The Jet Airways (Jet) stock gained 7 per cent after the company announced a stake sale to UAE-based Etihad Airways last week. Though the stock is up 75 per cent in the last six months, investors may hold on to it, given the likely boost to Jet’s earnings and cash flows from this deal.

However, fresh exposures need not be taken as the run-up in its share price, possibility of offer-for-sale to increase public shareholder stake, and uncertainty in Jet’s international business warrant caution.

At its current price of Rs 612, assuming that proceeds from Etihad are used to pay off debt, Jet’s enterprise value will be around 6.5 times its FY-13 operating profit (annualising 9 month EBIDTA till December 2012). This is in the range of what airlines in the Asia region currently command (6-8.5 times).

Big deal

Last week, Jet Airways entered into a landmark 24 per cent stake sale deal with Etihad Airways for Rs 2,060 crore. Also, Etihad which has already paid Jet $70 million (around Rs 380 crore) for purchase of three slots at London’s Heathrow airport will invest an additional $150 million (around Rs 800 crore) for majority equity stake in Jet’s frequent flyer programme.

Taken together, if all goes well and approvals come through, Jet would have received from Etihad nearly Rs 3,250 crore over the next few months.

Among the several positives for Jet from this deal, balance sheet repair by being able to repay a part of the huge Rs 12,000 crore debt will be the main one. If the entire proceeds from Etihad are used to pay off debt, which entails interest of 6 per cent on average, Jet could save nearly Rs 195 crore on interest cost annually. Around a fifth of the annual interest outgo in FY-12, this saving will add to the earnings of Jet’s shareholders and offset the expansion in the equity base. It will reduce the company’s standalone debt-to-equity ratio from 11 times to 3 times.

Possible access to low cost debt from Etihad, cost savings on aircraft maintenance and purchases of equipment and fuel may also help Jet’s earnings. Jet will also see a rise in its international traffic to and from UAE, thanks to the recent three-fold increase in seat allocation between India and Abu Dhabi.

A stronger balance sheet should also help Jet hold its own against competition in the domestic aviation market which is expected to grow well, notwithstanding the recent slump.

Concerns

On the flipside, there is a risk that Jet may end up becoming a feeder airline to Etihad’s Abu Dhabi airport, with fewer long haul flights to the US and Europe. Also, debt, while pared, will still remain high at around Rs 8,650 crore.

Jet’s debt-equity ratio on a consolidated basis, will remain above comfort levels (around 5 times) since the net worth of subsidiary JetLite is negative.

Public investors will not get to enjoy the 31.5 per cent premium being paid by Etihad to Jet for the stake buy.

The need for an open offer by Etihad to public shareholders has been circumvented by restricting the acquirer’s holding to 24 per cent — below the 25 per cent threshold which triggers such offers.

Also, reports suggest that before the deal with Etihad is completed (which may take some months), the promoters of Jet Airways may sell a part of their current 80 per cent holding to the public through the offer-for-sale route.

This may be done to comply with SEBI’s norm of 25 per cent public shareholding before June end.

Currently, public shareholding in Jet is 20 per cent. If Etihad’s stake of 24 per cent is considered to be part of the public shareholding and the deal is closed before June end, then total public shareholding will be in excess of 25 per cent and there may not be a need to issue more shares to the public.

But with uncertainty on the timeline for deal closure and the regulator’s position on categorisation of Etihad’s stake unclear, an offer for sale by Jet’s promoters in favour of the public may be in the offing.

Such a sale, if it happens at a discount to market price, could see the price of the Jet stock weakening.

Improving performance

Independent of the Etihad deal, Jet has improved its performance in the first nine months of FY-13 after a disastrous FY-12 when consolidated losses touched Rs 1,420 crore.

The airline has reduced its debt from Rs 13,100 crore as on March 2012 to around Rs 12,000 crore as on December 2012.

Also, improved yields due to the exit of Kingfisher Airlines, cost-control measures such as replacing costlier expatriate pilots with Indian ones, route rationalisation, and sale and leaseback of aircraft has helped Jet improve performance.

It registered standalone profit of Rs 85 crore for the December quarter and Rs 10 crore for the nine month period. This was despite domestic passenger traffic in India slowing in recent times. Most of Jet’s international routes are now profitable.

A cooling off in fuel prices, if it sustains, will aid Jet’s performance, and add to the benefits from the Etihad deal.

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