Those who did not apply for the high profile Jet Airways IPO and those who applied but did not get a good allotment must be ruing a lost opportunity. The stock opened for trading yesterday and surprised even diehard optimists closing above Rs1,300 - a gain of almost 18 per cent. Some investors could, perhaps, be considering buying the stock even now after yesterday's strong showing. Should they?
Granted, the civil aviation market in India is booming and has one of the fastest growth rates in the world. Granted again that Jet has a dominant market share in the domestic market. And yes, agreed, Jet has one of the fattest operating margins among all airlines in the world. But should one be a buyer at Rs1,300 per share or more than 20 times next year's projected earnings?
The answer, logically becomes evident in a dispassionate dissection of the sector Jet operates in and its own stock. First, let us look at the positives for the stock:
- Civil aviation in India can be safely expected to continue its growth momentum in the foreseeable future.
- Jet has a very strong brand and its service delivery matches global standards.
- Jet has a large number of peak hour slots at metro airports and therefore will continue to enjoy pricing power for such flights. New airlines will not get these prime slots till the airports increase capacity.
- Jet is very strong in the business travel segment, which is not as price sensitive as leisure travel.
- The company will shortly mount flights to East Asia, Europe and the US.
- The stock offers the only option to stock market investors who desire an exposure to this fast-growing sector, if one excludes Royal Airways which is planning to start SpiceJet.
Now the negatives:
- Jet is a full service airline. Low-cost carriers are rapidly gaining market share the world over and would become dominant players in due course. It will not be easy for Jet to convert itself into a low-cost carrier, if it decides to, without compromising its brand equity. The other option of launching a separate brand for low-cost operations would entail additional investments.
- The domestic market will see a good number of low-cost carriers in the near future. At least three of them, Kingfisher, SpiceJet and the one being promoted by Wadias of Bombay Dyeing will be strong players. Along with Air Deccan, they will provide serious competition to full service carriers like Jet. In future, expect global majors like Virgin and EasyJet to enter the domestic market as both have publicly stated their interest in India.
- Though Jet dominates the peak hour traffic from metros, this will not last forever as airports expand and start offering additional slots for other airlines.
- The other two full service carriers, Indian Airlines and Air Sahara, already have aggressive fleet expansion plans. Jet was able to gain market share from Indian Airlines partly because the aircraft acquisition programme of the state owned airline was stuck for almost 15 years. IA will add new aircraft starting next year. Sahara, under Rono Dutta former president of US Airways, has vastly improved service delivery and will offer tough competition in the business travel segment.
- Both IA and Sahara will have much more flexibility in pricing as they are not listed entities who have to worry about quarterly numbers. Once they have the additional aircraft, expect prices to go down further thereby reducing operating margins.
- Entry of new players in an industry like aviation, which requires specialised skills, would push up personnel costs. There is already a shortage of pilots in the industry. Expect it to worsen in future.
- Fuel is a major component of the operating costs of an airline. With crude prices very close to their all time highs, fuel prices will be increased in April. Worse still, oil analysts do not expect crude price to fall much from current levels in the foreseeable future. A further increase in oil prices is expected to ground many airlines across the globe.
- Jet could have expanded into smaller cities and developed them as a buffer against declining margins in the metro sector. But it has been slow in seizing this opportunity unlike Air Deccan, which has taken the lead. Air Deccan is connecting smaller markets not serviced by other airlines and is expanding rapidly by acquiring smaller turbo-prop aircraft.
- Jet's overseas forays will take a long time to break even, let alone make a profit. To start the operations, it will have to lease wide-bodied aircraft at the current high rates. The segments it is entering are highly competitive, serviced by large established airlines as well as price warriors. Many of these airlines can afford to drop prices only to kill new entrants. One can fly SriLankan to most Far East destinations from Delhi and back via Colombo for under Rs10,000, hotel accommodation at Colombo included.
- Jet does not have any major expansion plans for the domestic market. According to Jet's chairman himself, the airline would expand capacity by 10 to 15 per cent over the next few years. So there is a very real risk of Jet focusing its energies in stabilising the international routes while competitors eat into domestic market share.
No denying that Jet is an efficient and well-managed company. It is reasonably certain that the company will remain profitable in the short to medium term even in the face of increased competition and all the risks detailed above. But it is also reasonably certain that one or two years from now it will be extremely difficult for Jet to maintain, if not improve, the profit margins it is enjoying now. And there in lies the problem. The stock is just too over-priced as profitability can at best remain static, if not decline. For a medium to long term investor there are enough equally good and some even better stories in the market at far lower valuations.
Then why is the stock going up? No straight answers here. The most widely accepted theory is that a section of traders is building up positions as they expect foreign investors to start buying the stock. The theory goes further to say that foreigners cannot resist an exposure to the Indian aviation sector, which is emerging as one of the more prominent chapters in the India growth story. Can the stock go up further? Definitely it can and most probably it would in the very short term. For a short term trader with a very high risk appetite, this may be the one to ride while it lasts.
*A professional cost accountant, the author is a stock analyst and indepenent market trader
Disclaimer: The author does not have any position in the stock mentioned above at the time of writing this article. This analysis / report is only for the purpose of information and is not an investment advice. Readers are advised to consult a certified financial advisor before taking any investment decisions. While efforts have been made to ensure the accuracy of the information provided in the content the author or publisher shall not be held responsible for any loss caused to any person whatsoever.