Will this sector be ever out of woods?

Fri, 21 Nov Pre-Open

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We at Equitymaster wouldn't touch aviation stocks with a bargepole. This sector just does not fit in the bill, due its poor fundamentals.

Even while the Indian aviation sector is witnessing reasonable volume growth, the domestic airlines continue to incur huge losses. Rising price war is a permanent matter for the aviation stocks. In fact, this has been one of the reasons for the airlines witnessing huge losses in their books.

Among the other things, problems plaguing the industry are high fuel costs (aviation turbine fuel - ATF), high cost of capital and steep taxes. Among all these, ATF costs take the largest chunk of its operating costs. Over and above that, currency depreciation too has impacted these carriers.

We came across an interesting article on Economic Times which states why India's aviation companies haven't been able to benefit from crude oil prices, which have plummeted sharply in last one month. When we compare this with the US-based airlines, the impact of falling crude oil prices is positive. But, the scenario for the Indian carriers is quite different - stocks of Indian airline companies move down (not up) when crude prices soften. That means, there is hardly any correlation between the crude prices and the stock prices of Indian aviation companies.

Challenges and steep losses accompanied by weak balance sheet have been the key characteristics of the Indian airline companies. While, the airlines have been adopting various cost control measures, very little development has been witnessed in the financial health of these companies.

More recently, SpiceJet's quarterly result came as shock. The company has reported losses, and now has negative net worth of Rs 14,597 million. Not only that even the company's auditors have raised concerns over such a performance of this airline. This indicates, the company's financial health is not sound and thus this airline might become financially unviable to continue its business operations. Also, we are aware of the errant ending of the King of good times

The government's step to allow FDI (Foreign direct investment) in the Indian airlines will be certainly quite beneficial since the FDI has paved the way for much-needed equity infusion into Indian airlines. These initiatives are likely to help airlines which are tiding over high costs and negative profits. The Jet Airways and Etihad deal, for instance, is expected to bring down the operating cost and subsequently cushion up profits.

However, there is other side of the coin too. Competition will also intensify with more FDI entering the Indian aviation sector, indicating increased price war.

In crux, we believe that Indian airlines still have a very long way to go. In order to restructure their debt heavy and loss making businesses various smart initiatives are required. Else days will not be far when most of our Indian carriers will go the the Kingfisher way.