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The Industry Handbook: The Airline Industry
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Few inventions have changed how people live and experience the world as much as the invention of the airplane. During both World Wars, government subsidies and demands for new airplanes vastly improved techniques for their design and construction. Following the World War II, the first commercial airplane routes were set up in Europe. Over time, air travel has become so commonplace that it would be hard to imagine life without it. The airline industry, therefore, certainly has progressed. It has also altered the way in which people live and conduct business by shortening travel time and altering our concept of distance, making it possible for us to visit and conduct business in places once considered remote. (For more on the airline industry, read Is That Airline Ready For Lift-Off?)

The airline industry exists in an intensely competitive market. In recent years, there has been an industry-wide shakedown, which will have far-reaching effects on the industry's trend towards expanding domestic and international services. In the past, the airline industry was at least partly government owned. This is still true in many countries, but in the U.S. all major airlines have come to be privately held. The airline industry can be separated into four categories by the U.S. Department of Transportation (DOT): • International - 130+ seat planes that have the ability to take passengers just about anywhere in the world.

Companies in this category typically have annual revenue of $1 billion or more. National - Usually these airlines seat 100-150 people and have revenues between $100 million and $1

billion. • Regional - Companies with revenues less than $100 million that focus on short-haul flights. • Cargo - These are airlines generally transport goods. Airport capacity, route structures, technology and costs to lease or buy the physical aircraft are significant in the airline industry. Other large issues are: • Weather - Weather is variable and unpredictable. Extreme heat, cold, fog and snow can shut down airports

and cancel flights, which costs an airline money. Fuel Cost - According to the Air Transportation Association (ATA), fuel is an airline's second largest expense. Fuel makes up a significant portion of an airline's total costs, although efficiency among different carriers can vary widely. Short haul airlines typically get lower fuel efficiency because take-offs and landings consume high amounts of jet fuel. Labor - According to the ATA, labor is the an airline's No.1 cost; airlines must pay pilots, flight attendants, baggage handlers, dispatchers, customer service and others.

Key Ratios/Terms Available Seat Mile = (total # of seats available for transporting passengers) X (# of miles flown during period)

Revenue Passenger Mile =

(# of revenue-paying passengers) X (# of mile flown during the period) (Revenue) (# of seats available)

Revenue Per Available Seat Mile =

Air Traffic Liability (ATL): An estimate of the amount of money already received for passenger ticket sales and cargo transportation that is yet to be provided. It is important to find out this figure so you can remove it from quoted revenue figures (unless they specifically state that ATL was excluded). Load Factor: This indicator, compiled monthly by the Air Transport Association (ATA), measures the percentage of available seating capacity that is filled with passengers. Analysts state that once the airline load factor exceeds its break-even point, then more and more revenue will trickle down to the bottom line. Keep in mind that during holidays and summer vacations load factor can be significantly higher, therefore, it is important to compare the figures against the same period from the previous year. Analyst Insight Airlines also earn revenue from transporting cargo, selling frequent flier miles to other companies and up-selling in flight services. But the largest proportion of revenue is derived from regular and business passengers. For this reason, it is important that you take consumer and business confidence into account on top of the regular factors that one should consider like earnings growth and debt load. (For more about the consumer confidence survey, see Economic Indicators: Consumer Confidence Index.) Business travelers are important to airlines because they are more likely to travel several times throughout the year and they tend to purchase the upgraded services that have higher margins for the airline. On the other hand, leisure travelers are less likely to purchase these premium services and are typically very price sensitive. In times of economic uncertainty or sharp decline in consumer confidence, you can expect the number of leisure travelers to decline. It is also important to look at the geographic areas that an airline targets. Obviously, more market share is better for a particular market, but it is also important to stay diversified. Try to find out the destination to which the majority of an airline's flights are traveling. For example, an airline that sends a high number of flights to the Caribbean might see a dramatic drop in profits if the outlook for leisure travelers looks poor. A final key area to keep a close eye on is costs. The airline industry is extremely sensitive to costs such as fuel, labor and borrowing costs. If you notice a trend of rising fuel costs, you should factor that into your analysis of a company. Fuel prices tend to fluctuate on a monthly basis, so paying close attention to these costs is crucial. Porter's 5 Forces Analysis 1. Threat of New Entrants. At first glance, you might think that the airline industry is pretty tough to break into, but don't be fooled. You'll need to look at whether there are substantial costs to access bank loans and credit. If borrowing is cheap, then the likelihood of more airliners entering the industry is higher. The more new airlines that enter the market, the more saturated it becomes for everyone. Brand name recognition and frequent fliers point also play a role in the airline industry. An airline with a strong brand name and incentives can often lure a customer even if its prices are higher. Power of Suppliers. The airline supply business is mainly dominated by Boeing and Airbus. For this reason, there isn't a lot of cutthroat competition among suppliers. Also, the likelihood of a supplier integrating vertically isn't very likely. In other words, you probably won't see suppliers starting to offer flight service on top of building airlines. Power of Buyers. The bargaining power of buyers in the airline industry is quite low. Obviously, there are high costs involved with switching airplanes, but also take a look at the ability to compete on service. Is the seat in one airline more comfortable than another? Probably not unless you are analyzing a luxury liner like the Concord Jet. Availability of Substitutes. What is the likelihood that someone will drive or take a train to his or her destination? For regional airlines, the threat might be a little higher than international carriers. When determining this you should consider time, money, personal preference and convenience in the air travel industry.




5. Competitive Rivalry. Highly competitive industries generally earn low returns because the cost of
competition is high. This can spell disaster when times get tough in the economy. Key Links • Federal Aviation Administration - Get the latest regulation news, airport delays, etc. • AviationNow.com - Information and news on the airline/aerospace industry. • AirWise.com - Airport and aviation news

Read more: http://www.investopedia.com/features/industryhandbook/airline.asp#ixzz1Rcpa5ybM

SpiceJet is one of the fastest growing airlines in the aviation industry, with a market share of around 12%. Given its strong expansion plans, revival in the economy and strong passenger growth, we have assigned a target multiple of 9x FY2012E EPS of Rs9.3 to arrive at a target price of Rs84, implying an upside of 33%. oad factors expected to remain healthy: Driven by huge losses, most airlines reduced fleets and no new capacities were added since FY2009. With FCCs like Air India and Kingfisher still making huge losses, and Jet Airways barely breaking even, we expect negligible fleet additions over FY2010-11E. But demand has bounced back sharply in 9MFY2010 and Low-Cost Carriers (LCCs) have been reporting 80%+ load factors. Given that the demand is expected to outpace supply, the load factors are expected to remain around 77% for FY2011E. rofitability: With the Aviation industry characterised by very high operating leverage, an improvement in the load factor is expected to drive a substantial spurt in Profits. With 80% (66% in 3QFY2009) load factors, SpiceJet's Net Profit shot up to Rs109cr in 3QFY2010 vs. Rs43cr loss in 3QFY2009. Additionally, aided by a strong fleet addition (19% CAGR over FY2010-12E), we expect SpiceJet's Net Profit to grow at a 51% CAGR to Rs377cr in FY2012E.

SpiceJet is expected to build a strong cash reserve of Rs874cr as on FY2011E and of Rs1,311cr by FY2012E. In a worst-case scenario, even if SpiceJet witnesses a load factor of just 50% (lowest load factor till date of 67% in FY2009), it would have enough cash to sustain its operational expenditure for 14 months, without diluting any equity. With US $79.8mn FCCBs getting converted by December 2010 and ~Rs350cr of QIP (not factored), Balance Sheet strength will go up further, with a Net Worth of Rs989.4cr in FY2012E. +91 22 4040 3800 Ext: 338 Email: [email protected] May 3, 2010 Flying into Clear Skies CMP Rs62 Target Price Rs84 Stock Info Shareholding Pattern (%) Sector Airlines Market Cap (Rs cr) 1,505 Beta 0.9 52 Week High / Low 65/14 Avg. Daily Volume 3942106 Face Value (Rs) 10 BSE Sensex 17,559 Nifty 5,278 Reuters Code SPJT.BO Bloomberg Code [email protected]

Promoters 12.9 MF / Banks / Indian FIs 34.9 FII / NRIs / OCBs 28.0 Indian Public / Others 24.2 Abs. (%) 3m 1yr 3yr Sensex 5.4 52.5 23.5 SpiceJet 5.7 335.6 38.7 Investment Period 12 Months Source: Company, Angel Research Key Financials % chg 30.5 30.6 21.8 17.5 % chg 164.1 (147.0) 81.3 25.3 EBITDA Margin (%) (24.8) 5.9 11.9 12.6 P/E (x) (4.3) 9.1 8.4 6.7 P/CEPS (x) (4.4) 8.7 8.2 6.6 RoE (%) 175.6 (47.8) 172.2 47.0 RoCE (%) (135.9) 86.3 74.0 48.5 P/BV (x) (3.5) (5.7) 4.1 2.6 EV/Sales (x) 1.0 0.7 0.6 0.4 EV/EBITDA (x) (4.0) 11.2 5.2 3.1May 3, 2010 2 SpiceJet | Initiating Coverage Investment Arguments Passenger traffic poised for strong growth Prior to the economic turmoil, the domestic aviation industry witnessed strong demand in passenger traffic, registering a CAGR of 18% over FY2001-2008. With the growing demand in passenger traffic, airline companies started ramping up their capacity

(some by nearly 2 times) to meet the current and the future demand, which resulted in a huge increase in capacity in terms of Available Seat Kilometres (ASKM), which nearly doubled from 35,077mn in FY2006 to 60,590mn in FY2008). However, the Aviation sector was amongst the worst hit by the economic crisis in FY2009, where demand in terms of passenger traffic declined by 11%, from 44.5mn in FY2008 to 39.5mn in FY2009, which was the biggest fall in a decade. Due to the huge capacity expansion in the last few years and the plummeting demand in FY2009, almost all airlines suffered huge losses, which forced some companies to rationalise their capacity to cut down costs and to reduce future losses (Kingfisher rationalised its fleet from 88 to 66). However, demand has bounced back significantly over the last 9MFY2010 and is expected to grow by 13% for the whole FY2010E. Historically, economic growth has been the primary driver of air traffic and this relationship has been even more evident in developing countries. It has been observed that aviation grows at the rate of 1.2 to 1.8 times the GDP (1.2 times in developed nations and 1.8 times in developing countries with pent-up demand). Assuming an annual GDP growth of ~8% and a 1.5 times multiple, it is estimated that domestic aviation traffic alone will grow around by 12-13% annually, or by 2.5 times, from the current 40mn passengers to 100mn passengers by 2020. Given that the demand has historically grown at an average of around a 13.7% CAGR over the last ten years, we expect this trend to continue, with an expected GDP of 8-9% YoY for the next three years; thus, we expect the passenger traffic demand to register CAGR of around 13% over FY2010E-FY2012E. In absolute

terms, we expect the passenger traffic to be around 44.6mn FY2010E and 56.6mn in FY2012E. Source: DGCA, Angel Research Exhibit 1: Strong passenger growth to continue Passengers Carried (LHS) Growth (RHS) (20) (10) 0 10 20 30 40 50 0 10 20 30 40 50 60 FY2001 FY2002 FY2003 FY2004 FY2005 FY2006

FY2007 FY2008 FY2009 FY2010E FY2011E FY2012E (%) (mn) .May 3, 2010 3 SpiceJet | Initiating Coverage The long term demand is expected to remain high due to the low penetration of air traffic in India. It is estimated that only 43 travellers per 1,000 travel by air, which is 12 times lower when compared to the USA (520/1,000), and nearly 5 times lower than China (215/1,000). According to research done by IATA PaxIS, Global Insight and Airbus, it was noted that air trips per capita increases exponentially when the Real GDP Per Capita level rises above the US $1000 level, and until the US $10,000 level. After the US $10,000 level, the growth tends to slow down considerably, which can be seen in the case of all developed nations. Currently, India's Real GDP per capita is at US $1,032, and is expected to grow by around 12-14% annually. This implies that the Indian aviation sector as a whole is going to experience enormous growth over the next 15-20 years. Airbus expects the sector to register a 10% CAGR over the next 20 years. Source: IMF, Airbus Exhibit 2: India to experience highest domestic growth

Real GDP per capita (2009) 20 years annual domestic growth forecast 0 2 4 6 8 10 12 0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 50,000 India China Brazil RSA Russia Aus/NZ Cen. Eur.

West.Eur. U.S (%) (US $) Brazil 0.001 0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 50,000 55,000 0.01 0.1 1 Trips per capita - 2008 2008 Real GDP per Capita 10 Barbados Passenger originating from a particular country (per ‘000) Bahrain Bahamas New Zealand UAE Ireland Switzerland Netherlands USA UK Samoa Mauritius Panama

Saudi Arabia Bosnia Nigeria Iraq Niger Maldives Italy Slovenia South Korea Trinidad Portugal Hong Kong Greece Germany Kuwait Mexico Poland China India World average Russia Australia Exhibit 3: Large potential to increase propensity to travel Source: IATA PaxIS, Global Insight, Airbus; Note:GDP in 2005 US$ Low penetration of air traffic in India of air traffic in IndiaMay 3, 2010 4

SpiceJet | Initiating Coverage Indian Airlines 80 80 81 81 Jet Airways 63 63 63 73 Jet Lite 16 16 18 20 Indigo 25 34 42 52 Kingfisher 46 46 52 61 SpiceJet 19 23 27 27 Paramount 5 5 5 5 GoAir 8 8 8 8 yoy growth (%) 5 8 10 Exhbit 4: Low capacity addition Source: Company, Angel Research Demand expected to outpace supply The major triggers for profitability for the whole aviation sector in FY2011E and FY2012E will be lower capacity additions, which will lead to greater demand when compared to supply, resulting in higher profitability due to increasing load factors. FY2011E will see a major supply-demand gap being created, as demand is expected to increase by 13% while supply is expected to rise by only 5%. We expect the total Domestic fleet size to increase by around 5% in FY2011E and by around 8% in FY2012E. Prior to the economic downturn, huge orders were placed by Kingfisher, Indian Airlines and Jet airways, which have now been deferred by at least 18 months; thus, any major capacity expansion for these airlines will only come in after FY2012E, which will give a strong boost to LCC players like SpiceJet to expand

their market share and to maintain a high load factor. The major chunk of the growth in domestic fleet size in FY2011E and FY2012E will be added by the two LCCs, SpiceJet and IndiGo airlines, since these are the only companies that are going ahead with their orders and are expected to take delivery on time. around 8% in FY2012EMay 3, 2010 5 SpiceJet | Initiating Coverage Strong Passenger growth to resume for SpiceJet Currently, LCCs are the preferred mode for domestic airline travellers as, being cost-efficient, they can provide cheaper tickets. This would benefit LCCs such as SpiceJet, which can offer significantly lower fares to attract more value-conscious passengers. In fact, there has been a considerable shift in passenger traffic towards LCCs, with more than 55% passengers preferring them. This has even led to Full-Cost Carriers (FCCs) like Jet and Kingfisher to convert part of their capacity to a no-frills, low-cost model. SpiceJet is one of the fastest growing LCCs, and, given the change in preference from FCCs to LCCs, it is best placed to benefit from the economic recovery and the growing passenger traffic demand. Even when the Industry passenger traffic declined by 11% in FY2009, SpiceJet increased the number of passengers carried, from 4.5mn to 4.59mn in FY2009, due to its low-cost model. Moreover, the efficacy of the low-cost model was clearly noticeable, as Spicejet increased its market share by more than 50%, from 8% in FY2008 to around 12% in FY2009, with a corresponding increase of only 28% in fleet size in FY2009.

Source: DGCA, Angel Research Exhibit 5: Domestic airlines market share We expect SpiceJet's passenger growth to continue at the previous levels of around 50% CAGR and which will be supported by its fleet expansion plans. We expect the company to carry around 6.6mn passengers in FY2010E (a growth of ~44%), and expect this growth to continue to 7.9mn and 9.3mn passengers in FY2011E and FY2012E, respectively. around 12% in FY2009May 3, 2010 6 SpiceJet | Initiating Coverage Load Factors to improve due to lower capacity expansion With the demand coming back to normal after the economic recovery, and with only a few capacity additions (after the capacity rationalisation by FCCs in FY2009), all LCCs have currently reported strong Load Factors of around 80%+. SpiceJet has reported load factors to the tune of 82% and 81% for the months of January and February, 2010, respectively. Going forward, we expect the load factors to remain high, as the demand is expected to outpace the supply, with most companies (Jet Airways and Kingfisher) having deferred their orders, which will lead to a low growth rate in the ASKM and a higher growth in the RPKM (Revenue Performed Kilometres). We expect the domestic ASKM to remain constant for FY2010E at 59,160mn, as hardly any new fleets have been added during the year; for FY2012E, the ASKM is expected to be around 68,981mn. On the other hand, demand is expected to continue its robust growth; thus, the RPKM is expected to be around 42,606mn in FY2010E and to increase to 54,403mn in FY2012E. The overall domestic industry load factors are expected to be around 72% in FY2010E, 77% in FY2011E and 79% in FY2012E. Source: DGCA, Angel Research

Exhibit 7: ASKM to grow at a slower rate for the industry Domestic ASKM (LHS) Domestic RPKM (LHS) Load Factor (RHS) 0 10 20 30 40 50 60 70 80 90 0 10,000 20,000 30,000 40,000 50,000 60,000 70,000 80,000 FY00 FY01 FY02 FY03 FY04

FY05 FY06 FY07 FY08 FY09 FY10E FY11E FY12E Stagnant (km mn) (%) Source: Company, Angel Research Exhibit 6: SpiceJet to continue strong passenger growth Spicejet Pax Carried (LHS, mn) Domestic Pax Carried (LHS, mn) Domestic Growth (RHS, %) Spicejet Growth (RHS, %) 3.04 4.50 4.59 6.62 7.87 9.25 35.8 44.4 39.5 44.6 50.4 56.9

(20) 0 20 40 60 80 100 120 140 0 10 20 30 40 50 60 FY07 FY08 FY09 FY10E FY11E FY12E outpace the supplyMay 3, 2010 7 SpiceJet | Initiating Coverage Available Seat Kms(LHS, mn) KMS Performed(LHS, mn) Load Factor (RHS) 0 10 20 30 40 50

60 70 80 90 100 0 100 200 300 400 500 600 700 800 900 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09

Dec-09 Jan-10 Feb-10 (%) Source: DGCA Exhibit 8: SpiceJet registering strong load factors SpiceJet expected to outperform its peers We have conducted an analysis between the Financial Lease and the Operating Lease business models adopted by different airline companies, to find out which is best suited for the Indian aviation sector, and how the profitability of the companies is determined by the model that they adapt. Companies such as Kingfisher and Jet Airways, which use the financial lease mode where they own aircrafts, have shown weaker balance sheets, owing to a higher incidence of depreciation and interest costs, as compared to companies like SpiceJet, which follow the operating lease model, where, rather than buying the aircraft, they lease it for a fixed period of time. Full Cost Carriers v/s Low Cost Carriers - Jet Airways v/s SpiceJet SpiceJet is a no frills airline; thus, its ticket prices does not include any additional services, which helps the company reduce its average Pax yields. This is unlike Jet Airways, which provides food and beverage services, included in the cost of the ticket, and which results in higher Pax yields. SpiceJet operates the single-fleet type, Boeing 737 NG, which helps them to reduce their maintainance cost by 20% per seat. SpiceJet has the highest aircraft utilisation rate of 12 hours, which helps the company add one extra flight a day with a similar fixed cost, when compared to its peers. Additionally,

SpiceJet has a cost advantage over Jet Airways, as it has an average of 195 seats per aircraft, which is nearly 22% more when compared to an average of 160 seats/ aircraft for Jet Airways (Domestic). This difference in seats per aircrafts provides SpiceJet with an advantage over Jet Airways, since, with most of the costs are fixed per aircraft, these additional seats help SpiceJet in reducing its cost per aircraft by generating more revenue at the same cost. As a result of this, SpiceJet can reduce the average Pax yield without reducing its profitability margin. For 9MFY2010, The average Pax yield for SpiceJet is around Rs3,256, compared to a Pax yield of Rs4,706 for Jet Airways. It has been observed that when the Pax yield moves above Rs3,750, it results in a declining load factor. This is clearly visible in the case of SpiceJet (Pax yield of Rs3,256), which reported a 77% load factor, while Jet Airways (Pax yield of Rs3,750) managed to generate a comparatively lower load Factor of 71% for 9MFY2010. SpiceJet in reducing their cost per aircraftMay 3, 2010 8 SpiceJet | Initiating Coverage Due to its higher Pax yield, Jet Airways is able to generate a higher Revenue/ASKM of Rs4.3, compared to SpiceJet's Revenue/ASKM of only Rs2.4. However, on the EBITDA level, Jet Airways managed to generate only Rs0.4/ASKM, which was lower than SpiceJet's Rs0.5/ASKM, mainly because of higher operating costs. In percentage terms, Jet Airways reported an 8.8% margin, which is nearly half of SpiceJet's margin of 19%. However, Jet Airways (Domestic + International) registered a 77% load factor,

on the back of better performance from international operations (load factor of 80%). On the EBITDAR level, Jet Airways (Domestic + International) reported a margin of 18%. O

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