Jet Airways Q1 FY 2012-2013 analysis – prudent cost cutting leading to profits

When Mumbai based full service carrier Jet Airways reported a Rs. 33.3 Crore net pre-tax profit in the first quarter of fiscal year 2012-2013, it represented a resounding statement that the Indian airline industry may have finally found its footing.

Photo copyright Devesh Agarwal.

Having slipped to net losses in each quarter last year due to the near constant rise in fuel prices, insufficient control of other operating costs, and poor capacity discipline, Jet Airways swung to a profit due to increased profits from sale-leaseback of aircraft, stronger unit revenues thanks to increased capacity discipline in the market, and a boost from cutting underperforming international routes.

Digging into some of the specific trends for the quarter, (relatively) low fuel prices were certainly a huge factor in the quarterly improvement. Versus the fourth quarter of FY 2011-2012, the overall fuel bill increased just 7.9% against a 1.5% increase in available seat kilometers (ASKs), yielding a 6.3% rise in unit fuel costs (the more important measure in the aviation industry). This may seem like a big jump, but it is in fact very tame given that Jet over the past 4 quarters has been routinely recording jumps of between 12-17% in that very same metric. Year over year, fuel cost per ASK did jump more than 20%, but this increase was more than offset by Jet’s superb revenue performance; the first time Jet has achieved such growth during my entire tenure here at Bangalore Aviation.

For the quarter, Jet recorded an incredible 16.66% growth in unit revenue Revenue per Available Seat Kilometre, or RASK), despite 10.4% growth in ASKs and a whopping 29% increase in passengers carried to 4.82 million (both figures year over year). The RASK growth was particularly good on the international front, where Jet achieved an absolutely incredible 30.0% growth in unit revenues despite 7.8% growth in ASKs.

This growth was buoyed in part by the first part of Jet’s international capacity cuts taking place. During the quarter, Mumbai-Riyadh (1 of 2 daily frequencies), Trivandrum-Sharjah, Delhi-Colombo, Mumbai-Johannesburg, Chennai-Dubai, and Chennai-Kuala Lampur were all cut. These routes were all poor performers (especially Mumbai-Johannesburg), and pulling this capacity has definitely yielded benefits to Jet.

It is equally clear that Jet, along with all other Indian airlines, has benefited immensely from Kingfisher’s demise and the resultant capacity reduction. The environment also offered Jet an additional benefit from Kingfisher’s withdrawal from the long distance international market. IndiGo and SpiceJet are operating only on shorter distance routes to the Gulf, SAARC, and ASEAN markets. Air India’s long distance international operations were virtually closed, thanks to the pilot’s strike; and the benefits flowed to Jet’s London, Hong Kong, and Bangkok routes.

Of course the proverbial “elephant in the room” when considering this quarter’s results is in fact the growing sale leaseback income recorded by Jet. For the quarter sale-leaseback income recorded was Rs. 128.46 Crores, of course an integral part in Jet’s overall net profit. It is true to some degree that this sale-leaseback income masked Jet’s true performance in the quarter, but it should not overshadow the very real progress made. Jet broke even on an operating cost basis both domestically and internationally, and this is ultimately the most important metric. Furthermore, it is important to ask; why does it matter that Jet used sale-leaseback so shrewdly?

India’s largest domestic airline, IndiGo, has been using this strategy for several years now to increase cash on hand and lower operating costs by leveraging faster payments to obtain better discounts from vendors including airports. One could even make an argument that IndiGo has artificially lowered its fares by using sale-leaseback revenue to fund operations. Why should Jet be derided for taking advantage of the same? Jet meanwhile has built a fleet of more than 100 aircraft without using sale-leaseback excessively, but it has slowly caught on, and you should expect most of Jet’s narrowbody fleet growth and even non-leased widebody deliveries to occur with sale and lease-back.

Looking forward for Jet, the second quarter results should continue to be strong as the airlines have tempered capacity growth and Kingfisher continues to slide. On the downside, SpiceJet’s new Q400 operation in Delhi and the growing maturity of their other regional operations will put downwards pressure on domestic yields. Internationally, Jet will get positive yield growth as the second half of their cuts (including Brussels-New York) start to really kick in.

On the revenue side, Jet is re-configuring its Boeing 777-300ER (77W) fleet to increase economy class seating from 274 to 310. From a comfortable 9-abreast 3-3-3 18.5″ width, Jet is mimicking Emirates and Etihad to go 10 abreast in a cramped 3-4-3 17″ width seating. Jet’s 77Ws are primarily deployed on Jet’s London Heathrow routes, where Emirates flies Airbus A380 super-jumbos equipped with far more comfortable 19″ width seats in economy class.

The deployment of these re-configured aircraft will commence in 15 day intervals starting from October 16, in time for the winter rush traffic. It remains to be seen if passengers continue to pay the premium fares commanded by Jet on its London flights, for this cramped seating.

Right now, Jet Airways stock is trading roughly in the 370s, and the long term play looks relatively attractive. Assuming that the airline continues to leverage sale-leaseback shrewdly, earnings potential looks good over the next few quarters. While the current price to earnings (P/E) ratio is relatively high, it is important to note that Jet’s share price is more than 56% off its November 2010 peak. Especially if the airline can return to paying dividends (which it would in the case of sustained profits), Jet Airways stock looks like a smart long term buy.

About Vinay Bhaskara

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