Thursday, March 09, 2017

Can GoAir fly on Warren Buffett tailwinds?

Iconic investor Warren Buffett, who for the long considered airlines as a “death trap for investors”, reportedly picked up stakes in four US carriers in the third quarter of 2016. Ever since the Sage of Omaha’s newfound love for airlines came to be known, Indian investors have piled into stocks from the sector. In the past one month, Jet Airways   and SpiceJet   have rallied 11.5 percent and 17 percent respectively, outperforming a 2.6 percent gain in the Nifty. Recent press reports indicate that GoAir would like to strike when the iron is hot – the company is readying plans to go public and may want to ride the Buffett wave. So what has changed for the industry? A lot, according to Buffett. The value investor has seen quite a few fundamental factors turning positive in the space. Firstly, gains are coming from consolidation in the industry that has cooled capacity expansion. Secondly, airlines are turning profitable not only due to falling crude prices but also ancillary revenue from “unbundled” services—charging for checked bags, seat upgrades, food and other things. Thirdly, Buffett is bullish on the US economy. The airline industry can only do well if the broader economy does well, which is something Buffett anticipates. Finally, while the exact acquisition cost of his airlines position isn’t known, he nevertheless bought them relatively cheap – when crude had already rallied from its lows. So is there wind beneath the wings for Indian carriers? If we follow Buffett, some of the fundamental factors support the Indian aviation sector too. There is no gainsaying that India remains an attractive market which has been growing at a healthy clip - passenger growth has remained above 20 percent for the 13th consecutive month.
Like US markets where the top four carriers control 66.5 percent of the market, the Indian market too is virtually a four-player market – the top four carriers have cornered close to 82.2 percent share.

Ideally speaking, this should have translated into decent pricing power. However, yields (Measure of average fare paid per mile, per passenger) are falling due to hyper competition as nearly all airlines are reporting very decent Passenger load factor (capacity utilisation). Overall industry load factor is at a high of 88 percent.
In Q3 FY17, Indigo , SpiceJet and Jet Airways have reported 16.5 percent, 10 percent and 3.5 percent yoy drop in yields. It is down 10 percent in January despite rise in crude prices and the strength of the US Dollar. Hence, despite the improvement in load factor, earnings of airline companies have weakened as they face the twin headwinds of softer yield and rising crude (fuel nearly 40 percent of costs).
09/03/17 Madhuchanda Dey/Moneycontrol