Cost and competition may keep IndiGo's growth under check: Brokerages

Yields have been higher in Q2; market leader continues to gain market share

The stock of India’s largest airline InterGlobe Aviation (IndiGo) has gained about 23 per cent since the beginning of July. This was led by expectations of rising yields and market-share gains. While yields have remained high in a seasonally weak quarter, its market share in July was hovering just under 59 per cent. Brokerages are, however, divided over the extent of gains, given the concerns related to elevated fuel costs and competitive pressures.

The gains for IndiGo on yields emanate both on account of higher prices and capacity constraints. Citing IndiGo management, analysts Aditya Mongia and Teena Virmani of Kotak Institutional Equities (KIE) say yields are better than what seasonal trends in a weak second quarter (Q2) would imply. These reflect the growing comfort of customers to pay higher yields (over Rs 5) and competition, following IndiGo on price hikes. Both these trends are positive for a sector that has operated on small spreads for the most part of the last decade, they add.

Yields for the company had hit record levels of Rs 5.24 in the June quarter (demand is typically much stronger than the current quarter) and were ahead of Street estimates which had pegged the same at Rs 4. Yields — up 19 per cent on a sequential basis — were on account of the company’s focus on maximising revenue at the cost of load factors.

While load factors had improved to 79.6 per cent, compared with 76.5 per cent in the January-March quarter, given seasonality and revenge travel, the metric was lower compared to 89 per cent in the first quarter (Q1) of 2019-20 (pre-Covid levels).

What could keep yields and passenger load factors high are limited industry capacity additions, with incremental expansion expected in 2023-24 (FY24). The Street will keep an eye on Tata Group which has chalked out an aggressive fleet addition strategy for Air India.

While KIE has an attractive rating for the sector, Axis Securities believes the Street is overtly optimistic about the estimates for IndiGo on the yield and competitive scenario fronts.

Venkatesh Balasubramaniam of the brokerage says the only time IndiGo’s spreads have breached Rs 2.6 was in 2015-16 when aviation turbine fuel (ATF) prices were at a 13-year low of Rs 47.9 per litre. This is not the case at present.  

“Spreads (Axis estimates) at Rs 2.4 for 2022-23 (FY23) and 2.6 each for FY24 and 2024-25 seem optimistic against the backdrop of high ATF prices and competition,” he adds.

Brent crude oil prices are trading around the $100-to-a-barrel mark after witnessing a sharp jump to near all-time high levels of $147-per-barrel mark after the Russian invasion of Ukraine.

The pricing strategy of new airlines could also weigh on yields.

Low-cost airline Akasa Air has been pricing its tickets on a par or cheaper than IndiGo on some sectors. The government’s decision to remove price cap/floor from August 31 could result in a price war, leading to a seasonally weak Q2, believes the brokerage.

What could add to the cost increase is wage inflation which was visible in Q1FY23 and could inflate the cost bill in the current year.

With corporate travel and tourism back to pre-Covid levels and IndiGo’s unmatched network will mean market share gains in the near term. The pricing trajectory (amid multiple cost headwinds) will be a key factor to track.

While KIE’s fair value at Rs 2,710 translates into a 37 per cent return from the current levels, Axis Securities has pegged a target price of Rs 1,900 — this is about 3.5 per cent lower than the current price.