Rising crude oil prices may cap fare hike benefit for airlines
May make an impact only if airline capacity remains capped as demand is muted
The revision in air fare price band by up to 30 per cent is a move optically in the right direction, analysts said, but will not benefit airlines much amid steadily rising oil prices. The proposal, they believe, will make a meaningful impact only if the capacity remains capped amid plateaued passenger growth.
On Thursday, the Ministry of Civil Aviation revised the fare price band on flights with 90 to 120 minutes of duration to ~3,900, up from ~3,500 earlier. The cap on maximum chargeable fare has been raised to ~13,000 from ~10,000. However, the cap on airline capacity, currently at 80 per cent of the pre-covid level, has been extended till March 31.
“The recent price hike would only be beneficial if the airlines continue to operate at 80 per cent capacity. An increase towards 90 or 100 per cent airline capacity would again add pressure to the fares as demand remains muted along. Also, we are in the fourth quarter of the financial year, which is a seasonally weaker quarter,” says an analyst at a domestic brokerage who didn’t wish to be identified.
ICICI Securities, in a report on February 12, noted the hike in lower and upper fare caps while keeping the capacity limit of 80 per cent can be a near-term support considering the overall fare weakness. “But, it also points to the excess supply-demand mismatch even within the operational capacity. With international travel likely to remain suspended, complete capacity utilisation of Indian airlines may have to wait for some time,” it said.
Spicejet is operating at 72 per cent of pre-covid schedule, and Indigo is aiming to operate at 75-80 per cent capacity of Q4FY20. The erstwhile international capacity (nearly 25 per cent mix for Indigo/spicejet), however, remains grounded. “We understand this extension of floor and caps has happened on the back of lobbying by smaller/weaker airlines so as to prevent Indigo from taking its capacity deployment to 100 per cent and taking more market share as there is the concern of pressure on fares due to further capacity
deployment,” says Ashish Shah, research analyst at Centrum Broking.
Cost and revenue conundrum
Weekly average daily fliers stood at 248,000 in the week ended February 6, against 242,000 for the week ended January 30. Moreover, the average number of departures per day increased only marginally to 2,215 in the week ended February 6 vis-à-vis 2,211 in the week ended Jan 30. Amid this, a hike in air fare may dent traffic revival further, fear analysts.
“Considering that the majority of traffic continues to be of visiting friends or relatives (VFR) category, where price elasticity is relatively high compared to corporate traffic, the fare hike could also lead to lower demand. As alternate travel modes become more viable with the mitigation of Covid impact, airfare hikes can reroute some marginal travellers back to road/rail. Government support could have been more effective through aviation turbine fuel tax cut, albeit provisional,” said analysts at ICICI Securities in a report.
India had fixed a cap on air fares in May 2020 when Brent crude oil was hovering around $29 per barrel mark. This, however, jumped 107 per cent to $60 per barrel mark in February 2021. In comparison, the hike in air fares is up to 30 per cent, which, analysts say, will only partially off-set the increased input costs.
Investment strategy
Analysts remain divided on how to approach the listed players in this sector. While some suggest most positives are priced-in and the recent hike in air fare may not significantly impact the earnings, others remain bullish from a long-term perspective.
G Chokkalingam, founder and chief investment officer at Equinomics Research, notes that the pandemic has shrunk balance sheets of airlines with debt levels rising gradually. Moreover, oil prices, he says, may move higher going ahead and recommends investors cash out, especially in Indigo. That said, Shah of Centrum Broking maintains ‘Add’ on Indigo as he believes that even as this extension of capacity cap disrupts Indigo’s plans of reaching 100 per cent of domestic capacity deployment by March, it provides support to overall fare levels in the industry.
Shares of aviation firms — Interglobe Aviation and Spicejet — took off at the bourses on Friday, cheering the government’s decision.
The Reserve Bank of India (RBI) will introduce new 40year benchmark bonds next Thursday, it said in a notification on its website. The 40-year securities are the highest-tenured bonds issued by the government.
It was first introduced on October 26, 2015, and the government raised ~1 trillion from it. After that, another set of 40year bonds was issued on May 6, 2019, and ~83,462 was raised. However, in 2020, two 40-year bonds were issued – one on April 30 and another on August 31. The bonds have been used to borrow ~2 trillion from the market. The reason why the second bond came in quick succession to the first was because the first one had hit nearly the ~1-trillion borrowing mark. The government issued another set of papers to ease the redemption pressure.
The new bonds will be used to raise ~7,000 crore, and be part of a ~31,000-crore borrowing programme to be done using four securities. The central bank will decide whether to retain an additional ~2,000 crore in each security, it said in its statement.
Therefore, in this fiscal year, the government will be issuing three 40-year bonds – in line with its three 10-year benchmark bonds’ issuance.
The 40-year bonds are illiquid in the market. On Friday, only 18 trades happened in this segment for a total of ~245 crore. The most traded was a bond maturing in 2035, with 513 transactions for a value of ~5,495 crore.
The reason why the longest-tenure bonds are illiquid is because they are bought by insurance companies and pension funds, who hardly trade in the secondary market. Banks that buy these bonds keep them in the heldto-maturity (HTM) basket so that they don’t have to incur mark-to-market losses.
According to a senior bond dealer, the longer-tenure security is a better option in an oversupply condition because long-term investors crowd in to participate in auctions.
These ultra-long-term bonds are not popular with banks or other investors as they cannot be traded in the market later on. However, that would mean pushing payment liabilities way down the years, which increases burden for the government in the distant future.
Another measure pursued by the government is to convert short-term securities into longer-tenure bonds. In this, the government bunches up short-term securities in favour of a few long-term ones instead. According to schedule, this conversion was to take place every third Monday. However, according to a notification of the RBI, the next switch auction will not happen. The 40-year bond issuance announcement came after that.