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Airline stocks brace for rough weather on new aviation rules; should you go underweight?

If spike in oil prices wasn't enough to scare investors, a host of passenger-friendly measures announced on Saturday by Civil Aviation ministry, will surely do. Should you go underweight on these stocks?

Aprajita Sharma  New Delhi     Last Updated: June 13, 2016  | 14:05 IST
Airline stocks brace for rough weather on new aviation rules; should you go underweight?
Photo: Reuters

Are recently proposed passenger-friendly measures by the civil ministry, the revival of fare war and five times hike in air turbine fuel (ATF) prices this year enough to go underweight on aviation stocks?

Some analysts say yes, some beg to differ.

Aviation sector has been the one which has hogged a lot of limelight in the past one year. Be it SpiceJet stock's 251 per cent spurt or Jet Airways' 108 per cent jump, numbers say it all. Many domestic fund managers now hold these once-hated stocks in their portfolios, thanks to a slump in crude prices during the same period.

But with crude prices rebounding and air turbine fuel (ATF) prices being hiked for fifth time this calendar, these stocks are gradually losing some weight.

SpiceJet is down 18 per cent in the past one month, Jet Airways 13 per cent and InterGlobe Aviation 6 per cent. Fuel cost accounts for a third of airlines' top line.

If spike in oil prices wasn't enough to scare investors, a host of passenger-friendly measures announced on Saturday by Civil Aviation ministry, will surely do.

New rules to hurt airlines

The Civil ministry has proposed to cap cancellation charges, not exceeding the basic fare. The ministry has also come down hard on airlines when passengers are denied boarding despite having valid tickets due to overbooking. In such instances if the airline fails to organise another flight in next one hour, the airline will have to compensate the passenger with a whopping 200 per cent of one way basic fare and airline fuel charge. Also, the ministry has kept a mandatory 15 kg free baggage that a passenger can carry.

"If all proposals (5-fold hike in compensation for denied boarding, reduction in baggage fee to 1/3rd, cap on cancellation charges, etc) are implemented, the profitability of airline companies would be significantly impacted. Recently, the industry also intensified its competition as some of them slashed air fare. It is time to give under-perform to this sector in the stock markets," said G Chokkalingam.  

Amber Dubey, partner and India head of aerospace and defence at global consultancy KPMG, believes that the proposals would have a direct bearing on airline's bottom lines.

"The Indian aviation sector is finally coming out of the woods thanks to the low oil prices, rising economy and growing aircraft fleet. It needs 3-4 years of 18-20 per cent annual growth to consolidate and expand; and to recover the huge debt and losses of the past. Care should be taken by the government not to throttle the aviation sector so much in the name of honouring public sentiments that it takes us back to square one," Dubey told PTI.

Passenger growth a ray of hope

Riding on coattails of an unprecedented slump in oil prices, aviation major Jet Airways reported profits for the first time in eight years in fiscal year 2015-16, while budget carrier SpiceJet swung to profits after five years in FY16.

Experts believe the growth in passenger traffic, which grew 21.8 per cent in May 2016, the 20th month of double digit growth could hold the key for aviation stocks.

Abhishek Anand, Fund Manager, Centrum Broking believes with the economic activity improving, there is a possibility of the passenger growth improving further, which would be positive from demand perspective.

To that extent, the expert does not see deterioration in financials for airline companies in the near-term.  

Mustafa Nadeem, CEO, Epic Research also believes good days are not over in short or long term for aviation stocks as a whole as India is the only country  with fastest growth in domestic aviation fetching above 25 per cent beating china, Europe and US.

Pankaj Pandey, Head of Retail Research ICICI securities said the government is working on improving regional connectivity and supportive infrastructure to drive passenger traffic growth further.

"The new draft aviation policy provides various incentives to airline and infrastructure companies to improve regional connectivity and development of infrastructure for MRO services and regional airports in India. Hence, the next leg of growth will mainly come from these major initiatives," said Pandey.

Above $50 per barrel crude prices a worry?

Pandey said that despite Brent prices hovering at around $51 per barrel, airline companies could still generate healthy operating cash flows, which would again help them bring down debt significantly.

Given this, he expects airline companies to continue to post healthy profitability growth, going forward.

Taming non-fuel cost holds the key

While airlines cannot control their fuel costs, they can put in efforts to tame their non-fuel expenditure. However, in the fourth quarter of FY16, barring Jet Airways, SpiceJet and IndiGo both have reported a surge in non-fuel expenses.

Pandey believes that  the non-fuel cost can come down significantly only by keeping the average fleet age below three years and to do the same airline companies are now placing bulk orders for single fleet type aircraft.

"New aircraft like Boeing 737max and Airbus A330 Neos are fuel efficient aircraft, which burn 10-15% less fuel compared to the existing aircraft. Hence, by placing bulk orders for these types of fleet, carriers are not only focusing on the reduction of non-fuel cost but fuel cost as well, which will act as a hedge against rising crude oil prices," said Pandey.

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