Investment Report

On

Jet Airways (India) Ltd.

Submitted to: Dr. Ullas Rao Submitted by: Siddhartha Shankar Mishra (11050)
Somya Harsh (11171)

Background of Jet Airways

Jet Airways (India) Limited provides passenger and cargo air transportation services. The company also leases aircrafts. It operates flights to 76 destinations in India and internationally. As of June 20, 2012, the company operated a fleet of 103 aircrafts comprising 10 Boeing 777300 ER aircrafts, 12 Airbus A330-200 aircrafts, 61 next generation Boeing 737-700/800/900 aircrafts, and 20 modern ATR 72-500 turboprop aircrafts. Jet Airways (India) Limited was founded in 1993 and is based in Mumbai, India. Naresh Goyal, the founder Chairman of Jet Airways, Indias premier airline, has over 4 decades of experience in the Civil Aviation industry. Jet Airways acquired Sahara Airlines Limited in 2007.
Year 2004 2005 2006 2007 2008 2009 2010 2011 Jet Airways (in Rs. Crores) PBIT Total Liabilities ROIC 156.1 3796.16 0.041120501 582.12 5169.85 0.112599012 722.26 4312.07 0.167497281 51.36 8293.55 0.006192764 -412.58 16566.69 -0.02490419 -469.63 19741.92 -0.023788466 -467.55 17268.05 -0.027076016 46.63 16804.12 0.002774915 (Jet Airways (India) Limited, 2012)

Dividend History
Jet Airways (India) Ltd Industry :Transport Airlines Year End 201203 201103 201003 200903 200803 200703 200603 200503 200403 200303 200203 200103 Dividend 0 0 0 0 0 51.8 51.8 25.9 0 0 8.29 7.21 Dividend( Div %) Yield(%) 0 0 0 0 0 0 0 0 0 0 60 0.95 60 0.6 30 0.25 0 0 0 0 11.5 0 10 0 Dividend History

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Indian Aviation Industry

The Indian Aviation Industry has been going through a dark and depressive phase over the past several years and has been facing multiple obstacles like the rising oil prices and limited pricing power contributed by industry wide over capacity and periods of subdued demand growth. The Indian aviation sector was exposed to intense competition with the advent of a low-cost airline Air Deccan back in 2003. The success of Air Deccan spurred the entry of other LCCs like SpiceJet, Indigo, Go Air and subsequently low fare offerings from Jet airways and Kingfisher airlines. As a result, the sector which was completely dominated by full-service airlines till a decade ago is now dominated by low-cost airlines. However, longer term viability of LCCs models in India remains to be seen as airport charges are same for FSCs and LCCs in India.

ROIC
10.0% 5.0% 0.0% -5.0% -10.0% -15.0% 0.5% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 -0.9% -6.4% -9.7% -10.4% -11.5% -13.1% ROIC 4.0% 2.9% 3.4% 8.4%

While in the beginning of 2008-09, the sector was impacted by sharp rise in crude oil prices, it was the decline in passenger traffic growth which led to severe underperformance during H2, 2008-09 to H1 2009-10. The operating environment improved for a brief period in 2010-11 on back of recovery in passenger traffic, industry-wide capacity discipline and relatively stable fuel prices. However, elevated fuel prices over the last three quarters coupled with intense competition and unfavorable foreign exchange environment has again deteriorated the financial performance of airlines. Thus we can see that Pricing of Fuel is one of the most key considerations for the aviation industry and particularly in India. Besides these factors, intense Intra-competition has further deteriorated the profit margins of the domestic airline carriers. In our opinion, there are two key challenges: i) aviation economics is currently not favorable in India resulting in weak financial performance of airlines and ii) Internationally, too airlines are going through period of stress which could possibly dissuade their investment plans in newer markets. Besides, foreign carriers already enjoy significant market share of profitable international routes and have wide access to Indian market through code-sharing arrangements with domestic players. (CAPA, 2012)

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Growth Potential
Indian aviation industry promises huge growth potential due to large and growing middle class population, favourable demographics, rapid economic growth, higher disposable incomes, rising aspirations of the middle class, and overall low penetration levels (less than 3%). The industry has grown at a 16% CAGR in passenger traffic terms over the past decade. With advent of LCCs and resultant decline in yields, passenger traffic growth which averaged 13% in the first half has increased substantially to 19% CAGR during 2006-2011. Despite strong growth, air travel penetration in India remains among the lowest in the world. In fact, air travel penetration in India is less than half of that in China where people take 0.2 trips per person per year; indicating strong long term growth potential. A comparative statistic in United States, the worlds largest domestic aviation market stands at 2 trips per person per year. We expect passenger demand to remain stable and grow between 12-15% in the medium term, assuming a no major weakness in GDP growth going forward.

Earnings for airline carriers

Revenue based domestic revenues are largely INR denominated; Robust passenger traffic growth, but yields out of sync with cost structures due to intense competition, government support to national carrier and customer preference for LCC models. Airlines with international operations generate part of revenues in foreign currency; foreign carriers dominate in the longer haulage and premium service offerings. Other income based: Earnings from aircraft sub-leases (dry or wet) are mostly in $ terms, helps rationalize capacities. Low contributions from cargo and auxiliary revenue due to their modest adoption level Non-operating income: With capacity constraints at global aircraft manufacturers & rising commodity prices, market value of successful aircraft models often exceed book values making sale and lease back (conversion of Financial Lease to Operating Lease) an attractive option to book non-operating incomes, generate free cash flows and deleverage the balance sheet

The expenditure
ATF costs contributes 30-45% of overall operating costs for Full Service Carriers (FSCs) & 40-55% for Low cost carriers (LCCs) Domestic ATF prices are linked to fluctuation in crude oil prices and movement in INR vs. $ High central and state levies translates into a 60-70% higher. Most airlines follow an operating lease model for large part of their capacity; Lease rentals are also denominated in foreign currency thereby exposed to fluctuation in forex movement; Depreciation costs mainly for owned aircrafts (Financial Lease) significant rise in interest expenses due to deterioration in the capital structure, cash losses and increased working capital requirements besides overall rise in interest rates

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Hence, with combined impact of 1) moderating passenger growth 2) lower yields due to excessive competitive 3) rising ATF prices 4) steep rupee depreciation and 5) rising debt levels and interest costs, the profitability margins of the airlines industry have been severely impacted. The Global Airline industry is itself currently going through a tough phase (Bloomberg World Airline index down 22%, Asia-Pacific Airline index down 25% in last one year), due to below trend economic growth across advanced economies and high crude oil prices ($100-125/Barrel).

FCFF Valuation
We are using FCFF as a Fundamental method of valuation of Jet Airways, as it is evident from the companys dividend history above that they have not paid dividend since 2007. We are using here two-stage model, because there is upward change in growth pattern of the company after it acquired Air Sahara in 2006, followed by downward movement in the growth as Indian Airline industry suffered and now the companys growth seems to stagnate and its existence is in doubt, even though the competition, economic and government regulation scenario in the industry seems to ease up.

Firm Value=
Assumptions:

t 1

FCFFt FCFFn 1 1 + (1+WACC)t (WACC-g ) (1+WACC)n

(Damodaran)

Market risk premium 5.5% Risk free rate equivalent to Risk free bond 7.5% Beta in terminal stage assumed as 1, because the risk is assumed to converge with the market movement Growth at terminal stage is assumed to grow at the rate of Indian economy which risks possible degradation in credit rating by eminent credit agencies like S & P and Moodys The company is mostly fulfilling its obligations by debt.

Thus we initiate the two-stage FCFF model for valuation as follows:

Computation of FCFF - jet airways EBIT PBT Tax expense Effective tax rate NOPAT Net Capex Changes in working capital Working capital 2012 Working capital 2011 Reinvestments FCFF 1516.28 -1439.9 13.84 -0.96% 1530.85 142.8 -1553.58 -5567.31 -4013.73 -1410.78 2941.63

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FCFF = NOPAT Reinvestment WACC = (We * ke) + (Wd * kd)

Reinvestment = Net Capex Change in Working Capital Net Capex = Capex Depreciation NOPAT = EBIT (1-T) ; where T = Effective tax rate

Following is the concluding part of our two-stage FCFF valuation of Jet Airways
Year CY 1 2 3 4 5 6 7 8 9 TY NOPAT Reinvestments FCFF Disc WACC 2941.63 3106.137068 903.6226564 2202.514412 3279.843994 954.1566509 2325.687343 3463.265267 1007.516697 2455.74857 3656.944152 1063.860839 2593.083312 3861.454291 1123.355959 2738.098333 4077.401411 1186.17827 2891.223141 4305.42511 1252.513842 3052.911267 4546.200756 1322.559151 3223.641605 4800.441486 1396.521658 3403.919828 4901.25 TV 1029.2626 3871.98 67736.5072 Firm value (operating assets) Non-operating assets Total Assets less: Debt & Minority Interest Equity value No of shares Intrinsic value per share 44791.8655 574.29 45366.1555 12127 33239.1555 86 386.501 Disc FCFF 0.91093818 0.829808368 0.755904125 0.688581928 0.627255568 0.571391046 0.52050192 0.474145071 0.431916848 2006.35447 1929.874819 1856.310474 1785.550306 1717.487426 1652.019014 1589.046175 1528.473779 1470.210325

Result: the intrinsic value per share is 386.501 which is higher than the market price of around 350 in March 2012. This shows that the stock undervalued.

Risk Return Analysis

Systematic risk is due to the influence of external factor on an organisation. Such factors are normally uncontrollable from an organisation point of view. Investors can only reduce a portfolio's exposure to systematic risk by sacrificing returns. In case of Jet Airways stock there are following systematic risks: Price risk associated with this stock is higher Volatility for the stock is high Cost inflation risk due to increasing Air Traffic Fuel prices and fixed charges levied by airport authority

Unsystematic risk is due to the influence of internal factors prevailing within an organization. Unsystematic risk is a micro in nature as it affects only a particular organization. It can be planned, so that necessary actions can be taken by the organization to mitigate (reduce the effect of) the risk.

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In case of Jet Airways stock there are following unsystematic risks: Business or liquidity risk ( Jet Airways is literally struggling for liquidity) Financial or credit risk (Jet Airways is highly dependent on debt and its credit worthiness is regularly decreasing with possible degradation from its already low credit rating)

Jet Airways Mean Portfolio Return Standard Deviation Coefficient of Variance Rs. For 1 unit of risk

0.005284337 0.034648691 6.556866441 0.152511876

For systematic and Unsystematic risk Mean SD Beta Security var Systematic risk Unsystematic risk Jet Airways 0.005284337 0.034648691 1.3181 0.00120053 0.000147052 0.001053479 Market 0.0172 0.0092 1

Single Security Portfolio for Jet Airways Portfolio return 0.005284337 Systematic risk 0.000147052 Unsystematic risk 0.001053479 Portfolio variance 0.001200532 Portfolio risk 0.034648691

Result: Portfolio return is quite less compared to the risk associated with the portfolio. Beta for the company is very volatile, which signals instable stock price.

Why Relative Valuation is not much reasonable for Jet Airways?

Jet Airways didnt paid any dividend since 2008, and if we apply P/E ratio for the stock valuation, value becomes zero and we cant get any result, so I think Relative method of valuation for the Jet Airways stock is not applicable.( P/E ratio: Dividend paid/Earning per share)

Some Critical Observations

Promoter Holding:
A larger share of promoter holding indicates the confidence of people who run the company. We believe that a greater than 45% promoter holding indicates safety for retail investors. The promoter holding in Jet Airways stands at 80% as of now. We have assigned a risk rating of 2 to the stock on a scale of 1 to 10 and 10 being highest potent risk. Hence the Promoter holding looks promising.

Sales:
Jet Airways has posted consistent increase in sales from FY08 to FY12. The Company is expected to generate about 15% increase in sales amounting to Rs 17500 Cr. in FY13.On this basis, we would rate it 5 out of 10.

EPS:
The earnings per share is constantly worsening from -29.21 in FY08to -143.18 in FY12. This is a big alert for the company as it is not able to create shareholders value. On the Risk Scale, we would rate it 10 i.e. the maximum potent danger.

Current Ratio:
Jet airways average current ratio during the period FY08 to FY12 is estimated to be around 0.39 times, indicating the company's inability to pay up short-term obligations. A ratio under 1 suggests that the company is unable, at that point, to pay off its obligations if they came due. We assign a high-risk rating of 8 to the stock.

Debt to equity ratio:

A highly leveraged business is the first to get hit during times of economic downturn, as companies have to consistently pay interest costs, despite lower profitability. We believe that a debt to equity ratio of greater than 1 is a high-risk proposition. Jet airways debt to equity ratio has ridiculously gone from 4.57 in FY08 to 60.91 in FY12. It is beyond the scope of risk scale i.e. high potential for a financial collapse. These are the three Key ratios which are potentially dangerous for the stock in our view. The Company has posted a net loss of Rs. (996.70) million for the quarter ended September 30, 2012 as compared to net loss of Rs. (7136.00) million for the quarter ended September 30, 2011. Total Income has increased from Rs. 33320.70 million for the quarter ended September 30, 2011 to Rs. 41947.00 million for the quarter ended September 30, 2012.

Our Take:
When we talk of Jet airways, the stock is undervalued but it inherits a high level of risk and the profitability of the company itself is not encouraging as it has not paid any dividend in past 5 years. Besides, aviation economics still remain unfavourable in India due to intense competition, mandatory route dispersal guidelines, higher taxes on ATF and airport related charges. Seeing a low current ratio there could be a chance for long term investment, But Our advice would be better to wait for the deal to develop between Jet Airways and Ethihad, observe noticeable changes in company management, Revenues, government policy regarding ATF direct imports, OMCs monopoly and then invest at right time probably when the entire market corrects deeply. Foreign airlines are likely to be more cautious in their investment decisions and strategies are likely to be long drawn rather than focused on short-term valuations. Hence, though the government has allowed the FDI up to 49% in domestic carriers, the stake sale talk going right now around the streets seems to evaporate in near time. (IATA, 2012)

References
CAPA. (2012). Centre for Aviation. Retrieved from centreforaviation.com/analysis. Damodaran. (n.d.). Damodaran Book on Investment Valuation (2nd ed.). IATA. (2012, December 29). Hindu Business Line. Retrieved from http://www.thehindubusinessline.com/industry-and-economy/logistics/fdi-wont-come-toindian-aviation-till-high-costs-prevail-iata-chief/article4237882.ece. Jet Airways (India) Limited. (2012). Annual Report 2012. http://www.jetairways.com/doc/InvestorRelations/JAR_2012.pdf. www.capitaline.com. (n.d.). Capitaline Plus. Retrieved from www.capitaline.com. www.moneycontrol.com. (n.d.). moneycontrol.com. Retrieved from www.moneycontrol.com/india/stockpricequote/transport/jetairways/JA01.