IndiGo Airlines: Sell

Airline karma — that Vijay Mallya blamed for the fall of Kingfisher Airlines and Jet Airways — seems to have come to haunt IndiGo Airlines too. Just when the airline seemed set to make the most of Jet’s demise, there is danger that the no-holds barred public feud between the promoters Rakesh Gangwal and Rahul Bhatia could throw a spanner in its works.

In the near term, it may be business-as-usual for IndiGo. But the company’s medium to long-term decision-making, strategic direction, and execution of ambitious expansion plans run the risk of being impaired by the wrestling at the top. The Rakesh Gangwal group holds 36.68 per cent in the airline while the Rahul Bhatia group with 38.26 per cent owns a tad more; the rest is held by public shareholders.

Bitter infighting

Going by the contents and the tone of the public exchanges between the promoters, the chances of reconciliation between the warring parties appear remote. That the promoters are not on the same page was known for some months now. But the scale of the discord and the extent of the bitterness revealed by the documents submitted to the bourses last week take the crisis to another level.

In particular, allegations of violation of corporate governance norms and irregularities in related party transactions levelled by Rakesh Gangwal against Rahul Bhatia could get the company ensnared with SEBI and the Centre. The management, while it has put on a brave face, could also get singed. Reports say that SEBI is probing whether the management misled shareholders by downplaying the extent of the differences between the promoters. Also, the possibility of a purge within the ranks cannot be ruled out.

In his letter to SEBI and others including the Prime Minister’s Office, Rakesh Gangwal says, “We are grateful to all the whistle blowers who had the courage and wisdom to send information that allowed for this pursuit of almost a year. Without that information it may not have been possible to uncover some of the specifics and facts that formed the basis for the EGM requisition.”

Despite its only marginally higher shareholding than the Rakesh Gangwal group, the Rahul Bhatia group calls the shots in the appointment of the top brass and in the day-to-day operations of IndiGo. This is thanks to a shareholder agreement between Gangwal and Bhatia, and the company’s Articles of Association. The Bhatia group is unlikely to take kindly to what it will perceive as Gangwal’s moles within the organisation.

Not surprisingly, the market reacted with dismay to these unprecedented developments — the IndiGo stock lost more than 13 per cent last week. It is difficult to foresee how this bitter internecine feud will pan out. But a long-drawn war of attrition between the promoters could be on the cards; this will impact both tactical operations and long-term strategy at the airline, and could weigh down the stock. Besides, there are other concerns, including volatile fuel prices and major capacity infusion in the sector that could hurt pricing power. Weak market conditions don’t help too. Investors may be better off selling their IndiGo stock and booking profits.

Other risks lurk

Despite the hit last week, the IndiGo stock is up nearly 90 per cent since last October. At ₹1,356, the stock trades at 22 times one-year forward earnings, higher than the three-year average of about 18 times. The strong rally in the IndiGo stock since late last year coincided with the rapid descent of Jet Airways that culminated in the airline suspending operations in April.

Jet’s loss has indeed been a gain for rival airlines — especially IndiGo and SpiceJet. From prized airports slots to trained employees, Jet’s valuable assets were up for grabs and the competition moved in for the kill.

The removal of major capacity — Jet was the second largest airline in the domestic skies — also gave rival airlines the much-needed pricing power, a rare commodity in the brutally competitive Indian aviation market. This and a shift in passenger traffic from Jet saw rival airlines make a strong comeback in the March 2019 quarter, after a dismal show in the prior three quarters.

In a seasonally weak March quarter, IndiGo’s profit jumped five-fold Y-o-Y to ₹590 crore. It helped that fuel prices were relatively benign. The market is optimistic that IndiGo’s earnings in FY 2020 and beyond will grow strongly.

The airline’s domestic market share has risen to more than 49 per cent and is set to rise further with aggressive fleet expansion plans. Not just in the domestic skies, IndiGo is also pressing the throttle on international routes, moving in to occupy the space vacated by Jet.

But risks lurk. One, oil prices have turned volatile due to the US-Iran standoff; this could translate into a jump in fuel cost for airlines. It is moot whether Indian carriers, including IndiGo, will be able to continue passing on higher costs to the very price-conscious Indian flier. Already, domestic passenger traffic growth has slowed to lower single-digits in the five months ended May 2019 from double-digit growth in earlier years.

It does not help that the economy is not doing well and there is a perceptible slowdown across major swathes; this is likely to tell on air passenger traffic growth too. Besides, most airlines, including IndiGo, are on an expansion spree. IndiGo plans to increase its capacity by 30 per cent and SpiceJet is thinking of scaling up its capacity by 80 per cent in FY 2020.

These capacity additions will more than make up for the removal of Jet’s capacity. The mix of rising costs and unbridled capacity expansion that restricts fare increases has hurt many airlines in the past. A repeat cannot be ruled out.

It needs bearing that SpiceJet, though a distant second in domestic market share (15 per cent), is a formidable competitor and has lined up major domestic and international expansion plans. The allocation of many of Jet’s slots to SpiceJet had been a sore point with IndiGo and other Indian carriers. In the fight between IndiGo’s cats, the SpiceJet monkey might just walk away with the cake.