Aviation - Sector Initiation - Strong Bounce Back in Air Passenger Traffic - the Key Catalyst - Reliance Securities

Key Sectoral Tailwinds:

- Air passenger traffic is expected to clock 30% CAGR over the next 5 years
- Expected strong rebound in air passenger traffic in 2HFY22E post pandemic - the single biggest catalyst over near term
- Low penetration and changing preference for travel are the key boosters
- Rising affordability, focus on comfort and increasing tourism to fuel demand
- Increasing market share of Low-Cost Carriers (LCCs) and better cost control to drive margin

Key Highlights:

Indian domestic aviation sector - which clocked 18% CAGR over FY14-19 - was impacted in FY20 and FY21 due to COVID-19 pandemic. Looking ahead, we expect overall air passenger traffic to record a phenomenal 30% CAGR over FY21-FY26E, due to low base and expected strong revival. Air passenger traffic growth has a strong co-relation with GDP growth with a 1.5x multiplier. With GDP growth expected at ~7% over a long-run, the aviation industry is expected to record double-digit growth of 12-13% over the next decade. We expect the industry to stage strong bounce-back in the post pandemic scenario on lower base.

Therefore, we expect air passenger traffic to record 64% growth in FY22E followed by 76% and 9% growth in FY23E and FY24E, respectively.

Average air fare/km, which fell by 11% over FY14-FY20, resulted in decline in average air fare - as a percentage of per capita - declining from 5.5% to 3% over FY14-FY20 leading to better affordability.

Considering reducing differential between rail fare and air fare, massive shift from rail to air travel expected over next decade. This would also lead to steady improvement in pricing power.

Over FY06-FY21, the LCCs gained market share by 24 percentage points (accounting for 85% of domestic aviation market in FY21), which supported increase in PLF of industry.

Higher PLF and control on cost would expand operating margin of the aviation companies. Other cost control parameters like increasing block hours, reducing ownership cost/ASK by increasing owned aircrafts and introduction of new aircraft with more seats per aircraft and ~10-15% better fuel efficiency would drive their profitability.

ESG Analysis: Analyzing InterGlobe Aviation (INDIGO) and SpiceJet (SJET) on 20 key criteria under ESG Matrix, we have assigned an overall score of 68% and 62% to INDIGO and SJET, respectively. Under "Environmental Head", we have assigned 54%/54% score to INDIGO/SJET, as they emit radiation and consume conventional fuel, which pose a great danger to the environment. Under "Social Head", we have assigned 73%/60% score to INDIGO/SJET. Under "Governance Head", we have assigned 77%/73% score to INDIGO/SJET (please refer to page no. 5 for detailed ESG analysis).

Initiate Coverage on Aviation Sector with POSITIVE View

Considering strong revival from pandemic, rapidly increasing airfare (yield), likely healthy double-digit traffic growth for aviation sector over the next 5 years, margin expansion from current level, rising international base of Indian airline companies and valuation comfort, we initiate coverage on aviation sector with a positive view. We initiate coverage on INDIGO and SJET with BUY and 2-Year Target Price of Rs2,750 and Rs105, respectively. We prefer INDIGO, as it is the dominant player with the lowest cost/ASK in the industry and enjoys >50% market share currently. The stock currently trades at attractive valuation of 6.1x EV/EBITDAR FY24E.

Link to the report

Source : Equity Bulls

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