Airline Industry Analysis

Submitted in Partial Fulfillment of the requirements of the course

Investment Management
Project to
Prof. K.N. Badhani
On
30th August 2014

By
GROUP 6 SECTION B
Dasi Prithvi Tej

PGP13019

Binita Kumari

PGP13081

Rakesh Krishna V

PGP13108

Shital Kumar

PGP13118

Rohith Votarikari

PGP13129

Post Graduate Diploma in Management

IIM Kashipur

MACROECONOMIC ANALYSIS
Macro-economic factors affecting the Airlines Industry are:

Recovery in the global economy As global economy is expected to recover

after 2014, growth of passenger traffic is expected because of increase in
foreign tourists as well as NRIs. As Indian airlines is concentrating more on short
haul routes as well as heavy traffic destinations such as Middle east and
Europe, it is expected to grow significantly and become more affordable.

Proposed development of tourist circuits like Sarnath-Gaya-Varanasi

Buddhist Cicuit and five other tourist circuits will help to boost airline traffic in
longer run.

Electronic Travel Authorization (e-Visa) at nine airports It will give a push to

foreign arrivals and boost airline traffic over the long term.

Investment in Airport Infrastructure Investment of close to Rs 310 Billion is

expected to flow into airport infrastructure between 2013-2014 to 2017-2018.
It will boost the airlines industry and improve the airport facilities.

Grant of flying rights to oversees destination An increase in flying rights

between New Delhi and Abu Dhabi to 36000 seats per week has been granted,
similar grants to high traffic international routes such as Middle East and Europe
will improve the air passenger traffic significantly.

High ATF costs, no control over the volatility Aviation Turbine Fuel(ATF)
prices are driven by the volatility in demand-supply of global crude oil. Rising
fuel costs forces to increase price of ticket which eventually leads in the decline
in airline traffic.

Higher sales tax in India In India, ATF prices are more because of higher
sales tax ranging from 4 to 30 per cent because of which fuel cost escalate
leading to operational inefficiencies.

Facing Inflation in operating costs, no comparable hike in prices aircraft

and other technical costs, employee costs, landing and parking charges at
airports have risen sharply, but prices are not increasing in a commensurate
manner leading to low RKPM and rising expense per ASKM for airline
companies. Increase in price leads to decrease in air traffic. Besides that,
airline companies have been regularly giving heavy discounts to attract
customers and fill their capacity; any such discount without the actual
increment in passenger traffic will lead to further narrowing the operating
margin.

Government allows FDI by Foreign carriers in Domestic Airlines for the

operators, FDI will provide the much needed funding for highly leveraged
carriers, while for consumers, opening airlines to foreign players will ensure
worlds best practices in terms of better flying experience and improved
technology and safety systems. However, lack of required infrastructure and
the depreciating rupee, will create hurdles to have any material impact on ATF
costs.

Exchange Rate operating costs for airline companies include ATF costs,
aircraft lease rental costs, staff costs, selling costs, and administrative costs
etc., close to 70 percent of these costs are linked with US Dollar. Hence,
fluctuations in exchange rate directly impact the operating costs of the
companies.

Acutely sensitive to global factors like wars, economic instability and

environmental regulations - the industry thrives on the growth in disposable
incomes of consumers; any economic downturn hit it badly. War or terrorism
has direct impact on this industry as can be seen from the decline in air traffic
after 9/11. Recent accidents of international airlines have also impacted the air
traffic.

INDUSTRY ANALYSIS
Evolution of the industry and present competitive landscape

1997-98 to 200203: Dormant

sector

2003-04 to 200506: Competition

intensifies

2006-07 to 200708: Deflating

revenues and
inflating costs

2011-12: Strong
growth in
domestic
passenger traffic

2009-10 to 201011: PLFs reach a

record high,
backed by robust
demand

2008-09: Jump in
fuel costs hit
airlines'
operating
margins

2012-13: The
year of the low
fare carriers

2013-14:
Operating
margins
plummet

2002-03: Moderately competitive landscape

In 2002-03, competition in the domestic airlines industry was low with 2 players dominating
the industry: Jet Airways and Indian airlines group (Air India, Alliance Air & Indian Airlines)
together had 88 per cent market share. Sahara airlines also operated at this time and had a
smaller share of the overall domestic market. The players did not undercut each other on
ticket prices to grab market share and concentrated on profitability.
2006-07: Competition intensifies:
Low-fare carriers forayed into the industry, beginning with the launch of Air Deccan in 200304. Subsequently, three more - Spice Jet, Go Air and Indigo - began operations between
2005-06 and 2006-07. Two full-service carriers - Kingfisher and Paramount - also entered the
market in 2005-06. Thus, the number of carriers in the domestic airlines industry trebled from
3 in 2002-03 to 9 in 2006-07. LFCs offered tickets at much lower prices as compared to FSCs
and hence, managed to capture 42 per cent of the domestic market share in 2006-07.

2007-08: Extremely competitive landscape:

With competition rising rapidly, the new entrants and incumbent players rapidly expanded
their fleet, in a bid to capture market share. The share of LFCs rose to 47 per cent in 2007-08
from 42 per cent in 2006-07. However, this expansion heavily eroded players profitability.
Costs incurred by airlines on ATF, manpower etc, rose sharply, but companies were unable to
hike fares due to intense competition. This led to pressure on realizations, and profit margins
of most airlines slid into the red. The industry's combined losses amounted to Rs. 49 billion in
2007-08. The capital structure of most airlines deteriorated, while some carriers faced a
liquidity crunch and had to raise further debt to meet capital expenditure requirements.
The consolidation phase:
Steadily increasing losses eroded the net-worth of airline companies, forcing financially. The
consolidation phase weak companies to sell out or merge with stronger companies. This led

to consolidation in the industry, wherein JetLite (Air Sahara) was acquired by Jet Airways,
while Kingfisher bought Air Deccan. The government decided to merge Indian Airlines with
Air India to form a new entity, National Aviation Company of India Limited (NACIL). The
move was taken due to the steadily mounting losses of Air India and Indian Airlines. As a
result of such consolidation, the market share of the top three players NACIL, Jet Airways
group and Kingfisher airlines rose to around 70 per cent at the end of 2008-09.
2009-10: Growing market share of LFCs:
LFCs such as Go Air, Indigo and SpiceJet continued to gain market share by expanding their
fleet. As a result, the share of the top three players (Jet Airways, Kingfisher and NACIL)
dropped to around 60 per cent in 2009-10. To sustain and expand their market share, Jet
Airways and Kingfisher introduced low-fare operations under the Jet Konnect and Kingfisher
Red brands, respectively. Jet Airways converted two-thirds of its seating capacity to Jet
Konnect by the end of the second half of 2009-10. Consequently, more airlines shifted to the
LFC model from the FSC model.
2010-11: PLFs touch record highs:
Entry of LFCs, higher household income, strong economic growth, surging tourist inflow,
increased air cargo movement, sustained business growth and supportive government policies
were major drivers for the growth in the domestic aviation industry in 2010-11. During the
year, PLFs reached record highs due to limited fleet addition and strong demand from
business and leisure travellers. Few efficient airlines with better operating cost structure and
financials turned profitable. The market share of the top three players (Jet Airways+ Jetlite ,
Kingfisher and Indigo) in the industry was about 61 per cent in 2010-11. PLFs increased to
77 per cent in 2010-11 from 72 per cent in 2009-10.
2012-13: Pricing Discipline post kingfisher exit:
The period saw a marked decrease in passenger traffic due to ongoing economic slowdown
and high air fares. Kingfisher exited domestic operations beginning in the 3rd quarter on
account of its financial woes, leading to about 13 per cent of total domestic capacity going
out of market. The remaining 6 players namely Indigo, Air India, Jet Airways, Jetlite, Spicejet
and Go air registered marginally better PLFs of 77 per cent and higher realizations post
kingfisher's exit. Indigo, Jet Group (Jet airways+ Jet Lite) and Spicejet together captured
close to 73 per cent of the domestic market.

2013-14: Deals and Discounts:

The year saw discounting on ticket prices during the peak seasons too. Overall, the both
international and domestic realizations declined during the year. Also, Abu Dhabi based
Etihad Airways bought 24 per cent minority stake in Jet Airways for Rs 20.6 billion during
the year. As a part of the deal, Jet also sold three of its flying slots at London's Heathrow
Airport for a sum of USD 70 million to Etihad.
The entry of AirAsia India, a three-way venture between the Malaysia-based low-cost airline,
the Tata Group and investment firm Telestra Tradeplace, in June 2014 is expected to further
increase pricing competition among existing LFCs. Another joint venture between Tata
Group and Singapore Airlines awaits operating permit which will further intensify the
competition in the industry.

Player wise RPKM

Porter Five Forces:

Threat of New Entrant low

Threat of Substitutes low

Bargaining Power of
Suppliers - High

High cost of buying and

leasing aircrafts, safety and
security measures,
customer service and
manpower
It is not easy get approvals
from DGCA

No perfect substitute for

International carriers
Domestic airlines can be
substituted by Cars, Buses
& Train

Airline supply is dominated

by Boeing and Airbus
Aviation fuel prices are not
under control

Bargaining Power of
Buyers - High
Low cost in switching
airlines
Low cost carrier flights

Competitors - High
No Brand loyalty among
patrons
Intense price competition
Low returns

Profitability:

Capital
Intensive
Stronger
influence of
External
Factors

Fuel Costs &

Higher sales
tax

Profitabili
ty
Longer
Recessions,
Shorter
Recoveries

Congestion

Inflating
Costs &
Deflating
Costs

Aggressive
Pricing
Strategy

Capital-intensive:
The airlines industry is capital-intensive, with high fixed costs for aircraft acquisition,
leasing and maintenance. The cost of maintaining aircrafts and complying with aviation
safety norms are high. Additional costs incurred on training pilots, technical support staff and
crew members are fixed as well. Moreover, the airlines industry has had to contend with
higher security and insurance charges since the September 11, 2001 terror attacks in the US.

Fuel costs & higher sales tax:

Fuel costs, the largest cost component for airlines, are beyond carriers' control and
considerably impact their operating margins. Aviation turbine fuel (ATF) prices are driven by
the volatility in demand-supply of global crude oil. Rising fuel costs would force carriers to
increase ticket prices. Increase in ticket prices can lead to dip in demand and subsequently,
decline in passenger load factors (PLFs) of the carriers.

ATF prices in India are expensive as compared to the rest of the world, owing to high local
sales taxes which ranges from 4-30 per cent. Consequently, airlines' fuel costs escalate,
leading to operational inefficiencies.
Congestion:
Congestion affects the turnaround time of aircrafts and reduces average aircraft utilisation
rates. This leads to wastage of fuel and inefficient use of aircrafts by airline companies.
Congestion can also cause inconvenience to passengers, as delays in flight take-offs will
unsettle their time schedules.
Aggressive price strategy:
Carriers often employ aggressive pricing strategies in order to capture higher market share
and sell tickets at below breakeven levels. This strategy reduces average yields and increases

competition, leading to losses for the entire industry as others will be forced to follow suit
and bring down their fares as well.
Inflating costs and deflating revenues:
For airlines globally, aircraft and other technical equipment costs, employee costs, landing
and parking charges at airports have risen significantly, with ticket prices not increasing in a
commensurate manner.

This has led to low revenues per passenger kilometre (RPKM) and rising expense per
available seats per kilometre (ASKM) for airline companies. Also, domestic airline
companies are unable to pass on increased costs because of severe competition in the
industry.
EBITDAR AND EBITDA margin

Longer recessions, shorter recoveries:

New airline carriers enter the industry during periods of high economic growth. These forays
lead to a price war among players, resulting in considerable losses for the whole industry. The
price war continues until weaker players move out of the industry or merge with financially
strong companies.
Strong influence of external factors:
The airlines industry is acutely sensitive to external events such as wars, economic instability,
government policies and environmental regulations. The industry's PLFs declined
significantly following events such as the 9/11 terror attacks in the US and the outbreak of the
SARS syndrome in South-East Asia. The industry thrives on growth in disposable incomes of
consumers and the economic downturn seen since 2008 has impacted the overall profit
margins of the industry on the whole.

Technical Analysis
The term technical analysis is a complicated sounding name for a very basic approach
to investing. Simply put, technical analysis is the study of prices, with charts being the
primary tool. The roots of modern-day technical analysis stem from the Dow Theory
developed around 1900 by Charles Dow. Stemming either directly or indirectly from the Dow
Theory, these roots include such principles as the trending nature of prices, prices discounting
all known information, confirmation and divergence, volume mirroring changes in price, and

support/resistance. And of course, the widely followed Dow Jones Industrial Average is a
direct offspring of the Dow Theory. Here we mostly used Support/Resistance, MACD,
SMAVG (50), SMAVG (100), and SMAVG (200).
Bar charts

A bar chart displays a security's open (if available), high, low, and closing prices. Bar
charts are the most popular type of security chart. As illustrated in the bar chart in below
figure, the top of each vertical bar represents the highest price that the security traded during
the period, and the bottom of the bar represents the lowest price that it traded. A closing tick
is displayed on the right side of the bar to designate the last price that the security traded. If
opening prices are available, they are signified by a tick on the left side of the bar.

Moving Averages

Moving averages are one of the oldest and most popular technical analysis tools. A
moving average is the average price of a security at a given time. When calculating a moving
average, you specify the time span to calculate the average price (e.g., 25 days). A simple
moving average is calculated by adding the security's prices for the most recent n time
periods and then dividing by n. For example, adding the closing prices of a security for most
recent 25 days and then dividing by 25. The result is the security's average price over the last
25 days. This calculation is done for each period in the chart. Note that a moving average
cannot be calculated until you have n time periods of data. For example, you cannot display a
25-day moving average until the 25th day in a chart.

The classic interpretation of a moving average is to use it to observe changes in

prices. Investors typically buy when a security's price rises above its moving average and sell
when the price falls below its moving average.

MACD

The MACD is calculated by subtracting a 26-day moving average of a security's price

from a 12-day moving average of its price. The result is an indicator that oscillates above and
below zero. When the MACD is above zero, it means the 12-day moving average is higher
than the 26-day moving average. This is bullish as it shows that current expectations (i.e., the
12-day moving average) are more bullish than previous expectations (i.e., the 26-day
average). This implies a bullish, or upward, shift in the supply/demand lines. When the
MACD falls below zero, it means that the 12-day moving average is less than the 26-day
moving average, implying a bearish shift in the supply/demand lines. A 9-day moving
average of the MACD (not of the security's price) is usually plotted on top of the MACD
indicator. This line is referred to as the "signal" line. The signal line anticipates the
convergence of the two moving averages (i.e., the movement of the MACD toward the zero
line). The MACD is the difference between two moving averages of price. When the shorter
term moving average rises above the longer-term moving average (i.e., the MACD rises
above zero), it means that investor expectations are becoming more bullish (i.e., there has
been an upward shift in the supply/demand lines). By plotting a 9-day moving average of the
MACD, we can see the changing of expectations (i.e., the shifting of the supply/demand
lines) as they occur.

Company wise Technical Analysis

MACD
Global Vectra

Currently MACD goes on decreasing that is moving from positive to

negative side and it also running below the signal line, it shows the
condition of bearish and to sell out the stock.
Whereas, somewhere on February 14 and May 17 MACD moving from
negative to positive and running above the signal line , it shows the
condition of bullish and to buy.

Jet Airways

Here on July 15 signal line cross over is negative, though the difference
between MACD and signal line is very less, it shows the beginning of
bear market and suggest to sell out the stock.
Whereas, in September and April the difference between MACD and
signal line is very high and positive, which shows a condition of bullish
market and suggest to buy stock.

Jagson Airlines

Here also showing a condition of bear market, because the MACD is

moving from positive to negative and the gap between MACD and signal
line is also negative, so it suggests to sell out the stock
The arrow represents the upward and downward pressure on the stocks at
specific period.

Kingfisher Airline

Again it shows a condition of bearish market, because the gap between

MACD and signal line is negative.
In September the signal line cross over is very high and positive, so it
shows a condition of bullish market.

The arrow represents the upward and downward pressure on the stocks
at specific period.

Spice jet Airways

Here also after June 15 the MACD continually goes on decreasing and
showing negative signal line cross over, this indicates bearish market.

Support & Resistance

Global Vectra

Here prices are running somewhere around 50, which shows that there
is no trend.
Since past one year it doesnt come across the support zone i.e.
oversold territory. Whereas,
Somewhere during Feb, May and June, it was running under overbought
territory i.e. resistance Zone.

Jet Airways

Price are moving below 50 which means that stock losses are greater
than gain.
During April it was running under overbought zone, whereas for
sometimes in December and February it was running under oversold
zone.

Jagson airline

Here Prices are running much lower than 50 which means that stock losses
are much more greater than gain, it can be considered as bearish market
and suggest to sell the stock.

Kingfisher Airline

Here also price is moving much more below than 50 and showing a
condition of bearish market which suggests selling out the stock. During
February and March it was continuously running under oversold territory.

Spice Jet Airline

However prices are running below 50, but it started moving upwards with
expecting to increase in prices over a period of time.

Company Valuations:
SpiceJet
Valuing Airlines industry is difficult as operating profits itself are negative.
We have tried to value company Spicejet using discounted cash flow method
FCFF and used following assumptions

Assumptions of Valuation:
Currently Spicejet is in growth phase as we have observed it still makes
significant amount of Capital expenditure and also expanding its fleet
every year.
Terminal growth for Spicejet is assumed after 10 years.
High Growth phase for Spicejet is considered for coming 5 years after
which transition period is considered from year 6 to year 10.
Stable growth rate rate is assumed at 5% which would be on par with GDP
rate.
Instead of assuming overall growth rate in EBIT we have assumed
component wise growth rates as EBIT is negative for SpiceJet.
Beta in the stable growth phase will tend to one.
WACC is equal to return on Capital in stable growth phase.
Tax rate for the company is assumed to be zero due to previous years
high net operating loss

Values considered in Valuation:

Risk Free Rate
Indian Equity risk
Premium
Beta
Cost of Debt
Cost of Equity
Perpetual growth rate

8.50%
7.00%
1.83
10%
21.3%
5%

Individual Component Growth Assumptions for coming 10 years:

Year
1
2
3
4
5
6
7
8
9
10

Growth Rate in
Revenue
27%
25%
22%
20%
15%
15%
12%
12%
8%
6%

EBITDA/Reve
nue
-6%
-4%
-3%
-1%
0%
1%
2%
3%
4%
5%

Growth Rate in
Capital Spending
-50%
-50%
-50%
-20%
-20%
-10%
-10%
5%
5%
5%

Growth Rate in
Depreciation
15%
15%
15%
15%
10%
10%
10%
5%
5%
5%

EBIT Calculation with consideration of past Net operating Losses (NOL):

Year

Revenues

EBITDA

Depreciation

EBIT

71128.6106

4267.716636

960.7675

-5228.484136

88910.76325

-3556.43053

1104.882625

-4661.313155

108471.1312

1270.615019

-4524.748954

130165.3574

3254.133935
1301.653574

1461.207272

-2762.860846

5
6

149690.161
172143.6852

0
1721.436852

1607.327999
1768.060799

-1607.327999
-46.623947

192800.9274

3856.018548

1944.866878

1911.151669

215937.0387

6478.11116

2042.110222

4436.000938

233212.0018

9328.48007

2144.215733

7184.264337

Terminal Year

247204.7219

12360.23609

2251.42652

10108.80957

-3922.235
-1961.1175

960.7675
1104.882625

10875.35221
355.643053

Expected free cash flows to the firm

1
-5228.484136
2
-4661.313155

3
4
5
6
7
8

-4524.748954
-2762.860846
-1607.327999
-46.623947
1911.151669
4436.000938

7184.264337

10

10108.80957

-980.55875
-784.447
-627.5576
-564.80184
-508.321656
533.7377388
560.4246257
-588.445857

1270.615019
1461.207272
1607.327999
1768.060799
1944.866878
2042.110222

391.2073583
433.8845247
390.4960722
449.070483
413.1448444
462.7222257

2144.215733

345.4992619

2251.42652

279.8544021

7
1.5
19.00%
58.27%
13.76%

8
1.3
17.60%
58.27%
13.17%

Current Cost of Capital Calculation:

Total Debt in
2013
Market
Capitalization
Debt to Capital
Equity to
Capital
WACC

18022
12908
0.582672048
0.417327952
14.72%

Cost of Capital calculation with changing D/E

Year
Beta
cost of equity
Debt Ratio
cost of capital

1 to 5
1.83
21.31%
58.27%
14.72%

6
1.6
19.70%
58.27%
14.05%

Reinvestment rate in Stable Growth phase and Terminal value:

Return on capital at
perpetuity
Reinvestment rate in
stable growth
Terminal Value

12.30%
0.406504065
113299.2117

PV Calculation using FCFF

Year
s
FCF
F

Ter
min

10

1906
5.30
385

5873
.191
083

4625
.900
043

2519
.985
099

1018
.053
672

707.
5645
286

293
4.55
205

548
1.65
12

842
2.5
56

114
91.
94
113
299

al
FCF
F
PV
Calc
ulati
on

.2

1325
1.62
024

3431
5.30
265

4536
3.33
003

5683
0.13
745

6792
0.25
41

7893
6.15
501

8931
7.60
558

986
69.5
401

106
184.
337

111
127
.7

Final Share Price

PV of Equity
Outstanding Shares
Market Value when
valuation is done
Value of each share
Recommendation

5530.271537
535
18.2
10.33695614
Sell

Current price of SpiceJet is Rs. 12.80 so our Sell recommendation

is correct.

Relative Valuations
We have used Price/Sales multiple to relatively value all the companies. The
relative valuation results are as follows:
Company

Sales

Shares
outstan
ding

Jet Airway

176166.4

113.59

Jagson
Airways
Kingfisher
Global
Vectra
Spicejet

Sales/Sh
ares
outstan
ding
1550.897
086

20.168
5013.828

808.72

3301.26

14

63042.33

535

6.199708
181
235.8042
857
117.8361
308

Sales
Multipl
e

Relativ
e Price

0.16129
9
0.16129
9
0.16129
9
0.16129
9
0.16129
9

250.158
148

1.00000
673
38.0349
953
19.0068
5

Mark
et
Pric
e
254.
05
3.21
2.9
33.0
5
18.2

Note: Couldnt find the Sales of Jagson Airlines for the year 2013-14

Relative valuation shows that JetAirways and Kingfisher are overvalued and
Global Vectra and SpiceJet are undervalued in the industry when valued with
Sales Multiple.

Glossary
ASKM Available seats Kilometre
RPKM Revenue Passenger Kilometre
PLF Passenger Load Factor
ATF Aviation Turbine Fuel
LFC Low Fare Carriers
DGCA Director General of Civil Aviation