Top pick in the sector is InterGlobe Aviation due to its improved fleet profile, which is efficient than its peers.
With rise in crude oil prices, aviation turbine fuel (ATF) prices would also increase which will hurt the operating profit margins of aviation companies as ATF fuel cost is around 50 per cent of total operating cost.
Crude oil price has seen significant jump by about 8 per cent so far this year to USD 72 a barrel. From January 2017, Brent crude prices have witnessed a rise about 30 per cent owing to concerns that conflict between the United States and Russia may escalate in Syria.
Our top pick in the sector is InterGlobe Aviation due to its improved fleet profile, which is efficient than its peers. In addition, the company is presently the largest domestic airline (around 40 per cent market share) and one of the most efficient operators globally with superior return ratios (return on equity of 59 per cent in FY17). We believe the company is strongly placed to capitalise on strong domestic traffic growth (around 17 per cent YoY).
Recently on Directorate General of Civil Aviation's (DGCA) order, InterGlobe Aviation (IndiGo) had grounded 8 A320 neo aircrafts (with engine serial number of beyond 450). Aircrafts with these engines have faced mid-air engine failure and, DGCA has asked IndiGo (and Go Air) not to refit these engines, which are spare in their inventory.
As a result, the company had to cancel 47 flights per day. However, we believe, the situation will be under control soon as Pratt & Whitney has already begun to deliver production engines with upgraded configuration and expects it to complete by end of Q2CY18.
We are of the view that the valuations of the company (EV/EBITDA of 32x and P/E of 28x) are very high amidst concerns on increasing raw material cost and do not expect a upside from current levels.
In fact, we believe, going forward the company will witness pressure in its earnings growth owing to rise in ATF prices. In addition, IndiGo in the past one year added aircrafts on short-term leases (20-25 per cent expensive) to counter slower induction of neos in its fleet which would impact its margins although volume growth may not suffer.(Disclaimer: The author is Vice-president, Equity Research at Ajcon Global Services. The views and investment tips expressed by investment experts on moneycontrol.com are their own, and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions)