Markets
Drop in oil price may act as a tailwind for IndiGo
Summary
- Sustained lower crude price and better ticket prices will mean improved spreads.
Brent crude oil price has hit a fresh calendar year low of $71 a barrel, down by about 16% so far in Q2FY25 as against the Q1FY25 average. Predicting crude price is generally hard even when current news reports range from the slowdown in China to tensions in the Gulf region. Still, if the crude drop sustains, it could mean a bonanza for InterGlobe Aviation Ltd that runs the IndiGo airline.
Aviation turbine fuel (ATF), a crude oil derivative, has eaten into about 40-50% of IndiGo’s revenue earned from ticket sales over the last three financial years to FY24. A drop in the ATF cost flows directly to Ebitda. While companies consuming crude oil-based derivatives in other sectors might have to pass on the benefit of lower raw material price to their customers, there is no such pressure on IndiGo owing to the virtual duopoly in the Indian aviation market.
IndiGo and Tata group dominate the country’s skies with their respective domestic market shares at 62% and 28.8% in July, as per Directorate General of Civil Aviation. So, others such as SpiceJet Ltd and Akasa Air are much smaller.
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A relevant question here is whether the Street is factoring the lower crude oil price bonanza into their estimates? Jefferies India’s latest report shows that their estimates are conservative. Currently, the broking firm is assuming an ATF price of ₹100 per litre for FY25-FY27 versus around ₹104 per litre in FY24. However, even before the sudden drop in crude price over the last few days, ATF price in September is at about ₹95 per litre, according to Indian Oil Corp. Ltd’s website. ATF prices generally move in tandem with crude price with about a month’s lag between the crude oil price movement and the subsequent adjustment in ATF price. As such, each rupee fall per litre from Jefferies’ assumed ₹100 per litre would mean a bump-up of about ₹270 crore and ₹300 crore to their profit before tax projections for FY25 and FY26 of ₹7,600 crore and ₹8,300 crore, respectively.
Jefferies analysts expect 13% CAGR in number of passengers and passenger revenue over the three years to FY27 without any change in ticket prices. But if the analysts have not factored likely gains from the business class service launched with Delhi-Mumbai route in the first tranche, proposed to be extended to 12 routes by December 2025, there could be further uptick to the unchanged ticket prices expectations.
Collectively, sustained lower crude price and better ticket prices will mean improved spreads. In the June quarter (Q1FY25), IndiGo’s spread stood at ₹0.8 per seat kilometre. Spread is revenue per available seat kilometre (ASK) minus cost per ASK.
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Investors who don’t view IndiGo as a proxy play on crude oil price will have to take a call on valuation. Bloomberg consensus estimates show that the stock is trading at a price-to-earnings multiple of 22 times based on FY25 estimated earnings. But there is no comparable domestic peer to evaluate whether this is high or low.
Alternatively, Delta Airlines, the world’s largest aviation company by market capitalization, quotes at a price-to-earnings multiple of six times. However, it must be noted that Delta operates in a saturated market compared to IndiGo, which is present in the fast-growing Indian aviation market.
As such, IndiGo is well positioned to cater to the rising demand by increasing the ASK capacity to 200 billion by FY27 from 139 billion at FY24-end, according to Jefferies. Though IndiGo has weathered the aircraft engine snag issues well in the past, investors would hope that there are no faults in its aircraft fleet dominated by Airbus like the ones experienced with Boeing.
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