Breaking Up the Indigo Q1 Results

Indigo Airlines, part of the Interglobe Group, announced its quarter results for the June quarter on 31st July. While it is well known that the Indian aviation industry is growing at the rate of 25% per annum (Source: Annual Report of Indigo), the results of Indigo for the first quarter did come as a pleasant surprise. Over the last few months, the Indigo stock had been under pressure due to two fundamental reasons. Firstly, the price of crude had gone up in the aftermath of the OPEC production quotas late last year. These quotas had been implemented effective January 2017 and had its impact of boost oil prices in the first quarter. Secondly, tight competition among the key players in the Indian aviation industry ensured that prices were under pressure resulting in added stress on the margins of the airline companies. As a result, despite the 40% market share that Indigo enjoyed in the domestic aviation market, its profit number had come under pressure. Things definitely appeared to have improved for Indigo in the June quarter; at least that is what it appears till now.

Interesting shifts in the operating metrics of Indigo Airlines…

There has been a sharp improvement in the operating metrics of Indigo in the first quarter. The Average Seat Kilometres (ASK) for Indigo Airlines in the first quarter has gone up by 18.7% to 15.1 billion. The ASK is calculated by the total number of seats in all its flights multiplied by the total number of kilometres travelled. This is a proxy for the capacity creation by the airline as well as efficiency of operation. By reducing turnaround time, covering more routes and by increasing the number of planes; the ASK can be expanded.

On the revenues front, indigo saw a 25.6% growth in revenues in the quarter at Rs.5956 crore. This increase in revenues is normally a function of the ASK, as explained above and the pricing. Considering that the revenue growth has been better than the growth in ASK means that the airline has not taken any further hit on the pricing front. The revenue basket is likely to improve further as Indigo looks to further expand its network and also cover smaller towns under the UDAN scheme of the government of India.

Finally, we come to the costs and the profitability of the airline in the current quarter. The cost per average seat kilometre (CASK) was almost flat, which is a positive factor. However, if you were to exclude the impact of fuel then the CASK has actually gone down. But the bigger factor to evaluate is the spread between the RASK and the CASK. The RASK at Rs.3.82 and the CASK at Rs.3.08 gives a clear margin of Rs.0.74 for the airline. This spread has improved sharply from a level of Rs.0.58 in the first quarter of last year. Even on a sequential basis, the spread between the RASK and the CASK has shown a marked improvement. Even on sharply higher revenues, the airline has been able to report a small improvement in the EBITDA margin at 34.1%.

Beyond the operating margin; how interest savings got into the picture…

While it is true that Indigo Airlines benefited due to better operational metrics, there is a bigger story below the operating profits and that comes in the form of lower interest burden. During the last year, the company used some of its IPO proceeds to reduce its debt. As a result the debt burden of the company came down from Rs.3200 crore to Rs.2600 crore. As a result of this debt reduction, the financing cost of Indigo Airlines has fallen sharply by 34% to Rs.770 crore.

This debt burden of Indigo needs to be understood in a slightly broader perspective. For example, Jet Airways has a debt burden in excess of Rs.15,000 crore and Air India has a debt of over Rs.40,000 crore. From that standpoint, Indigo with a market share of 40% in the domestic aviation market has the lowest debt/market share ratio among the aviation companies. This gives Indigo tremendous leverage as it looks to a massive expansion of fleet in the coming quarters.

What are the challenges ahead for Indigo?

There is no gainsaying the fact that Indigo has managed its cash flows very effectively. However, the big challenges will come from oil prices. Currently, crude oil prices are below the $50/bbl mark as crude oil from Nigeria, Libya and the US is flooding the global oil market. If OPEC and Russia were to give a further thrust to prices with cuts in oil supply then we could see oil prices moving up further from here. That is something Indigo needs to be watchful about. Remember, aviation turbine fuel (ATF) comprises over 40% of the operating costs for Indigo and all other airlines.

The second challenge is how the competition pans out. Jet, Spice Jet, Go Air and Air India are aggressively planning to expand their fleet. They may look to adopt a loss-leader strategy to garner further market share and that will put pressure on the top-line of Indigo. However, for the time being Indigo appears to have got its formula for managing top-line and bottom-line bang on target. The next few quarters could be interesting for the aviation space!