Is Indigo's Negative Networth the Main Concern?

In this issue:
» Rajan criticizes IMF
»  Valuations of startup firms up by 167%
»  ...and more!

00:00		Chart of the day

It would be difficult to miss the story surrounding Indigo and its negative networth making rounds in business dailies today. For those who have no clue what we are talking about, it seems that the company's promoters have been receiving flak for paying out a dividend that has turned the company's networth negative for the quarter ended June 2015. Three months prior, the company's networth was positive. As such, it paid out more than what it earned in the quarter. And that just before the IPO hits the market!

From what we have gathered, the promoters are of the view that the company will keep its business model lean and thus will not need much cash. Indigo's low operating costs (through its standardisation and leasing model), young fleet (allowing it to have fuel cost efficiencies), and minimal ancillary costs differentiate it from its peers.

In fact, Indigo is one of the lowest cost airlines in the world. Through different measures (such as entering into contracts with original equipment manufacturers), it has been able to keep its costs low and show profits. In short, its capital requirements remain low.

But then...that raises the question: Why raise capital in the first place?

Well...turns out that about 60% of the issue size is an offer for sale. That is, the promoters are putting their shares on the block. Only the balance of 40% will be utilised internally.

So Indigo has some clear strong points in its favour but also raises some red flags.

But...should investors concern themselves with these aspects? Perhaps it would be better to look at the bigger picture in this case...

Yes, the opportunity in the aviation industry remains massive. But the sector's worldwide historical performance has been weak. Strong headwinds - regulatory hurdles coupled with volatile fuel prices as well as high competition and its effect on pricing power - have kept industry players from truly flourishing over time.

With these factors holding true in India as well, investors would do well to consider the big picture rather than worry about these relatively trivial controversies before investing in this sector.

The following chart puts this in perspective...

Aviation industry: one tough sector
As you can see, the return ratios of the two large aviation players have been anything but decent ('L' indicates latest year, 'L-1' indicates one year before latest, and so on).

Please note that we are not saying that Indigo's performance will necessarily resemble that of its peers. After all, it has proved to standout from the crowd.

But the fact is that certain industries have relatively dull economics compared to others. And investors would do well to keep this in mind, particularly in the case of aviation.

What should investors be more worried about - the controversy surrounding Indigo's promoters or the poor dynamics of the aviation industry? Let us know your comments or share your views in the Equitymaster Club.

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02:40

Time and again, we have praised the Reserve Bank of India and Raghuram Rajan in particular. For good reasons too. The RBI is a model central bank in many ways. It has a long track record of standing up to political pressure.

Governor Rajan has earned praise the world over for his inflation fighting credentials. We take comfort in the fact that he calls out risks in his public statements along with the opportunities. Thus, it came as no surprise to us that he chided his former employer, the IMF.

The International Monetary Fund is not supposed to be a cheerleader for global central banks. Sadly, it has not been critical of the easy money policies of developed world. As per Rajan, the least that the IMF can do is to question the success of these policies.

We are thankful that India has such folks heading key institutions. As a former chief economist at the IMF, Rajan is perfectly entitled to question its stance. There is almost no one to question the long-term damage that such easy money policies may cause.

Those who are skeptical of Rajan's comments need to only remember the last time he called out the risks facing the global economy. In 2005, he had warned of the same dangers and was proved right in 2008. He may well be right again.

03:50

Valuations in India's e-commerce space have clearly reached bubble territory. We have heard of all kinds of start-ups raising big money from venture capitalists (VCs). But the e-commerce firms are head and shoulders above them all. As per an article in the Business Standard, the valuations of these firms have increased by 167% over the last five years! To put things in perspective, this is the same as a listed stock's P/E ratio rising from 10 to 26.7. And e-commerce firms aren't even making profits yet. Venture capitalists are no fools. They have invested in these firms with the expectations that growth will lead to profitability. The VCs would obviously look to exit at that stage. However, things haven't turned out that way yet. These firms are nowhere near the breakeven points. And if their recent advertising blitz that we have seen is anything to go by, profits may be a distant dream.

04:40

In the meanwhile, Indian stock markets continued to trade near the dotted line after opening the day on a flat note. At the time of writing, the BSE-Sensex was trading up by around 55 points (+0.2%). Gains were led by power and auto stocks. Mid and smallcap stocks were trading firm as well, with their respective indices trading higher by about 0.6% and 0.7% respectively at the time of writing.

04:50

Today's investing mantra

"Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks." - Warren Buffett