Pie In The Sky: Indigo set to be biggest beneficiary of duopoly in the sector

• Strong yields and high PLF coupled with lower crude prices to drive Indigo’s earnings surprise in Q1FY24.
  
  
• Despite a 40% run up in the stock price, analysts believe stock is trading below fair value.
  
  
• Airline building its fleet to take its international mix to 40% from the current 23% by the end of the decade.

The stars are aligning for India’s largest airline Interglobe Aviation. The airline is expected to clock its best ever earnings in Q1FY24 since FY18, as its passenger load factor, yields and available seat kilometers have all shown healthy growth sequentially. With GoFirst opting to go to the bankruptcy court earlier this year, Indigo has been a clear beneficiary of capacity shrinking in the sector. Not surprising that the stock is up 40% since March this year, despite the overhang of Rakesh Gangwal looking to dilute his stake in the airline through block deals.


With GoFirst stopping operations, the aviation sector is also looking at a duopoly situation as is the case almost in the telecom sector. Interglobe’s market share stood at 57.5% in April. With a dominant market share and financial heft, the airline is better equipped than most to survive a little bit of turbulence in the air. With crude oil prices correcting, InterGlobe Aviation’s financial Q1 performance will get a further boost.


According to analysts at UBS, Indigo’s yields are now higher by 30-40% than pre-COVID, as demand has reached similar levels (FY20). A consistently strong passenger load factor despite high ticket prices points to rising consumer appetite for flying, underscoring the sector's structural growth. The brokerage is forecasting a post tax profit that is well ahead of consensus estimates. Given its strong prospects, UBS does not see significant risks from the potential sale of the Gangwal stake.


The optimism is not misplaced as India is expected to emerge as the world’s second largest aviation market. Currently it is the third largest domestic civil aviation market after China and the US. With its latest order of 500 aircraft placed with Airbus, Indigo is prepping for a future that is not just restricted to Indian skies. IndiGo placed an order for 500 Airbus A320 family aircraft. This order is not only IndiGo’s largest order, but is the largest-ever single aircraft purchase by any airline with Airbus.


Analysts say that the key strength of Indigo’s management has been its fleet management and cost-efficient operations since its very inception. Aviation experts believe that the airline has acted well in advance before it was hit by a capacity crunch. This move will also help with the cash flows, as benefits will flow in from the purchase of new aircraft. Not only will a younger fleet improve costs and efficiency, but it will also keep maintenance costs low.

What the analysts are saying

According to sector watchers, the airline is trading below fair valuations despite the run up in the stock recently. UBS values IndiGo at 11x FY25E EV/EBITDA, in line with its average since listing eight years ago. The stock trades at 9x FY25 EV/EBITDA, at a 22% discount to the average despite a record financial performance and significantly improved industry structure.

According to ICICI Securities, “IndiGo’s consistent approach to aircraft management has given it rich dividend by continuously being able to sustain cycles in terms of lowest cost structure and cash accretion. Maintain ‘BUY’ on InterGlobe Aviation with an unchanged target price of Rs3,000, based on 25x FY25E EPS of Rs120.”


Indigo’s previous order of 480 aircraft deliveries will be complete by 2030 and the latest order of 500 aircraft will make its ties with Airbus even stronger. The airline is also looking at expanding its footprint outside India. It has plans to increase its international mix to 30% over the next two years and 40% by this decade from 23% in FY23.


While this is the upside potential of the stock, there are risks too as there are in any business. Some of the risks facing the airline’s management include managing cost and fleet expansion in the midst of a global engine crisis, says ICICI Securities.The latest order will be delivered between 2030 and 2035. The airline will choose engines for this order over a period of time. IndiGo’s order book comprises a mix of A320NEO, A321NEO and A321XLR aircraft.