Sell Jet Airways; target of Rs 716: Citigroup Research

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Citigroup Research is bearish on Jet Airways  and has recommended sell rating on the stock with target price of Rs 716.

Citigroup Research report on Jet Airways:

Reiterate Sell

Sharp upward movement in the stock price reflects positives in the domestic market, but does not accurately reflect risks embedded in roll out of international operations. Integration of Air Sahara also remains a near-term risk factor. Reiterate Sell, new Rs 716 TP, based on 7x FY09E EV/EBITDAR. Revise Risk to Medium from High, as domestic competitive intensity abates

Earnings Revision

Revise FY08E profits downward by 41% on expectations of start up losses in new international routes. Increase FY09E profits by 36% on expectations of a turnaround in international operations on North America bound routes by FY09E. Expect international operations to be major driver of revenue growth going forward, to account for over 40% of overall revenues.

Domestic Profitability Returns

A positive for Jet, and reflects our revision in Jet's domestic EBITDAR margins to around 22-23% over FY08E-09E, vs 16% margins in FY07. Risks associated with international operations accentuated by the fact that international operations constitute meaningful proportion of revenues and profits.

Air Sahara Acquisition

We do not factor in the Air Sahara acquisition, given limited data available. Expect sustained profitability from FY09E (break even in 2HFY08E).

Key Risk Factors

Key upside risks are a) faster than expected turnaround of international routes, and b) rapid restructuring of Air Sahara's operations.

Reiterate Sell

We reiterate our Sell recommendation on Jet Airways, but revise our risk rating to Medium from High, which is consistent with the risk rating with of its regional peers. As competitive intensity in the domestic market recedes, we once again benchmark Jet with its regional peers (we had initiated on Jet with a Medium risk, but subsequently raised it to High Risk, as competitive intensity in the domestic market escalated). We raise our target price to Rs 716 (from Rs 390), on the back of earnings revisions and also a roll over to FY09E earnings. We believe the recent sharp run in the stock price does not adequately factor risks pertaining to the roll out of the international operations. Our thoughts on the 4 key issues on Jet are detailed below.

Air Sahara Acquisition - Long Term Positive

In Apr 2007, Jet agreed to acquire Air Sahara for a cash payout of Rs 14.5 billion. Jet had already paid Rs 5 billion as advance. The immediate cash outflow was for a further Rs 4 billion, with the residual Rs 5.5 billion to be paid over 4 equal annual installments, commencing March 2008. According to management, the NPV of the deal cash payments amounts out to Rs 12 billion. In addition to this is the Rs 1.8 billion invested in Sahara's operations, and the capitalized value of offbalance sheet operating leases (which we assume at a minimum of Rs 14 billion - Rs 2 billion per annum multiplied by a factor of 7). According to our estimates, the lease-adjusted EV of the acquisition thus amounts to Rs 28 billion. On our FY09E estimates (of Air Sahara), the acquisition is priced at a multiple of 8x FY09E EV / EBITDAR - slightly expensive when compared to peers in the region. But we caution that this multiple is based on profits "reverting to the mean" - not a distressed multiple and also assumes that Jet's management will effectively turn around the airline by FY09E. Given the lack of disclosures at this stage, we have not factored Air Sahara into our estimates.

Valuations

Given the excessive volatility in earnings of airlines, we prefer to utilize a more stable metric to value airlines. The price-to-book metric is a good fall-back measure for airlines, especially in times of distress, but it is not so appropriate for Jet Airways, which is entering a high growth phase, and wherein industry conditions (in the domestic market) are improving. We thus continue with EV/EBITDAR as our preferred valuation metric of choice. We compare Jet with the major established full service carriers in our coverage universe. While Jet arguably has superior growth opportunities to most of these carriers, Jet has still to demonstrate its ability to deliver robust and consistent earnings over time, and strong sustainable market share in the face of aggressive competition. Nevertheless, Jet's market position within the domestic market is fairly well entrenched, and its international operations are proceeding at a satisfactory pace. Ideally, given the volatility in this business, we would have liked to value Jet on 1 year forward earnings (ie FY08E), rather than FY09E. But FY08E remains a transition year, fraught with execution risk, as Jet will commence maiden operations to the US, and also doesn't correctly reflect its intrinsic profitability (as there will be significant start up costs, etc). Accordingly, we roll forward our EV/EBITDAR multiple to FY09E and pare it slightly to 7x (from 7.5x), which is a premium of almost 22% over other regional peers. When we initiated on Jet Airways 2 years ago, we had assumed a multiple of 8.2x FY07E EV / EBITDAR, which was a premium of around 20% to the Asian peer group. Subsequently, we pared the multiple to 7.5x, a 15% discount to the regional peer group, given the extremely competitive scenario in the domestic sector. As domestic competitive pressures stabilise, we believe that Jet should trade once again at a premium to peers - but rolling forward into FY09E, we find peers trading at far lower multiples of around 5.7x. Our new multiple of 7x, is thus again at a 22% premium to the peer group, consistent with our past methodology. We cannot fall back on trading bands at this juncture, given a) Jet's relatively limited trading history, and b) a rapidly changing business model (both in domestic and international operations), which has had a significant impact on a) valuations and b) earnings. At our target multiple, we assign a target price of Rs 716 per  share.