Stock Recommendation | InterGlobe Aviation - BUY - Target price : 950

Indigo's yields declined by a sharp 9.6% yoy and while 2Q is generally tepid, the extent of decline is worrying, particularly in the light of other cost pressures that the industry is reeling under. Management mentioned that (1) it is not Indigo's strategy to keep fares depressed, and airlines in financial distress are selling tickets cheap to generate high load factors and assured revenues, (2) competition in metro routes, and in the near-term booking window is particularly intense, and (3) Indigo believes that the current margin scenario is unsustainable, and hence is not toning down its future capacity addition plans.

Indigo has upped its capacity addition guidance to 35% yoy in 3QFY19 from 30% earlier, and is now looking to grow FY2019 capacity by 30%, implying 4QFY19 capacity growth would also be ~35% yoy. This increase is on the back of increased delivery momentum of A320neo aircraft, where most engine issues have been sorted. Given the negative margin scenario currently, capacity increase will be a drag on near-term earnings.

We now forecast a larger loss for FY2019 as we bake in weaker yields and higher capacities. We bake in 3-10% yield increases over FY2020-21 as we build in more rational fare pricing. Our view on margins remains unchanged - Indigo's 2QFY19 yield was the lowest ever reported by it in the past 19 quarters, suggesting that current fare situation is artificially low. There are already signs of at least one competitor reducing capacity by sub-leasing planes, and we believe more consolidation may follow. We revise down FY2020-21 EPS by 3-6%, which leads to a new TP of ₹950 (₹980 earlier).

2QFY19 results call: key highlights
▶ Yields. Yields remain depressed on account of forward selling of tickets at cheap fares by competition. Further, as Indigo seeks to add large capacities in the next two quarters, certain sectors may take time to mature, although they do not contribute much to overall capacity and yields. Metro routes, particularly routes such as Delhi-Mumbai remain extremely competitive as most carriers ply multiple flights in a day. Further, the near-term 15 day booking window is the real pain point, with relatively price inelastic business travelers being offered low fares. In fact, fares outside this window actually improved in 2QFY19. The proportion of tickets booked in the near-term window has also increased to 46% from 40% earlier, which has added to the yield pressure. Management mentioned that Indigo has never tried to keep fares artificially low, but it will continue to match fares with competitors in order to protect its share. The case in point was the fuel surcharge introduced in June 2018. Competitors did not follow suit and hence Indigo had to eventually roll it back. Company believes that core demand remains good and volumes would not change meaningfully even if fares went up 15-20% higher from current levels.
▶ Capacity. Capacity guidance has been increased as neo engine issues seem to be getting sorted. Indigo is now targeting 30% yoy capacity addition in FY2019, implying 35% yoy capacity addition in 2HFY19. Indigo has a fair amount of flexibility in timing its aircraft deliveries, and will assess fare trends over the next 2-3 quarters to firm up its FY2020 capacity addition. For the moment, it believes while high capacity addition can keep yields low, this will still be temporary and should even out over the medium term.
▶ Costs. In view of the high cost environment, Indigo is introducing new cost-saving initiatives such as more efficient landing processes and night operations. On a constant currency basis, Indigo's ex-fuel costs were up only 2.3% yoy.
▶ Network. Indigo is keen to add more short-haul international destinations - it added Dhaka in 2QFY19 and will add 6 new destinations (Hong Kong, Male, Abu Dhabi, Kuala Lumpur, Kuwait and Phuket) in 3QFY19. It will also take deliveries of its A321 aircraft in 3QFY19, which would add an additional hour of flying time and open up possibilities of adding more international destinations. Large-scale international strategy, while underway, is not something that is an immediate priority, and Indigo is yet to place orders for wide-bodied aircraft for the same.
▶ Fleet. Indigo added 20 new aircraft in 2QFY19, of which 17 were A320 aircraft and the remainder were ATRs. Indigo will take the delivery of its first A321 aircraft in 3QFY19, which will be used to fly to international destinations that may be farther off than destinations to which Indigo currently flies to.
▶ Infrastructure. Airport slots and parking bays should be analyzed together. Mumbai is clearly the airport that remains constrained. However, Delhi provides a lot of potential given it has large land available and further expansion is underway. Progress on other airports, particularly Tier-I airports is satisfactory, and overall capacity does not pose a hindrance to capacity growth.
▶ Balance sheet. Free cash as of September 2018 was ₹44 bn, and has declined from ₹71 bn as of March 2018. The key reason for the decline was the loss incurred in 2QFY19, opening up of LCs to take delivery of new aircraft which resulted in higher restricted cash allocation, as well as purchase of 3 ATR aircraft. Indigo would seek to limit aircraft purchases till profitability is restored. As most of the restricted cash is towards supplementary lease rent liability, Indigo is converting these deposits into US$- denominated deposits. This should reduce quarterly forex fluctuations going forward. Weak yields drive sharp FY2019 earnings cut
Continued weak momentum on yields and high input costs drive a sharp increase in our loss estimate to ₹16 bn in FY2019. We also bake in higher capacity addition in FY2019 - and in the current margin scenario this actually leads to incrementally higher losses.
We expect Indigo to revert to profits in FY2020 on the back of improved yields as well as fuel price reduction. This should drive margins (RASK-CASK) to more normalized levels.
Changes to FY2020-21 estimates are modest - we do bake in lower yields, though this gets offset by lower crude prices as we factor in the excise duty cut. Overall EPS still gets cut on account of lower other income due to higher losses in FY2019.

Definitions of ratings

BUY	-	We expect this stock to deliver more than 15% returns over the next 12 months.
ADD	-	We expect this stock to deliver 5-15% returns over the next 12 months.
REDUCE	-	We expect this stock to deliver -5-+5% returns over the next 12 months.
SELL	-	We expect this stock to deliver

Our target prices are also on a 12-month horizon basis.

Other definitions

Coverage view. The coverage view represents each analyst's overall fundamental outlook on the Sector. The coverage view will consist of one of the following designations: Attractive, Neutral, Cautious.

Other ratings/identifiers

NR	=	Not Rated. The investment rating and target price, if any, have been suspended temporarily. Such suspension is in compliance with applicable regulation(s) and/or Kotak Securities policies in circumstances when Kotak Securities or its affiliates is acting in an advisory capacity in a merger or strategic transaction involving this company and in certain other circumstances.
CS	=	Coverage Suspended. Kotak Securities has suspended coverage of this company.
NC	=	Not Covered. Kotak Securities does not cover this company.
RS	=	Rating Suspended. Kotak Securities Research has suspended the investment rating and price target, if any, for this stock, because there is not a sufficient fundamental basis for determining an investment rating or target. The previous investment rating and price target, if any, are no longer in effect for this stock and should not be relied upon.
NA	=	Not Available or Not Applicable. The information is not available for display or is not applicable.
NM	=	Not Meaningful. The information is not meaningful and is therefore excluded.

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