaluru-2nd stage
Kushinagar Airport
Kolkata Airport-Modernisation
Guwahati AirportModernisation
Source: Crisil

Promoter
City & Industrial Development
Corporation of Maharashtra
Maharashtra Airport
Development
Government of Goa
AAI
Gujarat Infrastructure
Government of Gujarat
Government of Gujarat
KGS Aranmula Airport Ltd

Start of
Construction

Expected
Completion

Project Cost
(Rs bn)

FY18 end

Post FY21

145

Jan'14

Land yet not finalised
Mid FY18
Post FY21
FY19 end
Post FY21
FY19 start
Post FY21
FY19 end
Post FY21
FY19
Post FY21
FY19 end
Post FY21
Under
construction
Early FY18

75
38
30
25
25
25
20

No
Oct'14
No
No
No
NA
No

19

Jan'13/ Feb'14

RFQ floated

Kannur International Airport Ltd
Maharashtra Airport
Development
AAI
Cochin Int'l Airport Ltd
GVK,AAI, Karnataka
Government
UP State Development
AAI

FY18 end
FY19 start
FY13

Post FY21
FY18

15-20
12
10

No
Dec'14
Yes

Early FY18
FY19 start
FY19 start

FY20
Post FY20
Post FY20

10
7.5
7

NA
Mar'14
Sep'13

AAI

FY19 start

6

Sep'13

Post FY21

Post FY20

11

Aviation sector, June 16, 2016

ICICI Securities

Indian aviation remain one of the best growth stories
In this section, we underline the strong growth phase of Indian airlines, how it is poised to maintain a strong footing in the presence of a favourable demographics and rising prosperity, and how is it benefitting from a congested railways with slow plans of modernisation. Global air traffic growth outlook remain strong. IATA forecasts strong global air travel growth suggesting traffic to nearly double in the next 20 years. However, assuming a liberal policy scenario, growth could be even higher. In essence, IATA forecasts a 1.8-2.8x growth in passengers, meaning additional 2.3bn-5bn passengers over the next 20 years.
Chart 2: Outlook for worldwide O-D passenger trips in millions

Source: IATA

Aviation research body Centre for Asia
Pacific Aviation
(CAPA) had in its forecast said that
India will have over
100 million fliers by
March 2017. India is set to become the third largest aviation market in the world by
2020.

12

Passenger growth will be region-specific, favouring developing economies.
Considering the drivers of air traffic to be improvement in living standards, young and working age population/demographics and cost dynamics of travel and economic growth, developing countries are likely to witness higher growth led by China and
India. However, the US continues to be strong, and likely to remain the world’s largest air market till 2030. India is best placed considering its sizeable middle class population, significantly favourable demographic advantage and relatively strong economic growth outlook.
IATA predicts Indian air traffic growth of 7% CAGR over the next 20 years, driven by improvement in living standards, population growth and favourable demographics and lower travel costs. CAPA predicted domestic passenger growth of 15% for FY16 and 8-10% for international passengers. CAPA estimated aggressive pricing to help achieve this growth, which should result in international traffic increasing to 54-55mn passengers and domestic traffic to around 80mn. However, the domestic passenger traffic already increased to 80mn in CY15.

ICICI Securities

Aviation sector, June 16, 2016

The average domestic air passenger growth over the past 32 years stands at
9%, while the average growth in the past 10 years has been 17%. Traffic growth in CY15 was 21.5%.
Chart 3: Indian domestic passenger growth – 21.5% in FY15.
Scheduled domestic passengers(000)
Scheduled domestic passengers growth (%) - RHS

90,000
80,000

50
40

70,000

30

60,000

21.5

50,000

20

40,000

10

30,000

0

20,000

2015

2013

2011

2009

2006-07

2004-05

2002-03

2000-01

1998-99

1996-97

1994-95

1992-93

1990-91

1988

(20)

1986

0

1984

(10)

1982

10,000

Source: DGCA

Chart 4: Strong drivers for Indian passenger air traffic growth

Source: IATA

13

ICICI Securities

Aviation sector, June 16, 2016

Triggers favouring strong air traffic growth in India
Indian aviation is a growing sector led by strong economic growth potential, low air penetration and favourable demographics. This has played its part in the exponential growth of air travellers and is the bedrock of investment in the sector. •

Frequency of trips rises disproportionately across income classes with increasing prosperity. There is exponential rise in air travel frequency with improving living standards. This again favors India as a travel and tourism market.
India’s middle class growth will accelerate quickly and will be adding more people than China to the global middle class in another 10 years. So, it is not surprising that the world’s travel market is carefully noting the trends, including Ireland,
Spain, South Korea, Indonesia, Macau (China) and Poland – all of which have recently opened tourist offices in India.

Table 18: Surge in air travel intensity with rising incomes
Low-income
Middle-income
High-income
Below US$20K per person
Above US$20K per person
Source: IATA

Trips/yr/ person
0.04
0.29
1.48
0.27
1.80

Months before next trip
300
41
8
44
7

However, growth reaches a plateau beyond a certain level of improvement in living standards. Chart 5: India is in the strong growing zone of air traffic

Source: IATA



14

Demographic dividend of India is very strong with a young population. Air travel is made more by working-age population and understandably India, with a relatively young workforce, has tremendous potential which is likely to manifest with higher air traffic growth.

ICICI Securities

Aviation sector, June 16, 2016
Chart 6:Air travel is largely dominated by the working-age poulation

Chart 7: India is very well placed with one of the world’s most young populations

Source: IATA

Source: IATA

This is also illustrated with the strong change expected in the flying population of India, the highest in the world expected over the next 20 years.
Chart 8: India is expected to witness one of the highest change in flying population over the next 20 years

Source: IATA

15

ICICI Securities

Aviation sector, June 16, 2016

Comparison of railways with airlines
Indian railways have seen extravagant growth in upper class passenger traffic.
While the passenger profile in railways and air traffic are not comparable, the growth in upper class non-suburban travel in Indian Railways is indicative of the growing purchasing power among Indian people along with the aspirational drive of young
Indians. This has also resulted in significant rise in the railway fares for the upper classes, consequently making air travel an increasingly viable option considering the additional time-saving benefit.
Table 19: Passenger and passenger-km growth comparison between upper and second class travel in
Indian Railways
Passengers originating (mn)
Second
Second
Total
Upper
Class
Class
Second
Year
Class
Ordinary Mail/Exp#
Class
1950-51
25
795
52
847
1960-61
15
803
96
899
1970-71
16
1,041
155
1,196
1980-81
11
1,342
260
1,602
1990-91
19
1,223
357
1,580
2000-01
40
1,460
472
1,932
2008-09
76
2,147
895
3,042
2009-10
86
2,301
983
3,284
2010-11
100
2,444
1046
3,490
2011-12
112
2,547
1188
3,735
2012-13
126
2,515
1303
3,818
2013-14
126
2,413
1306
3,719
2014-15
138
2,304
1277
3,581
CAGR 15 years
8.6
3.1
6.9
4.2
CAGR 5 years
6.7
(1.2)
4.1
0.5
#includes Sleeper class Source: Indian Railways, I-Sec research

The above average growth in upper class rail travel and convergence of fares between upper class rail fare and airline ticket prices underline the strong potential of the aviation sector in
India

16

Passenger-km (mn)
Total
Suburban
872
914
1,212
1,613
1,599
1,972
3,118
3,370
3,590
3,847
3,944
3,845
3,719
4.3
0.7

Upper
Class
3,790
3,454
4,394
5,140
8,712
26,315
49,468
55,182
62,203
72,148
82,624
89,117
101,215
9.4
10.2

Second
Class
Ordinary
43,639
40,190
52,886
75,620
89,300
119,267
244,079
254,045
278,547
282,456
281,990
288,561
279,514
5.8
0.1

Second
Class
Mail/Exp#
12,537
22,251
37,856
86,712
138,054
222,568
419,649
463,321
500,631
548,861
587,885
612,475
614,686
7.0
4.2

Total
Second
Class
56,176
62,441
90,742
162,332
227,354
341,835
663,728
717,366
779,178
831,317
869,875
901,036
894,200
6.6
2.8

Total
Suburban
59,966
65,895
95,136
167,472
236,066
368,150
713,196
772,548
841,381
903,465
952,499
990,153
995,415
6.9
3.4

Indian Railways is also capacity constrained, highly uneven and imbalanced. The broad gauge network, though forming 85.6% of the route, generated almost 98% of the passenger output (PKMs) and 99.9% of the freight output (NTKMs). Further, passenger trains utilise nearly 65% of network capacity but contribute less than 30% of total revenues. The Golden Quadrilateral and the diagonals connecting the four major metros, viz. Delhi, Kolkata, Chennai and Mumbai (along with the East-West diagonal extending to Guwahati), constitute less than 16% of the route, but account for more than 50% of the passenger and freight traffic. These routes have reached oversaturated levels of capacity utilisation and at present are strained to the breaking point. A line-capacity utilisation of 80% is considered optimum as smooth operation of trains requires some slack in the line-capacity to absorb and recover from unforeseen disruptions. ICICI Securities

Aviation sector, June 16, 2016

Chart 9: Railways are operating at very high capacity utilizations

Source: Ministry of Railways

Across zones, the availability of line capacity on high-density network routes and other important routes is strained with 492 out of total 1,219 sections, i.e.
40% of sections are running at 100% or above line capacity as of 2015.
Table 20: Line capacity utilisation on IR (2015)
Railway
< 80%
80-100%
100-120%
Central
34
9
11
East Coast
16
9
9
19
East Central
16
13
41
Eastern
22
22
7
North Central
11
3
12
North Eastern
12
6
4
North Frontier
18
10
29
Northern
70
26
6
North Western
39
7
23
South Central
20
32
14
South Eastern
24
13
9
South East Central
9
6
25
Southern
53
38
0
South Western
38
12
7
West Central
1
4
17
Western
32
18
233
Total
415
228
Source: Ministry of Railway, * One train only system

120-150%
12
16
22
1
22
6
14
23
3
8
17
7
15
0
6
21
193

> 150%
7
2
16
0
2
6
3
10
1
9
1
2
0
0
3
4
66

OTOS*
1
4
5
3
1
0
11
4
4
0
2
0
0
1
0
48
84

Total
74
56
91
89
46
42
60
162
60
92
71
33
131
51
21
140
1219

It would be seen that most of the Zonal Railways are in the range of optimal and higher-than-optimal utilisation of line capacity. Further, 161 out of the total of 247 sections, i.e. 65% of the sections, are running at 100% or above line capacity on highdensity network (HDN) routes.

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Aviation sector, June 16, 2016

Table 21: Line Capacity status of high density network on IR
Railway
Central
East Coast
East Central
Eastern
North Central
North Eastern
North Frontier
Northern
South Central
South Eastern
South East Central
Southern
West Central
Western
Total
Source: Ministry of Railways

< 80%
12
5
1
0
0
1
0
3
0
2
0
5
1
0
30

80-100%
4
0
5
3
1
3
3
4
14
2
0
8
0
9
56

100-120%
7
6
4
7
5
6
0
5
2
6
3
4
2
2
59

120-150%
12
8
3
0
19
1
5
7
2
6
5
0
2
9
79

> 150%
5
1
3
0
1
3
1
2
2
0
1
0
2
2
23

Total
40
20
16
10
26
14
9
21
20
16
9
17
7
22
247

Fare spread between rail and air travel has been converging
While the time advantage with air is a characteristic of air over rail journey, the price differential has sharply fallen over the years. While rail has increased fares of its upper classes and is also contemplating to increase cancellation charges and impose other tariffs, airfares have steadily declined following competition. The resultant dynamics has clearly favoured air travel in metro to metro routes and to some extent metro to non-metro routes. However, the railways still maintain edge in the non-metro to nonmetro routes.
Table 22: Fare comparison of rail and air
Origin - Destination
Mumbai- Delhi
Delhi- Mumbai
Mumbai- Nagpur
Nagpur- Mumbai

2AC
2865
2865
1880
1880

Tatkal- 2AC
3390
3390
2400
2400

3AC
2080
2080
1330
1330

Tatkal- 3AC
2500
2500
1705
1705

Train name
Mumbai Rajdhani
Mumbai Rajdhani
Nagpur Duronto
NGP CSTM Duronto

Journey time
15 hrs 35 mins
15 hours 50 mins
11 hrs 05 mins
11 hrs 15 mins

Chandigarh- Cochin

3645

2445

Kerala Sampark Kranthi

49 hrs 20 mins

Cochin- Chandigarh

3645

2445

Sampark Kranthi

50 hrs 55 mins

Source: IRCTC, Cleartrip, I-Sec research

18

Remarks

No other direct train
Available
only twice a week No other direct train
Available
only twice a week Lowest airfare
3500
3500
3000
2000

7500

5000

ICICI Securities

Aviation sector, June 16, 2016

Cost structure assumes obvious importance in a price based industry
Much of the difference in cost structure stems from the choice of fleet which over the period has given a clear edge to uniform fleet deriving economies in maintenance costs and favourable terms of rentals from bulk discounts. We have elaborated the same in greater details in our sector report.
Cost competitiveness is the be all and end all of a fiercely price based industry like aviation. IndiGo scores above all else in this regard.

Cost Comparison across competition-IndiGo has an edge
Lowest cost metrics among Indian airlines players offers a definitive advantage to IndiGo. We start at each major operating cost heads analysed over FY10-FY15, wherein we will see that IndiGo has the maximum advantage, which stems from the uniform, large and lowest-age fleet size, consolidated by the experienced management and the near-perfect implementation of the low-cost no-frills model.
Combining the operational costs, we present our summary in two divisions, operating cost ex-rentals, and total operating cost with rentals. The rental costs also include the interest liability of finance leases to give a complete picture. While calculating cost with rentals we have adjusted for the leasing revenue of Jet Airways. We have also not taken depreciation, which is normally included in CASK calculation for airlines. To give a perspective, the average CASK excluding depreciation and including interest during
FY10-FY16 for Indigo, SpiceJet and Jet was Rs3.06, Rs3.42 and Rs4.28.
Please refer to our IndiGo report for further deep dive analysis of the cost structures of respective airlines.

Chart 10: Total operating cost comparison without rentals Jet CASK ex rentals
Indigo CASK ex rentals

Chart 11: Total operating cost comparison with rentals Spicejet CASK ex rentals

Jet CASK with rentals
Indigo CASK with rentals
0.080

0.065

0.075

0.060

0.070

0.055

0.065

(US$)

0.085

0.070

(US$)

0.075

Spicejet CASK with rentals

0.050

0.060

0.045

0.055

0.040

0.050

0.035

0.045

0.030

0.040
FY10

FY11

FY12

Source: Company data, I-Sec research

FY13

FY14

FY15

FY10

FY11

FY12

FY13

FY14

FY15

Source: Company data, I-Sec research

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Aviation sector, June 16, 2016

Cost comparison across global airlines
Indian airlines have significantly lower cost than the west. This stems from the labour cost arbitrage along with the purest form of low cost business model adopted by them. This is one of the reasons why Asian airlines tend to trade at higher multiples than western peers.
Though, increased taxes erode the cost advantage of Indian airlines, which could otherwise have been even more competitive. The South East Asian countries have the lowest operating cost per ASK, while Indian airlines are efficient despite the higher tax burden through ATF imposed on them.
Chart 12: Operating cost ex rentals per ASK for select airlines
Southwest
Tiger

RyanAir
Air Asia

EasyJet
Cebu Pacific

Delta
Indigo

0.16
0.14
0.12
0.10
0.08
0.06
0.04
0.02
FY 2010
Source: I-sec research

20

FY 2011

FY 2012

FY 2013

FY 2014

FY 2015

Aviation sector, June 16, 2016

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Aircraft market –next-gens like neo provide safe haven We present counter theses to the general fear of a bubble in the aircraft market in the light of such a big order book. Yet, even in such a case, the next gens like neo/max are better placed. Globally, commercial jet backlogs are at a record high near 55% of the current fleet.
We try to assess how the value of A320neo can evolve over the next 15 years, considering that IndiGo has firm orders for 430 A320neos which will get delivered from now on to 2025. The value of these aircraft will likely have an important bearing on operators like IndiGo. We look at the aircraft market, how value of aircraft in the future is likely to be preserved even in the face of high orderbook. Secondly, we illustrate that even in a declining price environment; the next generation aircraft like neo and Max are likely to be safe harbours. Last, we illustrate how IndiGo is likely to significantly benefit from the big order A320neos compared to its competitors.
Is there a possibility of order bubble with the humungous aircraft orderbook size? It is a pertinent question considering a systemic order backlog of 12,000 aircraft valued at US$900bn, with the current backlog projected to feed only 35-40% of the demand over the next 20 years. We analyse some of the key indicators in the aircraft market, which indicate that there may have already been several measures taken to avoid such bubble.
Chart 13: Record-high commercial backlog at present

Source: Ascend



Longer delivery schedule: Aircraft dynamics have changed with time, which needs to be factored in estimating the supply-demand cycle. The current orderbook has a much delayed delivery horizon compared to earlier times. So, if
90% of the orderbook was supplied by the airframers in 5-10 years in 1991, the same is now stretched to 10-15 years. This protraction of order delivery schedule is an important deterrent to any bubble formation.

21

Aviation sector, June 16, 2016

ICICI Securities

Chart 14: Delivery horizons significantly longer today

Source: Ascend



Higher replacement rate: Over the past five years, 48% of deliveries have for replacements compared to 43% in the 1990s. This has been largely in line with the development of a wider lessor business and aircraft partout markets.

Chart 15: Over past 5-7 years, 48% of deliveries have been for replacement

Source: Ascend



22

Increased retirement indicates economic life is the key demand determinant
–not OEM production rate. Some elements of production surplus have lowered the economic life of aircraft from 30 to 25 years. There have been increased instances when aircraft have retired before 15 years in a number of cases in the past five years. This is a completely new phenomenon for the aircraft industry and points to the fact that economic life of an aircraft, which is now determined by supply-demand of that particular aircraft and other available options, is the key determinant of the demand cycle of the aircraft industry (and not the production rate of OEMs).

Aviation sector, June 16, 2016

ICICI Securities

Chart 16: Some elements of production ‘surplus’ have increased retirements at reduced age

Source: Ascend

Chart 17: Lessors have been retiring aircraft earlier

Source: Ascend



Regional risks differ; higher propensity of shifting to LCCs. Backlogs as a percentage of current fleet is highest in Middle East (90%) and Asia-Pacific (50%).
Traffic growth in Asia-Pacific is also expected to be lower than this supply growth in the region. While one may point to increasing oversupply risk in Asia in the coming years, at least more than any other region, a large portion of that is driven by almost five times the current respective fleet size orders from AirAsia and Lion
Air. The implied growth rate for these LCCs in Asia is almost 25%. However, one must understand that this can also indicate shift in market share towards LCCs from FSCs and retirement of legacy aircraft. Similar LCCs like Ryanair and easyJet have managed to maintain growth rates of 15% in the past for considerable periods of time with increasing dominance of the LCC model.



Upside to aircraft obsolescence from growing partout market. There are even instances of 10-15 years old aircraft being parted out to supply to an important segment of Use Serviceable Material (USM), which reduces maintenance costs.
To some extent, perceptions have lagged reality in this area with all aircraft being considered for parting out these days including likes of 2nd generation A320s,
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Aviation sector, June 16, 2016

A330s and B737s. The increased parting out has been driven from a number of reasons starting from the owner’s financial condition or economically higher value as USMs, or the exceptionally high-value premium for first movers in the partout market. However, as cycles will have it, this burgeoning partout business will eventually slow down as aircraft become worth more as a flying asset as the partout market heats up. After the first movers start supplying the various parts, subsequent partout deliveries fall sharply in value. With growing stockpiles, the risk of excess supply will eventually turn the tide to a longer life. The highest-value components for the airframe consist of the landing gears, API and avionics.

Why A320neo is one of the most popular aircraft and offers safe value to IndiGo
We discuss the value proposition of A320neo, which is the aircraft of choice for IndiGo in times ahead. The importance of the market for A320neo lies in the asset play which
IndiGo offers through its bulk orders. We believe that A320neo is one of the most popular aircraft and offers safe value to IndiGo. IndiGo has clearly gained a structural advantage with the high orderbook of 430 neos. We believe the next generation aircraft like neo and Max are going to rule the aircraft market in coming future.


Dominance of neo/Max in orderbook. As much as 60% of the backlog is dominated by next-generation aircraft like neo and Max, with neo having a significant larger orderbook than Max. In value terms, the share of next-generation aircraft is even larger at around 70%. As such, neo is likely to be one of the most liquid aircraft in the near future. However, transition to the next-gens can still be accompanied with a lot of issues as history has shown us. Yet, one has to keep in mind that the A320 ceo and neo are likely to retain similar fuselage.

Chart 18: Next-generation aircraft dominating the backlog

New generation
($275 bn)
7444
60%

Source: Ascend

24

Current generation ($590 bn)
4918
40%

Aviation sector, June 16, 2016

ICICI Securities

Chart 19: Transitioning to next-generation aircraft; orderbook details

Source : Ascend



No available slots for fresh orders of neo/Max available for the next five years. There will be a couple of years through which the manufacturing lines of
Boeing and Airbus completely transform to the next-gen airframes. Post that, there is no free single aisle open slots available for five years indicating that an airline which has not yet ordered is likely to resort to lessors for neo/Max. Higher demand will generate higher value.

Chart 20: Single-aisle demand largely committed over next five years

Source: Ascend



Burgeoning lessor market now almost 40% of current fleet size. Higher lessor market results in higher value for lessor-friendly aircraft and the A320neo has the right parameters for the same.



Single Aisle next gen aircraft have more lessor penetration. Lessors prefer single aisle narrow body aircraft as they offer lower risk with their inherent lower value and they gain higher share among the LCC markets. Around 50% of the single aisle fleet is being managed by operating lessors compared to 30% for that of twin aisle aircraft. Secondly, higher number of operators increases liquidity and lessor acceptance, thus pushing up the aircraft value. A320neo has the highest orderbook. 25

Aviation sector, June 16, 2016

ICICI Securities

Chart 21: Aircraft leasing penetration by class

Source: Ascend

There are certain risks though; including supply chain challenges post the transition to next-generation aircraft, significant decline in oil prices which render the increased rentals of next generations futile compared to the benefits from fuel efficiency and increase in interest rates which typically favour mid-life aircraft with lower value more attractive.

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Aviation sector, June 16, 2016

Ancillary revenues remain a growth lever
Globally ancillary revenues have a higher share

Chart 22: Top airlines with regards to percentage share of ancillary revenue
2013
2014

Ancillary revenue %

40.0
35.0
30.0
25.0
20.0

Volaris

AirAsia X

Flybe

Jetstar

Cebu Pacific

Tigerair

Ryanair

Jet2.com

Allegiant

Wizz Air

15.0

Spirit

Compared to 20% plus share of ancillary revenues,
Indian players currently gather only
12-14% of total turnover as ancillary revenues. Ancillary revenues are no longer a forte of LCCs. Everybody is benefitting from increasing ancillary revenues – LCCs to FSCs, Americas, Europe as well as AsiaPacific. Every airline is trying to boost its ancillary revenues in varying degrees.
However, it is the LCCs which have managed to best increase the share of ancillary revenues as a percentage of the topline. To some extent, the sustainability of this revenue stream is further enriched by usage of the valuable data generated from every customer transaction. Additionally, an increasing number of airlines has started disclosing the detailed breakup of ancillary revenues, highlighting the prominence of this revenue stream. We highlight below, the top airlines with regards to percentage share of ancillary revenues in their topline. LCCs have increasingly come to the forefront and openly talked about aiming to shore up the percentage share of ancillary revenues by providing lower fares and charging for everything else.

Source: IdeaWorks, I-Sec research

We highlight that there are various streams within ancillary revenues, from co-branded credit card fees to seat allocation fees to baggage and advertisements. The distribution of the various streams differs among various airlines. For example, while
Ryanair has ancillary revenues spread across various sources, Qantas has a large share generated from sale of miles or points to banks that issue co-branded credit cards. Table 23: Ancillary revenue profile of Ryanair
(mn Euros)
Non-flight Scheduled
In-flight Sales.
Internet-related
Ancillary Revenues
Scheduled Revenues
Total Revenues
% Ancillary Revenue
Source: I-Sec research

2010
494
87
84
664
2,325
2,988
22.2

2011
603
102
96
802
2,828
3,630
22.1

2012
677
107
102
886
3,439
4,325
20.5

2013
833
110
122
1,064
3,820
4,884
21.8

2014
1,012
117
118
1,247
3,790
5,037
24.8

2015
1,164
128
101
1,394
4,260
5,654
24.6

The key constituents of Ryanair’s ancillary revenues include excess baggage, travel insurance, accommodation services, car hire, bus tickets, car parking, SMS services,

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ICICI Securities

Aviation sector, June 16, 2016

advertising on boarding pass, extra legroom seats, full seat allocation, priority boarding and products sold on websites.
Table 24: Ancillary revenues for Cebu Pacific has been consistently above 20%
Cebu Pacific has many similarities with
Indian operators. Not only is it an LCC, it is an Asian airline with fleet size nearly like
SpiceJet.

(Philippine Peso)
Passenger revenue
Cargo
Ancillary
Excess baggage fee
Rebooking, refunds, cancellation fees
Others
Total
% Ancillary revenue
Source: I-Sec Research

2012
29,579,485,272
2,380,938,624
5,944,029,727
2,837,630,241
2,006,490,604
1,099,908,882
37,904,453,623
22.0

2013
31,662,949,847
2,609,444,919
6,731,701,515
3,106,766,079
2,391,871,202
1,233,064,234
41,004,096,281
22.8

2014
40,188,445,623
3,146,083,310
8,665,489,377
4,116,640,154
2,920,343,253
1,628,505,970
52,000,018,310
22.7

Chart 23: Ancillary revenue distribution at easyJet
Cargo revenues are not a part of ancillary revenues for global airlines as alongside for easyJet. Yet, for
IndiGo and other
Indian airlines, absence of dedicated cargo carriers has resulted in windfall revenue opportunities.
Cargo contributes around 5-6% of the total revenues of
IndiGo and 42% of the total ancillary revenue. Credit Card Payment fees

7%
20%

7%

EasyJet Plus Membership
8%
Assigned seating

8%
Checked Bags
Buy on board hotel and car rental

50%

A la carte component of bundled fares Source: IdeaWorks, * Annual subscriptions called easyJet Plus include assigned seating, fast track security, speedy boarding, and an additional carry-on bag for an annual price(~GBP170-200)

Ancillarisation of passenger revenues, bundling and unbundling
High ancillary revenues of global airlines have some components which are currently free of cost and within the ticket prices for Indian airlines. For example, checked bags constitute 50% of the ancillary revenue of easyJet. Indian airlines have till now not charged for checked baggages upto 15kgs on domestic routes. However, recently
SpiceJet started additional Rs200 off for passengers with no checked baggages. Such unbundling has two effect:




28

Lower base fare and higher ancillary revenue: Airlines will have a new low as far as base fare is concerned. With Rs200 off on SpiceJet for passengers with no checked baggages, the erstwhile light traveller, non-committal to any specific airline, would prefer to travel SpiceJet, and other competitors will follow suit. This will lower the effective base fares and eventually shift some of the revenues from the passenger to ancillary category.
The net benefit/loss will depend on loss due to unbundling and gain due to a-la-carte charges along with their respective volumes. So, is it a Rs200 off that the airline suffers or a Rs200 additional charge that the airline receives from checked baggages? The answer lies somewhere in the middle.

Aviation sector, June 16, 2016

Bundling of fares include sources of ancillary revenues like assigned seating, fast-track security, speedy boarding, annual membership card, hotel and car rental partnerships, etc. This will depend on the traveller’s association with the airline and the airline’s performance on parameters like flight punctuality, cleanliness, dependability and the brand image. IndiGo would typically rank high among Indian passengers in this regard. ICICI Securities

Bundled fares offer upside potential to ancillary revenues for IndiGo/SpiceJet.
Bundled fares are like an optional value proposition which can be taken to advantage by both LCCs as well as
FSCs. While LCCs may offer increasing bundled services to attract premium customers from FSCs, unbundling of some of the services help FSCs to attract some value customers from
LCCs. Yet, the revenue is a bonus for
LCCs compared to FSCs, since FSCs were anyways supposed to provide value-added services. However, brand loyalty and perceived value among
LCCs will define the ability of the LCC to do so. IndiGo is in a sweet spot in this case as the dominant LCC in the Indian domestic market. Does that implicate a higher brand value for IndiGo? Sure it does. However, there have been anomalies in this regard too. Southwest, despite being a LCC pioneer, never charged for up to two checked baggage until recently. It helped develop a brand for Southwest, which was bordering on passenger friendliness yet at low cost.
Co-branded promotions underline the brand value of IndiGo. Yet, till now, IndiGo has not resorted to any such schemes and maintained its low-cost focus and channelises all savings to lower airfares in a sustainable way. However, it has started using its brand for co-promotions as seen below.
In another example, American Express tied up with IndiGo Airlines and the Taj
Group as anchor partners to offer card members travel and lodging rewards and benefits. Some of the key highlights of the travel credit card include up to two complimentary return flights aboard
IndiGo for simply spending as low as
Rs190,000 in a year; up to four complimentary return flights aboard
IndiGo and up to two room nights stay at the luxurious Taj Group, on spending
Rs400,000 in a year. Our channel checks indicate that this card has done well for American Express. The unique advantage of these co-promotions is that they carry very little cost compared to a card program like that of Jet Airways with its own currency (JP Miles). Since these are not aimed to create loyalty, IndiGo would bear very little cost. However, selection of IndiGo by trade partners underlines how the
IndiGo brand is very easily acceptable to consumers.

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Aviation sector, June 16, 2016

Risk in an airline business




Higher crude prices which roughly contribute ~40% of the total costs.



Depreciation of rupee pose biggest upside risks to cost: To give a sense,
60-67% of the total costs are in dollars for airlines taking into account cost overheads of crude, maintenance and rentals. As such, depreciation of rupee has a direct bearing on the costs. The lowest cost structure will again be the critical parameter here considering that typically sensitivities would be highest for the lowest margin player. Large movements in exchange rates impact airlines through three main channels; consumer decisions (demand), airline decisions (supply) and financial impacts. Of these, the consumer (demand) response to a significant move in relative prices can be swift and may prompt a response from airlines, including adjustments to capacity (supply). The financial impact can be especially acute for airlines when it relates to sizeable changes in the value of the US dollar because a large proportion of airline costs (including fuel) are denominated in US dollars, and carriers need to convert domestic currency into dollars each year to meet their obligations giving rise to FX risk.



30

Economic growth measured by GDP is the single biggest factor which drive air traffic demand: We did an exercise on US airlines to understand the various influential forces in the aviation sector. US airlines do offer a long documented history, a matured industry and can be used to draw important inferences for the Indian airlines as well. We gathered the data for the top
1,000 domestic city pair markets of the US for the last 80 quarters, i.e. since
1996 including ASM, RPM, passenger, miles, PLF –and map it with the average fares, GDP growth and fuel prices. We find that the correlation between GDP growth rate and passenger growth rate to be 0.7. The last two decades in the airline industry have been characterized by two big events, that of 9/11 in 2001 and the 2009 financial crisis. Accordingly, we see big drop in passenger growth in these two time periods. The ASM in top 1,000 city pair markets has grown by 43% in the past two decades, an annual growth rate of
2%. (Refer Chart31- Annexure)

Adverse regulations: Fresh concerns have risen regarding possible clampdown in ancillary revenue sources for airlines post the draft changes in regulations limiting the excess baggage charges for luggage up to 20kgs. Yet, this is not material enough and the concern of the street is overdone. This will only result in minor change in ancillary revenue considering overweight above
20kgs has not been changed. Excess baggage roughly contribute less than
1% of the revenue. The proposed regulatory changes has been more to make airlines increasingly accountable and disciplined with penalties in the case of boarding denials, flight cancellations and transparent refund in case of cancellations. Aviation sector, June 16, 2016

ICICI Securities

The New Aviation Policy aimed to boost the sector
Cabinet cleared the new policy on 15th June, 2016. The essentials have remained the same as that envisaged in the draft policy released in Oct’15 with one major change of scrapping the 5/20 policy to a 0/20 policy. Despite being a positive for
Air Asia and Vistara in the international routes, the requirement of 20 aircraft will prevent any immediate increase in traffic. Air Asia and Vistara currently has 6 and 11 aircraft respectively.
Essentially, a long term plan, the policy aims to boost regional connectivity through
Government support and industry levy but will not have any short term impact.
However, regional scheme will open up more routes for the airlines with regional aircraft like SpiceJet, Air India and Jet who already have such fleet of aircraft.
Economics of viability remain to be tested. The biggest beneficiary of this policy will be the MRO industry which has been given a slew of incentives along with the commercial aero related manufacturing. An efficient domestic MRO industry has the potential of structurally reducing the cost of the domestic airlines, but again it is a long shot from here.
Increase in airports and development of
MRO sector can significantly boost the sector from a long term view.

Key targets highlighted in the report


The policy aims at making India the 3rd largest civil aviation market by 2022 from current position of 9th.



The domestic ticketing is expected to grow from 80mn in 2015 to 300mn in 2022.
Indian domestic and international passenger traffic was 80.7mn and 18.4mn respectively in 2015.



Airports having scheduled commercial flights are aimed to increase from 77 in
2016 to 127 by 2019.



Cargo volumes to increase by 4 times to 10 million tonnes by 2027



Taking flying to masses – Enabling Indians to fly at Rs. 2,500 per hour under
Regional Connectivity Scheme at unserved airports.



Requirement of 5 years of domestic flying for starting international operations removed •

Flexible and liberalized ‘open skies’ and ‘code share’ agreements



Incentives to MRO sector to develop as hub for South Asia.



Ensuring availability of quality certified 3,30,000 skilled personnel by 2025



Development of green-field airports and heliports



Enhancing ease of doing business through deregulation, simplified procedures and e-governance



Promoting ‘Make In India’ in Civil Aviation Sector

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Aviation sector, June 16, 2016

The Regional Connectivity Scheme (RCS)


These steps were mentioned in the detailed draft policy

MoCA will target an all-inclusive airfare not exceeding Rs2,500 per passenger, indexed to inflation for a one-hour flight on RCS routes. (Rs1,200 for 30 minute flight)



This will be implemented by way of:





Revival of un-served or under-served aerodromes and airstrips. Currently around 75 out of 476 airstrips/airports have scheduled operations. Revival of air strips, depending on demand, as no-frills airports will be done at a cost not exceeding Rs500mn, mostly through AAI. Requirement of 12% project
IRR will be relaxed for revival of these airports, wherever the airport is under
AAI control.
Concessions by different stakeholders.
Viability Gap Funding (VGF) for scheduled commuter airlines (SCAs).



RCS will be only in states which reduce VAT on ATF at airports to 1% or less.



State governments will provide free land and multi-modal hinterland connectivity.



For 10 years from the date of commencement of flight operations under RCS:







There will be no airport charges levied on SCAs for operations under RCS.
Service tax on tickets under RCS will be exempted.
State governments will provide police and fire services free of cost. Power, water and other utilities will be provided at substantially concessional rates.
ATF drawn by SCAs from RCS airports shall be exempt from excise duty.

Viability Gap Funding (VGF) will be funded by a small levy per departure on all domestic routes other than Cat II/ Cat IIA routes, RCS routes and small aircraft at a rate as decided by the Ministry from time to time. A detailed scheme will be put up in the Public domain for stakeholders’ consultations.

5/20 rule converted to a 0/20 rule
The requirement of 20 aircraft will essentially mean some time before players like
Vistara and Air Asia can start flying abroad. Currently, Air
Asia and Vistara have
6 and 11 aircraft respectively The 5/20 rule for commencement of international flight in operation since 2004 is replaced by a formulation which provides a level playing field and allows airlines, both new and old, to commence international operations provided they continue to meet some obligation for domestic operation. All airlines can commence international operations provided they deploy 20 aircraft or 20% of total capacity (in term of average number of seats on all departures put together); whichever is higher, for domestic operations. Maintenance, Repair and Overhaul (MRO) to be boosted
The MRO business of Indian carriers alone is around Rs50bn, 90% of which is currently spent outside India – in Sri Lanka, Singapore, Malaysia, UAE, etc. The government is keen to develop India as an MRO hub in Asia, attracting business from foreign airlines. MRO, ground handling, cargo and ATF at the airport would also be accorded the benefits of the 'infrastructure' sector along with a host of tax exemptions.
The tax regime has been a key dampener for MRO activity in India. Abolition of these taxes may now encourage Indian airlines to get MRO work done domestically and save some costs. The MRO industry also can grow significantly with the large number of additions expected to the Indian fleets. The incentives proposed include:

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Aviation sector, June 16, 2016

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MoCA will persuade State Governments to make VAT zero-rated on MRO activities •

Provision for adequate land for MRO service providers will be made in all future airport/heliport projects where potential for such MRO services exists.



Airport royalty and additional charges will not be levied on MRO service providers for a period of five years from the date of approval of the policy.

Bilateral Traffic Rights to get incrementally liberalised
India has Air Service Agreements (ASA) with 109 countries covering aspects relating to the number of flights, seats, landing points and code-share. The government will enter into an ‘Open Sky’ ASA on reciprocal basis with SAARC countries and countries with territory located entirely beyond a 5,000km radius from New Delhi. The government plans to liberalise the regime of bilateral rights leading to greater ease of doing business and wider choice to passengers. A method will be recommended by a
Committee headed by the Cabinet Secretary for the allotment of additional capacity entitlements wherever designated Indian carriers have not utilised 80% of their bilateral rights but the foreign airlines/countries have utilised their part and are pressing for increase in the capacity.
Open sky beyond 5,000km radius is likely to offer limited addition to current supply, which is fully representative of bilateral demand. Open Sky policy, by principle, would increase competition for International travel, but recent calibrated moves ensure that no major disruption is likely, particularly with Air India as one of the biggest stakeholders with a sizeable fleet of wide body aircraft.

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Route Dispersal Guidelines (RDG) remains incumbent upon airlines. Capacity actually deployed on Cat-II and III routes is in excess of the RDG threshold, highlighting the business potential in these regions. The following actions will be taken to rationalise the RDG scheme:


Category-I routes will be made more transparent. The criteria proposed for a Cat-I route is a flying distance of 700km, average seat factor of 70% and annual traffic of 500,000 passengers based on information available with DGCA. MoCA will endeavor that the rationalization of Cat-I routes does not cause undue financial and operational burden on airlines.



The traffic to be deployed on Cat II and IIA expressed in terms of a percentage of
CAT I traffic remains the same. The percentage for CAT III will be reduced in view of the Regional Connectivity Scheme coming into operation. Uttarakhand and
Himachal Pradesh have been included as part of category II routes.

Mumbai-Bangalore
Mumbai-Calcutta
Mumbai-Delhi
Mumbai-Hyderabad
Mumbai-Chennai
Mumbai-Trivandrum

Category-I routes
Calcutta-Delhi
Calcutta-Bangalore
Calcutta-Chennai
Delhi-Bangalore
Delhi-Hyderabad
Delhi-Chennai
Category-II routes

Routes connecting stations in the North-East, Jammu & Kashmir, Andaman & Nicobar, and Lakshadweep.
Himachal Pradesh and Uttarakhand have been added in this category.
Category-III routes
Routes other than those in Category-I and Category-II

Current Route dispersal guidelines: Any airline that operates schedule air transport service on one or more of the routes under Category-I, shall be required to provide such services in Categories-II&III as indicated below:


The operator will deploy on routes in Category-II at least 10% of the capacity it deploys on routes in Category-I, and



Out of the capacity thus required to be deployed on Category-II routes, at least
10% would be deployed on service or segments thereof operated exclusively within the North-Eastern region, Jammu & Kashmir, Andaman & Nicobar, and
Lakshadweep.



The operator had to deploy on routes in Category-III, at least 50% of the capacity it deploys on routes in Category-I. This will be reduced as discussed above.

However, a service operated on a Category-I route as a part of international air service will not be reckoned for the above purpose. Capacity deployed will be reckoned in
Available Seat Kilometres (ASKM).

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Aviation sector, June 16, 2016

New airlines will find it tough to gain ground from competition Case study – AirAsia
AirAsia India has remained a weak player. Comparing IndiGo and AirAsia India based on operations in the formative months would suggest a clear demarcation between AirAsia and IndiGo. IndiGo started its operations in Aug’06 and AirAsia in
Jun’14. If we compare the market shares of IndiGo and AirAsia from month-8 onwards, i.e. Jan’15 for AirAsia and Mar’07 for IndiGo, results will indicate that AirAsia has not been able to gain any ground in the Indian market. So, in the 20th month of operations, IndiGo had a market share of 10-11% compared to 2-3% of AirAsia. To some extent, such a trajectory is also a result of the undercapitalised nature of Indian businesses. AirAsia invested only US$30mn of initial capital for its Indian business compared to a minimum requirement of US$100mn. This is much lower than the initial promoter equity of US$100mn. Jet Airways had invested Rs600mn in 1993, equivalent to Rs1.75bn in today’s terms. For the sake of financials, AirAsia tripled its losses in the
Sep’15 quarter to Rs650mn and turned into a negative net-worth company.
IndiGo has clearly been more successful in its formative months compared to AirAsia.
Chart 24: RPK and PLF trajectory of AirAsia

RPK('000)

250,000

Chart 25: Market share comparison between
AirAsia and IndiGo in formative stages

PLF(%), RHS

Indigo Market Share(%)

90
85

200,000

Air Asia Market Share(%)

12
10

80
8

150,000
75

6

70

4

100,000
50,000

65

0

60

2

Source: DGCA, I-Sec research

Month 20

Month 19

Month 18

Month 17

Month 16

Month 15

Month 14

Month 13

Month 12

Month 11

Month 10

Month 9

Month 8

Jan'16

Dec'15

Nov'15

Oct'15

Sep'15

Aug'15

Jul'15

Jun'15

Apr'15

May'15

Mar'15

Feb'15

Jan'15

0

Source: DGCA, I-Sec research

AirAsia would require deleveraging and consolidation in core markets. Much of the relief from lower crude prices is likely to be diverted by AirAsia to deleverage itself and infuse better health to its associates. The Indonesian associates had been warned once during Jul’15 regarding possible negative net worth post which there was a broad plan for revival. In H1CY15, all the associates except AirAsia Malaysia and Thai
AirAsia were making losses. The company has a total of eight flying associate businesses. In such a scenario, it will depend upon the jurisprudence of the management to invest heavily in an already competitive Indian domestic market. The pressure from AirAsia to relax the 5/20 rule is indicative of the bias to use AirAsia India more like a feeder to the South East Asia hubs of AirAsia.

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Aviation sector, June 16, 2016
Table 25: AirAsia has high leverage, worse in associates
MYR mn
Net debt
Net Debt/Equity
Net Debt/EBITDA
Capital Expenditures
Revenue
Net Income
Source: Bloomberg

FY13
8,976.4
179
6.08
-2,269.9
5,111.8
362.1

FY14
11,959.6
263
7.88
-2,084.6
5,415.7
82.8

FY15
10,185.5
229
4.45
-272.7
6,299.1
540.9

FY16E
9,942.2

FY17E
9,520.4

5.15
-1,185.4
5,959.4
746.0

4.75
-1,342.1
6,357.7
826.6

AirAsia has significant diversified ventures. Tune Group, the holding company of
AirAsia, has invested in a multitude of related as well as unrelated industries. Its website indicates ventures into diversified businesses including hotels, prepaid mobile services, financial products, insurance, audio production services, education, racing car, football club, venture capital, etc.


Racing Car: The racing car business – Catherine group – was sold to Swiss company Engavest. Engavest undertook to pay all of the existing and future creditors, including the staff. The reason for sale was cited to be requirement of finance and increasing alignment of Mr. Tony Fernandes with the interests of his football club QPR. However, the process failed as Engavest did not comply with some pending payments.



Football team: The football venture, with owning of the club Queen Park
Rangers, has also not been without trouble. The team got relegated from Premier
League in 2013 and has had financial worries, with massive reduction in highbudget players, delayed wage payments and possible fines on account of breaching the financial fairplay rules. To give a context, financial fairplay indicts clubs that have not paid their dues.



Hotel: The Tune Group of Hotels has also lost its major partner, Red Planet
Hotels, which owned and operated several hotels under the Tune Hotel brand. The company recently sold one of its hotels in Melbourne while investing in new properties in Kenya.

AirAsia India has its own set of issues to be resolved. Amidst news of deep conflicts within the boardroom, there have been high profile management exits, claims of effective control by AirAsia parent group, and discord between shareholders. The
Federation of Indian Airlines (FIA), a lobbying body of five local carriers, is again up in arms against AirAsia India, raising questions over the airline's control following a management exodus. There have been charges regarding transactions between the airline and the maintenance and insurance companies controlled by the parent. Similar allegations were mentioned in one of the market reports in Jul’15 causing a precipitous fall in AirAsia’s share price.
Principles of Substantial Ownership and Effective Control (SOEC) The Federation of Indian Airlines (FIA), which represents leading domestic airlines –IndiGo, Jet
Airways, JetLite, SpiceJet and GoAir – has raised concerns over principles SOEC being flouted by foreign partners of ‘Indian airlines’, referring to AirAsia and Vistara, which as per them have been permitted to operate despite being effectively controlled by their foreign parent. The FIA feels that even though India is following the principles of SOEC by allowing 49% ownership by foreign airlines in Indian airlines, it has not clearly defined ‘effective control’ or properly ‘enforced’ it.

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Aviation sector, June 16, 2016

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Case study – Vistara
It has been tough going for Vistara till date. The joint-venture domestic airline between Tata Sons (51%) and Singapore Airlines (49%), started its operations in
Jan’15. It currently has nine aircraft in its fleet (A320) and expects to add four more in
2016. The company plans to grow the total fleet to 20 jets by the end of 2018. It currently flies to 12 destinations in India and is likely to expand both routes and frequency of flights. Mr. Bhaskar Bhat, also the Managing Director of Tata Groupcontrolled Titan, took over as chairman of Tata SIA Airlines, succeeding Mr. Prasad
Menon who retired in Jan’16.
Premium service policy has not worked thus far. Vistara will reduce premium seats in a cabin reconfiguration. The operations with business-class seats did not take off as hoped. It is not easy for any new airline with the policy of route dispersal guidelines, which binds it to fly some non-profitable routes. The company is planning to open passenger lounges at airports in 2016. Vistara will introduce on board wireless entertainment for domestic travellers to differentiate from other airlines. The company currently has a staff-strength of 900, which will increase with fleet additions.
With seven out of 10 domestic travellers flying in low-cost airlines, a three-class configuration – 16 business seats, 36 premium economy and 96 economy seats – may not have been the best choice for Vistara to start with.
Vistara trying to harness cost-cutting measures In a mid-year profitability review report released in Oct’15, the Tatas estimated that the combined losses for the two start-up carriers – Vistara and budget carrier AirAsia India – would hit up to
US$90mn. Aggressive cost-cutting is something usually associated with budget airlines but full-service carrier Vistara has adopted the same strategy wherever possible, such as in backend operations.
Singapore Airlines (SIA) has a strategic interest in Vistara. A presence in India – a key source market for Emirates, Qatar Airways and Etihad Airways – could prove an effective long-term strategy for SIA in terms of extending its network into Europe and the US, where the Middle Eastern carriers are expanding aggressively. Once Vistara gets its external wings, there will also be opportunities to work closely with SIA – for example, on code-share flights.

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Annexure
Fleet details of key Indian players
IndiGo has made characteristic big orders till date


The company placed firm order with Airbus for 100 A320 aircraft in Jun’05, all of which were delivered by early Nov’14, about two years ahead of the initially scheduled final delivery date.



The company placed firm orders with Airbus for 180 A320neo aircraft in Jun’11.



The company placed purchase orders with Airbus for 250 A320 Neo aircraft in
Aug’15. Deliveries on the orders are expected to start from 2018 subject to changes by Airbus.



Currently, all of the aircraft carry the V-2527-A5 variant of the V2500 SelectOne engine manufactured by IAE, and, upon delivery, all of the A320neo aircraft in
2011 order will utilize Pratt & Whitney engines. However, the company is yet to select the engines for the A320 Neo order of 2015. The seating configuration is optimized at 180, all in the economy class.

A320neo delivery schedule is back on track; targets 136 fleet strength by FY17
Delay in aircraft delivery addressed as of now. Delay in aircraft delivery can happen for a variety of reasons. In the recent case of A320neo, the cause of delay was the extra time required for cooling of the Pratt & Whitney Geared Turbofan engine under some circumstances. When Qatar Airways held itself back on accepting delivery of the first A320neo, Lufthansa stepped up to become the first airline to receive the same. While some teething problems will get resolved in time, Airbus has confirmed that the technical glitch will be addressed by H1FY16 and the very fact that a delivery has already been made is very much assuring.

Jet Airways fleet details
The company has a total fleet size of 116 aircraft of which 24 are owned and the rest are on operating lease.


Jet fleet has a total of 86 narrow body aircraft (68-B737 and 18-ATRs).



Jet’s total wide body fleet comprises 22 aircraft – split between 10 B777s and 12
A330s.



Jet Lite has a total of eight narrow body B737s

The company has given 10 aircraft on lease. Two Airbus A330-200s aircraft have been sub (dry) leased to Etihad Airways PJSC and three Airbus A330-200 aircraft have been sub (dry) leased to Turkish Airlines. Five Boeing 777-300ER aircraft have been sub (dry) leased to Etihad. The Turkish Airline sub-lease is long-term in nature – till 2020. One A330 given to Etihad is also long-term in nature (till 2020) while 777 leases are nearing expiry.

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SpiceJet fleet details
SpiceJet connects its network with fleet of 22 Boeing 737NG, 7 aircraft on wet lease
(A319, 320 and 737), along with 14 Bombardier Q-400s. The Airbus 320s have been taken on wet lease from Czech company CSA to be deployed on metro routes. Five
Boeing 737NGs are also on wet lease. The Bombardier Q400 was acquired under finance lease through an ECB from Export Development Canada. However, in view of overdue payments of interest and repayment of principal of ECB to the lender,
SpiceJet entered into an agreement with the lender for the forbearance of defaults and the discharge of overdue amounts of principal and interest aggregating Rs898mn through 12 equal monthly payments from Apr’15. As of FY15-end, the total amount under this ECB was Rs13.4bn.

GoAir fleet details
GoAir currently has 19 A320 ceo and 1 A320 neo which came from the 72 A320neo aircraft ordered. It took the delivery of its first neo (20th) after a significant delay.

Air India fleet details
Table 26: Fleet details of Air India as per its website
Aircraft type
Owned
Operational Fleet
Wide Body
B777-200LR
3
B777-300ER
12
B747-400
3
B787-800
9
Wide Body Total
27
Narrow Body
A319
19 (9+10*)
A320 (Twin Class)
4
A320 (Classic)
7
A321
20 (8+12*)
Narrow Body Total
50
Regional Aircraft
CRJ-700
0
ATR42
0
ATR72
0
Regional Aircraft Total
0
Total Fleet
77
Source: Company Data, * on finance lease

Sale & Lease Back

Dry Lease

Total

0
0
2
12
14

0
0
0
0
0

3
12
5
21
41

0
0
8
0
8

3
5
0
0
8

22
9
15
20
66

0
0
0
0
22

3
3
5
11
19

3
3
5
11
118

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ICICI Securities

Aviation sector, June 16, 2016
Table 27: Fleet projection for Indian Airlines
FY15
Carrier
AirAsia
Pegasus
TrueJet

Type
A320
Total
ATR72-500
Total
ATR72-500

Total
A320
Total
Air India
B747-400
B777-200LR
B787
B777-300ER
A320
A319
A321
A330
Total
AI Express B737-800
Total
Air Allied
ATR42-320
CRJ700
Total
Jet Airways B737-900
B737-900ER
B737-700
Vistara

JetLite

SpiceJet

Blue Dart
GoAir
IndiGo
Air Costa

B737-800/MAX
B777-300ER
A330-200/300
ATR72-500/600
Total
B737-700
B737-900ER
B737-800
Total
B737-800
B737-900ER
A319
DHC-8402
Total
B737-200
B757-200
Total
A320
Total
A320-200
Total
ERJ-170-100LR
ERJ190-100STD
ERJ190-E2
ERJ-195E2
Total

Total
Domestic
International
Source: I-Sec research

40

FY16

FY17

FY18

FY19

Fleet
4
4
2
2
2

Seat
180
720
66
132
66

Fleet
6
6
2
2
5

Seat
180
1,080
66
132
66

Fleet
8
8
3
3
5

Seat
180
1,440
66
198
66

Fleet
8
8
4
4
6

Seat
180
1,440
66
264
66

2
3
3
3
8
13
12
24
22
20
2
104
21
21
4
4
8
4

132
148
444
423
238
256
336
140/168/150
144/122
182
279
21,377
186
3,906
48
70
472
166

3

134

5
9
9
4
3
21
12
26
22
20
108
17
17
9
3
12
2
4
8

330
148
1,332
423
238
256
342
140/168/150
144/122
184
279
22,522
186
3,162
48
70
642
168
168
168

5
9
9
5
3
21
12
29
18
20
108
17
17
10
4
14
2
4
8

330
148
1,332
423
238
256
342
140/168/150
144/122
184
279
22,878
186
3,162
48
70
760
168
168
168

6
10
10
5
3
21
12
33
20
20
114
17
17
11
5
16
2
4
8

396
148
1,480
423
238
256
342
140/168/150
144/122
184
279
23,764
186
3,162
48
70
878
168
168
168

59
4
7
18
95
3
1
5
9
12
4

168
329
247
65
15,186
134
202
170
1,454
189
212

14
30

78
4,208

55
4
8
18
99
3
1
4
8
22
4
1
15
42

168
329
247
72
16,176
168
168
168
1,344
189
212
150
78
6,326

55
6
9
18
102
3
1
4
8
25
4
6
13
48

168
329
247
72
17,081
168
168
168
1,344
189
212
150
78
7,487

55
6
9
18
102
3
1
4
8
30
4
14
13
61

168
329
247
72
17,081
168
168
168
1,344
189
212
150
78
9,632

7

8

9

10

Fleet
10
10
5
5
7

FY20
Seat
180
1,800
66
330
66

Fleet
12
12
6
6
8

Seat
180
2,160
66
396
66

7
462
12
148
12
1,776
5
423
3
238
21
256
12
342
35 140/168/150
20
144/122
20
184
279
116
24,074
18
186
18
3,348
12
48
6
70
18
996
2
168
4
168
8
168

8
528
15
148
15
2,220
5
423
3
238
21
256
12
342
38 140/168/150
20
144/122
20
184
279
119
24,539
20
186
20
3,720
13
48
7
70
20
1,114
2
168
4
168
8
168

76
4
11
18
123
3
1
4
8
36
4
18
13
71

90
4
11
18
137
3
1
4
8
49
4
25
13
91

168
329
247
72
20,444
168
168
168
1,344
189
212
150
78
11,366

11

168
346
250
72
22,902
168
168
168
1,344
189
212
150
78
14,873

12

19

3420

19

3420

25

4500

29

5220

33

5940

41

7380

94
2
2

16920
60
112
98
100
344

106
0
5

19080
67
112
98
100
560

135
0
6

24300
67
112
98
100
672

149
0
8
0

26820
67
112
98
100
896

169
0
9
1

30420
67
112
98
100
1106

189
0
10
2
1
13

34020
67
112
98
100
1416

68,715
52,248
16,467

438

76,106
59,113
16,993

489

85,484
66,964
18,520

534

92,377
73,731
18,646

603

103,406
84,701
18,705

683

115,268
95,951
19,317

4
393

5

6

8

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Aviation sector, June 16, 2016

ICICI Securities

Airlines – a cyclical industry and the role of yield management
In this section we discuss the important role of yield management in airlines. Yield management is the pricing technique to maximise revenues, minimise losses, maximise PLFs, maximise market share and every other thing that can be done in the near to medium term through pricing based allocation of seats in various buckets in line with the expected demand of tickets with passage of time. It makes pricing a very dynamic function in airlines aided by real time price management software. While it has both positives and negatives, it being the singular control factor tends to favour market player with lowest cost structure, by which logic IndiGo has an edge in the domestic Indian air traffic market.
Cyclicity is normally due to tardy response to a negative feedback loop.
Aggregate airline industry earnings globally have exhibited large-amplitude cyclical behaviour globally since deregulation in 1978 with an average peak-to-peak period of approximately 10 years. Profit cycles are caused by a failure to fully account for delays in the negative feedbacks controlling inventory, capacity acquisition, or other resources. Unfortunately, the low salience of capacity on order together with long capacity lifetimes and high fixed-costs often limit the implementation of strategies to mitigate the cycle.
However, there is little proof of failure to account for supply lines in the airlines industry. Airlines are keenly aware of the need to adjust the supply line of aircraft on order to the desired number of aircraft they seek. Evidence from experimental studies and from other industries (e.g. commercial real estate and shipbuilding) suggests weak supply line adjustment and a role for inadequate supply line control in the genesis of industry cycles. However, the high price of aircraft, concentrated nature of the industry, and contractual terms for aircraft orders favour fully accounting for the supply line. This is illustrative of the fact that average tenure of delivery of aircraft has changed from time to time, with current delivery tenure almost triple from that in the
1990s. The airline market is characterised by a small number of producers, high barriers to entry, and few product variants. The supply line of capacity on order is well known to both manufacturers and their customers. These conditions favour a more complete accounting for the supply line in ordering decisions. Additionally, a fully functioning lessor market, which now accounts for nearly 40% of the aircraft share, does help in perfect supply management for airlines. So, depending upon the cycle, what tool does an airline have to maximise revenue or minimise losses? Yield management is the answer.
Revenue maximisation strategy involves yield management, which implies inventory control. Revenue management is a process where airlines manage fares of seats based on category and date of travel between the same origin-destination (OD) markets. Airlines manage the seat inventory availability to maximise revenues. With the evolution of LCC, the lever of different seat categories has also diluted significantly. Today, the likes of IndiGo have one plain vanilla seating class. Yet, yield management is important with the development of one-dimensional differential pricing mechanism in which same seat can be sold at different prices based only on time.
Leisure travel would involve buying discount tickets with longer time horizon; however, business travellers would pay higher for near time horizon tickets. Hence, a crucial strategy would involve optimum capacity control to protect seats for later booking, high fare business passengers. Without strong restrictions to impose demand segmentation
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Aviation sector, June 16, 2016

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by passengers’ willingness to pay, the only way an airline can force those with higher willingness to pay higher fares is to limit the seat availability in lower fare classes. This protection of high-yield seats and at the same time maximising the PLF is a function of the yield management. This is accomplished by forecasting the expected future booking demand for higher fare classes and performing mathematical optimisation to determine the number of seats that should be prevented from low fare bookings.
An example would be that of SpiceJet fares on the Delhi-Mumbai route. Although
SpiceJet is a low-cost airline, its advance booking tariffs are much higher than current booking. As we go down the time, it is no longer the lowest air fare airline, a position which it maintains for current bookings. This strategy is an example of yield management through inventory management through yield management again. So, while SpiceJet is happy to be lowest at Rs3,500 per ticket for current bookings, it is not the lowest-fare player at Rs2,900/2,800 for subsequent advanced bookings.
However, this is more applicable for low-capacity airlines like SpiceJet while a high market share player like IndiGo has to focus more on its generic strategy of low cost at all points of time.
Chart 26: Delhi-Mumbai booking fare for next 5-6 weeks as of Mar’16 (for Apr’16 bookings) Source: Cleartrip

Chart 27: Delhi-Mumbai booking fare for 7-15 weeks as of Mar’16 (for Jun’16 bookings) Source: Cleartrip

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Aviation sector, June 16, 2016

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Chart 28: Delhi-Mumbai booking fare for 16-25 weeks as of Mar’16 (for Jul’16 bookings) Source: Cleartrip

Chart 29: Delhi-Mumbai booking fare for 16-25 weeks as of Mar’16 (Aug’16 bookings) Source: Cleartrip

Marginal revenue management in a declining fare structure assumes importance. Revenue management optimisers also require to gauge the propensity of passengers to buy down in a given fare structure. This is based on the fact that while each incremental seat will be sold, making more seats available at lower fares may be revenue-negative for the airline even if some seats remain empty. Till the time there is negative marginal revenue, additional seat should not be made available to the lower class for revenue maximisation. Hence there needs to be an optimiser in yield management to manage this marginal revenue maximisation across fare categories.
This also directly indicates a salient consideration – Higher PLFs may result in lower aggregate revenues if the company fails to optimise the marginal revenue management in order to gain market share.
Yield management increases the stability in airline industry. The yield management feedback acts when increases in demand cause higher load factors, raising average industry ticket prices, which then decrease demand in a negative feedback. Yield management heuristics improve the stability of the system since estimated time to adjust ticket prices is very short compared to the lags in capacity acquisition. Yield management acts as an effectively immediate negative loop that
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damps the cycle. The stronger the effect of load factors on price, the greater the stabilising effect of the price-demand feedback. To give another example, what is the likely result of a congested Mumbai Traffic? How can equilibrium be created with a stronger demand compared to a capacity constraint which cannot be ramped up in a short time period? The adjustment has to happen again with the only available lever, yield management.
However, yield management also increases operating leverage and volatility of profits. With a positive demand shock, profits rise as load factor rises. If price also rises in response to the increase in demand, then profits will increase even further, because each seat is sold at a higher average price. Hence, the stronger the effect of yield management on prices, the greater the operational leverage of the industry.
Stronger yield management stabilises the fluctuations in capacity and increases mean reversal of cycles, but the initial response of profit to the demand shock is also much larger. So, while yield management increases the mean reversal tendency of the system, it simultaneously increases the short-run volatility of profits of the airlines and in turn the risk of the investors, as the industry responds to demand shocks.
Aggressive yield management will maximise average profitability and cause load factors to increase steadily. Yield management technology has enabled the average load factor of the fleet to rise steadily from about 0.6 in the 1980s to more than 0.8 in the last decade. Hence, any market is least likely to see a lower PLF from higher capacity, but yield management driven price cuts can be expected to retain steadystate PLFs assuming demand does not change drastically.
There are downsides to yield management. While aggressively cutting prices to fill empty seats boosts average profit, it also increases the response of profit to demand shocks. Pricing policies that generate higher average profits also induce higher variability in profits. While higher average profits are desirable, greater variability in airline profits increases the risk premium required for investors. Herein is the advantage that the market leader enjoys in this industry. It can use yield management to the peril of others while simultaneously do supply management without losing significant market share, which reduces cycle risks.

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Effects of competition in aviation industry
Dominant influence again has been price control
US airlines history shows that legacy carrier incumbents have predominantly decreased their average airfares once a low-cost carrier enters a route, which is consistent with the competitive effect. There has been this famous ‘Southwest Effect’, in which incumbent airlines decrease their average airfare when Southwest Airlines enters a route. It is evident from chart 5 below that the competitive effect has been the largest with the new entrant being Southwest in the US, which kind of justifies the name. We have seen similar strategy adopted by IndiGo whenever a new entry like AirAsia has entered any particular route. IndiGo has in fact always reacted and never been the first to start a fare-based competition, but nevertheless it has always exhibited this competitive effect.
Chart 30: Effect of new player on incumbent airline prices

Competition also leads to decreased price dispersion
The analysis pertaining to the dominance of the competitive effect can be extended to various points of the price distribution. In particular, incumbent firms can respond to
45

Aviation sector, June 16, 2016

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entry by rival firms by altering their 10th percentile price and 90th percentile price. In the airline industry, the 10th percentile airfare can be characterised as discount tickets, whereas the 90th percentile airfare describes full-fare prices. If the competitive effect truly dominates the airline industry, then legacy carrier incumbents would respond to entry by low-cost carriers by lowering both their 10th percentile and 90th percentile airfares. On the other hand, incumbents decreasing their 10th percentile airfare while increasing their 90th percentile airfare would be associated with the displacement effect, wherein they would decrease their 10th percentile airfare to attract pricesensitive consumers, while increasing their 90th percentile airfare to exploit their brand-loyal consumers.
It is found that the difference between more expensive full fares (90th percentile airfares) and cheaper discount fares (10th percentile airfares) is smaller for routes that are serviced by more airlines, confirming the competitive effect dominance. Although airfares seem to decrease at the mean and tails of the price distribution, the 10th percentile airfare tends to fall by a smaller percentage than mean airfares, while the
90th percentile airfares experience a larger percentage decrease than mean airfares.
Therefore, increased competition will effectively always reduce price dispersion.
This is also evident from a typical metro to metro fare distribution compared to metro to non-metro and a non-metro to non-metro. Metro to metro routes have more competition and lower price dispersion. Please refer to the airfare price charts given earlier.

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Tracking the key determinant forces of aviation
In this section we analyse different markets and how key factors shape the airline industry. While some of the factors are well known (such as GDP growth), fuel prices’ effect on fares is somewhat subjective. We illustrate those relationships here.
Additionally, we show that sustainable increase in ASMs always tends to result in increased market share, a likely outcome for IndiGo.
We did an exercise on US airlines to understand the various influential forces in the aviation sector. US airlines do offer a long documented history, a matured industry and can be used to draw important inferences for the Indian airlines as well. We gathered the data for the top 1,000 domestic city pair markets of the US for the last 80 quarters, i.e. since 1996 including ASM, RPM, passenger, miles, PLF –and map it with the average fares, GDP growth and fuel prices.

GDP growth is the singular strongest parameter
Though not surprising and pretty obvious, a data verification of the same is importantenough reinforcement. We find that the correlation between GDP growth rate and passenger growth rate to be 0.7. The last two decades in the airline industry have been characterised by two big events, that of 9/11 in 2001 and the 2009 financial crisis. Accordingly, we see big drop in passenger growth in these two time periods.
The ASM in top 1,000 city pair markets has grown by 43% in the past two decades, an annual growth rate of 2%.
Chart 31: Strong correlation GDP growth and passenger growth
US GDP growth (% YoY)

PAX growth (% YoY)

Chart 32: ASM and RSM trend in the US
300,000,000

15
10

RSM (000)

ASM (000)

280,000,000
260,000,000
240,000,000

5

220,000,000

0

200,000,000

(5)

180,000,000
140,000,000

(20)

120,000,000

(25)

100,000,000

Source: Bureau of Transportation Statistics, US

1996-Q1
1997-Q1
1998-Q1
1999-Q1
2000-Q1
2001-Q1
2002-Q1
2003-Q1
2004-Q1
2005-Q1
2006-Q1
2007-Q1
2008-Q1
2009-Q1
2010-Q1
2011-Q1
2012-Q1
2013-Q1
2014-Q1
2015-Q1

160,000,000

(15)

1997-Q1
1998-Q1
1999-Q1
2000-Q1
2001-Q1
2002-Q1
2003-Q1
2004-Q1
2005-Q1
2006-Q1
2007-Q1
2008-Q1
2009-Q1
2010-Q1
2011-Q1
2012-Q1
2013-Q1
2014-Q1
2015-Q1

(10)

Source: Bureau of Transportation Statistics, US

Correlation between fuel and fares is not decisive
We find that the correlation between average fares and fuel prices to be 0.5, indicating a weak positive relation. While there are other factors to be considered (such as hedging practices), an interesting observation can be derived from the rather sticky fares in the wake of falling crude prices. It is can be seen that while an increasing fuel price scenario has forced average fares to rise, fall in crude prices has not seen equally enthused fall in fares. The two periods of fall in crude prices (1996-99) and
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Aviation sector, June 16, 2016

(2014-current) have seen sticky fares. This can be attributed to the opportunistic profit booking tendency enjoyed by airlines in the wake of falling crude prices and inability of some airlines to take fare cuts due to hedged positions. This raises a question of the extent of fall in fares that Indian markets can witness in this falling crude price atmosphere. A key difference between Indian and US airlines is that the latter is quite matured and had gone through a series of consolidations to achieve a more predictable and steady state of affairs. Hence, with high competition in a growing market, Indian airlines are likely to cut the fares and pass some benefits of low crude prices to the consumer to gain some market share. Yet, we believe that a large part of that low crude low fare cycle has already been completed.

Correlation between PLF and fares is weak
This is another important factor which comes up in our analysis. The correlation between fares and PLF is weak at 0.4. This is indicative of the matured economy of the US wherein, post a certain level of GDP per capita, we see relatively low elasticity of PLFs with fares. Hence, although Indian markets may not be directly comparable, it is likely that we see lower change in PLFs with fares as air travel becomes more and more intrinsic to the lifestyle of Indian consumers. It is interesting to note that PLFs in the US have risen significantly over the past two decades with aggressive yield management. However, Indian PLFs have fast moved to reach similar levels to that of the US, indicating a faster maturing rate of the Indian markets.
However, this systemic PLF and fare relationship should not be extended to that of individual players. While systemic PLF and fare would not have a very strong relationship in the US, it will hold very strong relationship for individual airlines. We did similar exercise for Southwest airlines and found correlation of near-90%.
Chart 33: Trend of fuel prices and average fares – a weak positive
Fuel Price (RHS)
4.0

0.115
0.110
0.105
0.100
0.095
0.090
0.085
0.080
0.075
0.070

3.5
3.0
2.5
2.0
1.5
1.0
0.5

1996-Q1
1997-Q1
1998-Q1
1999-Q1
2000-Q1
2001-Q1
2002-Q1
2003-Q1
2004-Q1
2005-Q1
2006-Q1
2007-Q1
2008-Q1
2009-Q1
2010-Q1
2011-Q1
2012-Q1
2013-Q1
2014-Q1
2015-Q1

0.0

Source: Bureau of Transportation Statistics, US

Fare (US$/mile)

PLF (RHS) - %
90.0

0.115
0.110
0.105
0.100
0.095
0.090
0.085
0.080
0.075
0.070

85.0
80.0
75.0
70.0
65.0
60.0

1996-Q1
1997-Q1
1998-Q1
1999-Q1
2000-Q1
2001-Q1
2002-Q1
2003-Q1
2004-Q1
2005-Q1
2006-Q1
2007-Q1
2008-Q1
2009-Q1
2010-Q1
2011-Q1
2012-Q1
2013-Q1
2014-Q1
2015-Q1

Fare (US$/mile)

Chart 34: Trend of PLF with airfares – low correlation Source: Bureau of Transportation Statistics, US

Increasing ASMs always levitate to higher market share. Whether aggressive yield management or supply management based on passenger growth, increasing ASMs has always led to higher market share. Therefore, if expansion can be made with safe balance sheet management, market share can be boosted with strategic increase in
ASM. This is an important thesis underlying the strength of IndiGo considering a strong orderbook and strong balance sheet and a market pole position.

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PLFs always adjust to increasing ASMs by yield management
Increasing capacity naturally leads to lower PLFs when the feedback cycle generates a response of lower fare resulting in regain of PLF. We can see the same in case of
Southwest over the last 25 years. As its ASMs have increased steadily, PLFS have followed in a wave pattern indicating the feedback and cycle pattern. Although the trend of PLF and fare relation being positive is contrary to our finding for the US market as a whole, Southwest is a market leader and has to depend on yield management to maximise PLFs. So, even if the broader market correlation of fares and PLFs is weak, as explained earlier, the case of an active market leader is different. Likewise, IndiGo will also have to manage yields as it increases its capacity to maintain a systemic PLF depending upon passenger growth.

Chart 35: Trajectory of Southwest PLF(%) and
ASM
Southwest ASM (mn)

Chart 36: Trajectory of Southwest market share and ASM

Southwest PLF(%) - RHS
85

140000
120000

80

100000
80000

75

60000

70

150,000

Southwest ASM (mn)
Southwest Market Share (%) - RHS

140,000

19.0

130,000
120,000

17.0

110,000

15.0

100,000
90,000

40000
65

20000

13.0

80,000

11.0

70,000

2013

2011

2009

2007

2005

2003

2001

1999

1997

1995

1993

1991

1989

9.0

60,000

2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015

60

0

21.0

Source: Company Data, I-Sec research

Chart 37: Trajectory of Southwest PLF and Revenue per RPM indicate strong correlation Southwest PLF (%)

Southwest Pax Rev per RPM (cents) - RHS

85

17
16

80

15
75

14

70

13
12

65

11
10

1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015

60

Source: Company Data, I-Sec research

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Aviation sector, June 16, 2016

Chart 38: Trajectory of Delta Airlines’ market share and ASM
The sudden increase in market share of
Delta Airlines coincides with its acquisition of
Northeast Airlines in
2010.

120,000

Delta Airlines ASM(mn)-Domestic

Delta Market Share(%)

18.0
17.0

110,000
16.0
100,000

15.0
14.0

90,000
13.0
80,000

12.0
11.0

70,000
10.0
60,000

9.0
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Source: Company Data, I-Sec research

UK markets show similar trend of ASMs with market share for easyJet. We have seen similar pattern in case of UK, where easyJet has managed phenomenal growth in ASMs with a significant increase in market share.
Yet, PLFs have also increased in tandem with ASM for easyJet, not in the usual feedback and cycle wave pattern. In the UK, there has been a serious churn in the industry with only three of the top 10 airlines in 1997 still in service today. easyJet has been able to capture the market with the LCC revolution and fragile competition, which has meant that the PLFs have also risen with increasing ASMs. This has also been helped by lower increase in ASMs. Compared to an ASM growth of 43% in the US over the last two decades, UK ASMs have grown by 38% while its RSMs have grown by 49%.
Chart 39: easyJet’s growth in ASMs and market share ASK (mn)

Chart 40: easyJet’s growth in ASMS and PLFs

Market Share, RHS (%)

80,000

ASK (mn)
25
20

60,000
50,000

100

70,000

70,000

90
80

60,000

70

10

30,000
20,000

5

60
50

30,000

40
30

20,000

20

10,000
0

1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014

0

Source: Company Data, I-Sec research

10
0

0

1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014

10,000

50,000
40,000

15

40,000

50

PLF, RHS (%)

80,000

Source: Company Data, I-Sec research

Aviation sector, June 16, 2016

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Aviation Turbine Fuel: Supply-side to keep prices on the leash
We present highlights from the World Oil Outlook. Jet/kerosene comprises two similar products: jet kerosene used in the aviation sector and domestic kerosene used in the residential/commercial/agriculture sector. While demand for domestic kerosene is expected to decrease as a result of a switch to alternative fuels (mainly LPG and gasoil/diesel), demand growth for jet kerosene will continue. Currently, the aviation sector is the main source of demand for jet/kerosene with a share of 83% of total demand. It is expected that this share will increase in the future up to 88% by 2040.
Jet/kerosene is estimated to be the second-fastest growing refined product with an average growth of 1.2% p.a. between 2014 and 2040, rising from 6.7mb/d to 9.2mb/d during the period.

Demand growth will come from Asia-Pacific and Middle East
Demand for Jet/kerosene in the former region is expected to increase 1.9mb/d between 2014 and 2040 with China alone adding 0.6mb/d. Rising income levels and the expansion of the middle-class, together with strong aviation demand from the domestic and inter-regional market supported by the establishment of Low-Cost
Carriers (LCCs), will be the main drivers. Demand in the Middle East will grow 0.4mb/d on the back of development of business hubs, increasing connectivity services and the establishment of more traffic hubs.
The aviation sector consumed 5.2mboe/d of in 2013. The OECD region accounted for
3.1mboe/d, developing countries 1.9mboe/d an Eurasia 0.3mboe/d. Since 1990, demand growth has mainly come from developing countries. Between 1990 and 2013, sectorial demand for ATF more than tripled in the developing countries while in the
OECD it increased by only 21%. In Eurasia it shrank by 30%.

Increasing oil efficiency would remain a constant feature
Improvement in fuel efficiency has been a constant feature of the aviation market.
While air traffic has multiplied by 2.1 between 1995 and 2013, sectorial oil demand has multiplied by only 1.4 for the same period. In fact, average fuel consumption of the world passenger fleet has historically exhibited a marked downward trend. While in
1995 the average efficiency was 6.3-litres/100 RPK, 10 years later it reached 5litres/100 RPK. In 2013, an average fuel efficiency of just under 4-litres/100 RPK was achieved. This trend is expected to continue in the future as older airplanes are replaced by modern and more efficient units, which can achieve fuel efficiencies of
3.5-litres/100 RPK. Currently, the most efficient aircraft in service are the Airbus A380 and the Boeing B787. They consume only 3-litres/100 RPK. According to Airbus, out of 18,500 aircraft currently flying only 6,100 aircraft will stay in service by 2033.
Therefore, 12,400 aircraft will be replaced with more fuel-efficient units in the next 20 years along with the addition of 19,000 new units.

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Aviation sector, June 16, 2016
Chart 41: Air traffic and sectoral ATF demand (1995=100)

Source: World Oil Outlook

Table 28: Oil demand in aviation
(mboe/d)
OECD America
OECD Europe
OECD Asia Oceania
OECD
Latin America
Middle East & Africa
India
China
Other Asia
OPEC
Developing countries
Russia
Other Eurasia
Eurasia
World
Source: World Oil Outlook

2014
1.6
1.1
0.5
3.1
0.2
0.2
0.1
0.4
0.6
0.3
1.9
0.3
0.1
0.3
5.4

2015
1.6
1.1
0.5
3.2
0.3
0.2
0.1
0.4
0.6
0.3
2.0
0.3
0.1
0.3
5.5

2020
1.7
1.2
0.5
3.3
0.3
0.2
0.2
0.5
0.7
0.4
2.3
0.3
0.1
0.4
6.1

Levels
2025
1.7
1.2
0.5
3.5
0.3
0.3
0.2
0.7
0.8
0.4
2.7
0.4
0.1
0.4
6.6

2030
1.7
1.3
0.6
3.6
0.3
0.3
0.3
0.8
0.9
0.5
3.0
0.4
0.1
0.5
7.1

Chart 42: Growth in aviation oil demand by country/region

Source: World Oil Outlook

52

2035
1.7
1.4
0.6
3.7
0.3
0.3
0.4
1.0
1.0
0.6
3.5
0.4
0.1
0.5
7.7

2040
1.7
1.5
0.6
3.8
0.3
0.3
0.5
1.1
1.0
0.7
4.0
0.5
0.1
0.6
8.4

Growth
2014–2040
0.1
0.4
0.2
0.7
0.1
0.1
0.3
0.7
0.4
0.4
2.0
0.2
0.2
3.0

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Aviation sector, June 16, 2016

Higher supply scenario to prevail
In assessing the implications for regional product balances after capacity additions projected, it should be remembered that refiners have some flexibility to optimise their product slate depending on the market circumstances and seasons, either through altering feedstock composition and/or through adjusting process unit operating modes.
World Oil Outlook presents an estimation of the cumulative potential incremental output of refined products resulting from existing projects, grouped into major product categories, under an assumption that these new units are run at 90% utilisation rates.
Almost half (48%) of the increase by 2020 is for middle distillates (3.1mb/d) and another 2.2mb/d (35%) for the light products, naphtha and gasoline.
Table 29: Global cumulative potential for incremental output, 2015–2020
(mb/d)
Gasoline/Naphtha
2015
0.4
2016
0.8
2017
1.2
2018
1.6
2019
1.9
2020
2.2
Based on 90% utilisation for new units

Middle distillates
0.6
1.0
1.5
2.0
2.5
3.1

Fuel oil
(0.1)
(0.1)
(0.2)
(0.3)
(0.3)
(0.2)

Other products
0.2
0.4
0.6
0.9
1.1
1.3

Chart 43: Expected surplus/deficit according to product category

Source: World Oil Outlook

The Middle East is projected to be the one region with surpluses in every product group by 2020, and also by far have the highest aggregate surplus at 1.3mb/d. All other regions are expected to have aggregate surpluses in the range of 0.2-0.4mb/d in
2020, but with deficits in one major product category. Across all products combined, the cumulative global surplus in the medium term is some 2.5mb/d. Consistent with a total surplus 2.5mb/d across all products by 2020, ‘other products’ are projected to be in surplus by over 0.5mb/d and, interestingly, distillates too at close to 0.6mb/d. The distillate surplus reflects the industry shifting to add more distillate capacity, including hydro-cracking, and a dip in estimates for distillate demand growth, especially for
Asian countries. The regional imbalances indicate the potential for distillate trading trends, notably from the Middle East to Europe
The table below shows the reconciliation of ATF prices with the crude prices. The
Indian ATF prices are a sum of the crude prices, the Jet Kero crack, the marketing margins charged by Indian oil companies along with the cost of freight and transportation and taxes. The taxes include two major components: 1) excise duty
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Aviation sector, June 16, 2016

(raised from 8% to 14% in FY17 Union Budget), and 2) sales tax which ranges from
20-30% depending upon location.
Table 30: Reconciliation of crude prices with Indian ATF tariffs
Basic price (Rs/KL)-India
Basic price (Rs/L)
US$
Barrel to Litre Conversion
Basic Price (US$/bbl)-India
Dubai Crude
Jet kero Crack
Bloomberg Singapore Jet Kerosene
Differential- Marketing margin+Freight
Inland differential
State surcharge
Freight
Siding charges
Marketing cost
MSL cost
Assessable value
Excise Duty Rate
Excise Duty
Education Cess @3% on ED
Toll Tax
Posted Airfield Price per KL
HPCL Website Price
Sales Tax Rate
Sales Tax Amount
Surcharge on Sales Tax- Rate
Surcharge on Sales Tax- Rate
Final selling price per KL

Delhi
32,600
32.60
62.19
159.00
83.35
53.40
14.69
66.90
16.45
570
841
504
49
3,241
308
38,113
8
3,049
41,162
41,273
20
8,232
49,395

ATF retail price (Rs/KL)

49,338

Source: MoPG, I-Sec research

54

1-Apr-15
Kolkata Mumbai
33,280
32,710
33.28
32.71
62.19
62.19
159.00
159.00
85.09
83.63
53.40
53.40
14.69
14.69
66.90
66.90
18.19
16.73
3,210
946
954
100
5,581
3,490
308
308
43,334
37,554
8
8
3,467
3,004
46,800
40,558
46,891
40,570
25
25
11,700
10,140
58,500
50,698
58,614

50,713

Chennai
33,080
33.08
62.19
159.00
84.58
53.40
14.69
66.90
17.68
841
362
4,402
308
38,993
8
3,119
42,112
42,215
29
12,213
54,325
54,457

Delhi
25,769
25.77
67.13
159.00
61.03
34.41
12.07
47.75
13.28
485
600
403
49
2,313
308
29,927
8
2,394

10-Mar-16
Kolkata Mumbai
25,168
24,910
25.17
24.91
67.13
67.13
159.00
159.00
59.61
59.00
34.41
34.41
12.07
12.07
47.75
47.75
11.86
11.25

Chennai
25,419
25.42
67.13
159.00
60.20
34.41
12.07
47.75
12.45

FY17E
33,379
33.38
67.00
159.00
79.21
55.00
12.00
67.00
12.21
121
1,042
384
12
2,982
308
38,228
14
5,352

FY18E
35,486
35.49
67.00
159.00
84.21
60.00
12.00
72.00
12.21
121
1,042
384
12
2,982
308
40,335
14
5,647

FY19E
35,486
35.49
67.00
159.00
84.21
60.00
12.00
72.00
12.21
121
1,042
384
12
2,982
308
40,335
14
5,647

FY20E
35,486
35.49
67.00
159.00
84.21
60.00
12.00
72.00
12.21
121
1,042
384
12
2,982
308
40,335
14
5,647

2,291
764
3,984
308
32,514
8
2,601

675
80
2,491
308
28,464
8
2,277

600
289
3,142
308
29,758
8
2,381

32,321
31,598
20
6,464

35,115
36,831
25
8,779

30,741
30,741
25
7,685

32,139
32,552
29
9,320

43,580

45,982

45,982

45,982

25
10,786

25
11,381

25
11,381

25
11,381

38,785

43,894

38,426

41,459

54,366

57,363

57,363

57,363

38,785

43,894

38,426

41,459

54,366

57,363

57,363

57,363

Aviation sector, June 16, 2016

ICICI Securities

Index of Tables and Charts
Tables
Table 1: Domestic air traffic supply model ............................................................................ 3
Table 2: Indigo supply model ................................................................................................ 4
Table 3: Air Asia supply model ............................................................................................. 4
Table 4: Vistara supply model............................................................................................... 4
Table 5: Air India supply model............................................................................................. 5
Table 6: Jet Airways supply model ....................................................................................... 5
Table 7: SpiceJet growth model ........................................................................................... 5
Table 8: GoAir’s growth trajectory ........................................................................................ 5
Table 9: Indian Airport Traffic growth history ........................................................................ 6
Table 10: Traffic Profile of Bangalore Airports ...................................................................... 6
Table 11: Traffic Profile of Mumbai Airport ........................................................................... 7
Table 12: Traffic Profile of Hyderabad .................................................................................. 7
Table 13: Traffic Profile of Cochin ........................................................................................ 7
Table 14: Delhi Airport Traffic Profile .................................................................................... 7
Table 15: Traffic versus capacity status of 90% traffic of Indian airports ............................. 8
Table 16: Current domestic route map of Indian airlines ...................................................... 9
Table 17: Status of major airport projects ........................................................................... 11
Table 18: Surge in air travel intensity with rising incomes .................................................. 14
Table 19: Passenger and passenger-km growth comparison between upper and second class travel in Indian Railways ...................................................................................... 16
Table 20: Line capacity utilisation on IR (2015) .................................................................. 17
Table 21: Line Capacity status of high density network on IR ............................................ 18
Table 22: Fare comparison of rail and air ........................................................................... 18
Table 23: Ancillary revenue profile of Ryanair .................................................................... 27
Table 24: Ancillary revenues for Cebu Pacific has been consistently above 20% ............. 28
Table 25: AirAsia has high leverage, worse in associates ................................................. 36
Table 26: Fleet details of Air India as per its website ......................................................... 39
Table 27: Fleet projection for Indian Airlines ...................................................................... 40
Table 28: Oil demand in aviation ........................................................................................ 52
Table 29: Global cumulative potential for incremental output, 2015–2020 ........................ 53
Table 30: Reconciliation of crude prices with Indian ATF tariffs ......................................... 54

Charts
Chart 1: Excess capacity in non-metro airports .................................................................... 8
Chart 2: Outlook for worldwide O-D passenger trips in millions ......................................... 12
Chart 3: Indian domestic passenger growth – 21.5% in FY15. .......................................... 13
Chart 4: Strong drivers for Indian passenger air traffic growth ........................................... 13
Chart 5: India is in the strong growing zone of air traffic .................................................... 14
Chart 6:Air travel is largely dominated by the working-age poulation ................................ 15
Chart 7: India is very well placed with one of the world’s most young populations ............ 15
Chart 8: India is expected to witness one of the highest change in flying population over the next 20 years ........................................................................................................... 15
Chart 9: Railways are operating at very high capacity utilizations...................................... 17
Chart 10: Total operating cost comparison without rentals ................................................ 19
Chart 11: Total operating cost comparison with rentals ..................................................... 19
Chart 12: Operating cost ex rentals per ASK for select airlines ......................................... 20
Chart 13: Record-high commercial backlog at present ...................................................... 21
Chart 14: Delivery horizons significantly longer today ........................................................ 22
Chart 15: Over past 5-7 years, 48% of deliveries have been for replacement ................... 22
Chart 16: Some elements of production ‘surplus’ have increased retirements at reduced age ................................................................................................................................ 23
Chart 17: Lessors have been retiring aircraft earlier .......................................................... 23
Chart 18: Next-generation aircraft dominating the backlog ................................................ 24
Chart 19: Transitioning to next-generation aircraft; orderbook details ............................... 25
Chart 20: Single-aisle demand largely committed over next five years .............................. 25
55

Aviation sector, June 16, 2016

ICICI Securities

Chart 21: Aircraft leasing penetration by class ................................................................... 26
Chart 22: Top airlines with regards to percentage share of ancillary revenue ................... 27
Chart 23: Ancillary revenue distribution at easyJet............................................................. 28
Chart 24: RPK and PLF trajectory of AirAsia ...................................................................... 35
Chart 25: Market share comparison between AirAsia and IndiGo in formative stages ...... 35
Chart 26: Delhi-Mumbai booking fare for next 5-6 weeks as of Mar’16 (for Apr’16 bookings)
...................................................................................................................................... 42
Chart 27: Delhi-Mumbai booking fare for 7-15 weeks as of Mar’16 (for Jun’16 bookings) 42
Chart 28: Delhi-Mumbai booking fare for 16-25 weeks as of Mar’16 (for Jul’16 bookings) 43
Chart 29: Delhi-Mumbai booking fare for 16-25 weeks as of Mar’16 (Aug’16 bookings) ... 43
Chart 30: Effect of new player on incumbent airline prices ................................................ 45
Chart 31: Strong correlation GDP growth and passenger growth ...................................... 47
Chart 32: ASM and RSM trend in the US ........................................................................... 47
Chart 33: Trend of fuel prices and average fares – a weak positive .................................. 48
Chart 34: Trend of PLF with airfares – low correlation ....................................................... 48
Chart 35: Trajectory of Southwest PLF(%) and ASM ......................................................... 49
Chart 36: Trajectory of Southwest market share and ASM ................................................ 49
Chart 37: Trajectory of Southwest PLF and Revenue per RPM indicate strong correlation
...................................................................................................................................... 49
Chart 38: Trajectory of Delta Airlines’ market share and ASM ........................................... 50
Chart 39: easyJet’s growth in ASMs and market share ...................................................... 50
Chart 40: easyJet’s growth in ASMS and PLFs .................................................................. 50
Chart 41: Air traffic and sectoral ATF demand (1995=100) ................................................ 52
Chart 42: Growth in aviation oil demand by country/region ................................................ 52
Chart 43: Expected surplus/deficit according to product category ..................................... 53

56

Equity Research
INDIA

June 16, 2016
BSE Sensex: 26726

InterGlobe Aviation

BUY

Consolidating leadership
Reason for report: Initiating coverage

Aviation

InterGlobe Aviation (IndiGo) is the leader in the Indian domestic aviation industry with a market share of 37%, which is expected to increase to 41% by 2020 as it starts taking delivery of the bulk ordered neos from Airbus. Armed with the benefits of the lowest cost structure, largest existing orderbook with Airbus and the strongest balance sheet among competitors, IndiGo is the best play in the
Indian air traffic growth story by a margin.

Target price Rs1,268

Shareholding pattern
Dec
’15
86.2

Promoters
Institutional
investors
MFs and UTI
Insurance
FIIs
Others

7.2
1.2
0.0
6.0
6.6

I-Sec vs Bbg* consensus
(%)
Sales
EBITDA
Adj. PAT

FY17E
0.9
(5.9)
(11.1)

FY18E
(1.5)
14.2
14.3

Source: *Bloomberg, I-Sec research

Nov-15
Dec-15
Jan-16
Feb-16
Mar-16
Apr-16
May-16
Jun-16

(Rs)

Price chart
1600
1400
1200
1000
800
600
400
200
0

Rs1,011

Volume growth in the best way at the most opportune time leading to increase in market share. The historical orderbook with Airbus would provide
Indigo with the lowest cost way of fleet addition (guidance of 136 aircraft by FY17 and 154 by 2018 from 107 currently) in perhaps an exponential stage of Indian domestic aviation growth which saw 22% passenger growth in 2015. Our analysis of airport capacity shows ~45mn excess capacity in the existing airports, which have 90% of the current traffic apart from the remaining non metro destinations.
Cost asymmetry- biggest differentiator in a price driven industry. IndiGo will continue to enjoy lowest cost structure through its young and uniform A320 fleet which has all the favorable cost levers broadly based on incentives from Airbus, lowest maintenance costs and higher fuel efficiency(with neos coming in). What is ironical, albeit in a positive way, is that the only counterpoise to these cost benefits which may come from drop in incentives through a decline in market value of neos will only happen with a sharp drop in crude prices which anyways is a sweet situation for IndiGo and the sector. Yet, that it will receive an incentive in any case is itself a structural cost differential. However, the interplay of rentals, incentives and better fuel efficiency of the bulk ordered neo will always generate favorable equation for IndiGo. The credit stature and prominence of IndiGo allows it to pay lower supplementary rentals, which will continue ahead along with the benefits of a uniform and young fleet. To give a perspective, the average CASK excluding depreciation and including interest during FY10-FY16 for Indigo, SpiceJet and Jet was Rs3.06, Rs3.42 and Rs4.28.
Recommend BUY with a target price of Rs1,268 based on 8x FY18E
EV/EBITDAR. IndiGo is expected to increase its ASK/RPK/Pax from
42.8bn/35.9bn/33.1mn in FY16 to 59.3bn/50.3bn/47mn in FY18E, resulting in
EBITDAR growth from Rs56bn in FY16 to Rs87bn in FY18E (FY18E EBITDAR margin of 36%). The lease-adjusted RoCEs will remain ~20%. Our revenue model factors an average fare growth of 2/3% each in FY17/FY18 with a rising crude price assumption of US$55-60/bbl in FY17/FY18.
Market Cap
Reuters/Bloomberg

Rs364bn/US$5.4bn
INGL.BO/INDIGO IN

Shares Outstanding (mn)
52-week Range (Rs)
Free Float (%)

360.4
1343/720
13.9

Year to March
Revenue (Rs mn)
Net Income (Rs mn)
EPS (Rs)
% Chg YoY

FY15

FY16P

FY17E

FY18E

139,253

161,399

205,627

243,776

13,042

19,897

21,260

32,034

36.2

55.2

59.0

88.9
50.7

174.9

52.6

6.9

FII (%)

6.0

P/E (x)

27.9

18.3

17.1

11.3

Daily Volume (US$/'000)

NA

CEPS (Rs)

44.6

69.2

75.6

106.9

Research Analysts:

Absolute Return 3m (%)

26.4

EV/E (x)

20.4

11.9

10.5

6.8

Ansuman Deb

Absolute Return 12m (%)

NA

Dividend Yield (%)

3.46

4.25

1.98

1.98

ansuman.deb@icicisecurities.com

Sensex Return 3m (%)

9.4

RoCE (%)

23.6

29.5

27.9

35.3

+91 22 6637 7312

Sensex Return 12m (%)

1.9

RoE (%)

306.0

109.1

68.4

58.5

57

InterGlobe Aviation, June 16, 2016

ICICI Securities

TABLE OF CONTENTS
IndiGo growing in the best way at the right time........................................................ 59
IndiGo set to benefit from original order driven increase in fleet .................................. 59
Why is it an opportune time in Indian aviation? ............................................................ 61
IndiGo set to gain market share .................................................................................... 62
Can IndiGo manage a multi-period strong growth? ...................................................... 66
IndiGo fleet details – new, uniform, Airbus ................................................................... 67
Uniform fleet makes way for best OTP ......................................................................... 68
Higher utilisation compromises OTP............................................................................. 69
Airport capacity-is there room for IndiGo to grow? ................................................... 70
Cost advantage of IndiGo – a deep dive analysis ...................................................... 72
Bulk orders – genesis of cost advantage ...................................................................... 72
What if Incentives go down? ......................................................................................... 73
Incentives will continue to provide cost arbitrage ......................................................... 74
Cost Comparison across competition-IndiGo has an edge .......................................... 75
Supplementary rentals is another important cost differential ........................................ 81
Lowest cost structure enables lowest fares .................................................................. 82
The A320neo advantage of IndiGo ............................................................................... 84
The fuel factor- Neos will provide another cost differential in time ............................... 86
Strength of the balance sheet is a key strategic advantage for IndiGo ................... 87
RoCE to remain attractive even adjusting for operating leases ............................... 88
Average fares will move up with crude ....................................................................... 89
Assumptions ..................................................................................................................91
Valuation ......................................................................................................................... 91
Financials........................................................................................................................ 94
Index of Tables and Charts ........................................................................................... 98

58

InterGlobe Aviation, June 16, 2016

ICICI Securities

IndiGo growing in the best way at the right time
IndiGo set to benefit from original order driven increase in fleet

The original order from an airframer is likely to lead to the lowest rentals on the back of incentives/profit from sale and leasebacks and the characteristic discounts offered in bulk orders. Additionally, being absolutely new, these aircraft typically tend to have the minimum maintenance costs. The higher fuel efficiency of neos will further add to the cost advantage of IndiGo

It had made characteristic huge fleet orders in 2011 and 2015, which has started being delivered from 2016. IndiGo will receive the maximum direct orders (i.e. from airframers) in this duration. While GoAir has an order of 72 neos, which is likely to trickle through from CY17 onwards, the 75 Boeing-737Max orders of Jet Airways (Jet) is likely to stream in from late 2018 or 2019. SpiceJet ordered 42 737Max’s in Oct’13, but till date there has not even been any date announced for the first delivery, leave aside any schedule of delivery. This advantage for Indigo will be critical considering the current strong growth in the Indian aviation market. Clearly, the likes of SpiceJet,
Air India and Jet have missed a crucial trick of big bulk ordering in the past five years.
A reason could be the poor financial health of these airlines. IndiGo will capitalize on this position, something which is a structural construct in a market where the market leader enjoys a cost advantage and also has a natural reinforcement of that advantage stemming from this expanding fleet of low rental aircraft from an airframerled order rather than short-term leases.
Now, one may question the relevance of orderbook considering a perfectly functioning aircraft lessor market. While addition or delay/reduction in fleet size has been made more liquid with the active lessor market, implying that airlines can deploy more aircraft in a growing market with the help of short-term operating leases or wet leases, that mode of supply chain management inevitably leads to cost escalations.
Even a normal lessor arrangement is costly compared to the manufacturer order simply driven by the profit share of the lessor. Hence, very short-term or wet leases would levy even more burden on the operator. SpiceJet has gone for short-term leases as well as wet-leases to boost the capacity so as not to miss the high growing
Indian air traffic story. Air India has signed an agreement with Kuwaiti lessor ALAFCO for 14 A320neos, scheduled for delivery from 2017 onwards. However, Air India will have some retirements in line along with probable delays in these deliveries, which is likely to result in minimal fleet growth for it. These moves, while responsive to the higher demand in Indian domestic air traffic and the low oil price environment, will ultimately further erode the cost structures of the respective airlines compared to
IndiGo. So, the pecking order of fleet induction from the best to worst will be as follows: •

Original order from OEMs being used through placement to lessors.



Medium-term operating leases (3-6 years)



Short-term operating leases (1-3 years)



Very short-term operating leases (less than a year) and wet leases.

59

InterGlobe Aviation, June 16, 2016

ICICI Securities

Why longer term leases are better than short term leases?




Difference in expectation between lessor and lessee widens in short term leases. A one to three year lease is a different ball game, and a large gap often looms between the desires and expectations of lessor and lessee. The lessor – especially if it is a financial institution – usually has no appetite for retaining any risk, exposure or expense related to the aircraft. The lessee, on the other hand, regards the aircraft as a temporary solution to its needs. It is generally not interested in treating the airplane like something it owns, and certainly not in pouring money into it.



Maintenance burden is always an issue in short term leases. It is particularly troublesome during negotiations about the lessee’s responsibility for maintenance.
A reasonable lessor should be willing to share the cost of that inspection with the lessee and make some accommodation regarding downtime and give an extension to the lease term that wholly or partly covers the downtime.



60

Longer term leases more proximate to owning. In many ways, long-term leases are easier to negotiate because the longer the term, leasing comes closer to owning. In that case, the lessee expects to be responsible for all fixed and variable operating costs, just as if he were the owner. The financial institution, on the other hand, takes the residual risk on the aircraft’s value on lease termination.

Unscheduled maintenance can waste money and even shorten the effective time of the lease. Unfortunately, prorating costs between lessor and lessee doesn’t help much with unscheduled maintenance. Then there is an issue if the aircraft requires additional maintenance because of negligent operation by the lessee. Depending on the lease term, there will also be a full-blown pre-buy inspection to ensure that the aircraft is in good condition.

ICICI Securities

InterGlobe Aviation, June 16, 2016

Why is it an opportune time in Indian aviation?
The Indian aviation market has grown tremendously in the past decade with reasons galore. There is the burgeoning middle class, congested rail capacity, young demographics and the relatively high performing economy. This is best reflected in the domestic passenger growth trend, which has also been boosted by the low fares from a low oil price environment. We have highlighted the same in details in our sector note, where we have shown how India is poised in the exponential growth seat based on its GDP per capita and the low flight penetration. Though low penetration and high consumer base is a constant theme in India, applicable to most of the consumer facing industries, the story has played out absolutely along expected lines in Indian air traffic.
There has been a stellar growth in Indian air traffic post 2000, only interrupted for a short term during the 2009 on account of the global financial crisis.
Chart 1: Indian domestic passenger traffic growth,
21.5% in CY15.
Scheduled domestic passengers(000)
Scheduled domestic passengers growth (%) - RHS

90,000

50

Chart 2: Total international air traffic growth,
13.7% in CY15
Int'l traffic-Total

Int'l traffic-Growth (RHS)
20

50,000,000

80,000

60,000,000

15

40

70,000

30
20

50,000

40,000,000
30,000,000
20,000,000
10,000,000
0

Source: DGCA

2013-14

2011-12

2009-10

2007-08

1993-94

1982
1984
1986
1988
1990-91
1992-93
1994-95
1996-97
1998-99
2000-01
2002-03
2004-05
2006-07
2009
2011
2013
2015

(5)

2005-06

(20)

2003-04

0

0

2001-02

(10)

20,000

5

1999-00

10,000

30,000

1997-98

0

40,000

1995-96

10

10

(%)

60,000

Source: DGCA

Chart 3: International traffic share of domestic airlines have grown steadily
Int'l traffic-Indian airlines

Domestic operator share (RHS)
39.0

20,000,000
18,000,000
16,000,000
14,000,000
12,000,000
10,000,000
8,000,000
6,000,000
4,000,000
2,000,000
0

37.0

33.0
31.0

(%)

35.0

29.0
27.0
25.0

1993-94
1994-95
1995-96
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
2009-10
2010-11
2011-12
2012-13
2013-14
CY15

Domestic airlines have increased their share in total international air traffic from 29% in
1994 to 38% in
CY15.

Source: DGCA

61

ICICI Securities

InterGlobe Aviation, June 16, 2016

IndiGo set to gain market share
We have made a supply model of the planned capacity additions of all domestic airlines in India over the next four years, factoring the orders placed, probable delays, replacements and resultant average domestic seats for the period between FY17-FY20. We believe that yield management will ensure that most of the large airlines will operate along the 85% level of PLFs. However, some of the new and marginal airlines will not be able to garner such PLFs, simply due to the exorbitant high passenger growth required for them in order to achieve the same. The result of the exercise is the implied passenger growth of all airlines and also the total domestic passenger growth model.
Our domestic supply-demand model shows implied domestic passenger growth rate of 14%. Our supply demand model for domestic air traffic in India has a consolidated average growth of 14% over the next four years. This is the implied growth rate based on the capacity addition programs of domestic airlines. This model accounts for all the operating airlines in India along with their planned capacity additions, hence reflects competition. We have already established that, barring a perilous way of short-term operating lease/wet lease, the capacity addition options should be largely in line with the airline’s plan. Additionally, PLFs typically tend to be stable or modestly increasing at an aggregate level, thanks to the aggressive yield management practices adopted by the airline industry. These boundary conditions of rational capacity addition, passenger growth and PLF levels are the bedrocks of our
India domestic air traffic model.
Therefore, when we arrive at an average industry growth of 14% with these boundary conditions, it is but the implied growth rate of the system.
Table 1: Domestic air traffic supply model
It is a supply model to generate the implied demand growth. System
Passenger growth
Passengers carried
Avg km per passenger
RPK (mn)
Departure/plane
Effective seats (FY)
Avg km per seat
ASK (mn)
PLF (%)
Source: I-Sec research

FY16E
85,197,675
950
80,938
1,980
56,044
881
97,761
82.8

FY17E
15.5
98,363,142
954
93,838
2,000
64,504
890
114,817
81.7

FY18E
13.0
111,189,886
956
106,298
2,030
70,043
885
125,836
84.5

FY19E
14.1
126,879,624
956
121,297
2,040
78,812
881
141,644
85.6

FY20E
14.7
145,505,253
956
139,103
2,050
90,916
881
164,199
84.7

IndiGo is price setter in a competitive market from its high low-cost capacity at disposal. With a cost advantageous growing fleet in a growing market, IndiGo is a price setter. With active yield management which is so prevalent in the current airline business, PLFs normally tend to increase over time or best stabilize over time. This again is evident from all the international markets. We have studied the US and UK airlines industry and they have both witnessed rising PLFs over time. Though at the perils of operating in a near a complete price war based strategy leading to disastrous competition, the airlines industry has truly engaged in price management to maintain
PLFs. We have detailed the same in our sector piece. The reason we mention it here is that IndiGo is least likely to accept low PLFs, which would be a natural result post increase in its fleet size.

62

ICICI Securities

InterGlobe Aviation, June 16, 2016

IndiGo is likely to set prices accordingly to boost its PLF, ultimately increasing its market share. While low fares and price wars will affect IndiGo, it will affect the others even more because of IndiGo’s inherently high margins. The natural question that will arise now is whether there is a need for price war and cut-throat competition. As evident in our Indian passenger growth model, which has an implied passenger growth of 14% CAGR, even considering all the fleet addition programs, Indian air traffic should have enough natural growth to avoid irrational fare wars.
However, as is the case in an oligopoly and its related game theory, sanity and rationality are the virtues which often elude the psyche of industry players. Yet, in an adverse scenario of such an eventuality, IndiGo is likely to weather the storm and consolidate its dominant market share, considering its lowest cost structure, which we discuss in the successive sections.


Increase in IndiGo’s market share from 36.9% to 41.1% by FY20. This is largely driven by IndiGo’s capacity increase. However, the implied passenger growth is an average 18% for IndiGo between FY17-FY20. This is very much possible because, even then, IndiGo’s PLFs would remain in the 80-86% range.
Table 2: IndiGo supply model
System
FY16
Passenger growth
Passengers carried
31,453,451
Market Share
36.9
Avg. km per passenger
1,028
RPK (mn)
32,318
Departure/plane
2,510
Effective seats (FY)
16,895
Avg. km per seat
906
ASK (mn)
38,420
PLF (%)
84.1
Source: Company Data, I-Sec research



FY17
25.0
39,316,814
40.0
1,028
40,398
2,510
22,093
906
50,241
80.4

FY18
15.0
45,214,336
40.7
1,028
46,458
2,510
24,043
906
54,674
85.0

FY19
15.0
51,996,486
41.0
1,028
53,426
2,510
26,847
906
61,052
87.5

FY20
15.0
59,795,959
41.1
1,028
61,440
2,510
30,609
906
69,607
88.3

New entrants would struggle; exits would lead to further consolidation. The combined market share of the new players would remain low. To give a perspective, the combined market share of Air India Express, Air Alliance, Vistara,
True Jet, Pegasus, Air Costa and Air Asia would only manage to increase only by
1% between FY17 and FY20E. Although Air India Express and Air Alliance are not new, we have clubbed them in the group considering their low market share. This is the maximum market share they are able to reach with a passenger growth at
20% CAGR between FY17E-FY20E. Their PLFs would remain low, but increase in line with the growth in traffic. We believe it would be difficult for them to achieve a growth beyond 20% considering the market dominance of established players, the deep pocket of the market leader who also enjoys a cost advantage and no major fleet orderbook. Any growth beyond the 20% would imply an unsustainable erosion of net worth. Any exits by any of the players or weakening of position would further provide opportunity for consolidation of the industry. So, one wonders whether IndiGo has any such exits factored in with their big orderbook.

63

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InterGlobe Aviation, June 16, 2016
Table 3: Air Asia supply model
System
FY16E
Passenger growth
Passengers carried
1,705,808
Market share
2.0
Avg. km per passenger
1,104
RPK (mn)
1,883
Departure/plane
2,500
Effective seats (FY)
899
Avg. km per seat
1,045
ASK (mn)
2,348
PLF (%)
80.2
Source: Company data, I-Sec research

FY17E
20.0
2,046,970
2.1
1,104
2,260
2,500
1,260
1,045
3,292
68.7

FY18E
20.0
2,456,364
2.2
1,104
2,712
2,500
1,440
1,045
3,762
72.1

FY19E
20.0
2,947,636
2.3
1,104
3,254
2,500
1,620
1,045
4,232
76.9

FY20E
20.0
3,537,163
2.4
1,104
3,905
2,500
1,980
1,045
5,172
75.5

FY17E
20.0
1,707,133
1.74
1,028
1,755
2,000
1,332
1,010
2,691
65.2

FY18E
20.0
2,048,560
1.84
1,028
2,106
2,000
1,406
1,010
2,840
74.1

FY19E
20.0
2,458,272
1.94
1,028
2,527
2,000
1,628
1,010
3,289
76.8

FY20E
20.0
2,949,926
2.03
1,028
3,033
2,000
1,998
1,010
4,036
75.1

Table 4: Vistara supply model
System
FY16E
Passenger growth
Passengers carried
1,422,611
Market share
1.67
Avg. km per passenger
1,028
RPK (mn)
1,462
Departure/plane
2,350
Effective seats (FY)
888
Avg. km per seat
1,010
ASK (mn)
2,108
PLF (%)
69.4
Source: Company data, I-Sec research



Maximum decline in market share likely for Air India followed by Jet. A slower growth in capacity will drive this lower market share for ‘Air India and Jet. This is a missed opportunity for Air India/Jet who has not been able to manage their fleet inventory with long delays in orders and a higher share of wide body aircraft. To give a sense, Jet has had to lease 10 aircraft to Turkish Airways/Etihad, while Air
India has recently concluded an agreement with a Kuwaiti leasing company whose supply is not likely to come in before FY18.
However, it is not the missed opportunity from a strategy point of view, but more from the poor financial condition of these carriers. These airlines are big enough to take significantly more time to turnaround and as such it is in their best interest to focus on deleveraging rather than capacity expansion.
Table 5: Air India supply model
System
FY16E
Passenger growth
Passengers carried
12,742,163
Market share
15.0
Avg. km per passenger
961
RPK (mn)
12,245
Departure/plane
1,085
Effective seats (FY)
12,299
Avg. km per seat
1,159
ASK (mn)
15,470
PLF (%)
79.2
Source: Company data, I-Sec research

64

FY17E
3.0
13,124,428
13.3
961
12,613
1,085
12,430
1,159
15,634
80.7

FY18E
8.0
14,174,382
12.7
961
13,622
1,085
12,839
1,159
16,150
84.3

FY19E
5.0
14,883,101
11.7
961
14,303
1,085
13,437
1,159
16,902
84.6

FY20E
4.0
15,478,425
10.6
961
14,875
1,085
13,825
1,159
17,389
85.5

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InterGlobe Aviation, June 16, 2016
Table 6: Jet Airways supply model
System
FY16E
Passenger growth
Passengers carried
15,961,308
Market share
18.7
Avg. km per passenger
864
RPK (mn)
13,783
Departure/plane
1,825
Effective seats (FY)
12,877
Avg. km per seat
728
ASK (mn)
17,109
PLF (%)
80.6
Source: Company data, I-Sec research



FY17E
8.0
17,238,213
17.5
864
14,885
1,825
13,412
728
17,819
83.5

FY18E
3.0
17,755,359
16.0
864
15,332
1,825
13,443
728
17,860
85.8

FY19E
12.0
19,886,002
15.7
864
17,172
1,825
15,268
728
20,286
84.6

FY20E
15.0
22,868,902
15.7
864
19,747
1,825
18,275
728
24,280
81.3

SpiceJet and GoAir likely to have high PLFs and modest growth in market share. These two airlines are likely to increase their fleet size on the back of orders made earlier, albeit on a small scale compared to IndiGo. This will result in modest increase in market share. The limiting factor of capacity is evident from their relatively higher operating PLFs.
Table 7: SpiceJet growth model
System
FY16E
Passenger growth
Passengers carried
10,670,866
Market share
12.5
Avg. km per passenger
874
RPK (mn)
9,326
Departure/plane
2,100
Effective seats (FY)
5,775
Avg. km per seat
836
ASK (mn)
10,139
PLF (%)
92.0
Source: Company data, I-Sec research

FY17E
15.0
12,271,496
12.5
874
10,725
2,100
6,567
836
11,530
93.0

FY18E
20.0
14,725,795
13.2
874
12,870
2,100
8,220
836
14,432
89.2

FY19E
20.0
17,670,954
13.9
874
15,444
2,100
10,160
836
17,837
86.6

FY20E
20.0
21,205,145
14.6
874
18,533
2,100
12,780
836
22,437
82.6

FY17E
16.0
8,305,819
8.4
945
7,849
2,500
3,960
946
9,365
83.8

FY18E
22.0
10,133,099
9.1
945
9,576
2,500
4,860
946
11,494
83.3

FY19E
18.0
11,957,057
9.4
945
11,299
2,500
5,580
946
13,197
85.6

FY20E
18.0
14,109,328
9.7
945
13,333
2,500
6,660
946
15,751
84.7

Table 8: GoAir’s growth trajectory
System
FY16E
Passenger growth
Passengers carried
7,160,189
Market share
8.4
Avg. km per passenger
945
RPK (mn)
6,766
Departure/plane
2,500
Effective seats (FY)
3,420
Avg. km per seat
946
ASK (mn)
8,088
PLF (%)
83.7
Source: Company data, I-Sec research

65

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Can IndiGo manage a multi-period strong growth?
We believe it can, considering its pole position in the Indian aviation market and cost leadership. We have similar instances of strong growth in capacity and a resultant stronger market share growth exhibited by easyJet in the UK, Southwest in the US and Ryanair in Europe.

Chart 4: Growth in ASK and market share of
EasyJet
ASK (mn)

Chart 5: EasyJet PLFs tend to remain stable

Market Share, RHS (%)

80,000

ASK (mn)

PLF, RHS (%)

70,000
20

60,000
50,000

80,000

100

70,000

25

90
80

60,000

70

40,000
10

30,000
20,000

5

10,000

50,000

60

40,000

15

50

30,000

40
30

20,000

20

10,000

10

0

0

1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014

0

1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014

0

Source: UK Government website, I-Sec research

Source: UK Government website, I-Sec research

Chart 6: PLFs have steadily risen by yield management over the last decade

Chart 7: Growth in ASK and market share of
Southwest airlines

Southwest ASM (mn)

Southwest PLF(%) - RHS
85

140000
120000

80

100000
80000

75

60000

70

140,000
120,000

17.0
15.0

100,000
90,000

65

20000

13.0

80,000

11.0

70,000

2013

2011

2009

2007

2005

2003

2001

1999

1997

1995

1993

1991

1989

Source: Company Data, I-Sec research

60,000

9.0

2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015

60

0

21.0
19.0

130,000
110,000

40000

66

150,000

Southwest ASM (mn)
Southwest Market Share (%) - RHS

Source: Company Data, I-Sec research

InterGlobe Aviation, June 16, 2016

ICICI Securities

IndiGo fleet details – new, uniform, Airbus
IndiGo has made characteristic big orders till date
Option available to
IndiGo include using
189 seats instead of
180 and opting for a bigger A321 (220 seats)compared to
A320



The company placed firm order with Airbus for 100 A320 aircraft in June 2005, all of which were delivered by November 3, 2014, about two years ahead of the initially scheduled final delivery date.



It placed firm orders with Airbus for 180 A320neo aircraft in June 2011.



It placed purchase orders with Airbus for 250 A320neo aircraft in August 2015.
The orders are expected to start delivery from 2018 subject to increase or delay by Airbus.

Currently all of the aircraft carry the V-2527-A5 variant of the V2500 SelectOne engine manufactured by IAE, and, upon delivery, all of the A320neo aircraft in our 2011 order will utilize Pratt & Whitney engines. However, the company is yet to select the engines for A320 neo order of 2015. The seating configuration is optimized at 180, all of which is in the economy class.
A320neo delivery schedule is back on track; targets 136 fleet strength by FY17
Delay in aircraft delivery addressed as of now. Delay in aircraft delivery can happen for a variety of reasons. In the recent case of A320 neo, the cause of delay was extra time required for cooling of the Pratt & Whitney Geared Turbofan engine under some circumstances. When Qatar Airways held itself back on accepting delivery of the first A320neo, Lufthansa stepped up to become the first airline to receive the same. While some teething problem will get resolved, Airbus has confirmed that the technical glitch will be addressed and the very fact that a delivery has already been made is very much assuring.

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Uniform fleet makes way for best OTP
On-time performance (OTP) is critical to customers when choosing an airline to fly, so it is a key competitive dimension in the airline industry. Carriers with better on-time performance display comparative statistics on flight delays prominently on their websites. At the same time, airlines that are plagued by excessive flight delays receive a great deal of negative publicity. While the qualitative angle of customer delight and negative publicity is well known, punctual airlines seem to be more profitable. We present two snapshots of US/Europe airline operators which indicate the positive relationship between on-time performance and operating margins. Similar story is there for Indian operators as well, where not surprisingly, the best OTP operator also enjoys the highest margins and profitability.
Chart 8: OTP of Indian airlines operators (%)-thick line on the top is for Indigo
Jet Airways+Jetlite

Indigo

Spicejet

Go Air

Air India

100
95
90
85
80
75
70
65
60

Jan'16

Feb'16

Dec'15

Nov'15

Oct'15

Oct'15

Sep'15

Sep'15

Aug'15

Jul'15

Jun'15

May'15

Apr'15

Mar'15

Jan'15

Source: DGCA

The thick line is the OTP of IndiGo, which is distinctively superior to other airlines. We underline that this OTP of IndiGo is an example of its superior operations.
The other themes which come across from the chart are the weak performance of
SpiceJet and Air India. However, SpiceJet has made significant improvement in the past three quarters and has been able to improve its OTP.

Chart 9: Airline punctuality vs. operating margin –
US 1999

Source: Booze Allen & Hamilton Report

68

Feb'15

Dec'14

Nov'14

Oct'14

Sep'14

Aug'14

Jul'14

The three key parameters to push punctuality are network planning and control, aircraft availability and ground operations and departure process. Jun'14

55

Chart 10: Airline punctuality vs. operating margin
– Europe 1998

InterGlobe Aviation, June 16, 2016

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Higher utilisation compromises OTP
Utilisation and OTP are difficult to achieve simultaneously at higher levels.
There is a tradeoff between one particular way that airlines can reduce cost – namely, increasing aircraft utilisation – and a quality dimension that it is closely related to it –
OTP. With other things being equal, for any airline, reducing unit cost by increasing aircraft utilisation would hurt OTP, due to longer delays. Linking to the notion of closeness to the asset frontier, airlines that are operating close to their asset frontier, in that they are already at a high level of aircraft utilisation, incur a heavier penalty in terms of worsened OTP when they further increase aircraft utilisation, relative to airlines operating further away from their asset frontier.
Additionally, all else being equal, routes with greater capacity flexibility in terms of the ability to swap a different aircraft than the one scheduled for a flight, should incur lower delays, at the same level of aircraft utilisation.
Increasing load factors can also dampen OTP. Due to improvements in revenue management, airlines have made huge strides in increasing load factors over time.
However, since flying fuller planes increases the time needed for boarding, deplaning and ground activities, one would expect that if aircraft utilisation is high, increasing load factor could simultaneously worsen OTP.
As such, one does wonder the sustainability of the 90%-plus PLF pattern of
SpiceJet and the 13hour plus utilization of Jet Airways. They has managed a commendable turnaround and higher asset utilisation along with increase in
PLFs. However, they need to stand guard against another drop in OTP as has happened in the past.

69

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Airport capacity-is there room for IndiGo to grow?
The Indian airports have constraints with some of the airports already running above capacity. However, the overcapacity is in metros like Mumbai, Hyderabad, Pune and
Goa. We have elaborated the same in our sector piece. However, the non-metro tier 2 and 3 cities have enough room to grow. This is best described by mapping the airports which Indigo does not fly now despite being capable of accommodating an A320.

There is enough excess capacity in
Indian airports to absorb incremental
ASK of IndiGo

We have made a route map table for the major domestic airlines in India as shown in table below. The yellow shaded cells indicate cities with more than 10,000 passengers per month (Based on March 16). While most of these cities are covered by Jet/Air
India, there are several cities yet to be covered for IndiGo, SpiceJet and GoAir. This is especially positive for IndiGo, which will tap these markets as it aggressively ramps up its capacity. We have also indicated the cities which are capable of handling an A320
(relevant for IndiGo and GoAir). Airports which are big enough to host an A320 will also be capable to host a B737 (relevant for SpiceJet and Jet Airways).
The upcoming capacity of IndiGo is likely to target these growth cities. Based on the table below, there are 17 cities which have an airport capable of hosting an A320 and where IndiGo has no current flights.

Table 9: Current traffic and capacity of Indian airports (cumulative 90% of the traffic)
Airport
Pax (mn)
Delhi
48.40
Mumbai
41.67
Bangalore
18.96
Chennai
15.22
Kolkata
12.42
Hyderabad
12.36
Cochin
7.75
Ahmedabad
6.48
Pune
5.42
Goa
5.38
Trivandrum
3.47
Lucknow
3.24
Jaipur
2.89
Guwahati
2.78
Srinagar
2.31
Calicut
2.31
Bhubaneshwar
1.89
Visakhapatnam
1.80
Indore
1.69
Coimbatore
1.69
Mangalore
1.67
Nagpur
1.60
Source: Company Data, I-Sec research

Share(%)
21.6
18.6
8.5
6.8
5.6
5.5
3.5
2.9
2.4
2.4
1.6
1.4
1.3
1.2
1.0
1.0
0.8
0.8
0.8
0.8
0.7
0.7

Capacity
60.0
40.0
20.0
23.0
24.0
12.0
13.0
14.0
3.9
4.9
14.0
3.0
8.8
5.5
8.3
6.6
3.5
6.1
6.1
5.5
4.4
9.6

Post expansion
100
50
30
50
20
12
13
6

12
11

Current excess capacity
11.6
(1.7)
1.0
7.8
11.6
(0.4)
5.3
7.5
(1.5)
(0.5)
10.5
(0.2)
5.9
2.7
6.0
4.3
1.6
4.3
4.4
3.8
2.7
8.0

Cumulative Share
21.6
40.3
48.8
55.6
61.1
66.6
70.1
73.0
75.4
77.8
79.4
80.8
82.1
83.4
84.4
85.4
86.3
87.1
87.8
88.6
89.4
90.1

Table 10: Current domestic route map of Indian airlines
Destinations
Chandigarh
Bengaluru
Kochi
Goa
Srinagar
Jammu
Delhi
Jaipur
Ahmedabad
Lucknow
Bagdogra
Guwahati
Kolkata
Hyderabad

70

Jet Airways

Indigo

Spicejet

Go Air

Air India

Vistara

Air Asia

Monthly Traffic
159,138
1,380,333
280,739
449,877
191,332
101,945
3,274,512
244,888
502,893
238,786
108,934
270,479
1,004,200
867,021

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InterGlobe Aviation, June 16, 2016
Destinations
Jet Airways
Indigo
Chennai
Mumbai
Pune
Varanasi
Dehradun
Udaipur
Indore
Patna
Agartala
Vizag
Coimbatore
Trivandrum
Kozhikode
Nagpur
A320
Port Blair
Bhubhaneswar
Leh
A320
A320
Amritsar
Baroda
Bhopal
A320
Khajuraho
Imphal
Raipur
Vijaywada
A320
Madurai
A320
Mangalore
A320
Aurangabad
A320
Ranchi
Jodhpur
A320
Bhuj
A320
A320
Rajkot
Silchar
A320
Aizawl
A320
Rajahmundry
A320
Tiruchirapalli
Dharamsala
Allahabad
A320
Tirupati
Surat
A320
A320
Jabalpur
Dimapur
Dibrugarh
Gorakhpur
Jorhat
A320
Belgaum
Hubli
Pondicherry
Tuticorin
Mysore
Agatti
Agra
Dammam
Diu
Durgapur
A320
Gaya
A320
Gwalior
A320
Jamnagar
A320
Kullu
Lilabari
Pantnagar
Shillong
Tezpur
Source: Company Data, I-Sec research

Spicejet

Go Air

Air India

Vistara

Air Asia

Monthly Traffic
978,593
2,613,920
486,621
150,999
61,628
85,074
138,973
153,546
81,573
163,048
135,720
113,244
31,478
134,060
84,896
175,873
23,431
94,142
80,586
51,782
8,780
79,673
101,443
39,196
60,225
77,597
25,141
66,925
24,972
12,105
30,942
16,301
13,090
19,448
11,915
8,360
3,516
36,778
12,467
10,949
9,530
26,674
5,105
4,342
8,913
3,255
8,264
1,814
1,382
2,717
1,414
6,901
1,204
6,698
1,704
738
1,010
1,105
172

71

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Cost advantage of IndiGo – a deep dive analysis
Bulk orders – genesis of cost advantage
IndiGo’s cost advantage stems from two main strategies of bulk ordering and uniform A320 fleet. Now, bulk ordering would automatically result in a uniform fleet and, as such, we will further analyze the effects of the big bulk orders that IndiGo has made, and then ponder how it was possible to capitalize on the same from the selection of A320 as the aircraft for IndiGo.
IndiGo generates a lot of value through incentives received from Airbus. The incentives decrease the net rentals for IndiGo. Now one may question the sustainability of these incentives, whether they are a part of the core operations of an airline business and how investors should be looking at these payments. To give a fair assessment, IndiGo reported incentives of Rs17.6bn between FY10-FY15, which is almost 47% of its reported PAT during the same time period.
Incentives are a play on aircraft markets, but offers head start value. IndiGo purchases the right to buy aircraft in a bulk order from Airbus with 3-5% of the value as a down payment (which is big for weak balance sheet players). When the aircraft is ready for delivery, IndiGo can trade it to lessors to cash in the difference between the market value of the aircraft and the deep discount value at which it has booked from
Airbus. As such, IndiGo is a play not only on the airline market but also the aircraft asset market and this value capture happens through the incentives which decrease
IndiGo’s rental outgo. However, this asset play has a strategic advantage of the deep discounts that it has received from the OEM, which in turn is a result of the bulk order.
Bulk orders enable a value transfer from airframers to airlines. Bulk orders come with huge discounts to market price. Airframers like Airbus and Boeing depend on big orders to have a committed orderbook and dedicated assembly line, which should have some resistance to the vagaries of global economy and offer discounts to bulk orders where the final price can be 60-70% of the listed price or even lower depending on the order. The desired resistance comes in the shape of upfront payment required for the bulk order, which can be of significant help in the case of order cancellation or postponement. This value which gets transferred to the airlines comes at the simultaneous risk of the asset which is now transferred to the airline. Clearly, the importance of the bulk order cannot be underestimated. Without the bulk order, there is no value in risk interchange because there are no deep discounts.

72

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What if Incentives go down?
The direct relationship between the aircraft value and rentals offers a strategic hedge. The value and risk that was transferred to airlines which placed the bulk order now has another partner in the form of aircraft lessors. These aircraft lessors can now buy the aircraft from the airline and charge rentals. The direct relationship between the aircraft value and rentals would offer a hedge to the airlines in the following ways:


If the aircraft value would have increased between the order and delivery, the asset business of the airline would have given a very good value (deep discounts plus the market driven increase in asset value over time); partially offset by the airline business, which now has to pay higher rentals for a higher value asset.



If aircraft value would have decreased, to offset the entire strategic value of the discounts that was received from the bulk order, the asset business would have given a negative return, but the airline business will be the beneficiary from lower rentals, in line with lower asset price.



There is also a third case of a middle ground where there would be partial value from the asset business and partial value from the airline business when the drop in aircraft value is not enough to entirely offset the original discounts. This is the most likely case for IndiGO

Hence, these incentives are to be taken into account for value assessment as they reflect the value captured during the time of ordering of the aircraft, which can manifest itself through lower rentals and lower incentives, or a higher rental and higher incentives, in either of which there is value for an airline like IndiGo. It should however be clear that while the incentives will be received with each new delivery of aircraft, the value outgo through rentals will happen over the tenure of the lease.
This strategic hedge has been giving a positive return to IndiGo. Having established the benefits of a strategic hedge with the bulk orders, there is another value judgment to be made on the dynamics of a particular aircraft in a lessor market vis-a-vis an aircraft owner market. The extent of rise in asset value may not be similar to increase in rentals for each aircraft. IndiGo has been able to select its aircraft of choice, the A320family, which has given it the perfect result. The net effect has been an advantageous disposition with regard to incentive-adjusted rentals.

73

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Incentives will continue to provide cost arbitrage
The incentives are accumulated as earned in the balance sheet as deferred incentives under liabilities. The offsetting amount is usually cash, often netted against capital expenditures. This deferred incentive is amortized over the period of the lease in the profit and loss statement.
Now, these incentives would depend upon two heads: 1) the increase in aircraft value during the period between order and delivery, and 2) the discount that Airbus had offered to IndiGo.
Based on our positive assessment of IndiGo’s A320neo aircraft, we believe that incentives will remain significant for the company. While the value of A320neo should increase as next-gen aircraft demand increases, discounts will also increase as IndiGo has made successive big orders totaling 430 aircraft and is the largest customer of
Airbus. This will play out mostly with a high oil price outlook
However, we have factored incentives to go down. Compared to FY10-15, when the total incentive was 47% of the total Pat, we factor that the total incentive benefit will only constitute 13% of the total PAT between FY17-20. However, does it matter? We believe not. This is simply because that the entire incentive led earnings are incremental, much like a bonus to the basic cost structure when compared to the domestic peers of IndiGo. Secondly, that goes down also implies a lowering of the asset value of Neos. This in turn will again have a relief from lower rentals in line with lower value, which we have already discussed earlier in regards to how this offers a strategic hedge to IndiGo.
It is but ironical to mention here that the probable value erosion of IndiGo through lower incentive is based on a lower oil price scenario, which is the biggest positive for airlines as such.
Table 11: Incentive modeling for IndiGo
(Rs mn)
Deferred Incentives at beginning Amortized in P&L
Added in the year
Deferred Incentives at end
Net Aircrafts added
Aircrafts added through short term lease
Aircrafts Retired
Aircrafts added from Airbus
Increase in Incentives per addition (Rs mn)
Increase in
Incentives
per addition (US$ mn)
Amortized incentive per weighted fleet(US$ mn)
Source: I-Sec research

74

FY11

FY12

FY13

FY14

FY15

FY16E

FY17E

FY18E

FY19E

FY20E

5,680
(2,274)
3,493
6,899
14

6,899
(2,627)
7,532
11,804
16

11,804
(3,588)
7,088
15,304
11

15,304
(3,607)
5,836
17,533
11

17,533
(3,553)
3,537
17,516
17

17,516
(3,566)
1,882
15,832
13

15,832
(4,447)
6,716
18,101
28

18,101
(5,271)
3,242
16,072
14

16,072
(5,961)
4,632
14,742
20

14,742
(6,778)
4,632
12,596
20

10

3

14

20

20

14

16

11

11

7

10

7
8
29

250

471

644

531

505

188

232

232

232

232

5.5

9.8

11.8

8.8

8.3

2.9

3.5

3.5

3.5

3.5

1.6

1.2

1.1

0.8

0.7

0.5

0.5

0.6

0.6

0.6

ICICI Securities

InterGlobe Aviation, June 16, 2016

Cost Comparison across competition-IndiGo has an edge
Lowest cost metrics among Indian airlines players offers a definitive advantage to IndiGo. We start at each major operating cost heads analyzed over FY10-FY15, wherein we will see that IndiGo has the maximum advantage, which stems from the uniform, large and lowest-age fleet size, consolidated by the experienced management and the near-perfect implementation of the low-cost no-frills model.
Combining the operational costs, we present our summary in two divisions, operating cost ex-rentals, and total operating cost with rentals. The rental costs also include the interest liability of finance leases to give a complete picture. While calculating cost with rentals we have adjusted for the leasing revenue of Jet Airways. We have also not taken depreciation, which is normally included in CASK calculation for airlines.
Chart 11: Total operating cost comparison without rentals Jet CASK ex rentals
Indigo CASK ex rentals

Chart 12: Total operating cost comparison with rentals Spicejet CASK ex rentals

Jet CASK with rentals
Indigo CASK with rentals
0.080

0.065

0.075

0.060

0.070

0.055

0.065

(US$)

0.085

0.070

(US$)

0.075

Spicejet CASK with rentals

0.050

0.060

0.045

0.055

0.040

0.050

0.035

0.045

0.030

0.040
FY10

FY11

FY12

Source: Company data, I-Sec research



FY13

FY14

FY15

FY10

FY11

FY12

FY13

FY14

FY15

Source: Company data, I-Sec research

Net rentals are lower for IndiGo not only on the back of incentives. Incentives are an essential part of the IndiGo business model, which we have already illustrated in our earlier sections. However, it is not the only reason for the lower rentals. IndiGo does manage lower yields on its finance leases and manages to better utilize the aircraft leading to lower rentals per ASK. To prove our point, we have shown the rental cost per ASK on a comparative basis, with and without incentives. The rental cost of IndiGo per ASK remains lowest even without incentives. We calculate the rental cost taking into consideration the interest borne on financial leases along with the operating lease rentals paid out as a part of operating expenditure. The operating lease rentals include the normal expense and supplementary lease charges which depend upon the kilometers/hours flown in line with the contract with lessors. While IndiGo does not share the supplementary rentals separately, it is considered under maintenance costs for both SpiceJet and Jet. It is important to consider the cost head in USD terms as the payments are mostly denominated in them.
On an intuitive basis, IndiGo has the youngest fleet and no regional aircraft like SpiceJet/Jet Airways has, and no major long-haul operations like Jet, which should have resulted in higher rentals per ASK. Yet, the difference in
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rentals are stark even if we compare it on ASK basis. The answer lies in the supplementary rentals, which are basically contribution towards maintenance reserves. We have discussed it in detail in our next section.
Table 12: SpiceJet rental cost analysis
SpiceJet
Lease charges
Supplementary Lease Charges
Total Charges
Average Aircraft
ECB outstanding
ECB in US$ mn
Estimated ECB interest in US$ mn
Estimated ECB interest in Rs mn
Total Rental (operating rentals + financing interest)
Rental per aircraft
Rental per aircraft
(SpiceJet, US$ mn)
ASK(mn)
Rentals per ASK(SpiceJet, US$)
Source: Company data, I-Sec research

FY10
3,898
1,459
5,357
20
-

FY11
4,285
1,687
5,972
23
-

FY12
6,019
2,473
8,493
33
6,149
120
4.8
231

FY13
8,081
3,244
11,325
46
13,506
248
7.4
401

FY14
10,532
4,245
14,777
54
13,572
226
9.5
573

FY15
8,644
3,340
11,984
42
13,430
215
8.8
539

5,357
275

5,972
261

8,723
268

11,726
255

15,350
287

12,523
301

5.79
8,770
0.0129

5.72
10,467
0.0125

5.60
13,730
0.0132

4.69
16,106
0.0134

4.74
18,494
0.0137

4.93
14,541
0.0141

Table 13: IndiGo rental cost analysis
IndiGo
Rentals
FL charges
Total Charges
Average Aircraft
LT Finance Lease Liability
LT Finance Lease Liability (US$ mn)
Interest (mn US$)
Interest (mn Rs)
Rental per aircraft
Rental per aircraft(US$ mn)
IndiGo Incentive
IndiGo Incentive per aircraft
Net Rental per aircraft (IndiGo, US$ mn)
ASK(mn)
Rentals per ASK(IndiGo, US$)
Source: Company Data, I-Sec research

FY10
4,704
88
4,792
22
6,205
131
2
88
218
4.59
1,941
1.86
2.73
9,286
0.0065

FY11
6,372
300
6,673
32
7,416
163
7
300
209
4.58
2,274
1.56
3.02
12,491
0.0077

FY12
10,634
313
10,948
47
7,940
166
7
313
233
4.86
2,627
1.17
3.69
18,006
0.0096

FY13
17,150
364
17,514
61
14,421
265
7
365
289
5.32
3,588
1.09
4.23
24,977
0.0102

FY14
20,310
827
21,137
72
30,407
503
14
827
296
4.89
3,607
0.83
4.05
29,967
0.0097

FY15
23,076
929
24,005
86
36,261
593
15
928
281
4.59
3,553
0.68
3.91
35,327
0.0095

Table 14: Jet airway rental cost analysis
Jet
Aircraft and Engine Lease Rentals
Aircraft and Engine Variable Rentals
Revenue -Aircraft/Engines lease
Average Jet Fleet Size
Jet Lite fleet Size
Total Fleet
LT Finance Lease Liability
LT Finance Lease Liability (US$ mn)
Interest (mn US$)
Interest (mn Rs)
Total rental
Rental per aircraft
Rental per aircraft(Jet, US$ mn)
ASK(mn)
Rentals per ASK(Jet, US$)
Adj. Rentals per ASK(Jet, US$) (ex lease revenue)
Source: Company data, I-Sec research

76

FY10
11,591
2,296
7,177
86
25
111
93,739
1,977
79
3,750
17,637
159
3.36
34,398
0.0108

FY11
11,452
2,146
5,172
90
19
109
83,202
1,826
76
3,466
17,063
157
3.44
39,804
0.0094

FY12
12,050
3,211
4,521
98
19
117
82,555
1,722
71
3,402
18,663
160
3.33
44,472
0.0088

FY13
15,260
5,985
5,056
95
15
110
68,747
1,263
60
3,249
24,494
223
4.09
41,994
0.0107

FY14
20,899
11,474
6,872
93
12
105
59,994
992
45
2,727
35,100
334
5.53
42,001
0.0138

FY15
21,725
7,739
9,322
94
9
103
51,859
848
37
2,251
31,714
308
5.04
44,796
0.0116

0.0064

0.0066

0.0066

0.0085

0.0111

0.0082

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Chart 13: IndiGo has the lowest net rentals per aircraft 7.0

Adj. Rentals per ASK(Jet, US$)(ex lease revenue)
Rentals per ASK (Spicejet, US$)
Net Rentals per ASK(Indigo, US$)

Rental per aircraft(Jet, US$ mn)
Rental per aircraft (SpiceJet, US$ mn)
Net Rental per aircraft (Indigo, US$ mn)

6.5

Chart 14: IndiGo has lower net rentals than
SpiceJet, Jet is lowest due to long hauls

0.0150

6.0
5.5

0.0130

5.0
0.0110

4.5
4.0

0.0090

3.5
0.0070

3.0
2.5

0.0050
FY10

FY11

FY12

FY13

FY14

Source: Company data, I-Sec research

Jet Airways has managed to increase its rentals per ASK even with the longhaul operations as more and more narrow body aircraft are put in international operations and some of the older wide body aircraft are leased to other airlines. We have adjusted the rentals cost of Jet with the lease income it has received.

FY10

FY15

FY11

FY12

FY13

FY14

FY15

Source: Company data, I-Sec research

Chart 15: Even ex incentives, IndiGo has lowest rentals in the past two years
Rentals per ASK(Jet, US$)

Rentals per ASK (Spicejet, US$)

Gross Rentals per ASK(Indigo, US$)
0.0150
0.0140
0.0130
0.0120
0.0110
0.0100
0.0090
0.0080
0.0070
0.0060
0.0050
FY10

FY11

FY12

FY13

FY14

FY15

Source: Company Data, I-Sec Research

Chart 16: Maintenance cost per ASK for IndiGo remain lowest
0.010

Jet Airways

Chart 17: Average age of fleet as in FY15
10

SpiceJet

0.008

8

0.007

7

0.006

8.9

9

6

(US$)

(Yrears)

0.009

5.9

5

0.005

4

0.004

4.1

3.9

3.2

2.7

3

0.003

3.9

2

0.002

1

0.001

0

0.000

Indigo Spicejet
FY10

FY11

FY12

Source: Company data, I-Sec research

FY13

FY14

FY15

Jet
Go Air Air India Air Asia
Air
Airways
Costa

Source: Company data, I-Sec research

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Landing, Navigation and airport charges lower for IndiGo. These, being dependant on number of airports used by the airline, should have been significantly higher for IndiGo than SpiceJet. However, IndiGo has managed to attain economies of scale to bring it down on per ASK basis. It will also depend on the route dispersal guidelines factoring the airport charges at various Category-I, Category-II/IIA and
Category-III airports. Yet, uniform fleet would offer some advantage with navigation software charges. Ideally, these should have been lower for SpiceJet since the reqgional feet/turboprops enjoy lower charges than bigger jets.
These costs include landing charges, route navigation facility charges, terminal navigation landing charges, parking and housing charges, X-ray charges and CUTE charges (at CUTE-enabled airports). Airport-related charges are typically payable to the AAI or the operator of the airport. Airport charges are fixed by various airport operators and are primarily determined on the basis of number of passengers carried, aircraft weight and type of airport (domestic or international).
Chart 18: Landing, navigation and airport charges per ASK.
0.400

Jet Airways

Spice Jet

Indigo

FY12

FY13

0.350

(Rs)

0.300

0.250

0.200

0.150
FY10

FY11

FY14

FY15

Source: Company data, I-Sec research

Redelivery expenses, the bane of short-term operating leases and disadvantaged contracts. Airlines have in their fleet aircraft on operating lease. As contractually agreed under the lease agreements, the aircraft have to be redelivered to the lessors at the end of the lease term under stipulated technical conditions. Such redelivery conditions entail costs for technical inspection, maintenance checks, repainting costs prior to its redelivery and the cost of ferrying the aircraft to the location as stipulated under the lease agreement. These costs are estimated by management based on historical trends and data, and recorded in the financial statements in proportion to the expired lease period.
Table 15: Redelivery expense closing provision comparison
Closing Balance (Rs mn)
FY10
IndiGo
51
Jet Airways
628
SpiceJet
Source: Company data, I-Sec research

FY11
84
580

FY12
86
738

FY13
121
704

FY14
203
1,526

FY15
283
1,901
2,227

SpiceJet did not maintain any closing provision of redelivery expense prior to FY15.
However, in its FY15 annual report, it provided for Rs 2.2bn out of which Rs2.1bn was on account of early termination of aircraft lease. SpiceJet also expensed Rs3.2bn as
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operating expenses in FY15 and Rs291mn in FY14 as aircraft redelivery expense, suggesting similar expenses in the past, clubbed with other expenses. In 9MFY16,
SpiceJet expensed Rs364mn. However, it has also written back some of the provisions related to early termination of the Boeilng leases as a result of negotiations, which amounts to nearly Rs740mn in 9MFY16. Still, the construct of poor aircraft management, a lot of which emanates from historical bad decisions and financial constraints, gets across clearly.
This high redelivery expense has resulted in high outgo of SpiceJet and Jet Airways compared to IndiGo. This is a result of optimal duration of operating leases, avoiding the critical inspection periods and using new aircraft for operations, which IndiGo has done resulting in serious savings. The softer aspects of better aircraft management will involve management expertise, quality of recruits and the employee strength, which again is our next cost heading.
The importance of redelivery cost is futher accentuated considering that almost 90% of the same is incurred in foreign currency.
IndiGo remain cost leader on employee costs as well, with further economies expected. The flexibility of deploying workforce among the same aircrafts gives a definitive edge as pilots operate a particular aircraft alone. IndiGo again is a cost leader in this front.
Chart 19: Employee cost per ASK
0.60

Jet Airways

Spice Jet

FY12

FY13

Indigo

0.55
0.50

(Rs)

0.45
0.40
0.35
0.30
0.25
0.20
FY10

FY11

FY14

FY15

Source: Company data, I-Sec research

If we assume a steady 100-110 employees per aircraft, IndiGo has a employee base of 900-1,000 extra reserve, which includes the non-flight workforce. Assuming a historical average of 250 such personnel, IndiGo currently has 750 extra employees, which is likely to be deployed over the new A320neos. As such, the employee cost per
ASK is likely to come down. On the other hand, this non-flight workforce has come down for SpiceJet from 250-300 in FY10-11 to 30 in FY15, understandably as its fleet got depleted in FY15 and severe cost cutting ensued. SpiceJet will have to increase it further in coming years indicating a cost pressure in the offing. Employee costs form a significant ~10% of airline revenues with per employee salary per annum in the range of ~Rs1.2mn.

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However, the A320neo has a different engine than A320 and there are other differences that require additional training for operating crews and engineering staff.
There are new pylons, new wing structures and minor changes to the electrical and pneumatic systems. The crews have to undergo training to cover for all the differences and this will mean additional cost for IndiGo.
Fuel cost per ASK will further improve post induction of neos Fuel cost per ASK is entirely dependent on the global oil prices. However, with the introduction of neos, which supposedly should have 15% improved oil efficiency, IndiGo is likely to perform better than the rest.
In the recent conference call of Indigo, the management confirmed fuel savings of
13% being achieved with the already existing Neo aircraft in operations.
Chart 20: Fuel cost per ASK
Jet Airways

0.04

Spice Jet

FY12

FY13

Indigo

0.04
0.03

(US$)

0.03
0.03
0.03
0.03
0.02
0.02
0.02
0.02
FY10

FY11

Source: Company data, I-Sec research

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FY15

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Supplementary rentals is another important cost differential

While the maintenance reserves are strictly implemented on most airlines, many airlines have sufficient credit stature and prominence in the marketplace by which means they can reject paying maintenance reserves. Does it imply that
IndiGo may get away with lower supplementary rentals compared to its peers? We think so.
This can be one of the key factors that allows
IndiGo to pay overall lower money despite using considerably new aircraft.

Genesis of maintenance reserves lies in risk mitigation of lessors. Most operating leases provide that the lessee is liable for the ongoing costs related to maintaining an aircraft to the required standard. In the event that an aircraft is repossessed due to a default by the airline, the aircraft may require expensive investment in outstanding maintenance work before it is in a condition to be re-leased or sold to another airline/investor. Therefore, a lessor's primary risk in relation to maintenance is one where the lessee fails to pay, in whole or in part, for the maintenance utility it consumed. To mitigate maintenance exposure, most lessors have independent credit departments to evaluate the creditworthiness of lessees. Evaluation of an operator's credit standing generally involves the establishment of some financial test, the failure to meet which would invoke an obligation to establish more stringent collateral security in the form of security deposits and payment of maintenance reserves. Hence, maintenance reserves are payments made by the lessee to the lessor to accrue for those scheduled major maintenance events that require significant aircraft grounding time and/or turnaround time for certain major component overhauls. Put another way, maintenance reserves are payments for maintenance utility consumed.
Mathematically, Full-life Maintenance Value = Maintenance Utility Consumed +
Maintenance Utility Remaining, or Full-Life Maintenance Value = Maintenance
Reserves + Maintenance Utility Remaining, which understandably indicates that
Maintenance Reserves = Maintenance Utility Consumed.
Maintenance costs can generate cost asymmetry. Maintenance reserves are often the most contentious part of a lease negotiation; the lessor views reserves as a costcovering exercise, while the lessee views it as a burden on cashflow resources.
However, it is not this burden which is of the only interest. There is a differential in the levy of these maintenance reserves. While the maintenance reserves are strictly implemented on most airlines, many airlines have sufficient credit stature and prominence in the marketplace by which means they can reject paying maintenance reserves. Does it imply that IndiGo may get away with lower supplementary rentals compared to its peers? We think so. This can be one of the key factors that allows
IndiGo to pay overall lower money despite using considerably new aircraft.

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Lowest cost structure enables lowest fares
As hinted earlier, in a price-based competitive industry, it is but important to check the lowest airfares and which airline is offering them. We based our search on three categories of routes, metro to metro, metro to non-metro and non-metro to non-metro.
We also check for time distribution, with time zones spread up to 2-4 months horizon.
This is a direct advantage of better cost structure for IndiGo
Table 16: IndiGo is the lowest fare provider most of the time
Delhi-Mumbai

Mumbai-Nagpur

Cochin-Chandigarh

Metro to Metro – key highlights of the fare distribution Metro to Non metro-key highlights of the fare distribution

Non-Metro to Non-Metro

In the next 6-week window

The fare dispersion is very low compared to a metro to metro route

No deductible algorithm

Very little to choose between IndiGo and
SpiceJet who offer the lowest fares, while Jet and Air India have a little higher rates in line with in flight amenities provided by them.

Some of the players are not present, for example SpiceJet is not present in Bombay
Nagpur route

Jet has the lowest fare for a brief time period

The companies tend to capitalize during the long weekend of Holi in end-March.

IndiGo, again, offers the lowest fare

Air India, GoAir has low fares for significant time GoAir has comparatively higher rates than
IndiGo/SpiceJet

The only standalone high fare airline is Jet, but a low dispersion results in lower difference in fares

IndiGo is mostly the second lower but lowest on certain time periods as well

During the 7-15 week window
Air India charges are typically much lower than
Jet Airways
The lowest fares are held by SpiceJet, IndiGo and Air India
GoAir is at the lower end, but does not offer the lowest fares
The lowest fare is held by different entities within the time spectrum, initially by SpiceJet, followed by indigo and later joined by Air India
In the 16 to 25 week window
The lowest fares are consistently held by
IndiGo and Air India.
GoAir offers lower fare than SpiceJet
SpiceJet is only lower than Jet on this window
Source: Cleartrip, I-Sec research

We have also illustrated the fare distribution below only for Delhi-Mumbai route spread across timelines.

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Chart 21: Mumbai Delhi Fare in the next 5 weeks as of March16

Chart 22: Mumbai Delhi Fare in June 16 as of March16

Chart 23: Mumbai Delhi Fare in July 16 as of March 16

Chart 24: Mumbai Delhi Fare in Aug 16 as of March 16

Source: Cleartrip

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The A320neo advantage of IndiGo
In this section, we discuss the value proposition of A320 neo, which is the aircraft of choice for IndiGo. The importance of the market for A320 neo lies in the asset play which IndiGo offers through its bulk orders. We believe that A320 neo is one of the most popular aircraft and offers safe value to IndiGo. IndiGo has clearly gained a structural advantage with the high order book of 430 neos. We believe that the next generation aircrafts like neo and max are going to rule the aircraft market in coming future.


Dominance of neo/max in order book.60% of the order backlog is dominated by next generation aircrafts like neo and max, with neo having a significant larger orderbook than max. In value wise, the share of next generation aircrafts are even larger at around 70%. As such, neo is likely to be one of the most liquid aircrafts in the near future. However, the transition to the next gens can still be accompanied with lot of issues as history has shown us. Yet, one has to keep in mind that the
A320 ceo and neo are likely to retain the similar fuselage and may have a relative easy transition.

Chart 25: Next generation dominating the backlog

Current generation ($590 bn)
4918
40%

New generation ($275 bn)
7444
60%

Source: Ascend

Source: Ascend



84

Chart 26: Transitioning to next generation; orderbook details

No available slots for fresh orders of neo/max available for the next 5 years.
There will be a couple of years through which the manufacturing lines of Boeing and Airbus completely transform to the next gen airframes. Post that, there is no free single aisle open slots available for 5 years indicating someone who has not yet ordered is likely to resort to lessors for neo/max. Higher demand will generate higher value.

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Chart 27: Single-aisle demand largely committed over next five years

Chart 28: Aircraft leasing penetration by class

Source: Ascend

Source: Ascend



Burgeoning lessor market now almost 45% of the current fleet size. Higher lessor market result in higher values for lessor friendly aircrafts and A320 neo has the right parameters for the same. For one, lessors prefer single aisle narrow body aircrafts as they offer lower risk with their inherent lower value and they gain higher share among the LCC markets. Around 50% of the single aisle fleet is being managed by operating lessors compared to 30% for that of twin aisle aircrafts. Secondly, higher number of operators increases liquidity and lessor acceptance, thus pushing up the aircraft value. A320neo has the highest order book. Chart 29: Backlog as a % of fleet
In the recent conference call of
Indigo, the management underlined a 13% savings in fuel recorded by Neos.
The point that we strive to make is that even in a situation of an asset bubble resulting from such high aircraft orderbook, the nextgen aircraft with their popularity among operators and cost efficient features are likely to have the least value erosion.

Source: Ascend

There are certain risks though; including supply chain challenges post the transition to next generation aircrafts. Significant decline in oil prices which render the increased rentals of next generations futile compared to the benefits from fuel efficiency and increase in interest rates which typically favor mid-life aircrafts with lower value more attractive. However, the benefits are likely to outweigh the risks. Essentially, in due time, these neo will offer an additional cost advantage, something which is of the paramount importance in a price driven industry.
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The fuel factor- Neos will provide another cost differential in time
The greatest sensitivity to the airline model is that of passenger fares. The passenger fares in turn depend on the fuel prices, passenger growth and competition. Typically, the fares vary with fuel prices. The airlines pass some of the benefits of low oil prices to the passengers and similarly pass some of the increase in case of rising fuel prices. As such, the correlation of fares and fuel prices is only modestly positive (~0.5). We did an exercise on the top-100 domestic routes in the US for the past 20 years based on the average fare and the fuel prices and found that the correlation between average fares and fuel prices to be 0.5, indicating an indecisive relation. While there are other factors to be considered, such as hedging practices, we derive an interesting observation of rather sticky fares in the wake of falling crude prices. It can be seen that while increasing fuel price scenario has forced average fares to rise, fall in crude prices have not seen equally enthused fall in fares. The two periods of fall in crude prices (199699) and (2014-current) have seen sticky fares. This can be attributed to the opportunistic profit booking tendency enjoyed by airlines in the wake of falling crude prices and inability of some airlines to take fare cuts due to hedged positions. This raises a question of the extent of fall in fares that Indian markets can witness in this falling crude price atmosphere. A key difference between Indian and US airlines is that the latter is quite matured and has gone through a series of consolidations to achieve a more predictable and steady state of affairs. Hence, with high competition in a growing market, Indian airlines are likely to cut the fares and pass some benefits of low crude prices to the consumer to gain some market share.
Chart 30: Trend of fuel prices and average fares – indecisive correlation
Fare (US$/mile)

Fuel Price, RHS
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0

0.115
0.110
0.105
0.100
0.095
0.090
0.085
0.080
0.075
0.070

1996-Q1
1996-Q4
1997-Q3
1998-Q2
1999-Q1
1999-Q4
2000-Q3
2001-Q2
2002-Q1
2002-Q4
2003-Q3
2004-Q2
2005-Q1
2005-Q4
2006-Q3
2007-Q2
2008-Q1
2008-Q4
2009-Q3
2010-Q2
2011-Q1
2011-Q4
2012-Q3
2013-Q2
2014-Q1
2014-Q4
2015-Q3

The correlation between fares and fuel prices is 0.5, based on the domestic US air traffic data for the past 20 years.

Source: Bureau of Transportation Statistics, USA

Indigo has indicated a fuel saving of 15% achievable with the neo fleet. We factored
12-13% fuel savings over a 3 year period. In the recent conference call, the company affirmed that the delivered neos have been 13% more efficient from the current A320 ceo fleet.

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Strength of the balance sheet is a key strategic advantage for IndiGo
Table 17: Balance sheet comparison across major airlines
SpiceJet FY16
(Rs mn)
Net Worth
(6,316)
Gross Debt
12,882
Cash
1,085
Net Debt
11,797
EBITDA
4,322
Net Debt to EBITDA
2.73
Net Debt to Equity
NM
Source: Company data, I-Sec research

Jet FY16
(52,104)
114,210
19,881
94,329
22,361
4.22
NM

Air India-FY14
(166,466)
484,095
6,566
477,530
(55,344)
NM
NM

Indigo FY16
18,238
57,431
61,836
(4,405)
30,055
(0.15)
(0.24)

Balance sheet strength is one of the structural reasons that have made it possible for
IndiGo to make those big orders. Apart from the deep pocket which can help undercut competition, the characteristic big orders from IndiGo require significant upfront cash.
IndiGo has relied on cash from internal accruals and borrowings to finance the aircraft pre-delivery payments under the 2011(part) and 2015(all of it) aircraft purchase agreements with Airbus.
From a cost perspective, imported fuel is much cheaper than domestic fuel on account of taxes. However, imported fuel payment happens in advance and will not enjoy credit facilities as with domestic suppliers. Hence, imported fuel procurement capability is also dependent on the liquidity position of the company – again an advantage for IndiGo.
Working capital remains non-issue. With advanced payment structure of passenger tickets, IndiGo has negative working capital days and no working capital debt. This is one of the strengths in the general airlines business model. IndiGo has generated sufficient cash through its operations to provide for working capital requirements. The company also has a number of fund-based working capital financing facilities totaling
Rs1,500mn which remain undrawn. The company has mentioned its liquidity position has consistently enabled it to get supplier discounts.
Table 18: Working capital details of IndiGo
FY10
(Rs mn)
Net Working Capital
(4,971)
Inventory days
6
Receivable Days
3
Other current Assets
6
Other Current Liabilities
41
Payable days
11
Source: Company data, I-Sec research

FY11
(6,002)
5
2
6
37
10

FY12
(10,410)
2
3
5
48
10

FY13
(14,310)
2
3
4
41
11

FY14
(18,015)
2
3
5
44
13

FY15
(19,621)
4
3
7
41
12

FY16E
(22,881)
4
4
9
41
17

FY17E
(29,763)
4
3
7
42
17

FY18E
(34,618)
4
3
7
42
17

Component cost accounting to result in higher depreciation, but lower volatility in R&M costs: IndiGo has started component cost accounting effective Apr’15. Now the major inspection cost related to engine and aircraft components and other heavy maintenance are identified as a separate component for aircraft on finance lease and depreciated over their expected life between major overhauls estimated to be in the region of
4-12 years. This has resulted in higher depreciation compared to the previous years when component accounting was not mandated. So, prior to component accounting, all the major repairs, etc. would be taken as and when they incurred pertaining to aircraft on finance lease. Effective 1-Apr’15, post adoption of component accounting, the company will identify these major repairs, set them up as a component and depreciate it over a period of 4-12 years, which means that in the future, as and when the company incurs these costs, it will be capitalizing it and then depreciating it over the same 4-12 years period.

87

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InterGlobe Aviation, June 16, 2016

RoCE to remain attractive even adjusting for operating leases
Table 19: IndiGo profitability / return ratios without adjusting for operating leases
Return/Profitability Ratio (%)
Recurring Net Income Margins
RoCE
RoNW
Dividend Payout Ratio
EBITDA Margins
Source: Company data, I-Sec research

FY10
18.4
33.1
166.3
20.4

FY11
15.1
34.6
564.0
99.4
18.6

FY12
2.5
5.2
57.8
0.9

FY13
8.5
25.0
201.4
82.2
9.7

FY14
4.3
8.5
112.5
93.4
4.6

FY15
9.4
23.6
306.0
96.4
13.4

FY16E
12.3
29.5
109.1
77.6
18.6

FY17E
10.3
27.9
68.4
33.9
15.9

FY18E
13.1
35.3
58.5
22.5
19.1

Though these return ratios look very attractive, one must not forget the asset-light model of leasing in airlines. Equating the rental outgo in an operating lease as an interest expense towards asset acquisition, the RoEs should not change in principle.
RoEs would remain high on the back of an extremely high leveraged business.
However, the comparison is different in case of RoCE. The operating lease rentals should be added back to EBIT, while the equivalent asset should be added to capital employed. In a growing phase, when an increasing number of aircraft are being acquired, equivalent asset can be estimated at 7x/8x the current rental (operating
+finance). So, while the finance lease asset is already factored in the assets, we add
7x operating lease rentals to the assets to derive adjusted RoCEs in line with the global practice for equivalent debt estimation.
While the rentals paid by IndiGo will be mostly long-term operating leases (5-7 years), it does have 12 aircraft on short-term operating leases, which will be retired with the addition of neos. So, basing debt estimation on 7x the current operating rentals will have an upward bias since typically short-term leases are higher and will not have the benefits of incentives likely from neos. Even if we adjust for the off balance sheet assets under operating lease, the company would retain attractive RoCEs (20%).
Table 20: RoCEs post adjustment for operating leases
FY10
(Rs mn)
Total Assets
16,517
7x gross operating rentals
32,927
Total adjusted asset
49,443
EBIT
5,468
Adding gross rentals
4,704
Adjusted EBIT
10,171
Adjusted RoCE
20.57
Source: I-Sec research, Company data

FY11
21,976
44,607
66,583
7,597
6,372
13,970
20.98

FY12
24,476
74,441
98,917
1,263
10,634
11,898
12.03

FY13
41,884
120,047
161,930
10,451
17,150
27,601
17.04

FY14
69,834
142,172
212,006
5,962
20,310
26,272
12.39

FY15
83,154
161,529
244,682
19,621
23,076
42,696
17.45

FY16E
100,321
207,812
308,134
29,638
29,687
59,326
19.25

FY17E
113,454
283,808
397,261
31,684
40,544
72,228
18.18

Chart 31: Lease-adjusted RoCE for IndiGo
Adjusted RoCE

30
25

(%)

20
15
10
5
0
FY10

FY11

FY12

FY13

Source: Company data, I-Sec research

88

FY14

FY15 FY16E FY17E FY18E FY19E FY20E

FY18E
133,062
317,931
450,993
47,036
45,419
92,455
20.50

InterGlobe Aviation, June 16, 2016

ICICI Securities

Average fares will move up with crude
Low fuel prices have already been captured in the falling average fares. IndiGo has seen an average fare decline of 14% in FY16. We factor an average fare of
Rs4298 in FY17 (gain of 2% Y-Y) and Rs4427 in FY18 (increase of 3% Y-Y). This is against a backdrop of rising crude price assumption of US$55/60 per barrel in
FY17/FY18 respectively. We assume a constant INR/USD assumption of 67 and no change in the current tax structure. We are factoring the higher excise duty of 14% on
ATF as introduced in the FY17 Union Budget.
Why do we believe that there is a case for rising fares in FY17-18E? Yes, the crude prices will remain under a low bias, but the current prices have already factored that. Hence, as crude steadily increases back, the average fares will also increase.
Secondly, there will be case for dropping profitability of airlines like SpiceJet, Jet and
GoAir with increasing crude prices which will force them to take price hikes. The limiting condition of airline fares has to be the profitability of the weaker airlines. IndiGo is likely to benefit from the same. Last, but not the least, the intrinsic growth of Indian aviation sector should easily accommodate 5-10% passenger fare hikes as verified by our domestic passenger capacity model coupled with the already constrained metro routes. Our domestic supply demand model shows implied growth rate of 14%. The average fare is a key determinant of profits for an airline, but it depends on two key factors of crude and competition. While we have discussed crude, another parameter is the competition. Our supply demand model of domestic air traffic in India has a consolidated average growth of 14% over the next four years. This is the implied growth rate based on the capacity addition program of domestic airlines. This model accounts for all the operating airlines in India along with the planned capacity addition and hence reflects competition. We have already established the fact that barring a perilous way of short term operating lease/wet lease, the capacity addition options are fairly limited. Another constraint will be the fact that the PLFs typically tend to be stable or modestly increasing at an aggregate level, thanks to the modern day yield management practices adopted by airline industry. Therefore, when we arrive at an average industry growth of 16% with increasing PLFs and factoring all the capacity additions, it is but the implied growth rate of the system.
Actual growth would likely outrun this implied growth rate indicating increase fare trajectory. This implied growth rate of 14% is low considering that the average annual growth rate of passengers in India has been more than 20% since 2000 excluding three years of the 2001-02 US terrorist attacks and subsequent global crisis, the great 2009 financial recession and 2012 when Kingfisher went bankrupt.
Hence at an implied growth rate of 14% and an incrementally increasing oil price scenario, our average air fare growth of 2-3% for IndiGo over FY17/18E is conservative. 89

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InterGlobe Aviation, June 16, 2016

Sensitivity analysis

It is only at the levels of US$70/bbl, that
IndiGo target prices recede below
Rs1,000 per share, keeping fare growth constant. Combined factors of crude and currency: The sensitivity of airlines will largely depend upon the fares which is again a function of several external factors like competition and demand. However, the two factors which are external but significantly determine the results of airline operations are crude prices and currency. Typically, currency has a ripple effect across cost items starting from rentals, maintenance contracts, redelivery expenditure as well as crude. As such, while it is less volatile than crude, it has higher sensitivity to currency.
Table 21: The sensitivity of Target Price with Crude and INR
TP
45
50
Crude
55
(US$/bbl)
60
65
70
Source: I-Sec Research

64
1,687
1,600
1,513
1,426
1,339
1,251

(Rs)
66
1,616
1,527
1,437
1,347
1,257
1,167

68
1,546
1,453
1,361
1,268
1,176
1,083

70
1,441
1,344
1,247
1,150
1,054
957

72
1,370
1,271
1,171
1,072
972
873

Combined factor of crude and passenger fare: The sensitivity shows high dependence of the airline business model on passenger fares. This reflects the high operating leverage nature of the airline business which has high fixed costs, including lease and other aircraft acquisition charges, engineering and maintenance charges, financing commitments, staff costs and IT costs. Significant operating expenses, such as airport charges, do not vary according to passenger load factors.
Table 22: Sensitivity of crude and passenger fare growth (FY18E)

The number of instances where
Target Price goes below Rs1000 significantly increases indicating the high sensitivity to fare hikes.

TP
-10%
-5%
Fare Growth
0%
(%)
3%
5%
10%
Source: I-Sec Research

45
977
1,196
1,415
1,546
1,634
1,853

Crude (US$/bbl)
50
55
884
792
1,103
1,011
1,322
1,230
1,453
1,361
1,541
1,448
1,760
1,667

60
699
918
1,137
1,268
1,356
1,575

65
607
825
1,044
1,176
1,263
1,482

70
514
733
952
1,083
1,171
1,389

Combined factor of passenger fare growth and currency: Even higher sensitivity is seen here as higher numbers of cost items including crude depend on currency.
Table 23: Sensitivity of INR and passenger fare growth
(Rs)
TP
-10%
-5%
Fare Growth
0%
(%)
5%
10%
15%
Source: I-Sec Research

90

65
857
1,075
1,294
1,426
1,513
1,732

68
778
997
1,216
1,347
1,435
1,653

70
699
918
1,137
1,268
1,356
1,575

72
581
800
1,019
1,150
1,238
1,457

74
503
721
940
1,072
1,159
1,378

76
424
643
862
993
1,080
1,299

ICICI Securities

InterGlobe Aviation, June 16, 2016

Assumptions
Table 24: The Key assumptions in our model
Assumptions
Fare Growth
Average Ticket (Rs)
US$
Crude Prices(US$/bbl)
Realized ATF prices (Rs/kl)
Scheduled Passengers (mn)
RPK(mn)
ASK(mn)
PLF(%)
Ancillary Revenue (Rs mn)
Total Revenue(Rs mn)
EBITDA (Rs mn)
EBITDAR (Rs mn)
PAT (Rs mn)
Source: I-Sec research

FY16E
-14%
4,214
65.3
46.0
47,748
33.1
35,968
42,826
84.0
21,223
161,399
30,055
56,176
19,897

FY17E
2%
4,298
67.0
55.0
54,366
41.0
44,124
54,785
80.5
28,646
205,627
32,594
68,691
21,260

FY18E
3%
4,427
67.0
60.0
57,363
47.0
50,296
59,355
84.7
35,075
243,776
46,446
86,594
32,034

FY19E
1%
4,471
67.0
60.0
57,363
53.8
57,379
65,872
87.1
43,521
284,959
60,245
106,408
43,332

FY20E
1%
4,516
67.0
60.0
57,363
61.7
65,512
74,572
87.9
53,703
333,111
75,295
129,524
55,045

Valuation
Low-Cost Carriers (LCCs) tend to trade at higher multiples compared to FSCs, and
Asian LCCs enjoy additional premium on account of their low cost structure and high traffic growth. High volatility in crude prices and global economy have a direct bearing on the airline stock prices and, as such, it is best to consider the average 1-year forward EV /EBITDAR for the last 5years/10years to ascertain an average cycle multiple. The average 1-year forward EV/EBITDAR for LCCs is 7.5 while the same for
Asian LCCS is 9.5. As such, we ascribe 8x EV/EBITDAR to IndiGo based on
FY18E to arrive at a target price of Rs1,268 per share.
Table 25: Valuation based on 8x EV/EBITDAR
(Rs mn)
EBITDAR
EV@8xEV/EBITDAR
Gross Debt
Cash
Rentals@7x
Net Debt
Equity Value
Shares (mn)
Equity Value
Source: I-Sec research

FY18E
86,594
692,752
53,431
98,746
281,033
235,718
457,034
360.4
1,268

Our Target Price implies a PE of 14x based on FY18E earnings which is lower than the average PE band of global airlines. Considering the volatile nature of earnings, long term average multiple is more relevant. This is even more pertinent considering that the aviation sector has different growth triggers at different phases of the industry itself. We have highlighted the PE charts of four major LCC airlines.

91

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Chart 32: Easy Jet trading average one year forward PE has been 17x with a trading history of 15 years
60

1yr fwd PE

Avg

+1 Stdev

-1 Stdev

50

(x)

40
30
20
10

May-16

Jun-15

Jun-14

Jun-13

Jul-12

Jul-11

Jul-10

Jul-09

Aug-08

Aug-07

Aug-06

Aug-05

Sep-04

Sep-03

Sep-02

Oct-01

0

Source: Company data, I-Sec research

Chart 33: SouthWest average one year forward PE has been 22x with a trading history of 30 years
90

1yr fwd PE

Avg

+1 Stdev

-1 Stdev

80
70

(x)

60
50
40
30

Avg: 22.3

20
10

May-16

Dec-14

Jun-13

Dec-11

Jul-10

Jan-09

Aug-07

Feb-06

Aug-04

Mar-03

Sep-01

Mar-00

Oct-98

Apr-97

Oct-95

May-94

Nov-92

Jun-91

Dec-89

Jun-88

Jan-87

0

Source: Company data, I-Sec research

Chart 34: Ryan air one year average forward PE has been 19x
1yr fwd PE
+1 Stdev

Chart 35: Cebu Pacific one year average forward
PE has been 23x
1yr fwd PE
+1 Stdev

Avg
-1 Stdev
45
40

35
30
25

Avg: 19.3

(x)

20
15
10

35
30
25

Avg: 22.8

20
15
10
5

Source: Company data, I-Sec research

Source: Company data, I-Sec research

Jun-16

Jan-16

Aug-15

Mar-15

Oct-14

May-14

Dec-13

Jul-13

Feb-13

Sep-12

Apr-12

Nov-11

0

Jun-11

May-15

Nov-13

Jun-12

Dec-10

Jul-09

Jan-08

Jul-06

Feb-05

Aug-03

Mar-02

Sep-00

Apr-99

0

Jan-11

5

92

Avg
-1 Stdev

ICICI Securities

InterGlobe Aviation, June 16, 2016

Table 26: Average EV/EBITDAR multiples of Global airlines
The grey colored airlines are LCCs while the bold ones are Asian

EV/EBITDAR
Southwest Airlines Co.
JetBlue Airways Corporation
Allegiant Travel Company
Controladora Vuela Compania
GOL Linhas Aereas Inteligentes SA
AirAsia Bhd.
Cebu Air Inc.
Tiger Airways Holdings Limited
SpiceJet Limited
Air Berlin PLC easyJet plc
Ryanair Holdings Plc
Norwegian Air Shuttle ASA
InterGlobe Aviation Ltd
LATAM Airlines Group SA
Aeroflot-Russian Airlines PJSC
Avianca Taca Holdings S.A Pfd
Thai Airways International Public Co. Ltd.
Copa Holdings, S.A. Class A
Korean Air Lines Co., Ltd
Hawaiian Holdings, Inc.
PT Garuda Indonesia (Persero) Tbk Class B
United Continental Holdings, Inc.
Cathay Pacific Airways Limited
Asiana Airlines Inc.
Alaska Air Group, Inc.
Air Canada
China Airlines Ltd.
Singapore Airlines Ltd.
Qantas Airways Limited
Eva Airways Corporation
Air France-KLM SA
Grupo Aeromexico SA de CV
Deutsche Lufthansa AG
Delta Air Lines, Inc.
American Airlines Group, Inc.
Finnair Oyj
Air China Limited Class H
China Eastern Airlines Corporation Limited Class H
Air New Zealand Limited
ANA Holdings Inc.
International Consolidated Airlines Group SA
Japan Airlines Co., Ltd.
Virgin Australia Holdings Limited
Virgin America, Inc.
SAS AB
Jet Airways (India) Limited
Average-Total
Average(LCC)
Average Asia
Average Asia-LCC
Source: Factset

FY1 Average
-5AY
4.7
5.1
7.1
3.1
8.1
7.7
5.8
17.3
17.7
2.7
5.9
7.6
5.4
5.9
8.4
3.1
4.9
6.2
7.6
6.8
2.9
1.7
3.9
6.4
4.5
4.0
4.1
8.9
3.0
3.1
6.5
3.0
2.9
3.1
4.7
4.6
2.4
6.5
5.9
2.7
4.7
3.8
3.3
4.1
3.4
2.1
9.8
5.47
7.49
6.55
9.29

FY1 Average
-10AY
4.7
5.1
7.1
3.1
8.1
7.8
5.8
17.3
17.7
2.4
5.8
7.6
5.4
5.9
8.7
3.2
4.9
6.2
7.6
6.8
2.9
1.7
3.8
6.4
4.5
4.0
4.0
8.9
3.3
3.1
6.5
3.0
2.9
3.1
4.7
4.6
2.4
6.5
5.9
2.7
4.7
3.7
3.3
4.1
3.4
2.2
9.6
5.47
7.49
6.56
9.29

93

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InterGlobe Aviation, June 16, 2016

Financials
Table 27: Profit & Loss statement
(Rs mn, year ending March 31)
Total operating revenue

FY14
111,166

FY15
139,253

FY16P
161,399

FY17E
205,627

FY18E
243,776

Expenses
Aircraft fuel expenses
Aircraft and engine rentals
Less: Cash and non-cash incentives
Aircraft and engine rentals (net)
Purchase of stock in trade
Changes in inventories of stock in trade
Employee benefits expense
Other expenses
-Landing and navigation
-Maintenance Costs
-Selling and Distribution
-Other Expenses
Total operating expenses

55,134
20,310
(3,607)
16,703
584
7
9,206
24,466
8,794
3,162
6,945
5,564
106,100

57,485
23,076
(3,553)
19,522
817
(32)
11,887
30,877
10,901
4,175
8,730
7,071
120,557

47,793
29,687
(3,566)
26,122
1,148
(11)
17,899
38,394
14,100
5,400
10,410
8,473
131,344

66,830
40,544
(4,447)
36,097
1,000
(20)
20,242
48,884
17,825
7,001
13,263
10,795
173,033

73,339
45,419
(5,271)
40,148
1,000
(20)
23,751
59,113
21,964
8,627
15,724
12,798
197,330

5,066
4.6
21,769
19.6

18,697
13.4
38,219
27.4

30,055
18.6
56,176
34.8

32,594
15.9
68,691
33.4

46,446
19.1
86,594
35.5

Finance costs
Depreciation and amortization expense
Other Income
Finance income
Non-operating non finance income

1,226
2,260
3,155
2,864
292

1,155
3,022
3,946
3,740
206

1,349
5,031
4,614
4,514
100

1,312
6,000
5,090
5,000
90

1,274
6,500
7,090
7,000
90

Profit before tax

4,736

18,465

28,290

30,372

45,762

(9)

5,424

8,392

9,112

13,729

4,744

13,064

19,897

21,260

32,034

EBITDA
(Margin%)
EBITDAR
(Margin%)

Tax (charge)/benefit
Profit for the period / year
Source: Company data, I-Sec research

94

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InterGlobe Aviation, June 16, 2016
Table 28: Balance sheet
(Rs mn, year ending March 31)
FY14
Equity and Liabilities
Share capital
Reserves and surplus
Shareholders’ funds
Non-current liabilities
Deferred tax liabilities (net)
Long-term borrowings
Other long-term liabilities
Long-term provisions
Deferred incentives
Current liabilities
Short-term borrowings
Trade payables
Other current liabilities
-Current Maturity of Debt
Deferred incentives
Total Current liabilities
Total
Assets
Non-current assets
Net Tangible fixed assets
Net Intangible fixed assets
Capital work in progress
Non-current investments
Deferred tax asset (net)
Long-term loans and advances
Other non-current assets

Current assets
Current investments
Inventories
Trade receivables
Cash and bank balances
Other current assets
Total
Source: Company data, I-Sec research

FY15

FY16P

FY17E

FY18E

344
3,874
4,217

344
3,918
4,262

3,604
14,635
18,238

3,604
27,499
31,102

3,604
51,136
54,740

529
30,807
12,958
5,013
13,654
62,962

4,091
35,884
20,170
2,051
13,317
75,514

5,180
29,331
24,722
7,694
11,778
78,705

5,180
27,331
24,722
7,694
14,047
78,974

5,180
25,331
24,722
7,694
12,018
74,945

3,828
16,149
2,655
3,878
23,855
91,034

4,755
19,008
3,378
4,199
27,962
107,738

7,517
21,507
3,378
4,054
33,079
130,022

9,577
27,039
3,378
4,054
40,670
150,746

11,354
31,429
3,378
4,054
46,837
176,521

39,407
152
39,560
0
10,243
14,315
24,559
64,119

48,664
96
5
48,765
0
12,792
16,056
28,848
77,613

47,133
96
5
47,234
0
14,199
14,978
29,178
76,412

51,133
96
5
51,234
0
14,199
14,978
29,178
80,412

54,633
96
5
54,734
0
14,199
14,978
29,178
83,912

12,715
673
891
11,015
1,621
26,916
91,034

5,168
1,306
1,046
19,994
2,612
30,125
107,738

9,741
1,270
1,570
37,050
3,980
53,611
130,022

9,741
1,896
1,690
53,063
3,944
70,334
150,746

9,741
2,163
2,004
74,027
4,675
92,610
176,521

95

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InterGlobe Aviation, June 16, 2016
Table 29: Cashflow statement
(Rs mn, year ending March 31)
FY14
Cashflow from operating activities
Net profit before tax
Adjustments for:
Depreciation and amortisation expense
Provision for redelivery cost (adjusted for provision utilised / reversed during the period / year)
PBDDLA
Provision for inventory obsolescence
Loss / (profit) on sale of fixed asset (net)
Non cash incentives (net)
Assets written off
Unrealised foreign exchange loss (net)
Foreign exchange loss on forward contract
Amortisation of discount on forward exchange contracts Advances written-off
Interest expense
Finance lease charges
Employee stock compensation cost
Interest income on fixed deposits
Mark to market (loss) on forward contracts
Net gain on sale of current investments
Dividend from current investments
Operating profit before working capital changes
Adjustment for:
(Increase)/decrease in trade receivables
(Increase)/decrease in inventories
(Increase)/decrease in loans and advances and other assets
Increase/(decrease) in trade payables, other liabilities and provisions
Increase/(decrease)in deferred incentives
Cash generated from operating activities
Taxes paid
Net cash generated from operating activities
Cashflows from investing activities
Purchase of fixed assets (including capital advances), net of cash incentives
Deposits made with banks due to mature within 12 months from the reporting date (net)
Deposits made with banks due to the mature after
12 months from reporting date (net)
Proceeds from sale of fixed assets
Purchase of mutual funds/ shares
Proceeds from sale of mutual funds
Interest received
Dividend received
Net cash generated from / (used in) investing activities Cashflows from financing activities
Proceeds from secured loans
Repayment of secured loans
Repayment of unsecured loans
Interest paid
Finance lease charges paid
Issue of share capital
Dividend paid
Tax paid on dividends
Net cash generated from / (used in) financing activities Net increase / (decrease) in cash and cash equivalents during the year / period (A+B+C)
Source: Company data, I-Sec research

96

FY15

FY16P

FY17E

FY18E

4,736

18,357

28,290

30,372

45,762

2,260

3,022

5,031

6,000

6,500

63
0
24
(1)
26
1
563
-

63
71
21
0
(1)
0
1,192
-

0
193
827
(1,869)
(639)
(356)
5,828

1
107
929
(2,704)
(1,036)
20,025

(1,407)
1,349

1,312

1,274

(4,614)

(5,090)

(7,090)

28,648

32,594

46,446

(210)
(174)

(225)
(654)

(524)
35

(120)
(626)

(314)
(266)

391

2

(1,368)

36

(732)

8,987
2,208
17,030
(1,075)
15,955

8,607
35
27,790
(3,951)
23,839

10,904
(1,684)
36,011
(7,304)
28,707

7,591
2,269
41,744
(9,112)
32,633

6,167
(2,029)
49,273
(13,729)
35,544

(23,242)

(10,171)

(3,500)

(10,000)

(10,000)

2,051

(7,617)

(3,496)

-

-

(8,908)
5
(71,176)
70,483
1,292
356

(1,504)
2
(65,075)
73,658
1,303
-

4,614

5,090

7,090

(29,138)

(9,405)

(2,382)

(4,910)

(2,910)

18,153
(4,516)
(186)
(603)
-

8,137
(4,320)
(100)
(670)
(13,575)
(2,553)

(2,000)

(2,000)

(2,000)

(1,349)

(1,312)

(1,274)

12,091
(18,012)

(8,396)

(8,396)

12,848

(13,081)

(9,270)

(11,709)

(11,670)

(334)

1,353

17,056

16,014

20,964

ICICI Securities

InterGlobe Aviation, June 16, 2016
Table 30: Key ratios
(Year ending March 31)
FY14

FY15

FY16P

FY17E

FY18E

13.2
13.2
19.4
12.3
11.7

36.2
36.2
44.6
34.9
11.8

55.2
55.2
69.2
42.8
50.6

59.0
59.0
75.6
20.0
86.3

88.9
88.9
106.9
20.0
151.9

Growth Ratios (%)
EBITDA
EBITDAR
Recurring Net Income

(43.3)
(3.2)
(39.4)

269.0
75.6
174.9

60.7
47.0
52.6

8.4
22.3
6.9

42.5
26.1
50.7

Valuation Ratios (x)
P/E
P/CEPS
P/BV
EV / EBITDA
EV / EBITDAR
EV / FCF

76.6
51.9
86.1
73.3
17.1
(51.0)

27.9
22.6
85.2
20.4
10.0
27.9

18.3
14.6
19.9
11.9
6.4
14.2

17.1
13.3
11.7
10.5
5.0
15.1

11.3
9.4
6.6
6.8
3.7
12.4

Operating Ratios (%)
Fuel/Sales
Net Rentals/Sales
Other Income / PBT
Effective Tax Rate
NWC / Total Assets
Inventory Days
Receivables (days)
Payables (days)
Net D/E Ratio (x)

49.6
15.0
66.6
(0.2)
8.2
2.3
2.9
12.6
1.99

41.3
14.0
21.4
29.4
6.7
4.0
2.7
12.5
4.27

29.6
16.2
16.3
29.7
23.8
3.5
3.6
17.0
(0.24)

32.5
17.6
16.8
30.0
29.1
4.0
3.0
17.0
(0.72)

30.1
16.5
15.5
30.0
36.9
4.0
3.0
17.0
(0.83)

4.3
8.5
112.5
93.4
4.6

9.4
23.6
306.0
96.4
13.4

12.3
29.5
109.1
77.6
18.6

10.3
27.9
68.4
33.9
15.9

13.1
35.3
58.5
22.5
19.1

Per Share Data (in Rs.)
EPS(Basic Recurring)
Diluted Recurring EPS
Recurring Cash EPS
Dividend per share (DPS)
Book Value per share

Return/Profitability Ratios (%)
Recurring Net Income Margins
RoCE
RoNW
Dividend Payout Ratio
EBITDA Margins
Source: Company data, I-Sec research

97

InterGlobe Aviation, June 16, 2016

ICICI Securities

Index of Tables and Charts
Tables
Table 1: Domestic air traffic supply model .......................................................................... 62
Table 2: IndiGo supply model ............................................................................................. 63
Table 3: Air Asia supply model ........................................................................................... 64
Table 4: Vistara supply model............................................................................................. 64
Table 5: Air India supply model........................................................................................... 64
Table 6: Jet Airways supply model ..................................................................................... 65
Table 7: SpiceJet growth model ......................................................................................... 65
Table 8: GoAir’s growth trajectory ...................................................................................... 65
Table 9: Current traffic and capacity of Indian airports (cumulative 90% of the traffic) ...... 70
Table 10: Current domestic route map of Indian airlines .................................................... 70
Table 11: Incentive modeling for IndiGo ............................................................................. 74
Table 12: SpiceJet rental cost analysis .............................................................................. 76
Table 13: IndiGo rental cost analysis .................................................................................. 76
Table 14: Jet airway rental cost analysis ............................................................................ 76
Table 15: Redelivery expense closing provision comparison ............................................. 78
Table 16: IndiGo is the lowest fare provider most of the time ............................................ 82
Table 17: Balance sheet comparison across major airlines ............................................... 87
Table 18: Working capital details of IndiGo ........................................................................ 87
Table 19: IndiGo profitability / return ratios without adjusting for operating leases ............ 88
Table 20: RoCEs post adjustment for operating leases ..................................................... 88
Table 21: The sensitivity of Target Price with Crude and INR ............................................ 90
Table 22: Sensitivity of crude and passenger fare growth (FY18E) ................................... 90
Table 23: Sensitivity of INR and passenger fare growth .................................................... 90
Table 24: The Key assumptions in our model .................................................................... 91
Table 25: Valuation based on 8x EV/EBITDAR .................................................................. 91
Table 26: Average EV/EBITDAR multiples of Global airlines ............................................. 93
Table 27: Profit & Loss statement ....................................................................................... 94
Table 28: Balance sheet ..................................................................................................... 95
Table 29: Cashflow statement ............................................................................................ 96
Table 30: Key ratios ............................................................................................................ 97

98

InterGlobe Aviation, June 16, 2016

ICICI Securities

Charts
Chart 1: Indian domestic passenger traffic growth, 21.5% in CY15. .................................. 61
Chart 2: Total international air traffic growth, 13.7% in CY15............................................. 61
Chart 3: International traffic share of domestic airlines have grown steadily ..................... 61
Chart 4: Growth in ASK and market share of EasyJet ....................................................... 66
Chart 5: EasyJet PLFs tend to remain stable ..................................................................... 66
Chart 6: PLFs have steadily risen by yield management over the last decade .................. 66
Chart 7: Growth in ASK and market share of Southwest airlines ....................................... 66
Chart 8: OTP of Indian airlines operators (%)-thick line on the top is for Indigo ................ 68
Chart 9: Airline punctuality vs. operating margin – US 1999 .............................................. 68
Chart 10: Airline punctuality vs. operating margin – Europe 1998 ..................................... 68
Chart 11: Total operating cost comparison without rentals ................................................ 75
Chart 12: Total operating cost comparison with rentals ..................................................... 75
Chart 13: IndiGo has the lowest net rentals per aircraft ..................................................... 77
Chart 14: IndiGo has lower net rentals than SpiceJet, Jet is lowest due to long hauls ...... 77
Chart 15: Even ex incentives, IndiGo has lowest rentals in the past two years ................. 77
Chart 16: Maintenance cost per ASK for IndiGo remain lowest ......................................... 77
Chart 17: Average age of fleet as in FY15 .......................................................................... 77
Chart 18: Landing, navigation and airport charges per ASK. ............................................. 78
Chart 19: Employee cost per ASK ...................................................................................... 79
Chart 20: Fuel cost per ASK ............................................................................................... 80
Chart 21: Mumbai Delhi Fare in the next 5 weeks as of March16 ...................................... 83
Chart 22: Mumbai Delhi Fare in June 16 as of March16 .................................................... 83
Chart 23: Mumbai Delhi Fare in July 16 as of March 16 .................................................... 83
Chart 24: Mumbai Delhi Fare in Aug 16 as of March 16 .................................................... 83
Chart 25: Next generation dominating the backlog ............................................................ 84
Chart 26: Transitioning to next generation; orderbook details ............................................ 84
Chart 27: Single-aisle demand largely committed over next five years .............................. 85
Chart 28: Aircraft leasing penetration by class ................................................................... 85
Chart 29: Backlog as a % of fleet ....................................................................................... 85
Chart 30: Trend of fuel prices and average fares – indecisive correlation ......................... 86
Chart 31: Lease-adjusted RoCE for IndiGo ........................................................................ 88
Chart 32: Easy Jet trading average one year forward PE has been 17x with a trading history of 15 years ......................................................................................................... 92
Chart 33: SouthWest average one year forward PE has been 22x with a trading history of
30 years......................................................................................................................... 92
Chart 34: Ryan air one year average forward PE has been 19x ........................................ 92
Chart 35: Cebu Pacific one year average forward PE has been 23x ................................. 92

99

InterGlobe Aviation, June 16, 2016

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100

ICICI Securities

Equity Research
INDIA

June 16, 2016
BSE Sensex: 26726

SpiceJet

HOLD

Recovery priced in
Reason for report: Initiating coverage

Aviation

Target price Rs64

Shareholding pattern
Promoters
Institutional investors MFs and UTI
Insurance
FIIs
Others

Sep
’15
60.3

Dec
’15
60.3

Mar
’16
60.3

0.6

1.4
0.1
0.0
1.3
38.3

3.1
0.0
0.0
3.1
36.6

0.0
0.6
39.7

I-Sec vs Bbg* consensus
(%)
Sales
EBITDA
Adj. PAT

FY17E
(4.6)
(31.8)
(43.1)

FY18E
1.0
(8.6)
(16.2)

Source: *Bloomberg, I-Sec research

Price chart
100

(Rs)

80
60
40

Jun-16

Dec-15

Jun-15

Dec-14

Jun-14

Dec-13

Jun-13

20
0

Rs66

With a new ownership, SpiceJet (SJET) has emerged like a phoenix from the despair of insolvency, and staged a heartening turnaround in CY15. The company has not only capitalized on benign crude prices, but its earnings profile too has improved on asset utilisation, cost rationalization and innovative pricing to register consecutive quarterly profits since Q4FY15 along with significant improvement in on time performance. We delve into the company’s innovative inventory control mechanisms, which have helped it improve its RASK significantly, helped by favourable working capital contracts and lower redelivery expenses. However, the overriding point of despair for SJET remains its lack of any big order with any airframers. This is a missed opportunity for the company considering the exponential stage of growth in the Indian aviation industry. With a 5x rally in share prices over the last one year, we believe that the recovery is fully priced in now.
Cost structure remains vulnerable without bulk order. As SJET resorts to normal leases (wet/dry) which do not fortify its cost structure, we believe the company remains levered to crude prices. Our aircraft market analysis indicates a significant delivery time-lag for any big order from the perspective of at least Airbus or Boeing, which already have significantly committed orderbook. Maintenance costs will remain elevated with higher utilisation and a mixed fleet. Additionally, some of SpiceJet’s favorable contracts with convenient payables and redelivery expenses will be temporary in nature and the higher asset utilisation/higher PLF model will have to decelerate in time to become more sustainable.
Corporate actions will have a major bearing ahead. SJET will have to decide on prospective funding for expansion including decision on a prospective strategic partner. While the company has managed to deleverage with Rs6.5bn net debt reduction in FY16, the same will increase with a bulk order. We factor a bulk order for 150 aircrafts in FY17. The pending decision of the warrants issued to the expromoters remains another overhang with possible equity dilution of 25-30%.
We recommend HOLD on SJET with a target Price of Rs64 based on 7x FY18E
EV/EBITDAR. SJET is slated to increase its ASK/RPK/Pax from
12.9bn/11.7bn/11.9mn in FY16 to 17.3bn/15.3bn/16mn in FY18E, resulting in
EBITDAR growth from Rs12.3bn in FY16 to Rs20bn in FY18 (FY18E EBITDAR margin of 28%). The lease adjusted ROCEs will remain ~18-20%. Our revenue model factors an average fare growth of 2%/3% in FY17/FY18 with a rising crude price assumption of US$55/60 in FY17/FY18.
Market Cap

Rs39.8bn/US$593mn

Reuters/Bloomberg

SPJT.BO/SJET IN

Year to March

FY15

FY16P

FY17E

FY18E

Revenue (Rs mn)

52,015

50,881

59,272

72,414

(7,484)

3,435

3,667

6,383

Shares Outstanding (mn)

599.5

Net Income (Rs mn)

52-week Range (Rs)

90/17

EPS (Rs)

(12.5)

5.7

6.1

10.6

% Chg YoY

(25.4)

(145.9)

6.7

74.1

(5.3)

11.5

10.8

6.2

Free Float (%)
FII (%)

39.7
1.3

Daily Volume (US$/'000)

12,907

Absolute Return 3m (%)

9.4

P/E (x)
CEPS (Rs)
EV/E (x)

Research Analysts:

Absolute Return 12m (%)

Ansuman Deb

Sensex Return 3m (%)

9.4

RoCE (%)

ansuman.deb@icicisecurities.com

Sensex Return 12m (%)

1.9

RoE (%)

+91 22 6637 7312

267.9

Dividend Yield (%)

(10.4)

7.7

8.3

12.8

(8.8)

11.9

11.3

6.1

-

-

-

-

(62.5)

35.1

14.3

20.5

59.2

(54.4)

(138.4)

171.0

101

ICICI Securities

SpiceJet, June 16, 2016

TABLE OF CONTENTS
Missed opportunity for capacity addition ................................................................. 103
Bulk order on the radar, but will have financial implications ....................................... 103
SpiceJet will receive the aircraft with significant time lag ........................................... 103
Remarkable turnaround story..................................................................................... 105
RASK and PLFs have increased simultaneously ....................................................... 105
Inventory control has driven RASK improvement ....................................................... 105
Working capital has benefitted from easier payment terms ........................................ 108
CASK has benefitted from lower crude and redelivery costs...................................... 109
CASK structurally higher due to maintenance cost ................................................. 110
Supplementary rentals has been a key drag .............................................................. 112
RoCE to improve ahead .............................................................................................. 115
Debt will increase on account of the upcoming bulk order .................................... 116
Prospective dilution is an overhang .......................................................................... 117
Average fares will move ahead with crude ............................................................... 118
Sensitivity analysis ...................................................................................................... 119
Valuation ....................................................................................................................... 120
Financials...................................................................................................................... 121
Index of Tables and Charts ......................................................................................... 125

102

SpiceJet, June 16, 2016

ICICI Securities

Missed opportunity for capacity addition
SpiceJet fleet – a mix of turboprop, Boeing and Airbus: SpiceJet connects its network with fleet of 22 Boeing 737NGs, 7 aircraft on wet lease (A319, 320 and B737) along with 14 Bombardier Q-400s. The two Airbus 320s have been taken on wet lease from Czech company CSA to be deployed on metro routes. Five Boeing 737NGs are also on wet lease. The Bombardier Q400 was acquired under finance lease through an ECB from Export Development Canada. However, in view of overdue payments of interest and repayment of the ECB principal to the lender, SpiceJet entered into an agreement with the lender for the forbearance of defaults and the discharge of overdue amounts of principal and interest aggregating Rs898mn through 12 equal monthly payments from Apr'15. As of FY15-end, the total amount due under this ECB was Rs13.4bn.

Bulk order on the radar, but will have financial implications
The SpiceJet management is keen to place a big order of more than 100 aircraft and is looking for options. Media has been rife about overtures from Boeing, Airbus as well as other players. We reckon such a big order may be placed sometime in FY17, which will have corresponding financing implications post the necessary advance payment involved in such orders. However, there will be some time gap before the aircraft from the order start getting delivered to SpiceJet. To give an example, let’s say, the bulk order ensures a final list price of US$80mn per new aircraft. Assuming SpiceJet will have to pay 4% of the order upfront, it will entail a payment of Rs21.4bn to the airframer. SpiceJet will receive the aircraft with significant time lag
This is due to the already committed orderbook for the two big airframers – Airbus and
Boeing. This is especially the case with next-gen aircraft like Neo and Max. There will be a couple of years through which the manufacturing lines of Boeing and Airbus completely transform to the next-gen airframes. Post that, there is no free single aisle open slots available for five years indicating that a fresh buyer who has not yet ordered is likely to resort to lessors for neo/Max.
SpiceJet ordered 42 737 Max’s in Oct’13, but till date there has not even been any date announced for the first delivery, leave aside any delivery schedule. We wonder on the deal dynamics between SpiceJet and Boeing considering there are talks of a new bulk order when such an order is still pending delivery. Considering that SpiceJet went through a restructuring process, does this order get delayed? Typically, the delivery dates are also declared once it has a dedicated slot.

103

ICICI Securities

SpiceJet, June 16, 2016

Chart 1: Single aisle demand largely committed over the next three years

Source: Ascend

Missed opportunity for SpiceJet considering the growth in air traffic: SpiceJet’s current PLF is above 90%, underlining the high systemic volume growth along with suitable yield management and inventory control. With increase in capacity, PLF will drop to more sustainable 85% levels with passenger growth assumption of 20%. Our model borders on the three boundary assumptions of sustainable PLFs, sustainable passenger growth, and rational increase in capacity. The capacity will increase for
SpiceJet primarily through short term leases. Though it has an existing order of 42
Boeing-737Max, the same has no delivery schedule as of date in the Boeing website.
The company had earlier guided for 49 aircraft as of FY17 exit. Hence, there is a case of missed opportunity for SpiceJet with respect to fleet size. This is one of the reasons why SpiceJet has opted for wet leases during peak periods. Such short-period operating leases have higher rentals and lead to higher CASK, hence is not sustainable, which is why one of our boundary assumptions includes rational increase in capacity.
Table 1: Passenger and capacity growth for SpiceJet
System
Passenger Growth
Passenger Carried
Market Share
Avg. km per passenger
RPK(mn)
Departure/plane
Effective seats(FY)
Avg. km per seat
ASK(mn)
PLF (%)
Source: I-Sec research

104

FY16
10,670,866
12.5
874
9,326
2,100
5,775
836
10,139
92.0

FY17
15.0
12,271,496
12.5
874
10,725
2,100
6,567
836
11,530
93.0

FY18
20.0
14,725,795
13.2
874
12,870
2,100
8,220
836
14,432
89.2

FY19
20.0
17,670,954
13.9
874
15,444
2,100
10,160
836
17,837
86.6

FY20
20.0
21,205,145
14.6
874
18,533
2,100
12,780
836
22,437
82.6

ICICI Securities

SpiceJet, June 16, 2016

Remarkable turnaround story
We analyze SpiceJet’s turnaround story in detail in this section. There has been a common perception about the benefits of lower oil prices being the singular factor in the turnaround. However, a detailed deep-dive P&L analysis will reveal other factors as well. A large part of the turnaround has been possible through reworking of redelivery expenses and favorable working capital terms, which we believe will continue in the medium term.

RASK and PLFs have increased simultaneously
With spectacular rise in PLFs, one of the common notions has been to attribute the same to lower tariffs. The easy assumption is that the higher PLFs must be on account of lower tariffs. However, ASK being the basic selling unit, it is imperative that comparison be made on ASK basis. We see that, despite the flash sales and discounts, SpiceJet has managed to increase Revenue per ASK (RASK). On a YoY comparison, it has managed to increase the RASK for past two quarters along with a higher PLF of ~92%. So, one has to give the credit to SpiceJet for the increase in
RASK, which is a vital factor in its turnaround story. If we compare with IndiGo,
SpiceJet’s RASK has been a steady Rs0.24 lower than IndiGo for the past three quarters. We must remember that some part of the lower RASK will be structural on account of SpiceJet’s turboprop fleet, which being small won’t have comparable passenger fare/cargo revenues/ancillary revenues.
Table 2: Quarterly Revenue per ASK (RASK) has significantly improved for SpiceJet
Q1FY15
ASK-domestic (000)
3,822,025
ASK-Int'l (000)
422,080
ASK-Total (000)
4,244,105
Revenue (Rs mn)
16,786
Total RASK
3.96
PLF (%)
78.2
PAX Revenue (Rs mn)
15,505
Ancillary revenue (Rs mn)
1,275
PAX RASK
3.65
Fare (Rs)
4340
Passengers(mn)
3.57
Source: Company Data, I-Sec Research

Q2FY15
3,823,594
511,574
4,335,168
14,499
3.34
82.6
12,749
1,442
2.94
3,373
3.78

Q3FY15
2,931,793
589,345
3,521,138
13,112
3.72
84.6
11,973
1,023
3.40
3,968
3.02

Q4FY15
1,886,704
553,858
2,440,562
7,863
3.22
81.7
6,973
891
2.86
3,512
1.99

Q1FY16
2,222,951
603,185
2,826,136
11,063
3.91
89.8
10,040
1,003
3.55
3,711
2.71

Q2FY16
2,282,580
598,068
2,880,648
10,401
3.61
92.8
9,095
1,205
3.16
3,192
2.85

Q3FY16
2,754,028
690,376
3,444,404
14,600
4.24
91.6
12,680
1,707
3.68
3,852
3.29

Q4FY16
2,879,795
885377
3,765,172
14,750
3.92
92.1
12792
1707
3.40
3,600
3.39

So, how has been SpiceJet been able to increase its RASK in a competitive environment? We believe the answer lies in better utilisation, better coordination between the turboprops and B737s, and inventory control. We delve deeper into the inventory control next.

Inventory control has driven RASK improvement
Revenue management is a process by which airlines manage fares of seats based on category and date of travel between the same origin-destination (O-D) markets.
Airlines manage the seat inventory availability to maximize revenues. With the evolution of Low-Cost Carriers (LCCs), the lever of different seat categories has also diluted significantly. Today, the likes of IndiGo/SpiceJet have one plain vanilla seating class. Yet yield management is important with the development of one-dimensional differential pricing mechanism in which same seat can be sold at different prices only
105

SpiceJet, June 16, 2016

ICICI Securities based on time. Leisure travel would involve buying discount tickets with longer time horizon; however, business travelers would pay higher for near time horizon tickets.
Hence, a crucial strategy would involve optimum capacity control to protect seats for later booking, high fare business passengers. Without strong restrictions to impose demand segmentation by passengers’ willingness to pay, the only way an airline can force those with higher willingness to pay higher fares is to limit the seat availability in lower fare classes. This protection of high-yield seats and at the same time maximizing the PLF is a function of yield management. This is accomplished by forecasting the expected future booking demand for higher-fare classes and performing mathematical optimization to determine the number of seats that should be prevented from low-fare bookings.
An example would be that of SpiceJet fares on the Delhi-Mumbai route. Although,
SpiceJet is a low-cost airline, its advance booking tariffs are much higher compared to competition versus the current booking. As we go down the time, it is no longer the lowest air fare airline, a position which it maintains for current bookings. This strategy is an example of yield management through inventory control through yield management again. So, while SpiceJet is happy to be lowest at Rs3,500 per ticket for current bookings, it is not the lowest fare player at Rs2,900/2,800 for subsequent advanced bookings.
This is further illustrated by the ‘other current liabilities’ in the balance sheet. The
‘other current liabilities’ carries the forward sales. Adjusting for the current portion of long-term debt, the ‘other current liability’ of SpiceJet has reduced from Rs10.1bn in
FY14 to Rs6.6bn in FY15.

106

ICICI Securities

SpiceJet, June 16, 2016

Chart 2: Delhi-Mumbai booking fare for next 5-6 weeks as of Mar’16 (April booking) Chart 3: Delhi-Mumbai booking fare for 7-15 weeks as of Mar’16 (June booking)

Chart 4: Delhi-Mumbai booking fare for 16-25 weeks as of Mar’16 (July and
August bookings)

Source: Cleartrip

107

ICICI Securities

SpiceJet, June 16, 2016

Chart 5: Delhi-Mumbai booking fare for 16-25 weeks as of Mar’16 (July and
August bookings)

Source: Cleartrip

Inventory Control has corresponding effect on working capital management.
While the inventory control strategy of selling higher share of tickets in the immediate future will increase the RASK, it also denies the airline valuable working capital funds which can be earned through advanced sales. So, is the SpiceJet strategy sustainable? Can it sustain this strategy in light of working capital funding? We analyze SpiceJet’s working capital status in this light.

Working capital has benefitted from easier payment terms
Typically, airlines would not have any receivable outstanding as all the payments are made on an advanced basis while payments to oil firms and other creditors can be made in due time. We see that SpiceJet’s payable days have indeed increased in
FY15 when it was 63 days compared to 40 days for FY12-FY13. This might have been due to the favorable terms of payment received by the company as a part of the restructuring plan and the company has rightfully capitalized on the same. We expect this benefit to continue till FY18 post which it may be revoked gradually. However, the key headwind in maintaining a front-loaded inventory distribution is the redelivery cost, which we will discuss in detail later in this report.
Table 3: Working capital schedule for SpiceJet
FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

Net WC (Rs mn)
(790)
(2,811)
Receivable Days
3
3
Inventory Days
3
4
Other CA Days
Payable Days
40
22
Other CL Days
73
271
Source: Company Data, I-Sec Research

(1,094)
0
3
21
150

(2,221)
3
2
2
27
71

(2,578)
3
2
26
100

(4,646)
2
3
33
57

(7,077)
2
3
1
38
43

(7,581)
7
3
14
43
42

(17,019)
9
2
8
54
52

(14,579)
9
3
1
63
41

(10,935)
3
5
5
61
49

FY06

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CASK has benefitted from lower crude and redelivery costs
CASK has also improved and obviously benefitted from low crude prices, but there is more. Not harping on the obvious effect and reason for low fuel costs, another item which has reduced for SpiceJet is the redelivery costs. So how did redelivery costs spiral down in H2FY16 and can it remain low?
Lower redelivery costs have relieved a lot of cash expectations from working capital. SpiceJet has been maintaining provisions for redelivery expenses, which stands at Rs1679mn as of FY16 end. The company has been able to rework some of the redelivery expenses based upon revised lease terms and as such, some of the historical accruals have been reversed through other income (e.g. Rs16mn in
Q3FY16, Rs654mn in Q2FY16 and Rs71mn in Q1FY16). However, in Q4FY16, the company had made net accrual after write-back of Rs143mn. Hence, the redelivery costs have gone down from an average of Rs674mn each quarter between Q4FY14 to
Q4FY15 to an average of Rs160mn in the Q1-Q4FY16. This has eased considerable pressure on working capital as a means of cash generation. These reworking of contracts is likely to remain in favor of the company through additional orders from Boeing/Bombardiers. In fact, this provides an additional case for new aircraft orders from SpiceJet in favor of Boeing/Bombardier instead of Airbus apart from complementing the existing Boeing and Bombardier fleet.
Table 4: CASK analysis of SpiceJet
Per ASK
Fuel
Lease rentals
Airport Charges
Maintenance
Redelivery
Other operating expense
Employee
Other expense
CASK

Q1FY15
1.82
0.65
0.26
0.45
0.11
0.10
0.33
0.42
4.12

Q2FY15
1.82
0.60
0.25
0.48
0.06
0.11
0.34
0.30
3.96

Q3FY15
1.60
0.61
0.27
0.45
0.51
0.12
0.41
0.35
4.31

Q4FY15
1.17
0.47
0.28
0.47
0.27
0.12
0.44
0.29
3.52

Q1FY16
1.27
0.57
0.29
0.51
0.01
0.15
0.41
0.35
3.56

Q2FY16
1.17
0.59
0.29
0.57
0.01
0.18
0.40
0.38
3.60

Q3FY16
1.06
0.66
0.28
0.48
0.09
0.16
0.37
0.33
3.43

Q4FY16
0.87
0.66
0.29
1.05
0.07
0.13
0.35
0.38
3.81

RASK-CASK
(0.17)
Source: Company Data, I-Sec research

(0.62)

(0.59)

(0.30)

0.35

0.01

0.81

0.11

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ICICI Securities

CASK structurally higher due to maintenance cost
Our detailed deep-dive cost analysis has been shown earlier in our IndiGo report, hence is not being repeated here. However, while the previous analysis has been on the basis of FY10-FY15, here we present a quarterly analysis for the Q1-Q4 period of
FY16. These are the quarters more relevant for SJET as it captures the effect of the restructuring and various measures taken by the new management.
We focus more on costs ex-rental initially for the quarters between Q1-Q4FY16, which will be the period under consideration (PUC) in this section. Is there any other construct for cost differential between the SJET and IndiGo apart from rentals?
In this PUC, SJET actually has lower comparable or lower cost per ASK for parameters like employee, fuel and aircraft landing and en route charges. These lower charges can be explained by the 14 Q400 aircraft in its fleet, which enjoy lower charges compared to bigger aircraft. For example, the Q400 has lower fuel tax rates
(~4% compared to 25% for big jets) and lower landing and navigation charges. This is partially offset by the increased departures and landing of the turboprops, which will require more fuel burn.
However, SpiceJet has much higher other expenses compared to IndiGo (refer table 5 below. These other expenses comprise of maintenance charges, supplemental lease charges, redelivery costs, selling and distribution costs, and other expenditures like software charges and insurance. We have clubbed these costs to make an equivalent comparison between IndiGo and SpiceJet. IndiGo has not separately given the cost for these items in their quarterly disclosure.
Taking all these costs, combined average quarterly cost during the PUC for
SpiceJet was average Rs1.07 per ASK compared to 0.59 for IndiGo (delta of
Rs0.48).
Typically, selling and distribution cost per ASK is again much lower for SpiceJet than
IndiGo (Rs0.05 delta). It has averaged Rs0.26 for IndiGo in the past five years whereas SpiceJet has managed it at a cost of Rs0.19.
Maintenance cost is indeed lower for IndiGo (Rs0.10 delta). The lower maintenance costs can be on account of IndiGo’s well-known uniform fleet factor and a relatively lower fleet age, but the delta suggests it is not the key differentiator compared to the total delta of Rs0.48 for other expenses.
Considering the S&D and maintenance costs, we can only explain a delta of Rs0.5 thus far. So, where is the remaining delta? The answer lies in the supplementary rental charges and redelivery expenses. Again, the redelivery expenses are not significant. Higher maintenance costs will remain with higher utilisation and mixed fleet
The entire cost differential comes down to the significant supplementary rentals paid by SpiceJet. Similar supplementary rentals are also being paid by Jet
Airways (Jet). So, in our answer to the cost differential, this is a key construct apart from incentives which favor IndiGo over other players. The entire
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supplementary rentals for IndiGo are included in the rentals and not separately disclosed. Therefore, one has to believe that the supplementary rental for
IndiGo is significantly low considering it also includes the supplementary rentals. This is additional to the fact that IndiGo has a younger fleet and all narrow body big jets, which should have implied higher gross rentals.
Supplementary rentals are based on aircraft utilisation and calculated on number of hours flown or cycle operated. So, is SpiceJet/Jet overworking its fleet so that supplementary rentals are being paid? The answer is in the negative since ASK per aircraft is in fact similar for IndiGo/SpiceJet/Jet at around 400mn per year. So, can there be a differential between airlines in payment of supplementary rentals? We discuss it in our next section.
Table 5: Indigo quarterly CASK

Other Expenses
CASK
CASK without incentives
RASK-CASK
RASK-CASK without incentives
Source: Company Data, I-Sec research

Q1FY16
4.15
1.33
0.59
0.09
0.38
0.32

Q2FY16
3.36
1.18
0.60
0.08
0.42
0.32

Q3FY16
4.00
1.08
0.63
0.08
0.43
0.33

Q4FY16
3.60
0.90
0.62
0.08
0.43
0.34

0.57

RASK
Fuel
Net Rentals
Incentives
Employee
Landing fees and en-route charges

0.61

0.60

0.60

3.19
3.28
0.96
0.87

3.13
3.21
0.22
0.14

3.08
3.16
0.92
0.84

Comments

2.89
2.97
0.71
0.63

Marginally higher for IndiGo
This is not applicable to SpiceJet
Higher for IndiGo
Lower for SpiceJet, concessions for regional aircraft
This is significantly lower for IndiGo (Q1-Q3 average of 0.59 compared to 1.07 for SpiceJet)

Table 6: Detailed ‘other expenses’ between SpiceJet and IndiGo
SpiceJet has a significant outlay on account of supplementary rentals. Similar supplementary leases are also paid by Jet
Airways.

Other expenses per ASK
Maintenance (avg. 5 years)
Supplementary rentals
Selling and distribution (avg. 5 years)
Insurance (avg. 5 years)
Redelivery
Software charges (avg. 5 years)
Other
Total
Source: Company data, I-Sec research

Q1FY16
0.21
0.30
0.19
0.08
0.01
0.04
0.18
1.02

SpiceJet
Q2FY16
Q3FY16
0.21
0.21
0.36
0.26
0.19
0.19
0.08
0.08
0.01
0.09
0.04
0.04
0.25
0.18
1.15

1.05

Q4FY16
0.21
0.84
0.19
0.08
0.07
0.04
0.20
1.63

Indigo
Average
0.118
0.237
0.08
0.25
0.60

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Supplementary rentals has been a key drag
Leases, and sometimes loans, often have provisions that require the operator to pay maintenance reserves based on months, flight cycles and flight hours to cover future maintenance costs. This is primarily a risk mitigant in case of default. To avoid issues in case of bankruptcy, such reserves are often substituted by ‘supplemental rent’.
These are normally collected on a monthly basis and on submission of the relevant claims – when certain defined work is accomplished, the operator will be refunded the cost. Some engine manufacturers or third party maintenance providers offer ‘powerby-the-hour’ deals, where maintenance is provided against pre-agreed usage fees.
Genesis of maintenance reserves lies in risk mitigation of lessors. Most operating leases provide that the lessee is liable for the ongoing costs related to maintaining an aircraft to the required standard. In the event that an aircraft is forcibly repossessed due to a default by the airline, the aircraft may require expensive investment in outstanding maintenance work before it is in a condition to be re-leased or sold to another airline/investor. Therefore, a lessor's primary risk in relation to maintenance is one where the lessee fails to pay, in whole or in part, for the maintenance utility it consumed. To mitigate maintenance exposure, most lessors have independent credit departments to evaluate the creditworthiness of lessees. Evaluation of an operator's credit standing generally involves the establishment of some financial test, the failure to meet which would invoke an obligation to establish more stringent collateral security in the form of security deposits and payment of maintenance reserves. Hence, maintenance reserves are payments made by the lessee to the lessor to accrue for those scheduled major maintenance events that require significant aircraft grounding time and/or turnaround time for certain major component overhauls. Put another way, maintenance reserves are payments for maintenance utility consumed.
Mathematically, Full-life Maintenance Value = Maintenance Utility Consumed +
Maintenance Utility Remaining, or Full-Life Maintenance Value = Maintenance
Reserves + Maintenance Utility Remaining, which understandably indicates that
Maintenance Reserves = Maintenance Utility Consumed.
Maintenance costs can generate cost asymmetry. Maintenance reserves are often the most contentious part of a lease negotiation; the lessor views reserves as a costcovering exercise, while the lessee views it as a burden on its cashflow resources.
However, it is not this burden which is of the only interest. There is a differential in the levy of these maintenance reserves. While the maintenance reserves are strictly implemented on most airlines, many airlines have sufficient credit stature and prominence in the marketplace by which means they can reject paying maintenance reserves. Does it imply that IndiGo may get away with lower supplementary rentals compared to its peers? We think so. This is one of the reasons why the maintenance reserves are a part of the loans and advances for
SpiceJet/Jet while it is part of other long-term liabilities for IndiGo.

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Maintenance reserves are based on specific metrics and specific events.
Maintenance reserve payments are calculated on flight hour, flight cycle, and/or calendar basis and are usually paid on a monthly basis in arrears. Accumulated reserves are reimbursed (subject to limitations) after major maintenance events are completed. In general, reserves become the property of the lessor immediately upon payment. Customarily, the lessee will cause the required maintenance to be completed and then claim reimbursement for the qualified portion of the work from the reserve account held by the lessor. Repayment takes place only if payment into the reserve account is fully up to date, and only up to the amount held in the specific reserve account. Thus, if a particular event is carried out, and the cost of that work exceeds the total in the specific reserve account, the excess cost is the responsibility of the lessee. Funds generally cannot be transferred from other reserve accounts for the same aircraft to cover any shortfall incurred. So, for example, a lessee cannot siphon a fund used for engine maintenance and funnel those proceeds to subsidize the cost of airframe heavy check. In the event a lessee negotiates to not pay maintenance reserves, it may still be required to provide collateral security in the form of an End of Lease Financial Adjustment or through a Letter of Credit (LC).
A lease agreement will specify what maintenance events are to be covered through payment of reserves and for which the lessee may draw down against the accrued amounts. Areas of maintenance typically covered by reserves are as follows:


Airframe Heavy Structural Inspections



Landing Gear Overhauls



Engine Performance Restoration



Engine Life Limited Parts (LLPs)



Auxiliary Power Unit (APU) Restoration

The baseline maintenance reserves are derived by each lessor from internally generated reserve claims, industry publications, and manufacturer-published cost data. Maintenance utility calculation for new aircraft will depend upon OEM specifications shared in the Maintenance Planning Document (MPD). The A320neo and Boeing 737Max may fall in this category although they will share lot of similarities between these new generation aircraft with their predecessors. Such a specification will be beneficial for an operator who inducts virgin new aircraft from any OEM –such as Indigo. However, such a benefit is non-relevant considering that IndiGo is likely to use its market position and balance sheet not pay any supplemental rentals/maintenance reserves outgo.
Aircraft age has significant bearing on this maintenance reserve. As an aircraft ages, subsequent airframe heavy checks are expected to require higher levels of nonroutine maintenance, which is defined to be the work required to rectify routine maintenance tasks. The non-routine ratio – sometimes referred to as the defect ratio – is the ratio of non-routine manhours to routine manhours, and is a measurement of the incremental time required to correct routine defects.
As an aircraft ages, the non-routine ratio can easily exceed 100%, which explains why successive maintenance checks tend to be more costly. Therefore, when developing airframe maintenance reserves, it is important to adjust the rate to account for the
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particular phase within the airframe’s maintenance cycle. The airframe’s maintenance cycle can be broken into three phases consisting of: first-run, mature run, and agingrun.


First-Run is the initial operating years, often referred to as the honeymoon period and generally considered the first 4-6 years of in-service operation. The structure, systems, and components are new, and there is less non-routine maintenance and material scrap rate.



Mature-Run begins after the newness phase and runs through the first maintenance cycle. This period typically falls between the first heavy maintenance visit and the second maintenance visit.



Aging-Run begins after the end of the first maintenance cycle when the effects of airframe age result in higher non-routine maintenance costs. This period typically begins after the second heavy maintenance visit and continues to increase with time. Flight Length is another crucial parameter. The impact of lower flight length results in higher cyclical loads on an engine’s parts and accessories with the consequence of higher non-routine maintenance. Smaller flight segments also force engines to spend a larger proportion of total flight time using take-off and climb power settings resulting in more rapid performance deterioration, which translates to higher DMC.
This is definitely one of the negative offsets attributable to maintaining a regional aircraft/turboprop feet. SpiceJet/Jet/Air-India all have such fleet and will have to bear the higher maintenance costs on account of the same. IndiGo does not have any such small aircraft fleet.

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RoCE to improve ahead
One must not forget the asset-light model of leasing in airlines. Equating the rental outgo in an operating lease as an interest expense towards asset acquisition, the
RoEs should not change in principal. RoEs would remain high on the back of an extremely high leveraged business.
However, the comparison is different in case of RoCE. The operating lease rentals should be added back to EBIT, while the equivalent asset should be added to capital employed. In a growing phase, when an increasing number of aircraft are being acquired, equivalent assets can be estimated as a 7x/8x the current rental (operating
+finance). So, while the finance lease asset is already factored in the assets, we add
7x operating lease rentals to the assets to derive adjusted RoCEs in line with the global practice for equivalent debt estimation.
Even if we adjust for the off balance sheet assets under operating lease, the company would retain attractive RoCEs (~18-20%)
Table 7: Attractive RoCEs ahead, adjusted for operating lease rentals
FY10
FY11
(Rs mn)
EBIT
848
1,394
Capital Employed
2,436
4,152
RoCE
34.8
33.6
Rentals
772
1,367
Op. Lease Debt
5,402
9,569
Adjusted EBIT
1,619
2,761
Adjusted CE
7,838
13,721
Adjusted RoCE
20.7
20.1
Source: I-Sec research, Company Data

FY12
(5,535)
9,618
(57.6)
2,526
17,682
(3,009)
27,299
(11.0)

FY13
(754)
17,177
(4.4)
3,589
25,125
2,836
42,302
6.7

FY14
(8,666)
8,812
(98.3)
3,898
27,287
(4,768)
36,099
(13.2)

FY15
(5,849)
9,356
(62.5)
4,285
29,994
(1,564)
39,350
(4.0)

FY16E
4,589
13,072
35.1
6,019
42,133
10,608
55,206
19.2

FY17E
5,268
36,739
14.3
8,081
56,567
13,349
93,306
14.3

FY18E
8,649
42,121
20.5
10,532
73,722
19,181
115,844
16.6

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Debt will increase on account of the upcoming bulk order The leverage path for SpiceJet will depend on a key decision to place a bulk order. As explained earlier, bulk order will have an initial outgo of ~Rs2bn. To give an example, let’s say, the bulk order ensures a final list price of US$80mn per new aircraft.
Assuming SpiceJet will have to pay 4% of the order upfront, it will entail a payment of
Rs21.4bn to the airframer. This item is shown in the security deposits in the balance sheet under loans and advances. We assume such a bulk order to be placed by
SpiceJet during FY17, which will raise its leverage contour.
Table 8: Leverage portfolio of SpiceJet
FY12
6,504
2,050
135
719
1,531
10,940
2,359

FY13
14,300
2,482
225
1,003
1,241
19,251
2,171

FY14
12,363
2,800
291
1,104
1,926
18,484
51

FY15
11,199
2,986
255
1,682
2,375
18,496
236

FY16E
9,237
1,050
220
2,375
12,882
1,085

FY17E
29,237
1,050
220
2,375
32,882
7,436

FY18E
28,237
1,050
220
2,375
31,882
16,292

Net Debt
8,581
Source: Company Data, I-Sec research

17,080

18,433

18,260

11,797

25,446

15,590

(Rs mn)
Long-Term Borrowing
Short-Term Borrowing
Other Long-Term Liabilities
Trade Payables
Current maturity of LT debt
Borrowing
Cash

Chart 6: *Debt prop-up likely for SpiceJet in FY17 owing to the anticipated bulk order 30,000
25,446

25,000
20,000

18,433

18,260

17,080

15,000

15,590
11,797

10,000

8,581

5,000
0
FY12

FY13

FY14

FY15

FY16E

Source: Company Data, I-Sec research
*The debt does not include the preferance shares given to ex-promoters

116

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Prospective dilution is an overhang
SpiceJet’s shareholders, in their meeting held on 24-Sep’14, approved the aggregate issue of 189,091,378 warrants convertible into equivalent number of equity shares having a nominal value of Rs10 each at a premium of Rs6.3 to previous promoters for a consideration aggregating to Rs3,082mn. The ex-promoters paid Rs2,305mn towards this in FY15 making them eligible for 141.1mn shares.
Additionally, in Jan’15, the Board of Directors approved the issue of up to 3,750,000 non-convertible redeemable preference shares of Rs1,000 each on basis of the subscription offer received by the previous promoters subject to the approval of the shareholders and such other approvals as may be required. The ex-promoters paid
Rs1,200mn towards this. Being non-convertible, it will not add to dilution but remain as debt. The ex-promoters also paid Rs500mn in Q1FY16, which might have been toward the non-convertible preference shares. Although the company has not disclosed it, the dilution ratio of earnings per share indicates likewise.
Therefore, on a combined basis, SpiceJet has Rs4bn recorded as advance money received against securities issued and/or proposed to be issued. Among, this considering the dilution prospect incidental from the warrants, additional shares issued to the ex-promoters could be 142mn, assuming there is no further money subscribed by the ex-promoters. This would imply ~24% dilution to SpiceJet’s earnings. In case there is full subscription of the warrant program, the ex-promoters can apply for additional 48mn shares on a payment of Rs778mn. This would imply a higher dilution of near 32%. The entire calculation of dilution is based on the price of Rs10 plus a security premium of Rs6.3 (implying a conversion price of Rs16.3).
Table 9: Quarterly earnings of SpiceJet indicating the dilution prospects
(Rs/share)
Q4FY15
Basic Earnings per share
0.38
Diluted earnings per share
0.31
Dilution %
22.6
Source: I-Sec research, Company data

Q1FY16
1.20
0.97
23.7

Q2FY16
0.40
0.32
25.0

Q3FY16
3.98
3.02
31.8

Q4FY16
1.22
0.93
31.2

Table 10: Timeline of the warrants and preference shares issued by SpiceJet to ex-promoters
Date
Mar’16
Oct'15

Event
Reclassification of Rs1785.92mn from short term borrowing to Advance money against securities to be issued
Additional money received toward CRDPS of Rs500mn.

The Board of the Company approved the issue of up to
3,750,000 non-convertible redeemable preference shares of
Rs1,000 each basis the subscription offer received by the previous promoters subject to the approval of the
Shareholders of the Company and such other approvals as may be required.
Allotment of 1,91,69,000 equity shares to Mr. Kalanithi Maran
Nov'14
and 4,50,00,000 equity shares to M/s Kal Airways
Private Limited respectively, having nominal value of Rs10 each against conversion of options attached to warrants issued on a preferential basis.
The shareholders of the Company in their meeting held on
Sep'14
24-Sep’14 approved the aggregate issue. of 189,091,378 warrants convertible into equivalent number of equity shares having a nominal value of Rs10 each at a premium of Rs6.3 to previous promoters for a consideration aggregating to Rs3082.189mn.
Source: I-Sec research, Company data
Jan'15

Comment
Total warrant/crdps money now stand as Rs5790.89mn
Addl. money received toward warrants/ CRDPS of Rs500mn.
Total warrant/CRDPS money now stands as Rs4, 005mn.
The Marans have paid Rs1, 200.29mn towards this.
They can get 1.2mn preference shares on this account.
Preference shares not convertible.
This was exercised based on warrants issued as in Mar'14.

The Marans have paid Rs2, 304.68mn toward this.
Based on payment made, they will be able to hold 141.4mn shares. 117

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Average fares will move ahead with crude
The biggest delta which swings the profitability of any airline is the average fare growth. This is a typical characteristic of the high operating leverage nature of the airline business. We factor 2%/3% growth in average passenger fare for SpiceJet in
FY17/FY18.
Increase in fare should never be seen in isolation, but with rising crude price assumption of US$55/60 per barrel for FY17/FY18 and a strong passenger growth.
We assume a constant INR/USD assumption of 67 and no change in the current tax structure. We are factoring the higher excise duty of 14% on ATF as introduced in the
FY17 Union Budget.
Our domestic supply-demand model shows an implied growth rate of 14%. The average fare is a key determinant of profits for an airline, but it depends on two key factors, namely, crude prices (which we have discussed) and competition. Our supplydemand model of domestic air traffic in India has a consolidated average growth of
14% over the next four years. This is the implied growth rate based on the capacity addition program of domestic airlines. This model accounts for all the operating airlines in India along with their planned capacity additions, hence reflects competition.
We have already established that, barring a perilous way of short-term operating lease/wet leases, the capacity addition options are fairly limited. Another constraint will be that PLFs typically tend to be stable or modestly increasing at an aggregate level, thanks to the modern-day yield management practices adopted by the airline industry.
Therefore, when we arrive at an average industry growth of 14% with increasing PLFs and factoring all the capacity additions, it is but the implied growth rate of the system.
Actual growth would likely outrun this implied growth rate indicating increased fare trajectory. The implied growth rate of 14% is low considering that the average annual growth rate of passengers in India has been more than 20% since 2000 excluding the three years of the 2001-02 US terrorist attacks and subsequent global crisis, the great 2009 financial recession, and 2012 when Kingfisher Airlines went insolvent. Hence at an implied growth rate of 14% and an incrementally increasing oil price scenario, our average air fare growth estimate of 2/3% for SpiceJet over FY17/FY18 is conservative. Table 11: Domestic air traffic supply and demand
System
Passenger growth
Passenger carried
Avg km per passenger
RPK (mn)
Departure/plane
Effective seats (FY)
Avg km per seat
ASK (mn)
PLF (%)
Source: I-Sec research

118

FY16
85,197,675
950
80,938
1,980
56,044
881
97,761
82.8

FY17
15.5
98,363,142
954
93,838
2,000
64,504
890
114,817
81.7

FY18
13.0
111,189,886
956
106,298
2,030
70,043
885
125,836
84.5

FY19
14.1
126,879,624
956
121,297
2,040
78,812
881
141,644
85.6

FY20
14.7
145,505,253
956
139,103
2,050
90,916
881
164,199
84.7

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SpiceJet, June 16, 2016

Sensitivity analysis
These sensitivities should be not be looked in isolation since there are countermeasures adopted between the three factors of in crude, dollar and fares. It is at the crude price levels of US$6070/bbl that our target price for SpiceJet recedes below Rs60 per share.

Combined factors of crude and currency: The sensitivity of airlines will largely depend upon the fares which is again a function of several external factors like competition and demand. However, the two factors which are external but significantly determine the results of airline operations are crude prices and currency. Typically, currency has a ripple effect across cost items starting from rentals, maintenance contracts, redelivery expenditure as well as crude. As such, while it is less volatile than crude, it has higher sensitivity to currency.
Table 12: Sensitivity of target price with crude prices & INR-USD exchange rate

Crude
(US$/bbl)

TP
40
45
50
55
60
70

(Rs)
65
122
110
99
87
76
53

63
132
121
110
99
88
66

67
111
100
88
76
64
41

70
96
83
71
59
46
22

72
85
73
60
47
35
9

Source: I-Sec research

Combined factor of crude price and passenger fare: The sensitivity analysis shows high dependence of the airline business model on passenger fares. This reflects the high operating leverage nature of the airline business, which has high fixed costs, including lease and other aircraft acquisition charges, engineering and maintenance charges, financing commitments, staff costs and IT costs. Significant operating expenses, such as airport charges, do not vary by passenger load factors.
Table 13: Sensitivity of crude prices and passenger fare growth

The number of instances where target price goes below Rs60 significantly increases, indicating the high sensitivity to fare hikes.

Fare growth
(%)

TP
-10%
-5%
0%
3%
5%
10%

40
35
65
94
111
123
152

Crude (US$/bbl)
45
50
24
12
53
41
82
70
100
88
111
99
140
129

55
(0)
29
58
76
88
117

60
(12)
17
47
64
76
105

70
(35)
(6)
23
41
52
81

Source: I-Sec Research

Combined factor of passenger fare growth and currency: Even higher sensitivity is seen here as higher numbers of cost items including crude depend on currency.
Table 14: Sensitivity of INR-USD exchange rate and passenger fare growth
(Rs)

Fare growth
(%)

TP
-10%
-5%
0%
3%
5%
10%

63
12
41
70
88
99
129

65
(0)
29
58
76
88
117

67
(12)
17
47
64
76
105

70
(30)
(0)
29
46
58
87

72
(41)
(12)
17
35
46
75

74
(53)
(24)
5
23
34
64

Source: I-Sec research

119

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SpiceJet, June 16, 2016

Valuation
LCCs tend to trade at higher multiples compared to FSCs. Asian LCCs enjoy additional premium on account of their low cost structure and high traffic growth. High volatility in crude prices and the global economy have a direct bearing on airline stock prices and, as such, it is best to consider the average 1-year forward EV /EBITDAR for the last 5/10 years to ascertain an average cycle multiple.
The average 1-year forward EV/EBITDAR for LCCs is 7.5 while the same for Asian
LCCS is 9.5. As such, we ascribe 7X EV/EBITDAR to SpiceJet based on FY18 estimates to arrive at a target price of Rs80 per share without dilution. Post dilution, our target price comes to be Rs64 per share.
We value SJET at 7x compared to 8x for IndiGo to account for the better balance sheet, significantly higher market share and lower cost structure of IndiGo compared to SJET. Higher leverage and smaller scale also makes SJET more sensitive to crude and other cost escalations.
Table 15: Valuation based on 8x EV/EBITDAR
FY18E
20,086
140,605
31,882
16,492
77,162
92,552
48,053
599.5
80
64

(Rs mn)
EBITDAR
EV @7x EV/EBITDAR
Gross debt
Cash
Rentals @7x
Net debt
Equity value
Shares (mn)
Equity Value
Post dilution
Source: I-Sec research

Assumptions
Table 16: Key assumptions in our model
Assumptions
Fare Growth
Average ticket (Rs)
INR-US$
Crude Prices(US$/bbl)
Realized ATF prices (Rs/kl)
Scheduled Passengers (mn)
RPK (mn)
ASK (mn)
PLF (%)
Ancillary Revenue (Rs mn)
Total Revenue (Rs mn)
EBITDA (Rs mn)
EBITDAR (Rs mn)
PAT (Rs mn)
Source: I-Sec research

120

FY16E
-14.8%
3,744
65.3
46.0
47,748
11.9
11,699
12,916
90.6
6,274
50,881
4,322
12,376
4,072

FY17E
2.0%
3,819
67.0
55.0
54,366
13.5
13,146
14,363
91.5
7,565
59,272
5,732
15,675
3,667

FY18E
3.0%
3,933
67.0
60.0
57,363
16.0
15,339
17,321
88.6
9,403
72,414
9,063
20,086
6,383

FY19E
5.0%
4,130
68.0
60.0
58,116
19.0
17,963
20,784
86.4
11,829
90,261
14,437
26,989
11,893

FY20E
5.0%
4,337
68.0
60.0
58,116
22.6
21,102
25,444
82.9
14,860
112,655
22,630
36,597
19,942

ICICI Securities

SpiceJet, June 16, 2016

Financials
Table 17: Profit & Loss statement
(Rs mn, year ending March 31)
Revenue

FY14
63,042

FY15
52,015

FY16P
50,881

FY17E
59,272

FY18E
72,414

Operating Expenses
Aviation turbine fuel
Lease charges
Aircraft R&M
Supplemental lease charges
Consumption of stores and spares
Aviation insurance
Landing, navigation and other airport charges
Cost of inflight food and beverages
Aircraft navigation software expenses
Aircraft redelivery costs
Other operating expenses
Employee wages
Selling expenses
Other expenses
Total Expenses

60,082
32,527
10,532
4,758
4,245
929
329
4,740
535
742
291
454
5,757
3,521
2,194
71,554

48,058
24,096
8,644
2,660
3,340
721
212
3,815
244
705
3,185
435
5,375
2,794
2,372
58,598

37,009
13,920
8,054
2,613
5,329
763
199
3,710
390
662
640
729
4,928
2,544
2,077
46,559

42,669
17,271
9,942
3,320
3,561
916
241
4,474
552
781
1,000
611
6,213
2,845
1,814
53,540

50,307
21,977
11,023
3,789
4,380
1,152
270
5,148
750
849
200
768
7,251
3,476
2,317
63,351

EBITDA

(8,512)

(6,582)

4,322

5,732

9,063

EBITDAR

2,020

2,062

12,376

15,675

20,086

Other Income
Interest Income
D&A
Interest expense

944
385
1,483
1,366

1,803
197
1,266
1,635

1,313
130
1,176
1,154

500
320
1,284
1,602

500
400
1,314
2,267

(10,032)
(10,032)
(10,032)

614
(6,871)
(6,871)
(7,484)

637
4,072
4,072
3,435

3,667
3,667
3,667

6,383
6,383
6,383

Extraordinary
PBT
Tax
PAT
Adjusted PAT
Source: Company data, I-Sec research

121

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SpiceJet, June 16, 2016
Table 18: Balance sheet
(Rs mn, year ending March 31)
Share Capital
Advanced money received against securities/proposed to be issued
Reserves and Surplus
Networth

FY14
5,353

FY15
5,995

FY16P
5,995

FY17E
5,995

FY18E
5,995

583

3,505

5,791

5,791

5,791

(15,881)
(9,945)

(22,145)
(12,645)

(18,102)
(6,316)

(14,435)
(2,650)

(8,052)
3,733

12,363
2,800
291
1,104
1,926
18,484

11,199
2,986
255
1,682
2,375
18,496

9,237
1,050
220
2,375
12,882

29,237
1,050
220
2,375
32,882

28,237
1,050
220
2,375
31,882

273

3,506

6,506

6,506

6,506

Trade Payables
Others
Current Liability

10,515
10,143
20,658

10,105
6,604
16,710

7,762
6,204
13,966

10,268
6,601
16,869

12,150
7,810
19,960

Total Equity and liability

29,470

26,066

27,038

53,607

62,081

Gross Fixed Assets
-Depreciation
Net Fixed Assets

21,734
2,959
18,774

21,138
3,999
17,138

21,196
5,175
16,021

21,396
6,459
14,937

21,896
7,773
14,123

Loans and advances
Other LT assets

4,393
2,665

6,453
344

6,739
1,247

27,739
1,247

27,739
1,247

Current Investments
Inventories
Trade Receivables
Cash
Other current Assets
Current Assets

452
1,557
51
1,579
3,638

451
1,217
236
227
2,131

200
665
434
1,085
647
3,031

200
440
1,462
7,436
147
9,684

200
521
1,786
16,292
174
18,972

29,470

26,066

27,038

53,607

62,081

Long Term Borrowing
Short Term Borrowing
Other Long Term Liabilities
Trade Payables
Current maturity of LT debt
Borrowing
Provisions

Total Assets
Source: Company data, I-Sec research

122

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SpiceJet, June 16, 2016
Table 19: Cashflow statement
(Rs mn, year ending March 31)
FY14
CASHFLOW FROM OPERATING ACTIVITIES
Profit / (Loss) before tax
Adjustments to reconcile profit before tax to net cash flows Depreciation and Amortization
Provision for doubtful claims / advances
Provision for doubtful debts
Interest income
Interest expense
Loss / (profit) on sale of assets (net) / assets written off
Translation loss / (gain) on monetary assets and liabilities
Profit on sale of aircraft under sale and leaseback arrangement Operating profit / (loss) before working capital changes Movements in working capital:
(Increase) / Decrease in trade receivables
(Increase) / Decrease in other current assets
(Increase) / Decrease in inventories
Increase / (Decrease) in trade payables and other liabilities Increase / (Decrease) in provisions
Cash generated / (used) in operations
Income taxes paid (net of refunds)
Net Cashflow from / (used) in operating activists (A)
CASHFLOW FROM INVESTING ACTIVITIES
Purchase of fixed assets (including capital advances)
Sale of fixed assets
Margin money deposits placed
Margin money deposits withdrawn
Interest received
Investments change
Net Cashflow from / (used) in investing activities (B)
CASHFLOW FROM FINANCING ACTIVITIES
Proceeds from issue of share capital (including share premium) Money received against share warrants
Advance received against share warrants
Advance money towards subscription of NCCRPS
Proceeds from long term borrowings
Proceed from issue of 13% CCD
Proceeds from short-term borrowings
Repayment of short-term borrowings
Repayment of long-term borrowings
Interest paid (including ancillary cost for arranging the borrowings) Net Cashflow from / (used) in financing activities (C)
NET INCREASE IN CASH AND CASH EQUIVALENTS
(A + B + C)
Source: Company data, I-Sec research

FY15

FY16P

FY17E

FY18E

(10,032)

(6,871)

4,072

3,667

6,383

1,483
133
92
(385)
1,366
17
(54)

1,266
505
(197)
1,635
(585)
(53)

1,176

1,284

1,314

(130)
1,154

(320)
1,602

(400)
2,267

-

-

(7,380)

(4,299)

6,272

6,232

9,563

(507)
422
5

428
(281)
0

783
(420)
(214)

(1,028)
500
225

(324)
(27)
(81)

8,013
82
635
(45)
590

(3,122)
3,233
(4,041)
(68)
(4,109)

(2,744)

2,903

3,091

3,677
3,677

8,833
8,833

12,223
12,223

(821)
5
(12,847)
12,803
363

(118)
1
(2,000)
4,313
295

(440)

(200)

(500)

(497)

2,491

130
(864)
(1,174)

320
(21,000)
(20,880)

400
(100)

407
333
250
-

999
2,055
1,200

(1,000)

20,000

(1,000)

500

1,250
(932)
(2,177)

1,545
(1,377)
(1,164)

(1,345)
(2,213)

(1,454)
1,804

(1,154)
(1,654)

(1,602)
18,398

(2,267)
(3,267)

(2,120)

185

849

6,351

8,856

123

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SpiceJet, June 16, 2016
Table 20: Key ratios
(Year ending March 31)
FY14

FY15

FY16P

FY17E

FY18E

Per Share Data (in Rs.)
EPS(Basic Recurring)
Diluted Recurring EPS
Recurring Cash EPS
Dividend per share (DPS)
Book Value per share

(16.7)
(16.7)
(14.3)
(16.6)

(12.5)
(12.5)
(10.4)
(21.1)

5.7
5.7
7.7
(10.5)

6.1
6.1
8.3
(4.4)

10.6
10.6
12.8
6.2

Growth Ratios (%)
EBITDA
EBITDAR
Recurring Net Income

333.7
(67.0)
425.0

(22.7)
2.1
(25.4)

(165.7)
500.3
(145.9)

32.6
26.7
6.7

58.1
28.1
74

Valuation Ratios (x)
P/E
P/CEPS
P/BV
EV / EBITDA
EV / EBITDAR
EV / FCF

(3.9)
(4.6)
(4.0)
(6.8)
28.7
41.1

(5.3)
(6.4)
(3.1)
(8.8)
28.0
(14.5)

11.5
8.6
(6.3)
11.9
4.2
12.5

10.8
8.0
(14.9)
11.3
4.1
7.2

6.2
5.1
10.6
6.1
2.7
4.3

51.6
23.4
(13.2)
(193.1)
2.3
9.0
53.6
(1.85)

46.3
23.0
(26.7)
(155.8)
2.8
8.5
62.9
(1.44)

27.4
26.3
42.0
(83.7)
5.2
3.1
60.8
(1.87)

29.1
22.8
22.4
(19.6)
3.0
9.0
70.0
(9.60)

30.3
21.3
14.1
(2.3)
3.0
9.0
70.0
4.18

(15.9)
(98.3)
100.9
(13.5)

(14.4)
(62.5)
59.2
(12.7)

6.8
35.1
(54.4)
8.5

6.2
14.3
(138.4)
9.7

8.8
20.5
171.0
12.5

Operating Ratios (%)
Fuel/Sales
Net Rentals/Sales
Other Income / PBT
Effective Tax Rate
NWC / Total Assets
Inventory Days
Receivables (days)
Payables (days)
Net D/E Ratio (x)
Return/Profitability Ratios (%)
Recurring Net Income Margins
RoCE
RoNW
Dividend Payout Ratio
EBITDA Margins
Source: Company data, I-Sec research

124

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SpiceJet, June 16, 2016

Index of Tables and Charts
Tables
Table 1: Passenger and capacity growth for SpiceJet ..................................................... 104
Table 2: Quarterly Revenue per ASK (RASK) has significantly improved for SpiceJet ... 105
Table 3: Working capital schedule for SpiceJet ................................................................ 108
Table 4: CASK analysis of SpiceJet ................................................................................. 109
Table 5: Indigo quarterly CASK ........................................................................................ 111
Table 6: Detailed ‘other expenses’ between SpiceJet and IndiGo ................................... 111
Table 7: Attractive RoCEs ahead, adjusted for operating lease rentals ........................... 115
Table 8: Leverage portfolio of SpiceJet ............................................................................ 116
Table 9: Quarterly earnings of SpiceJet indicating the dilution prospects ........................ 117
Table 10: Timeline of the warrants and preference shares issued by SpiceJet to expromoters .................................................................................................................... 117
Table 11: Domestic air traffic supply and demand............................................................ 118
Table 12: Sensitivity of target price with crude prices & INR-USD exchange rate ........... 119
Table 13: Sensitivity of crude prices and passenger fare growth ..................................... 119
Table 14: Sensitivity of INR-USD exchange rate and passenger fare growth.................. 119
Table 15: Valuation based on 8x EV/EBITDAR ................................................................ 120
Table 16: Key assumptions in our model .......................................................................... 120
Table 17: Profit & Loss statement ..................................................................................... 121
Table 18: Balance sheet ................................................................................................... 122
Table 19: Cashflow statement .......................................................................................... 123
Table 20: Key ratios .......................................................................................................... 124

Charts
Chart 1: Single aisle demand largely committed over the next three years ..................... 104
Chart 2: Delhi-Mumbai booking fare for next 5-6 weeks as of Mar’16 (April booking) ..... 107
Chart 3: Delhi-Mumbai booking fare for 7-15 weeks as of Mar’16 (June booking) .......... 107
Chart 4: Delhi-Mumbai booking fare for 16-25 weeks as of Mar’16 (July and August bookings) ..................................................................................................................... 107
Chart 5: Delhi-Mumbai booking fare for 16-25 weeks as of Mar’16 (July and August bookings) ..................................................................................................................... 108
Chart 6: *Debt prop-up likely for SpiceJet in FY17 owing to the anticipated bulk order ... 116

125

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126

Equity Research
June 16, 2016
BSE Sensex: 26726

INDIA

Jet Airways (India)

ADD

Sustainability of turnaround remains key
Reason for report: Initiating coverage

Aviation

Target price Rs621

Shareholding pattern
Sep
’15
51.0

Dec
’15
51.0

Mar
’16
51.0

38.1
7.7
0.2
2.1
28.1
10.9

Promoters
Institutional
investors
MFs and UTI
Banks/FIs
Insurance
FIIs
Others

38.0
7.5
0.2
2.1
28.1
11.1

38.6
7.8
0.1
2.1
28.6
10.4

I-Sec vs Bbg* consensus
(%)
Sales
EBITDA
Adj. PAT

FY17E
5.4
(34.9)
(49.5)

FY18E
6.0
(33.6)
(31.1)

Source: *Bloomberg, I-Sec research

Jun-16

Jun-15

Dec-15

Jun-14

Dec-14

Jun-13

Dec-13

(Rs)

Price chart
900
800
700
600
500
400
300
200
100
0

Rs561

Jet Airways (Jet) is a one of the strongest players in the Indian aviation sector with the second-highest market share in the Indian domestic space (21%) and highest international market share of 20% when measured along with its global partner Etihad Airways (Etihad). With India’s second-highest fleet strength of 116 aircraft, Jet is well poised to ride the strong air traffic growth coupled with the benign oil price outlook. Jet’s history has been riddled with continual losses from FY08 to FY15 driven by high cost of operations amidst aggressive pricing by LCCs along with elevated fuel prices and a leverage driven-expansion, further exacerbated by acquisitions. As Jet manages to return to profits in FY16, the positives for the company stem from its turnaround plan, which has a few structural initiatives that we think can give a meaningful sustainability to earnings, in addition to the benefits from a low crude price outlook. Jet’s net debt has significantly reduced (by 25% in the past three years) with the equity infusion by Etihad. However, a levered balance sheet will not allow expansion of fleet and such ASKs are likely to remain flattish for Jet during FY17/FY18. Systemic troughs in utilisation remain a risk.
The turnaround strategy has been successful for Jet based on certain structural changes. These structural initiatives include cost synergies from the strategic alliance with Etihad, strong increase in utilizations, cost deceleration driven by thirdparty maintenance contracts, dollarization of debt, homogenization of the B737 fleet and reorientation of routes centered on strong growth in codeshare traffic.
Cost structure has improved in line with the strategy. The most important factors driving the reduction in costs include higher utilisation, synergies realized from the Etihad alliance and reduction in leverage. The higher utilisation though difficult to improve can remain elevated driven by higher feeder traffic to and from
Middle East beneficiated by the wider codeshare programs. The cost synergies through Etihad alliance is generated through better bargaining power for contracts along with driving shared programs. Between FY12 and FY16, Jet has pared down
Rs32bn of net debt, largely driven by strategic sale of assets and equity infusion by
Etihad.
Recommend ADD with a target price of Rs621 based on 7x FY18E
EV/EBITDAR. Jet is expected to increase its ASK/RPK/Pax from
50.1bn/41.4bn/25.8mn respectively in FY16 to 51.9bn/44.4bn/28.7mn in FY18E, with EBITDAR of Rs43.1bn in FY18E (FY18E EBITDAR margin of 17%). The lease-adjusted RoCEs will remain at ~20%. Our revenue model factors fare growth of 2%/3% in FY17/FY18 with a rising crude price assumption of US$55-60/bbl in the two years.
Market Cap

Rs63.8bn/US$950mn

Reuters/Bloomberg
Shares Outstanding (mn)
52-week Range (Rs)

JET.BO/JETIN IN
113.6
776/253

Year to March

FY15

FY16P

FY17E

FY18E

Revenue (Rs mn)

209,656

222,070

240,198

255,894

Net Income (Rs mn)

(20,974)

12,117

5,771

8,484

EPS (Rs)

Free Float (%)

49.0

% Chg YoY

FII (%)

28.6

P/E (x)

Daily Volume (US$/'000)

Research Analysts:

Ansuman Deb ansuman.deb@icicisecurities.com +91 22 6637 7312

50,212

Absolute Return 3m (%)

5.8

Absolute Return 12m (%)
Sensex Return 3m (%)
Sensex Return 12m (%)

121.8

CEPS (Rs)
EV/E (x)
Dividend Yield (%)

(184.6)

106.7

50.8

74.7

(49.2)

(157.8)

(52.4)

47.0

(3.0)

5.3

11.0

7.5

(117.3)

194.4

128.3

154.4

(48.2)

7.5

9.7

7.6

-

-

-

-

9.4

RoCE (%)

(6.0)

27.7

18.9

20.6

1.9

RoE (%)

33.2

(23.3)

(12.5)

(22.4)

127

Jet Airways India, June 16, 2016

ICICI Securities

TABLE OF CONTENTS
Jet’s turnaround strategy has worked – a look at the five key components......... 130
Increase in utilisation................................................................................................... 130
The Etihad connection- structural positive for Jet ....................................................... 132
Adoption of third party maintenance contracts ........................................................... 134
Dollarization of debt leading to lower interest expense .............................................. 135
Integration of domestic and international fleet ............................................................ 136
Has Jet managed to stem the costs? ........................................................................ 137
Rentals have decreased with higher utilizations ......................................................... 137
Fuel cost has reduced with crude and higher utilisation ............................................. 138
Employee costs, though down remain volatile ............................................................ 138
S&D costs have increased, but expected to cool off .................................................. 139
Maintenance /other costs remain volatile, but declined as well .................................. 140
How have yields fared for the company – and the resultant spreads? .................. 142
RoCE to improve ahead .............................................................................................. 145
Sensitivity analysis ...................................................................................................... 146
Valuation ....................................................................................................................... 147
Financials...................................................................................................................... 148
Index of Tables and Charts ......................................................................................... 152

128

ICICI Securities

Jet Airways India, June 16, 2016
Chart 1: International traffic growth has been robust
Int'l traffic-Total

60,000,000

Int'l traffic-Growth (RHS)

20

50,000,000

15

40,000,000

(%)

10

30,000,000
5

20,000,000

0

10,000,000
0

CY15

2013-14

2012-13

2011-12

2010-11

2009-10

2008-09

2007-08

2006-07

2005-06

2004-05

2003-04

2002-03

2001-02

2000-01

1999-00

1998-99

1997-98

1996-97

1995-96

1994-95

1993-94

(5)

Source: DGCA

Chart 2: Domestic operators’ have continually increased int’l traffic share
Int'l traffic-Indian airlines

Domestic operator share (RHS)
39.0

20,000,000
18,000,000
16,000,000
14,000,000
12,000,000
10,000,000
8,000,000
6,000,000
4,000,000
2,000,000
0

37.0

33.0
31.0

(%)

35.0

29.0
27.0

1993-94
1994-95
1995-96
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
2009-10
2010-11
2011-12
2012-13
2013-14
CY15

25.0

Source: DGCA

Chart 3: Jet plus Etihad holds ~20% of the total international traffic of India
Others (~70 airlines), 25.90

Jet
Airways+Etihaad,
19.2

Singapore
Airlines, 2.4
Air India, 16.3

Spicejet, 2.5
Srilnkan
Airways, 2.5
Thai Airways, 2.8
Saudia, 2.8
Oman Air, 3.0
Indigo, 3.2

Emirates
Airline, 10.7
Qatar
Airways, 5.2

Air Arabia, 3.6
Source: DGCA

129

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Jet Airways India, June 16, 2016

Jet’s turnaround strategy has worked – a look at the five key components
The company started a 3-year turnaround program in 2015, which has seen some broad strategy adoption that has yielded positive results. We appreciate the capacity increase and cost reductions which have happened for the company under these strategies as they are incremental to the fuel cost savings. So. what were these strategies? Increase in utilisation
Jet has increased its utilisation to more than 13 hours. This is one of the highest utilizations at the global level. If we compare between domestic and international segments, the capacity measured in ASKs have increased for both. To give a sense, over the last two calendar years ending Dec’15, international capacity has increased
21% and domestic capacity has increased 13%. The increase in domestic capacity was more in focus during 2015, when domestic/international ASKs increased by
24%/4% respectively.
Chart 4: Domestic capacity expansion gathered momentum largely in 2015

Chart 5: International capacity expansion has now stabilised Domestic ASK-including Jetlite (mn)

Int'l ASK (mn)
8,000

5,300
5,100
4,900
4,700
4,500
4,300
4,100
3,900
3,700
3,500

7,500
7,000
6,500
6,000
5,500

Source: Company Data, I-Sec Research, DGCA

Q4FY16

Q3FY16

Q2FY16

Q1FY16

Q4FY15

Q3FY15

Q2FY15

Q1FY15

Q4FY14

Q3FY14

Q2FY14

Q1FY14

Q4FY16

Q3FY16

Q2FY16

Q1FY16

Q4FY15

Q3FY15

Q2FY15

Q1FY15

Q4FY14

Q3FY14

Q2FY14

Q1FY14

5,000

Source: Company Data, I-Sec Research, DGCA

How much room is there for further increase in capacity based on utilisation ?
We feel limited. The 13-hour utilisation per aircraft is already an industry-high. While international ASKs had bulk of their increase in 2014, domestic ASKs increased in
2015.

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Jet Airways India, June 16, 2016
Chart 6: Domestic ASKs per hour

Chart 7: International ASKs per hour

Domestic Jet ASK/hour

Int'l Jet ASK/hour

72,000

Source: DGCA

Mar'16

Jan'16

Feb'16

Dec'15

Nov'15

Oct'15

Sep'15

Aug'15

Mar'16

Feb'16

Jan'16

Dec'15

Oct'15

Nov'15

Sep'15

Aug'15

Jul'15

Jun'15

Apr'15

May'15

Mar'15

Feb'15

Jan'15

65,000

Jul'15

66,000

Jun'15

67,000

Apr'15

68,000

May'15

69,000

Mar'15

70,000

Jan'15

71,000

Feb'15

150,000
149,000
148,000
147,000
146,000
145,000
144,000
143,000
142,000
141,000
140,000

Source: DGCA

One must take note of the already declining ASKs in both domestic and international routes during Jan-Mar’16 which should be looked against the context when both of them were increasing in Jan-Mar’15.
Chart 8: Domestic hours recorded – including
Jetlite (Subsidiary of Jet)

Chart 9: Monthly OTP performance of Jet+JetLite
Jet Airways+Jetlite

Total Domestic hours

Source: DGCA

Jun'14
Jul'14
Aug'14
Sep'14
Oct'14
Nov'14
Dec'14
Jan'15
Feb'15
Mar'15
Apr'15
May'15
Jun'15
Jul'15
Aug'15
Sep'15
Oct'15
Sep'15
Oct'15
Nov'15
Dec'15
Jan'16
Feb'16
Mar'16

Mar'16

60

Feb'16

65

18,700

Jan'16

19,700

Dec'15

70

Oct'15

20,700

Nov'15

75

Sep'15

21,700

Aug'15

80

Jul'15

22,700

Jun'15

85

Apr'15

23,700

May'15

90

Mar'15

24,700

Feb'15

95

Jan'15

25,700

Source: DGCA

While this increase in utilisation may be looked in sync with the hedged maintenance costs under third-party contracts, the factor of On-Time Performance (OTP) will also have to be monitored for sustainable higher utilisation. OTP has declined for Jet in recent months.
Even if we check with US airlines, it is only LCCs which have managed an elongated strech of higher utilisations (considering more than 12 hours as higher utilisation) in the past 13 years.

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Jet Airways India, June 16, 2016
Table 1: Average daily block hour utilisation at all airlines in the US
(Hours)
American
Continental
Delta
Northwest
United
US Airways
America West
Sub Network
Southwest
JetBlue
AirTran
Frontier
Virgin AmericaSub LCC
Alaska
Hawaiian
Allegiant
Sub Other

2000
10.04
10.48
10.34
9.67
10.53
10.07
10.99
10.23
10.98
11.99
10.65
12.80
11.04
10.76
7.57
5.23
9.95

2001
9.65
10.26
9.58
9.12
9.95
12.32
9.73
9.95
10.81
11.60
9.91
11.84
10.78
6.52
7.34
2.05
6.61

2002
9.54
9.59
9.17
8.69
9.58
9.71
12.84
9.49
10.92
12.69
10.57
20.40
11.29
10.60
9.02
6.57
10.26

2003
9.57
9.59
9.19
8.67
9.18
9.47
10.04
9.32
10.83
13.34
10.95
10.24
11.01
10.56
7.69
10.49
9.98

2004
10.31
9.91
12.53
8.83
10.31
9.41
10.91
10.30
10.88
13.58
10.94
12.40
11.28
11.02
8.44
6.71
10.32

2005
9.91
10.58
12.35
9.00
10.86
9.64
10.95
10.41
11.13
13.39
11.55
11.59
11.49
11.63
8.95
6.87
10.80

2006
9.94
11.12
12.75
9.40
11.15
9.48
11.00
10.65
11.22
12.74
11.13
12.33
11.50
11.00
9.38
12.80
10.85

2007
10.01
11.65
11.06
9.42
11.17
9.83
11.14
10.55
11.19
12.84
11.04
12.54
10.11
11.51
10.93
9.50
7.03
10.09

2008
9.83
11.04
11.12
9.49
10.72
9.86
10.33
10.95
9.45
11.05
18.80
11.89
11.20
10.63
9.29
6.42
9.61

2009
9.71
10.60
10.40
9.22
10.79
9.47
10.04
10.26
11.28
10.99
8.80
12.75
10.50
9.75
9.18
6.68
9.01

2010
9.63
10.69
10.24
11.01
9.52
10.16
10.20
11.66
11.04
13.31
13.92
10.84
9.94
8.96
6.20
8.87

2011
9.58
10.72
10.39
10.71
9.78
10.19
10.46
11.68
11.04
24.02
17.42
11.35
10.70
9.69
5.71
9.23

2012
9.78
10.21
10.65
9.60
10.14
11.46
11.81
9.94
18.43
11.68
10.66
9.63
5.50
9.08

2013
9.85
10.25
10.46
11.89
10.41
11.65
11.96
10.08
12.43
11.66
10.64
9.79
5.32
9.06

Total All Sectors
10.31
Source: I-Sec research

9.88

9.74

9.59

10.46

10.62

10.84

10.74

10.51

10.10

10.26

10.44

10.47

10.64

The Etihad connection- structural positive for Jet
The US$750mn that Etihad assisted Jet with, is broken down into US$70mn coming in from through the sale and lease-back of the London-Heathrow slot, US$380mn in the form of equity, US$150mn as a guarantee which was given to an ECB borrowing, and the balance US$150 was in the form of Etihad’s 50% equity subscription to Jet
Privilege Private Limited. However, the consolidation has helped Jet in renegotiating contracts and achieving cost-efficiencies in a host of items including fleet acquisition, maintenance, joint purchasing opportunities for fuel, spare parts, equipment and catering supplies, as well as external services such as insurance and technology support. Other areas of cooperation include joint training of pilots, cabin crew and engineers, as well as maintenance of common aircraft types and consolidation of guest loyalty programs.
Etihad is executing a turnaround plan for its Global alliance members. Etihad has a unique business model, which has its supporters as well as detractors.
Nonetheless, it has a plan. Global alliance is at the center of the business model.
Etihad launched the ‘equity alliance’ strategy in 2011 when it came to the rescue of loss-making Air Berlin by purchasing a 29% stake. At first, that deal raised a few eyebrows. But, as further minority stakes were acquired in other airlines, the thinking behind the strategy became apparent. Next up was Air Seychelles, in which Etihad took a 40% stake after Abu Dhabi was approached to help out. Etihad has subsequently taken stakes in Virgin Australia (24%), Air Serbia (49%), India's Jet
Airways (24%), Alitalia (49%) and Darwin Airlines (34%).In recent financial postings all of these investments have experienced significant turnarounds and, in some cases, moved into profitability for the first time in many years, although Air Berlin reported losses on account of its fuel hedging at a massive cost to its bottom-line. Each of these airlines have detailed their turnaround plan based on more generic business

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Jet Airways India, June 16, 2016

parlances of more customer focus, improving customer services, efficient pricing models, rebranding and cost controls.
However, cost synergies and more efficient traffic routing are apparently benefitting the alliance members. There have been instances of intra-alliance aircraft rentals. There has been reported renegotiation of engineering and maintenance contracts with the likes of GE Aviation, Air France Industries, KLM
Engineering and Maintenance, Lufthansa Technik and many other service providers. Even management expertise has been shared between alliance members. The current Jet CEO Cramer Ball is moving to Alitalia, another lossmaking strategic member in the Etihad alliance. The alliance has also helped shore up increased benefits in frequent flyer programs.
In the case of Jet, apart from these cost benefits, the basic operational model has changed itself to a more focused feeder operation for Etihad. This alliance is the leader in the Indian international traffic market. We believe the Jet-Etihad combination is unique in the way that fellow Indian airlines (IndiGo and SpiceJet) cannot divert significant traffic to international routes due to their domestic focus and that no other international airlines can expect to tap into a wide network of Indian cities without a considerable gestation period.
Table 2: PLF distribution for Jet
Routewise PLFs Q2FY14 Q3FY14
Domestic PLF
70.3
69.4
International PLF
82.6
81.6
-UK
84.6
80.3
-ASEAN
77.5
77.6
-Gulf
83.5
85.6
-SAARC
74.9
77.3
-Europe (Paris)
-Brussels
86.2
83.0
-Abu Dhabi
80.9
80.5
Source: Company data, I-Sec research

Q4FY14
71.2
82.6
85.8
77.0
84.9
78.7
84.6
76.8

Q1FY15
71.9
84.5
83.1
83.9
88.7
74.1
68.5
84.4
84.6

Q2FY15
70.7
82.7
87.8
81.3
82.2
76.0
71.0
87.5
74.9

Q3FY15
82.0
82.0
86.3
83.3
83.6
79.2
70.4
82.7
72.3

Q4FY15
87.6
87.8
91.3
86.1
90.8
83.3
86.4
85.3
84.5

Q1FY16
80.3
83.7
86.0
84.3
85.0
67.6
81.3
84.3
81.9

Q2FY16
79.9
83.1

Q3FY16
80.5
83.4
85.5
88.1
84.2
74.7
71.4
84.5
78.2

Q4FY16
81.5
84.6

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Jet Airways India, June 16, 2016

Importance of the India-UAE route
India-UAE routes accounted for the bulk of international air passenger traffic -- about one-third -- in the first nine months of FY16. This is an effect of the increasing trade between India and UAE which was over US$59bn in FY15, making the UAE one of
India's top trading partners. India was the UAE's third-largest trading partner in 201415 after China and the US. In Sep’15, the UAE and India agreed to boost bilateral trade by 60% over the next five years, which implies increase in air travel between the two countries. Accordingly, the India-UAE route will continue to lead growth in international passenger traffic.
Among India-UAE routes, India-Dubai route is expected to continue to dominate international passenger traffic growth; it constituted about one-fifth of total international traffic in the first nine months of FY16. The route predominantly features business travelers and Indian expatriates in Dubai, who undertake frequent trips to India (a sizeable NRI population works in the Middle East). Other heavy overseas traffic routes include India-Singapore, India-London and India-Bangkok.
Jet has a strategic presence in the Middle East route through its partner Etihad managing to provide a strong global connectivity through codeshares.
Chart 10: Destination-wise distribution of international traffic
Dubai
20%
Others
39%
Abu Dhabi
8%
Singapore
7%
London
4% Muscat
Sharjah
5%
5%

Doha
7%
Bangkok
5%

Source: Crisil

Adoption of third party maintenance contracts
Known as the Power by the hour contracts, this is aimed at more predictable maintenance expenses, which have been very bumpy for the company in the past.
Service agreements are primarily designed to provide an operator with a predetermined fixed cost per flight hour over a period or volume of shop visits.
Agreements are often signed as part of an aircraft order – i.e. the airline commits to an engine service agreement in order to get a bigger discount on the new engine sale price. For smaller airlines, being enrolled on such a programme mitigates the risk of unexpected maintenance events that can lead to extensive downtime and unforeseen costs. 134

Jet Airways India, June 16, 2016

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There are many forms of service agreements, covering from very little to almost everything, but the two most common types that must be distinguished from each other are:


Fixed-term plans – a fixed period of operation for each engine, over a fixed term, usually the first 10-12 years or first lease. The cost of all anticipated shop visits within that fixed term is amortized over the duration of the term.



Life-plans – this programme takes into account all of the shop visits during an engine’s life (essentially mature engine shop visit cost) and spreads the cost over the life of the engine. The hourly rate on such plans is normally higher than fixed-term plans because the user is slowly paying towards higher maintenance costs later in the engine’s life from day one.

Historically, lessors have collected maintenance reserves as a method of protecting their assets’ residual value, especially with operators of weaker credit. Yet with the rising popularity of service agreements, airlines are already paying the engine OEM an hourly rate toward maintenance and therefore reluctant to pay maintenance reserves in addition to their service agreement fees. In the beginning, this left aircraft owners exposed in the event of a default, because most of the time they had no recourse to fees collected by the engine OEM. In more recent years, lessors and some OEMs started working together more to form tripartite agreements, in which the lessor will gain some access to funds held by the OEM in the service agreement. Initially this was in the form of a credit towards the next shop visit, but more recently with advanced service agreements, lessors may even get access to some cash, even if not the full amount collected by the OEM

Dollarization of debt leading to lower interest expense
Currently, 80% of Jet’s debt is in US dollars, which used to ~50% two years back. This has been enabled by the ECB guarantees offered by Etihad. We consider interest in finance lease payments as a part of the rental cost for better comparison. As such, dollarization has lowered that cost.
To give a sense, between FY12 and FY16, the company has pared down Rs32bn of debt. A large portion of the repayment has been enabled by the sale and leaseback of aircraft/slots and sale of Jet Privilege stake to Etihad, apart from the equity infusion by
Etihad. The company still has 24 owned aircraft with substantial equity left in them. So, between FY12 and FY15, Jet has brought down its total gross fixed assets from
Rs191bn to Rs160bn.
In our debt calculation, we have also taken other long-term liabilities ex the money received from the JPPL slump sale and advance received from Godrej Buildcon against property leased out. Along with reduction in debt, Jet has also dollarized the debt portfolio to reduce the interest burden. Currently, 83% of the debt is in US dollars.
We believe the peak debt burden is behind us with earnings support to bring down the debt further ahead.

135

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Jet Airways India, June 16, 2016
Chart 11: Total borrowings of Jet Airways
190,000

Gross Debt

Net Debt

170,000

(Rs mn)

150,000
130,000
110,000
90,000
70,000
50,000
FY09

FY10

FY11

FY12

FY13

FY14

FY15 FY16E FY17E FY18E

Source: I-Sec research

Chart 12: Debt breakup as of Q3FY16
2000
1800

1750

1600

(USD mn)

1400
1200
1000

(736)

800

667

600

(347)

552
(115)

400
200
0
Total Debt

Aircraft loan

Working capital Term debt

Free cash

Net term debt

Source: I-Sec research

Integration of domestic and international fleet
The Etihad connection has allowed smooth deployment of narrow-body B737s in the international market, A330s in the Delhi-Mumbai corridor and better utilisation of resources in general. A common configuration of 12 cabin and 156 economy seats across the B737 fleet has also helped in this cause.

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Jet Airways India, June 16, 2016

Has Jet managed to stem the costs?
We analyze each cost item for Jet over the past 12 quarters to assess the strength of the company in terms of cost positioning and the resultant fixed-cost profile.

Rentals have decreased with higher utilizations
It is important to underline that Jet’s rental costs declared in the quarterly numbers are exclusive of the supplemental rentals that the company provides towards maintenance reserves. As such, these will depend on the number of aircraft which have not significantly changed over the past two years, although more of them are now being utilized under operating leases as the company has made sale and leasebacks of several of them to raise cash. Additionally, to arrive at a per ASK basis, one should also adjust the lease rental income, which Jet receives from several wide-body aircraft which they have let off to Turkish Airlines / Etihad Airways. We have also added the interest component of the finance leases to arrive at true rental cost per ASK. The variability will increase on adjusting for lease income, which will have certain milestone-related payments that may not match with the rental outgo. Needless to mention, the cost should be looked at in USD terms for true comparison across periods. Chart 13: Rentals per ASK not adjusted for lease income including finance lease outgo Q4FY16

Q3FY16

Q2FY16

Q1FY16

Q4FY15

Q3FY15

Q2FY15

Q4FY14

Q3FY14

Q2FY14

Q1FY14

Q1FY15

RASK ex lease income (Rs)

4.6
4.6
4.5
4.5
4.4
4.4
4.3
4.3
4.2
4.2
4.1

Source: Company data, I-Sec research

Clearly the costs have come down due to two reasons – one being higher utilisation and the other being dollarization of debt and repayment of aircraft-related loans. Jet’s operations have changed post the alliance with Etihad with increasing narrow-bdies of
Jet being offered to the Abu Dhabi/Europe gateway as feeders to the Etihad network and vice versa on return routes. Such feeder networks can be operated with narrowbody aircraft, hence the deployment of wide-body aircraft to other airlines might have worked for Jet. It remains to be seen whether the increase in international traffic post the network sharing can be high enough for Jet to recall some of the wide-body aircraft. We don’t think wide-body dynamics would make sense in domestic routes, although there has been much clamorr about it considering the traffic growth, especially keeping in light the traffic congestion in Mumbai.

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Jet Airways India, June 16, 2016

Chart 14: Rentals per ASK adjusted for lease income with finance lease outgo
Rentals per ASK (US$)

0.0105
0.0100
0.0095
0.0090
0.0085
0.0080

Q4FY16

Q3FY16

Q2FY16

Q1FY16

Q4FY15

Q3FY15

Q2FY15

Q1FY15

Q4FY14

Q3FY14

Q2FY14

Q1FY14

0.0075

Source: Company data, I-Sec research

Fuel cost has reduced with crude and higher utilisation
With 30-40% of fuel procurement denominated in USDs, essentially outside India, the reduction in costs of Jet is higher than that of domestic airlines like Indigo/SpiceJet due to the tax structure of India.
Chart 15: Fuel cost per ASK in USD terms
Fuel per ASK (US$)

0.035
0.030
0.025
0.020
0.015

Q4FY16

Q3FY16

Q2FY16

Q1FY16

Q4FY15

Q3FY15

Q2FY15

Q1FY15

Q4FY14

Q3FY14

Q2FY14

Q1FY14

0.010

Source: Company data, I-Sec research

Employee costs, though down remain volatile
With a variety of aircraft, comes the typical problem of managing employee costs effectively in line with the returns provided by the various aircraft. Notwithstanding the
HR issues, international operations will also involve expat pilots with typical severance-related payments and clauses and conditions, which can be a burden if not managed effectively. However, Jet has managed to control these costs effectively after increasing the utilisation on to 13-hour levels.

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Jet Airways India, June 16, 2016
Chart 16: Employee cost per ASK
Employees per ASK (Rs)

0.60
0.58
0.56
0.54
0.52
0.50
0.48
0.46

Q4FY16

Q3FY16

Q2FY16

Q1FY16

Q4FY15

Q3FY15

Q2FY15

Q1FY15

Q4FY14

Q3FY14

Q2FY14

Q1FY14

0.44

Source: Company Data, I-Sec Research

Spikes in employee costs in the past


Q4FY15 saw higher employee costs due to one-offs involved in reducing expat pilots. During FY15, the company reduced closer to 50 employees on expat pilots as a result of which it had to pay their retrenchment compensation. Additionally, some excess payment was also required to be made to domestic employees in line with increased capacity and there was a small increase on the headcount apart from increase in gratuity due to the decrease in the discount rate.



Higher employee costs in Q4FY14 was on account of lower ASKs as several widebody aircraft remained grounded on account of lower profitability of international operations. S&D costs have increased, but expected to cool off
This is typically driven by higher sales, fees given to GDS systems and commissions payable for corporate bookings. One would expect synergies driven by the alliance with Etihad to take the costs down, though the management has been guiding for 1011% of revenue for S&D costs. This is higher compared to international full-service players as well as domestic players like Indigo/SpiceJet.
S&D costs have increased steadily from a quarterly run rate Rs3.3bn in FY14 to
Rs6.3bn in H1FY16 and is now on the declining trend.

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Jet Airways India, June 16, 2016
Chart 17: Selling and Distribution (S&D) cost per ASK
Selling and Distribution per ASK (Rs)

0.60
0.55
0.50
0.45
0.40

Q4FY16

Q3FY16

Q2FY16

Q1FY16

Q4FY15

Q3FY15

Q2FY15

Q1FY15

Q4FY14

Q3FY14

Q2FY14

Q1FY14

0.35

Source: Company data, I-Sec research

Jet’s S&D costs increased for a variety of reasons – from higher computer reservation system costs to higher incentive schemes to prop up sales, and due to higher forward sales. This is in line with efforts to boost the PLFs, which have risen accordingly. The highest S&D cost recorded in Q4FY15 was also due to change in the accrual method of miles associated with the Jet Privilege program, since it got hived off to a subsidiary company. The selling cost started including the frequent flying miles cost, which increased with increasing members on the frequent flyer program. Annual inflationary cost of the global GDS system along with depreciating currencies have also accounted for the higher costs.
Though structurally higher for Jet, S&D costs have declined due to increasing utilisation and are expected to progressively decline due to synergies derived from the
Etihad alliance. The recent decline in S&D costs has been in line with increased negotiations, which have resulted in significant discounts for the company.

Maintenance /other costs remain volatile, but declined as well
The quantum has remained steady at Rs12bn-13bn quarterly with certain exceptions resulting in higher spikes in some quarters. However, these spikes were mostly related to maintenance costs in the form of variable rentals which used to increase depending on engine shop visits. The company has entered into third-party contracts with regards to maintenance, which will even out the costs going ahead. Jet has entered in Power by the Hour contracts, which will result in scheduled maintenance-related costs paid regularly to third-party MRO providers and the same will be accounted under P&L. The supplementary rentals payable towards maintenance reserves will be provided under loans and advances as receivables from lessors.

140

ICICI Securities

Jet Airways India, June 16, 2016

Chart 18: Other expenses including repair and maintenance per ASK
Other expenses including R&M per ASK (Rs)

2.50
2.30
2.10
1.90
1.70
1.50

Q4FY16

Q3FY16

Q2FY16

Q1FY16

Q4FY15

Q3FY15

Q2FY15

Q1FY15

Q4FY14

Q3FY14

Q2FY14

Q1FY14

1.30

Source: Company data, I-Sec research

The spikes in other expenses:


The higher other expenses in Q4FY14 were due to a host of reasons, which have been addressed. There was an increase in variable rentals because more aircraft were on operating lease. There was also a one-off aircraft maintenance provision related to catch-up in costs post transfer to Power by the Hour agreement regime as well as higher redelivery provisioning. There was also an increase in expenditure related to food and cabin and the passenger amenities and also the landing and navigation; which has the full year’s impact sitting herein, because a majority of airports revised their tariff effective February 2013. It was just a one and a half months impact in the last fiscal versus the full year’s impact in
FY14.



The higher other expenses in Q4FY15 was due to provision for penalties related to TDS and one-off configuration costs due to homogenization of seating configuration to 12 cabin and 156 economy seats.

141

ICICI Securities

Jet Airways India, June 16, 2016

How have yields fared for the company – and the resultant spreads?
While competition and subsequently lower fares have kept yields under pressure, spreads have been positive for the company on account of both oil and non-oil related savings. Surely, the airlines have not passed the entire benefit of lower crude prices, which is an industry-wide phenomenon, but the synergistic benefits of alliance with
Etihad and higher USD debt along with higher utilizations remain the key drivers of a positive spread.
Chart 19: RASK including lease income has declined in line with price cuts

Chart 20: CASK with finance lease interest has decreased RASK (Rs)

4.8

4.80

4.7 4.7 4.7 4.6

4.70
4.60

4.4

6.0

6.0

4.7

5.5

4.5

4.4

4.4
4.3

4.40

4.4

5.0
4.7 4.8 4.7

4.8

5.0

4.9

4.4

4.3 4.2

4.5

4.30

3.9 3.8

4.0

4.20
4.10

Q4FY16

Q2FY16

Q1FY16

Q4FY15

Q3FY15

Q2FY15

Q1FY15

Q4FY14

Q3FY14

Q2FY14

Q1FY14

Q4FY16

Q3FY16

Q2FY16

Q1FY16

Q4FY15

Q3FY15

Q2FY15

Q1FY15

Q4FY14

Q3FY14

Q2FY14

Q1FY14

3.5

Q3FY16

4.50

CASK with finance lease (Rs)

6.5

Source: Company Data, I-Sec research

Source: Company Data, I-Sec research

Chart 21: Spread thereafter (RASK-CASK) has increased Chart 22: CASK ex-fuel, including finance lease, has decreased

RASK-CASK (Rs)

142

3.0

Source: Company Data, I-Sec research

Q4FY16

Q3FY16

2.9

Q2FY16

Q4FY16

Q3FY16

Q2FY16

Q1FY16

Q4FY15

Q3FY15

Q2FY15

Q1FY15

Q4FY14

Q3FY14

Q2FY14

Q1FY14

Source: Company Data, I-Sec research

3.0

2.7

2.9

3.1

Q1FY16

(1.3)
(1.5)

3.2

Q4FY15

(1.0)

3.2

3.2

Q3FY15

(0.6)

3.2

Q2FY15

(0.3)

Q1FY15

(0.2)
(0.5)

3.8

Q4FY14

(0.1)

0.0

0.1

(0.0)

CASK ex fuel with finance lease
4.1

Q3FY14

(0.0)

0.2 0.2

4.3
4.1
3.9
3.7
3.5
3.3
3.1
2.9
2.7
2.5

Q2FY14

0.5
0.5

0.6

Q1FY14

1.0

ICICI Securities

Jet Airways India, June 16, 2016

International operations have historically been more profitable for Jet. Hence, we believe that a strong focus on international operations needs to be maintained keeping the domestic travel infrastructure intact. No doubt, it is a difficult balancing act, but is incrementally better achievable with the global codeshare programs and alliance partners. How do we find out that international operations have been more profitable?
The segmental numbers shared by Jet have a huge un-allocable cost, which makes it difficult to ascertain the profitability of domestic compared to international operations.
We look back at history to find out the (RASK-CASK) spread, which the three distinct segments of Jet used to book before it stopped disclosing them separately, namely
Jet-domestic, Jet-International and JetLite.
Table 3: Jet (international operations) per ASK statistics
Jet (international)
Q1FY14
Employee
0.27
Fuel
1.52
S&D
0.27
Others
1.13
Operating lease rentals
0.30
Jet Int'l CASK
3.49
Jet Int'l RASK
3.87
Jet Int'l RASK-CASK
0.38
Source: Company Data, I-Sec Research

Q2FY14
0.29
1.79
0.30
1.49
0.34
4.21
4.24
0.03

Q3FY14
0.31
1.86
0.28
1.25
0.34
4.03
4.19
0.16

Q4FY14
0.33
1.88
0.28
1.65
0.36
4.49
4.12
(0.38)

Q1FY15
0.37
1.85
0.31
1.53
0.38
4.44
4.20
(0.24)

Table 4: Jet (domestic operations) per ASK statistics
Jet (domestic)
Q1FY14
Employee
0.90
Fuel
2.01
S&D
0.50
Others
1.77
Operating lease rentals
0.58
Jet Domestic CASK
5.76
Jet Domestic RASK
5.53
Jet Domestic RASK-CASK
(0.23)
Source: Company data, I-Sec research

Q2FY14
0.83
2.35
0.61
2.17
0.72
6.67
5.03
(1.64)

Q3FY14
0.95
2.55
0.58
1.94
0.70
6.71
5.74
(0.97)

Q4FY14
1.05
2.47
0.75
2.06
0.78
7.11
6.09
(1.01)

Q1FY15
0.91
2.22
0.70
1.82
0.60
6.26
5.87
(0.39)

Q2FY14
0.45
2.38
0.18
0.99
0.65
4.65
3.63
(1.02)

Q3FY14
0.44
2.56
0.19
0.81
0.73
4.72
4.60
(0.12)

Q4FY14
0.51
2.61
0.29
1.74
0.82
5.97
4.77
(1.20)

Q1FY15
0.54
2.51
0.31
0.81
0.72
4.88
4.67
(0.21)

Table 5: Jetlite per ASK statistics
JetLite
Q1FY14
Employee
0.49
Fuel
2.14
S&D
0.24
Others
0.92
Operating lease Rentals
0.66
JetLite CASK
4.45
JetLite RASK
4.49
JetLite RASK-CASK
0.04
Source: Company data, I-Sec research

With lower fuel prices, Jet’s international operations will derive a higher benefit of lower crude prices coupled with increasing traffic from alliance codeshare programs, which should incrementally favor the international business. However, increased deployment of narrow-body aircraft in international operations and leasing out widebodies to other airlines would mean some benefits of economies achievable in long haul operations have been sacrificed.

143

ICICI Securities

Jet Airways India, June 16, 2016

Jet Airways fleet details
The company has a total fleet size of 116 aircraft of which 24 are owned and the rest are on operating lease.


Jet’s fleet has a total of 86 narrow-body aircraft (68-B737 and 18-ATRs).



Jet’s total wide-body fleet comprises 22 aircraft – split between 10 B777s and 12
A330s.



Jetlite has a total of eight narrow-body B737s

The company has given 10 aircraft on lease. Two A330-200s have been sub/(dry)leased to Etihad Airways PJSC and three A330-200s have been sub/(dry)-leased to
Turkish Airlines. Five B777-300ER aircraft have been sub/(dry)-leased to Etihad. The
Turkish Airlines sub-lease is long-term – till 2020. One A330 given to Etihad is also long-term (till 2020) while B777 leases are nearing expiry.
Rental income is around Rs200mn per aircraft per quarter
Chart 23: Quarterly rental income from leases per aircraft
270
260
250

(Rs mn)

240
230
220
210
200
190
180
Q1FY15

Q2FY15

Q3FY15

Source: Company Data, I-Sec research

144

Q4FY15

Q1FY16

Q2FY16

Q3FY16

Q4FY16

ICICI Securities

Jet Airways India, June 16, 2016

RoCE to improve ahead
One must not forget the asset-light model of leasing in airlines. Equating the rental outgo in an operating lease as an interest expense towards asset acquisition, the
RoEs should not change in principle. RoEs would remain high on the back of an extremely high leveraged business.
However, the comparison is different in case of RoCE. The operating lease rentals should be added back to EBIT, while the equivalent asset should be added to capital employed. In a growing phase, when an increasing number of aircraft are being acquired, equivalent assets can be estimated as a 7x/8x the current rentals (operating
+finance). So, while the finance lease asset is already factored in the assets, we add
7x operating lease rentals to the assets to derive adjusted RoCEs in line with the global practice for equivalent debt estimation.
Even if we adjust for the off balance sheet assets under operating lease, Jet would retain attractive RoCEs (~15-20%)
Table 6: Adjusted RoCEs
FY12
FY13
(Rs mn)
Total Assets
139,102
102,332
7x gross operating rentals
84,349
106,819
Total adjusted asset
223,451
209,151
EBIT
(6,073)
3,196
Gross rentals
12,050
15,260
Adjusted EBIT
5,977
18,456
Adjusted RoCE
2.67
8.82
Source: I-Sec research, ROCE based on pre tax EBIT

FY14
71,660
146,295
217,955
(23,278)
20,899
(2,379)
(1.09)

FY15
70,742
152,076
222,818
(4,277)
21,725
17,449
7.83

FY16E
69,873
160,000
229,874
19,389
22,857
42,246
18.38

FY17E
73,144
167,996
241,140
13,796
23,999
37,796
15.67

FY18E
79,128
173,559
252,687
16,334
24,794
41,128
16.28

Chart 24: Improving ROCEs ahead

Source: I-Sec research

145

ICICI Securities

Jet Airways India, June 16, 2016

Sensitivity analysis
Combined factors of crude and currency: The sensitivity of airlines will largely depend upon the fares which is again a function of several external factors like competition and demand. However, the two factors which are external but significantly determine the results of airline operations are crude prices and currency. Typically, currency has a ripple effect across cost items starting from rentals, maintenance contracts, redelivery expenditure as well as crude. As such, while it is less volatile than crude, it has higher sensitivity to currency fluctuations.
These sensitivities should be not be looked in isolation since there are countermeasures adopted between the three factors of in crude, dollar and fares. Table 7: Sensitivity of target price with crude prices & INR-USD exchange rate
TP
40
45
Crude
50
(US$/bbl)
55
60
70
Source: I-Sec research

INR
65
1,757
1,533
1,309
1,085
861
414

63
1,970
1,753
1,536
1,319
1,102
668

67
1,544
1,313
1,082
851
621
159

70
1,224
983
742
500
259
(223)

72
1,011
763
515
266
18
(478)

Combined factor of crude price and passenger fare: The sensitivity analysis shows high dependence of the airline business model on passenger fares. This reflects the high operating leverage nature of the airline business, which has high fixed-costs, including lease and other aircraft acquisition charges, engineering and maintenance charges, financing commitments, staff costs and IT costs. Significant operating expenses, such as airport charges, do not vary by passenger load factors.
Table 8: Sensitivity of crude prices and passenger fare growth
TP
-10%
-5%
Fare
0%
Growth
(%)
3%
5%
10%
Source: I-Sec research

40
(185)
480
1,145
1,544
1,810
2,475

45
(416)
249
914
1,313
1,579
2,244

Crude (US$/bbl)
50
(647)
18
683
1,082
1,348
2,013

55
(878)
(213)
452
851
1,117
1,782

60
(1,109)
(443)
222
621
887
1,552

70
(1,570)
(905)
(240)
159
425
1,090

Combined factor of passenger fare growth and currency: Even higher sensitivity is seen here as higher numbers of cost items including crude depend on currency.
Table 9: Sensitivity of INR-USD exchange rate and passenger fare growth
INR
TP
-10%
-5%
Fare
Growth
0%
(%)
3%
5%
10%
Source: I-Sec research

146

63
(627)
38
703
1,102
1,368
2,033

65
(868)
(203)
462
861
1,127
1,793

67
(1,109)
(443)
222
621
887
1,552

70
(1,470)
(805)
(140)
259
525
1,190

72
(1,711)
(1,046)
(381)
18
284
950

74
(1,952)
(1,286)
(621)
(222)
44
709

ICICI Securities

Jet Airways India, June 16, 2016

Valuation
LCCs tend to trade at higher multiples compared to FSCs. Asian LCCs enjoy additional premium on account of their low cost structure and high traffic growth. High volatility in crude prices and the global economy have a direct bearing on airline stock prices and, as such, it is best to consider the average 1-year forward EV /EBITDAR for the last 5/10 years to ascertain an average cycle multiple
In line with the long-term average EV/EBITDAR multiple for Asian airlines, we value
Jet Airways at 7x FY18 EV/EBITDAR at Rs621 per share. Recommend ADD on the stock. We value Jet at 7x compared to 8x for IndiGo to account for the better balance sheet, significantly higher market share and lower cost structure of IndiGo compared to Jet.
Higher leverage and higher cost structure also makes Jet more sensitive to crude and other cost escalations compared to IndiGo.
Table 10: Valuation based on 8x EV/EBITDAR
(Rs mn)
EBITDAR
EV@7xEV/EBITDAR
Gross Debt
Cash
Rentals@7x
Net Debt
Equity Value
Shares (mn)
Equity value
Source: I-Sec research

FY20E
43,111
301,780
109,210
51,490
173,559
231,279
70,501
113.6
621

Assumptions
Table 11: Assumptions for our estimates
Assumptions
FY16P
Fare Growth
-7%
Average Ticket (Rs)
7,374
US$
65.3
Crude Prices(US$/bbl)
46.0
Realized ATF prices (Rs/kl)
32,469
Scheduled Passengers (mn)
25.8
International
7.4
Domestic
16.0
Jetlite
2.4
RPK(mn)
41,387
ASK(mn)
50,116
PLF(%)
82.6
Ancillary Revenue (Rs mn)
32,093
Total Revenue(Rs mn)
222,070
EBITDA (Rs mn)
22,361
EBITDAR (Rs mn)
45,218
PAT (Rs mn)
12,117
Source: I-Sec research, Company data

FY17E
2%
7,521
67.0
55.0
36,969
27.5
7.5
17.2
2.4
43,162
51,310
84.1
33,132
240,198
16,074
40,074
5,771

FY18E
3%
7,747
67.0
60.0
39,007
28.7
7.7
17.8
2.4
44,393
51,969
85.4
33,425
255,894
18,317
43,111
8,484

FY19E
5%
8,134
68.0
60.0
39,519
31.0
7.8
19.9
2.4
47,041
55,026
85.5
39,222
291,710
24,490
51,667
16,128

FY20E
5%
8,541
68.0
60.0
39,519
34.2
8.0
22.9
2.4
50,449
59,664
84.6
44,580
336,843
37,074
67,131
28,401

147

ICICI Securities

Jet Airways India, June 16, 2016

Financials
Table 12: Profit & Loss statement
(Rs mn, year ending March 31)
Revenue

FY14
190,358

FY15
209,656

FY16P
222,070

FY17E
240,198

FY18E
255,894

Aircraft Fuel Expenses
Employee Benefit Expenses
Selling and Distribution Expenses
Aircraft and Engine Lease Rentals
Other Expenses
-Aircraft Variable rentals
-Insurance
-Landing, navigation, airport charges
-Aircraft maintenance
-Others
Total Expenditure

81,253
20,778
15,304
20,899
70,719
11,474
919
15,725
22,474
20,129
208,953

73,656
24,191
21,244
21,725
72,425
7,739
938
16,924
23,184
23,640
213,240

54,034
25,323
23,608
22,857
73,887
5,893
966
18,794
24,930
23,318
199,709

62,359
27,018
24,020
23,999
86,728
8,594
1,002
20,203
27,859
29,070
224,124

66,308
28,909
25,589
24,794
91,975
8,705
1,002
21,486
29,252
31,531
237,576

EBITDA
Margin (%)

(18,595)
(9.77)

(3,584)
(1.71)

22,361
10.07

16,074
6.69

18,317
7.16

EBITDAR
Margin(%)

2,304
1.2

18,141
8.7

45,218
20.4

40,074
16.7

43,111
16.8

4,095
8,778
(23,278)
10,836

6,961
7,653
(4,277)
9,205

6,991
9,962
19,389
8,850

6,530
8,808
13,796
8,075

7,075
9,058
16,334
7,900

(7,174)
(41,288)
(1)
(11)
(41,298)

(7,532)
(21,014)
0
40
(20,974)

1,480
12,020

5,721

8,434

97
12,117

50
5,771

50
8,484

Other Income
Depreciation
EBIT
Finance Cost
Exceptional items
PBT
Tax
Share of Associates
PAT
Source: Company data, I-Sec research

148

ICICI Securities

Jet Airways India, June 16, 2016
Table 13: Balance sheet
(Rs mn, year ending March 31)
FY14
1,136
(42,885)
(41,749)

FY15
1,136
(64,384)
(63,248)

FY16P
1,136
(53,240)
(52,104)

FY17E
1,136
(47,469)
(46,333)

FY18E
1,136
(38,985)
(37,849)

21,679
65,461
3,650
3,650

30,211
62,103
9,035
3,650

30,211
59,603
9,035
3,650

30,211
57,103
9,035
3,650

18,625
109,415

36,443
66,073
11,484
3,650
985
6,849
16,511
130,511

16,511
117,860

16,511
115,360

16,511
112,860

3,993

3,479

4,118

4,118

4,118

51,609
47,832
26,539
255
99,441

57,879
42,351
31,330
3,652
100,230

61,200
41,905

61,404
44,825

65,089
47,515

103,105

106,229

112,605

Total Equity and liability

171,101

170,972

172,979

179,373

191,733

Gross Assets
Depreciation
Net Fixed Assets

158,727
62,281
96,446

162,631
70,093
92,538

168,163
80,055
88,107

176,163
88,864
87,299

181,163
97,922
83,241

11,724
6,657
22,743

6,697
26,563

7,176
30,636

7,176
30,636

7,176
30,636

8,594
12,872
12,065
33,530

9,635
13,911
21,628
45,175

260
5,000
10,641
16,277
14,881
47,059

260
5,000
9,825
15,794
23,383
54,261

260
5,000
10,414
16,826
38,179
70,679

171,101

170,972

172,979

179,373

191,733

Share Capital
Reserves and Surplus
Networth
Short Term Borrowing
Long Term borrowing
Other LT liabilities
Advance from Developer
Advance from Customers
Deferred Revenue (Refer note 38)
Current portion of LT liabilities
Borrowings
Provisions,DTL
Trade Payables
Other Current liabilities
-Forward Sales
-JPPL sales
Current Liabilities

Goodwill
LT investments
Loans and advances
Other Current Assets
Current Investments
Inventories
Trade Receivables
Cash
Current Assets
Total Assets
Source: Company data, I-Sec research

149

ICICI Securities

Jet Airways India, June 16, 2016
Table 14: Cashflow statement
(Rs mn, year ending March 31)
FY14

FY15

FY16P

FY17E

FY18E

(412,988)

(209,740)

12,020

5,721

8,434

71,739
87,778
10,469
(9,171)
665
(37)
108,360
(1,228)
(7,354)
(13,058)
3,194
2,350
11,643
287
12
1,801

75,322
76,531
16,031
(12,334)
14
(90)
92,047
(180)
(9,030)
(2,416)
3,536
5,176
4,609
789
66
12
(26,248)
2,366

9,962

8,808

9,058

8,850

8,075

7,900

(6,894)

(6,480)

(7,025)

(145,538)

16,461

23,938

16,124

18,367

(13,192)
(1,120)
61,729
204,967
106,846
(5,665)
101,181

(28,811)
(13,985)
(35,144)
135,333
73,854
304
74,158

(1,006)
(2,365)

816
483

(590)
(1,032)

2,875
23,442
23,442

3,123
20,547
20,547

6,376
23,122
23,122

Cash Flow from Investing Activities
Purchase of Fixed Assets (Including CWIP)
Proceeds from Sale of Fixed Assets
Purchase of Current Investments
Sale of Current Investments
Sale of Non-Current Investments
Investment in Equity Shares of Associate
Changes in Fixed Deposits with Banks
Interest Received on Bank and Other Deposits
Net Cash Flow used in Investing Activities

(40,043)
83,149
(110,000)
110,037
1
(66,365)
(9,410)
6,025
(26,606)

(171,048)
169,841
(188,995)
189,085
4
(391)
(29,509)
8,941
(22,072)

(7,000)

(8,000)

(5,000)

(18,830)
6,991
(18,839)

6,530
(1,470)

7,075
2,075

Cash Flow from Financing Activities
Net Increase in Short Term Loans
Proceeds from Long Term Loans during the year
Repayment of Long Term Loans during the year
Share Issue
Finance Cost
Unclaimed Dividend Paid
Net Cash from / (used for) Financing Activities

3,713
171,914
(328,269)
205,562
(110,137)
(6)
(57,223)

147,636
153,599
(192,331)
(94,946)
(3)
13,955

(2,500)

(2,500)

(2,500)

(8,850)

(8,075)

(7,900)

(11,350)

(10,575)

(10,400)

17,352
14,537
31,889

66,041
31,889
97,930

(6,747)
21,628
14,881

8,502
14,881
23,383

14,796
23,383
38,179

Cash flow from Operating Activities :
Net Loss Before Tax
Adjustment for :
Exceptional Items
Depreciation and Amortisation
Provision for Stock Obsolescence
Profit on Sale of Fixed Assets (Net)
Loss on Scrapping of Fixed Assets
Profit on Sale of Investments
Finance Cost
Interest on Income Tax Refund
Other Income
Provision No Longer Required Written Back
Provision for Compensated Absences and Gratuity
Unrealised Foreign Exchange Losses (Net)
Provision for Doubtful Debts
Provision for Doubtful Deposit / Advances
Bad Debts Written Off
Provision for Wealth Tax
Recognition upon fulfillment of commitment
Inventory Scrapped During the Year
Marked to Market-Derivatives (Gain)
Contribution Receivable from Lessors
Exchange Difference
Operating Profit / (Loss) Before WC
Adjustment for :
Inventories
Trade Receivables
Loans and Advances
Trade and Other Payables
Cash Generated from Operations
Direct Taxes (Paid) / Refund (Net)
Net Cash from Operating Activities

Net Increase in Cash and Cash Equivalents
Cash at the beginning of the year
Cash at end of the year
Source: Company data, I-Sec research

150

ICICI Securities

Jet Airways India, June 16, 2016
Table 15: Key ratios
(Year ending March 31)
FY14

FY15

FY16P

FY17E

FY18E

Per Share Data (in Rs.)
EPS(Basic Recurring)
Diluted Recurring EPS
Recurring Cash EPS
Dividend per share (DPS)
Book Value per share

(363.5)
(363.5)
(286.3)
(367.5)

(184.6)
(184.6)
(117.3)
(556.8)

106.7
106.7
194.4
(458.7)

50.8
50.8
128.3
(407.9)

74.7
74.7
154.4
(333.2)

Growth Ratios (%)
EBITDA
EBITDAR
Recurring Net Income

(373.3)
(89.6)
429.6

(80.7)
687.2
(49.2)

(723.9)
149.3
(157.8)

(28.1)
(11.4)
(52.4)

14.0
7.6
47.0

(1.5)
(2.0)
(1.5)
(8.7)
69.9
1.1

(3.0)
(4.8)
(1.0)
(48.2)
9.5
0.7

5.3
2.9
(1.2)
7.5
3.7
5.5

11.0
4.4
(1.4)
9.7
3.9
5.5

7.5
3.6
(1.7)
7.6
3.2
4.9

42.7
17.0
10.9
8.0
(92.0)
15.0
24.7
83.6
90.2
(2.33)

35.1
14.1
11.5
10.1
(77.8)
16.5
24.2
72.5
99.1
(1.72)

24.3
12.9
11.4
10.6
(80.2)
16.0
24.0
73.0
100.0
(1.98)

26.0
13.6
11.2
10.0
(71.0)
16.0
24.0
73.0
100.0
(1.99)

25.9
13.1
11.3
10.0
(53.0)
16.0
24.0
73.0
100.0
(1.97)

(21.7)
(32.5)
98.9
(9.8)

(10.0)
(6.0)
33.2
(1.7)

5.5
27.7
(23.3)
10.1

2.4
18.9
(12.5)
6.7

3.3
20.6
(22.4)
7.2

Valuation Ratios (x)
P/E
P/CEPS
P/BV
EV / EBITDA
EV / EBITDAR
EV / FCF
Operating Ratios (%)
Fuel/Sales
Net Rentals/Sales
Employee/Sales
Selling cost/sales
NWC / Total Assets
Inventory Days
Receivables (days)
Other Current Liabilities Days
Payables (days)
Net D/E Ratio (x)
Return/Profitability Ratios (%)
Recurring Net Income Margins
RoCE
RoNW
Dividend Payout Ratio
EBITDA Margins
Source: Company data, I-Sec research

151

Jet Airways India, June 16, 2016

ICICI Securities

Index of Tables and Charts
Tables
Table 1: Average daily block hour utilisation at all airlines in the US ............................... 132
Table 2: PLF distribution for Jet ........................................................................................ 133
Table 3: Jet (international operations) per ASK statistics ................................................. 143
Table 4: Jet (domestic operations) per ASK statistics ...................................................... 143
Table 5: Jetlite per ASK statistics ..................................................................................... 143
Table 6: Adjusted RoCEs.................................................................................................. 145
Table 7: Sensitivity of target price with crude prices & INR-USD exchange rate ............. 146
Table 8: Sensitivity of crude prices and passenger fare growth ....................................... 146
Table 9: Sensitivity of INR-USD exchange rate and passenger fare growth .................... 146
Table 10: Valuation based on 8x EV/EBITDAR ................................................................ 147
Table 11: Assumptions for our estimates ......................................................................... 147
Table 12: Profit & Loss statement ..................................................................................... 148
Table 13: Balance sheet ................................................................................................... 149
Table 14: Cashflow statement .......................................................................................... 150
Table 15: Key ratios .......................................................................................................... 151

Charts
Chart 1: International traffic growth has been robust ........................................................ 129
Chart 2: Domestic operators’ have continually increased int’l traffic share ...................... 129
Chart 3: Jet plus Etihad holds ~20% of the total international traffic of India ................... 129
Chart 4: Domestic capacity expansion gathered momentum largely in 2015 .................. 130
Chart 5: International capacity expansion has now stabilised .......................................... 130
Chart 6: Domestic ASKs per hour ..................................................................................... 131
Chart 7: International ASKs per hour ................................................................................ 131
Chart 8: Domestic hours recorded – including Jetlite (Subsidiary of Jet) ......................... 131
Chart 9: Monthly OTP performance of Jet+JetLite ........................................................... 131
Chart 10: Destination-wise distribution of international traffic........................................... 134
Chart 11: Total borrowings of Jet Airways ........................................................................ 136
Chart 12: Debt breakup as of Q3FY16 ............................................................................. 136
Chart 13: Rentals per ASK not adjusted for lease income including finance lease outgo 137
Chart 14: Rentals per ASK adjusted for lease income with finance lease outgo ............. 138
Chart 15: Fuel cost per ASK in USD terms....................................................................... 138
Chart 16: Employee cost per ASK .................................................................................... 139
Chart 17: Selling and Distribution (S&D) cost per ASK .................................................... 140
Chart 18: Other expenses including repair and maintenance per ASK ............................ 141
Chart 19: RASK including lease income has declined in line with price cuts ................... 142
Chart 20: CASK with finance lease interest has decreased ............................................. 142
Chart 21: Spread thereafter (RASK-CASK) has increased .............................................. 142
Chart 22: CASK ex-fuel, including finance lease, has decreased .................................... 142
Chart 23: Quarterly rental income from leases per aircraft............................................... 144
Chart 24: Improving ROCEs ahead .................................................................................. 145

152

Jet Airways India, June 16, 2016

ICICI Securities

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153

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...Culture Zelda Johnson Global Human Resources Management Professor: Dr. David Smith June 11, 2015 Let me begin with introducing my company “Freshness Food Market” I been in business for 20 years. My grandfather started this business with the intention of giving affordable and quality produce and food to our consumers at an affordable price. From a small, struggling cooperative with ten members now over 100 stores in three different states. Freshness Food Market employs more than 5,000 people throughout Pennsylvania, Delaware and Maryland. Even though we have grown from the small “Mom and Pop” stores of the 1950s, most of our stores are still family owned and operated businesses.  When we buy in volume this enables our stores to offer their customers the lowest possible overall prices, and the highest value, in the marketplace. At the heart of Freshness charitable giving is the idea that being a good corporate citizen is an ongoing responsibility. By helping to create stronger communities, we enhance the quality of life for customers and associates. We know being a good neighbor also means providing for our customers beyond our store's walls. Here at Freshness, we're determined on providing our customers with a fresh and healthy proficiency every time they enter our stores. One of our charitable missions is to support ending hunger in our local community. We support local establishments providing wide-ranging from hunger relief......

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Culture

...Culture Culture is the most important and basic concepts of sociology. Culture is a blueprint to how each group will live their lives. In sociology culture has a specific meaning. Sociologist believe every human being is cultured, every human being participates in a culture. According to Tischler (2014) Culture is defined as all that human beings learn to do, to use, to produce, to know, and to believe as they grow to maturity and live out their lives in the social groups to which they belong, (p. 50). Culture is a product of society and it is shared by the members of society. There are so many topics culture hits on, some are: Culture and Biology, Culture Shock, Ethnocentrism, Material Culture, Nonmaterial culture, Language and Culture, Symbols of Culture. Culture is an individual choice. Culture determines and guides us through life. Culture is transmitted from one generation to another is a learned behavior and not inherited biologically. We are raised the way our parent’s culture would raise their children for example; Catholics when the child is new born they get baptized, live their communion, confirmation, get marry and so on. We are programmed from young to this way of living. Other religions or cultures way of living is different. (Culture and Biology). From young we grow accustom to our way of living our culture. So when we travel to other countries we expect to continue our normal daily activities. But we experience culture shock when we aren’t able......

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Culture

...Introduction to Culture Lesson 1 Cultural Log What does "Service Before Self" mean to you? In your log, write a few words or a few sentences to respond to this question. Then think about what beliefs and values the motto represents. Write those down, too. Do you think all Americans share these beliefs and values? What American cultural groups share them apart from the Air Force? [You may use the space below to type and save your document, or you may print this page and write your response.] To me it means bearing the brunt so that the rest may live, doing those things you have to do to ensure everyone may have peace. It is a sacrifice of your personal desires, wants, needs, for the better of all. A lot of communities have this feeling but in my opinion none have it as much or as passionately than the American military. The American farmer has this feeling everyday it is his livelihood, The Majority of our Single parents have this belief with the education, safety and care of their children. Service before Self I believe is instilled in us all in some shape or form sacrificing your comforts. I’m not in the Coast Guard but “So that others may live” sums it up pretty good. What did you learn about yourself and Air Force culture by writing this log exercise? You probably already knew that you share many values with other service members. You may or may not have discovered that your idea of "Service Before Self" means something a little different to people outside the......

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