Cost turbulence, rising competition may put pressure on airline stocks

Price hikes may plague demand, robust passenger traffic notwithstanding

Record high prices of aviation turbine fuel (ATF), a depreciating rupee, demand trends in the upcoming lean season, and competitive pressures could dent near-term prospects of listed aviation stocks - InterGlobe Aviation (IndiGo) and SpiceJet.

Both airline stocks have shed about 11 per cent each since the start of June. Given the multiple headwinds faced by the aviation sector, there could be more downsides for the two airlines.

The biggest worry for the sector though is the rise in jet fuel price, which accounted for 40 per cent of their costs in 2021-22.

Oil-marketing companies on Thursday announced a hike in price to its highest-ever levels. These vary between Rs 1.41 lakh per kilolitre and Rs 1.47 lakh per kilolitre, depending on state taxes.

ATF prices are up 120 per cent year-on-year and 36 per cent on a sequential basis. The movement of ATF prices will need to be tracked, given crude oil prices have corrected to three-week lows on Friday due to demand worries brought on by interest-rate hikes.

Another factor that could inflate costs is the movement of the rupee against the dollar. Last week, the rupee had plunged to its record low of Rs 78.22 against the greenback. Although the rupee has recovered somewhat, it is down 3.5 per cent in the quarter. With 70 per cent of airline costs linked to the dollar, the strengthening of the American currency will be a major headache for Indian aviation companies.

Says Ajay Singh, chairman and managing director, SpiceJet, “The sharp increase in jet fuel prices and the depreciation of the rupee have left domestic airlines with little choice but to immediately raise airfares. We believe a minimum 10-15 per cent increase in fares is required to ensure the costs of operations are better sustained.”

While IndiGo had earlier indicated that the prevailing fares are much lower than the pricing caps in force and that higher fares have so far not influenced demand, the cost surge could well change this.

Say Ashutosh Somani and Heet Vora of JM Financial Research, “Despite taking a significant price increase, airlines may be required to take further hikes to offset the surge in ATF price, possibly reaching a point of demand elasticity in the travel industry.”

A 5 per cent movement in crude oil is expected to impact operating profit before rentals by 8.5 per cent, they add.

What should support higher fares are strong traffic trends. Average daily fliers are upwards of 375,000 in June - this is about 2 per cent higher than the May numbers. Given that the number of daily departures, too, has increased by a similar quantum, load factors have remained steady. Most brokerages point out that the overall monthly passenger traffic in May and June so far at around 11-11.5 million (94 per cent) are near pre-pandemic levels.

The ideal situation for airline companies is price hikes and improving load factors. However, capacity additions and rising competition could lead to a focus on keeping passenger traffic at elevated levels.

IndiGo has indicated a 55-60 per cent increase in available seat miles/kilometres in 2022-23 (FY23).

Competitive intensity is set to increase with the entry of Akasa Air and Jet Airways. A lot will depend on their stance vis-à-vis pricing.

Say Ashish Shah and Vaibhav Shah of Centrum Broking, “Given  the  steep  losses  suffered  by  airlines  over  the past  two  years, we  expect  the  current  pricing  discipline in the industry to continue, adjusted for any seasonality impact. Any significant increase in competitive intensity could derail this assumption.”

The Street will track the movement of yields, given the multiple moving parts in this space. ICICI Securities highlights that yields will be tested in the second quarter of FY23 against a seasonally weak period and some improving capacity.

Given the elevated costs and competitive overhang, investors should stay away from the sector caught right now between costs and competitive pressures on the one side and possible demand hit due to higher ticket prices on the other.