Low Fuel Prices Propel Aviation Stocks Skywards

Indian aviation stocks— InterGlobe Aviation Ltd (IndiGo airlines), Jet Airways (India) Ltd and SpiceJet Ltd have been flying high this year, rising in the range of 56-98%, with SpiceJet leading the race.

The jump in airline shares is on the back of comforting factors such as a favourable exchange rate (strong rupee), strong growth in domestic air traffic and soft crude oil prices.

The most crucial variable among them is easily the crude price given the huge impact it can have on profitability. To be sure, the returns that these stocks have delivered so far are lower since 28 September 2016 when Opec (Organization of the Petroleum Exporting Countries) first announced it will cut output. Aviation stocks had declined during the December quarter, as pricing pressures and demonetization weighed on the sector.

“There were concerns that crude will start rallying from January onwards helped by Opec’s efforts to balance the oil markets but those have abated now,” said an analyst requesting not to be named. Aviation industry demand supply dynamics are expected to be favourable for this financial year. Load factors are healthy too. In fact, if crude prices remains benign and chances are they will, these firms may well report improved year-on-year profits this year.

In financial year 2016, despite an unfavourable demand-supply scenario, the industry retained three-fourths of the fuel cost savings, pointed out Joseph George of IIFL Institutional Equities in a report on 28 June.

The brokerage expects a similar scenario to play out in financial year 2018. IIFL’s current assumptions are based on crude price of $50 and for FY18 it estimates IndiGo’s pre-exceptional earnings per share (EPS) to increase 24% year-on-year while that of Jet’s to decline 4.4%.

It goes without saying that if crude prices average lower, then airlines will stand to gain more.

If we assume $45 (crude price) for the whole of FY18 and 60% benefit retention, it would result in 15-20% upside to EPS estimates for IndiGo and 40-50% upside to estimates for Jet, said IIFL in the report.

However, an average of $45 a barrel for this year may be an optimistic scenario. Brent crude oil prices are forecast to average $51 a barrel in 2017 and $52 a barrel in 2018, according to the US Energy Information Administration’s latest Short-Term Energy Outlook. All said, while aviation stocks have rallied remarkably, further appreciation will depend on how low crude prices can drop further, which is unlikely to be a lot. In any case, the sharp increase in shares already—the IndiGo stock touched a 52-week high on Friday—suggests much of the optimism is priced in.

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