Aviation stocks may not fly much on FDI

Analysts say operating landscape hasn?t changed and even a large equity infusion won?t meaningfully reduce interest costs. But, gains for are likely power exchanges

The government’s move to widen foreign direct investment in aviation has got a mixed response from analysts, while that for power exchanges is seen in a positive light. Though aviation stocks (barring Jet Airways) have zoomed 17-29 per cent since Friday, buoyed by the announcement that foreign carriers could buy up to 49 per cent in Indian airline companies, analysts such as J P Morgan’s Princy Singh and D S Harchandani say investors should use the rally to sell these shares. They argue the operating landscape (high oil prices, slowing growth) has not changed and more capital could increase competition and reverse the benefits of the current consolidation. Also, foreign airlines might not pay a premium to invest in local carriers.

Further, most foreign investors would be awaiting more reforms, especially on reducing the taxes on aviation turbine fuel (ATF). If states reduced taxes or ATF was moved to a declared goods category, attracting a uniform four per cent sales tax across India, “it would be a game changer, as lower costs if passed on will boost passenger numbers”, says a Kotak Securities report. While it will be positive, as things stand, there might not be significant benefits for foreign airlines. Jamshed Dadabhoy and Arvind Sharma of Citi Research say even a large equity infusion will not meaningfully reduce the interest burden on the large debt domestic players have. They also have a code share with international carriers and international airlines have a sizeable share in key international routes into India, limiting the probability of investment. A better option is to start a new airline with a local partner, they add, given few entry barriers.

On the other hand, the decision to allow foreign investment of up to 49 per cent (FDI of 26 per cent and FII limit of 23 per cent) in power exchanges will help companies tap funds for growth. India’s power exchanges, in a nascent stage wherein only two to three per cent of the electricity generated is traded, are expected to gain from increase in trading volumes led by capacity additions, availability of distribution infrastructure and reforms in the distribution space.

In this light, SpiceJet (with a less leveraged balance sheet and significant market share) and Financial Technologies are among the stocks seen as key beneficiaries of the government move.

SpiceJet
A preferred pick after the FDI policy announcement, the company is India’s fourth largest domestic carrier, with a market share of 17.8 per cent. Analysts say it is in a better position than other listed peers, due to a relatively unimpaired balance sheet. A Kotak Research report pegs FY12 gross debt at Rs 1,000 crore with working capital debt (representative of cash losses) of only Rs 400 crore, while the rest of the debt is on account of aircraft (Q-400s) acquisitions. Echoing similar views, J P Morgan analysts while attributing a premium to the company over Indian full service carriers say this is on account of efficient operations, higher growth over the next two years, a strong balance sheet and a low cost structure. At Rs 38, the stock is trading at 7.4 times its FY14 EV/Ebitdar (31 times FY14 EV/Ebitda). Investors could look at buying on dips.

Jet Airways
Due to the high promoter stake (classified as FDI), the company is unlikely to gain from the government’s move. While its peers have been making sharp gains, the stock has remained flat over the past two days. Though the carrier slipped to the number two position in July, with a market share of 26.6 per cent, a Citi report (which has a buy on the company) says Jet has a market share of 32-35 per cent (annual basis), which is unlikely to decline. While the Jet management has not given any indication about inducting a foreign partner, any move along those lines will be a positive, feel analysts. Kotak Institutional Equities, however, is cautious on the company due to its high leverage (net debt of Rs 12,244 crore) and has a sell rating. The stock (Rs 359) is trading at 7.1 times its FY14 EV/Ebitdar (12x EV/Ebitda).
 

HOPING FOR FRIENDLY SKIES
In Rs crore	Jet Airways		SpiceJet		Kingfisher
	FY12	13E	FY12	13E	FY12
Net sales	16,703	19,831	3,998	6,174	5,715
% change y-o-y	15.0	18.7	38.9	54.4	-11.8
Ebidta	-27	1,493	-518	129	-855
% change y-o-y	PTL	LTP	PTL	LTP	PTL
Net profit/loss	-1,420	-295	-605	9	-2,328
% change y-o-y	PTL	–	PTL	LTP	–
E: Estimates       PTL: Profit to loss, LTP: Loss to profit       Source: Companies, Kotak Institutional Equities

Kingfisher Airlines
The star among aviation scrips has been Kingfisher, with investors lining up for part of the action after the policy announcement. Despite the fact that it is burdened with debt and its operations are in a shambles, the scrip shot up 35 per cent over the past three days. Praveen Sahay of B&K Securities says fund infusion through FDI will be a big relief for domestic carriers such as Kingfisher in the near future. While the company has been looking for equity infusion and will benefit by inducting a foreign partner, the chances of this happening do not look bright. BoAML analysts Anand Kumar and S Arun, in a recent report, say the company will struggle to attract any FDI in the near term due to large debt ($1.8 billion) and vendor payments, small market share (3.4 per cent in July) and a large proportion of impaired fleet.

Financial Technologies
Of the two power exchanges in India, Financial Technologies has co-promoted IEX along with PTC India Financial Services (PFS), an arm of the country’s largest power trader, PTC India (accounts for 95 per cent of traded power). FT’s 33 per cent holding in IEX, considered the key beneficiary of the reform in the sector, is worth Rs 500 crore, based on the last deal where PFS sold 14.01 per cent (in IEX) for Rs 70.76 crore. However, thereafter the valuations have gone up as a result of higher profits.

In FY12, IEX reported Rs 34 crore profit, which analysts see rising to Rs 54-55 crore in FY13. Even if one gives a PE of 20 times, the value of IEX would work out to about Rs 1,000 crore, with the value of FT’s stake working out to Rs 330 crore (about eight per cent of FT’s current market capitalisation). While value unlocking could happen on stake sale or by bringing strategic investors in IEX, the benefits might not be significant (given the impact on FT’s valuations). The gains could be larger, considering the growth potential of the business and assuming FT holds on for the long haul.

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