Valuation gap between Indigo and Spicejet to narrow: CAPA

A combination of lower fuel costs, moderate capacity addition and strong passenger growth will drive growth in domestic aviation, feels Kapil Kaul of Centre for Asia Pacific Aviation (CAPA). In an interview with CNBC-TV18, Kaul says the huge gap between valuations of Indigo and Spicejet should narrow, but much would depend on the business case that Spicejet management is able to make to investors.Kaul says Indigo's initial public offer will be crucial for the aviation sector, and it could even encourage GoAir to come out with a public offer. Kaul expects Spicejet to raise capital after the Indigo IPO.Below is the transcript of Kapil Kaul’s interview with Sonia Shenoy and Latha Venkatesh on CNBC-TV18.Sonia: The comments that the SpiceJet management has made are very interesting but what is the sense you are getting about how much this sector could be rerated or what the growth could be now that we have the IndiGo initial public offering (IPO) as well on the anvil?A: The IndiGo IPO is critical for the sector not only for the airlines sector, it is critical for the entire aviation sector because I think it is fundamentally going to rerate the sector, especially the kind of competitive dynamics that we saw over the last 7-10 years and here is a IPO which is potentially going to value an airline in India at about USD 4 billion. That is remarkable. That will be a step up change towards the next decade of stability in growth perhaps for the sector.
I am sure once the IndiGo rerating happens, the second step would be that you may have another IPO. Potentially, the capital raising of SpiceJet, which is critical to me, would perhaps happen post the IPO.Latha: What has changed in the airlines space? Just two years ago, one big airline had capitulated and another one was so desperately in need of money, that it had to change its promoters, that was also a bailout situation. What has changed? Is it that the number of players have come down? Is the market picking up? What has changed?A: Both. The fuel has changed the dynamics. Aviation turbine fuel (ATF) has been a big challenge for the sector. It almost in certain years touched 60 percent of the revenues. Now, with the fuel price which is currently under USD 50 per barrel, if you see Brent is under USD 50 per barrel though even the fuel benefits are not fully passed on that has structurally changed the sector. If I have to take one single factor that has changed the outlook of the sector is the fact that ATF is pretty low. I think the ATF is going to stay lower at least in the near-term. That to me is the first important factor that is the basis of this optimism.Second, the growth has been stable. You are seeing growth rates, which are similar to what we see in 2004 to 2009, which saw the domestic growing at about a compounded annual growth rate (CAGR) of about 18.5. So, the growth is stable and we are going to see a high growth rate. The cost structure will be lower, driven by fuel cost there is likely currency stability. Overall it is good for the sector.Third important factor was that over the last one to two years, we did not see the kind of capacity that normally is inducted to the sector. So, it is a combination of moderation of capacity, it is a lower cost base, it is a stable growth rate, a combination of these factors. I see that these three factors will continue to play in the near-term which will be positive for all the players.Sonia: You have tracked SpiceJet for many years now. What did you make of the comments that the management had that Ajay Singh told us that if IndiGo can be valued at Rs 25,000 crore, he does not see why SpiceJet should be valued at just about Rs 2,000 crore or so. Do you think SpiceJet deserves much higher valuations and do you expect the profitability to continue?A: SpiceJet obviously would want to wait for the IndiGo IPO. There would be a sense of rerating for the sector. Obviously, if IndiGo gets valued at USD four billion, there would be an optimism that the promoters of SpiceJet would go look at a significantly higher valuation that currently exists.The valuation of SpiceJet would depend upon their business case. It is going to be depending upon -- I think they are looking for a 100 aircraft order, so they need a fleet delivery programme which is committed and there is a clear financing committed for that fleet plan. It needs a new management structure. It needs further stability.I would think the next two three quarters of profitability, especially from Q3 of this fiscal would further enhance the valuation expectations from SpiceJet. SpiceJet’s future and their valuation will depend upon their business case. I do not know what the business case is there currently from 5 to 10 year perspective but as long as there is a solid business case with fleet bets that are taken which is significant, the management structure gets changed and there is a consistency in profitability, I would see no reason why over the next three to four quarters or maybe in mid of FY16 or later, the valuation of SpiceJet would reflect the fundamentals of the sector.

Sonia: So, you are saying that there is a case to be built that these companies like SpiceJet and Jet Airways have seen the worst behind them and they will continue to see profitability from here?A: Yes, though Q4 would have a modest loss but overall I see a profitable year. Spicejet's valuation -- obviously the fundamentals of the market are very strong. There needs to be a strong business case as well, which the promoters need to build -- a solid business case which will have a clear direction towards sustainable profitability. Market would play its role, SpiceJet’s management needs to play its role in terms of building a business case, which will help them to look at higher valuations.Latha: So, a narrowing of the valuation gap is not a given. SpiceJet will have to prove it?A: I do not think there could be a – for Rs 24,000 crore, obviously I expect SpiceJet to be valued much higher depending upon their business case and how they set themselves up. There will be a significant gap between IndiGo and SpiceJet but it will be much better than what the valuation of roughly about 300 million plus that currently SpiceJet has.Sonia: Between the three, IndiGo, SpiceJet and Jet Airways, is it a no-brainer that IndiGo will continue to be the best performer or do you think that from an investment point of view perhaps even some of these beaten down names like SpiceJet and Jet Airways have a chance at outperforming?A: IndiGo is not stopping at what they have done. They are closer to 100 aircrafts and we see them getting about 50-60 new A320neos into the sector in the next three years. I see them closer to 50 percent market share. So, IndiGo is going to get further stronger. I do not see any reason why IndiGo would not be stronger. But that does not means airlines like Spice or Jet would not have a upward direction in terms of their valuation and growth plans. There is enough appetite in the sector.As long as the fundamentals stay as what they are and I think both the managements of SpiceJet and IndiGo build a business case, which investors believe in, I see no reason why there would not be an upward revision in the valuation of both these airlines. But largely, depending upon how the promoters of both these airlines build a solid business case going forward.