August 18, 2010 Kingfisher Airlines (DECAVI)content.icicidirect.com/mailimages/ICICIdirect...…but...

August 18, 2010

ICICIdirect.com | Equity Research

Initiating Coverage

Not out of the woods yet… High leverage, low profitability and a potential market share loss make Kingfisher Airlines (KAL) a laggard in our coverage universe in the domestic aviation sector. We believe that KAL, with a market share of 21.1% (Q1FY11), will find it tough to maintain its share in the highly price-sensitive domestic market due to strong competition from low fare carriers (LFCs). In our view, the bottomline will continue to remain under pressure, despite KAL being expected to generate positive operational results for the first time in FY12E, primarily due to the high debt on its balance sheet. We are initiating coverage on the stock with a REDUCE rating and a price target of Rs 52.

Market share loss due to strong competition

With the expected revival of domestic pax traffic in FY10-12E (14.1% CAGR vs. -11.1% in FY09) and KAL’s increased focus on budget travel (~65% of capacity shifted to low-cost service, Kingfisher Red), we expect robust growth of revenues in FY10-12E to Rs 7,162 crore (18.9% CAGR vs. -3.3% YoY in FY10) and higher load factor (77.3% in FY12E vs. 71.8% in FY10). However, we believe that KAL will lose market share (20.5% in Q4FY12E vs. 21.1% in Q1FY11E) due to strong competition from the market leader, Jet Airways (~70% of capacity shifted to its low cost service) and aggressive fleet expansion plans by LFCs.

Bottomline to remain under pressure

KAL is expected to generate positive operating results for the first time in FY12E (EBITDA margin of 2.3%) on the back of higher revenues and load factor. However, we expect the balance sheet to remain stretched due to the high leverage and difficulty faced by the management to infuse fresh capital, resulting in continued pressure on the bottomline (negative EPS of Rs 15 in FY12E vs. negative EPS of Rs 62 in FY10).

Valuations

At the CMP of Rs 55, the stock is trading at 1.3x FY12E EV/sales. The stock has underperformed the Sensex (by 22.8% YTD) due to its continued operational losses and failure by the management to infuse fresh capital. Although the management is expected to raise capital worth ~Rs 446 crore (US$100 million) in Q2FY11E, it falls short of the company’s short-term payment obligation (~Rs 2,700 crore at the end of Q1FY11). Accordingly, we value KAL at 1.25x Y12E EV/sales, at the adjusted mean of its Asian peers. We initiate coverage on the stock with a REDUCE rating, deriving a target price of Rs 52 (downside risk of 5.5%).

Exhibit 1: Financial summary FY08# FY09 FY10 FY11E FY12E

Operating Revenues 1,441.4 5,239.0 5,067.9 6,422.8 7,162.3EBITDA -724.1 -1,806.7 -899.4 -194.6 152.3Net Profit -200.2 -2,151.8 -1,647.2 -1,093.8 -571.1Diluted EPS (Rs) -13.7 -58.0 -44.4 -23.0 -12.0P/E (x) -3.5 -0.6 -0.8 -1.7 -3.3Price / Book (x) 3.8 -0.5 -0.3 -0.4 -0.3Price/sales (x) 0.0 0.0 0.0 0.0 0.0EV/EBITDA (x) -2.8 -3.9 -9.7 -44.5 56.9

Source: Company, ICICIdirect.com Research, # - FY08 data is for the period of 9months (1 July 2007-31 March 2008).

Kingfisher Airlines (DECAVI) Rs 55

Rating Matrix Rating : Reduce

Target : Rs 52

Target Period : 12 months

Potential Upside : -5.5%

YoY Growth (%)

FY09 FY10 FY11E FY12EOperating Revenues 263.5 -3.3 26.7 11.5EBITDA -149.5 50.2 78.4 178.3Net Profit -974.6 23.4 33.6 47.8EPS -448.8 23.4 52.3 47.8 Stock Metrics Bloomberg/Reuters Code KAIR:IN /KING.BOSensex 18,220Average volumes 586,142.7Market cap (Rs crore) 1,36952 week H/L 65.8/39.6Equity Capital (Rs crore) 266Promoters Stake (%) 66.3FII Holding (%) 5.1DII Holding (%) 5.1

Share price movement

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Apr-1

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3000

3500

4000

4500

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KFA (LHS) NIFTY (RHS)

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FY09 FY10 FY11E FY12ETarget PE -0.6 -0.8 -1.6 -3.1EV/EBITDA -3.8 -9.6 -43.9 56.2EV/Sales 1.3 1.7 1.3 1.2Price/BV -0.5 -0.3 -0.3 -0.3

Analyst’s name Rashesh Shah [email protected]

Kingfisher Airlines (DECAVI)


Company Background Kingfisher Airlines Ltd (KAL), formerly known as Deccan Aviation Ltd, is the second-largest full service carrier (FSC) in India with a domestic market share of 21.1% in Q1FY11. KAL began operation as a privately-held company in June 1995 and subsequently got listed in January 2005. The company strengthened its domestic position by acquiring Air Deccan (rechristened Kingfisher Red) in May 2008. As on June 2010, KAL operated 66 aircraft (39 Airbus and 27 ATRs) to 68 destinations (including eight international destinations). Of the total fleet, ~61 aircraft were dedicated to domestic operations (2,500 flights per week) while the remaining were dedicated to international operations (200 flights per week). The company began its international operation in September 2008 and currently provides services to destinations including South-East Asia (Singapore), Saarc (Bangkok, Colombo, Dhaka and Kathmandu) and the GCC region (Dubai). In FY10, international operations accounted for 12.1% of total revenues (18.8% in Q1FY11). During FY10, KAL’s revenues declined by 3.3% to Rs 5,068 crore due to lower yields (Rs 4.8 vs. Rs 5.2 in FY09) and high base effect (revenue contribution from newly acquired LFC, Air Deccan in FY09). During FY07-10, KAL’s revenues grew strongly at 46.2% CAGR driven by strong growth in domestic pax traffic (average annual growth of 17.4%) fuelled by robust economic growth (average annual GDP growth rate of 8.5%) and improved income levels (GDP per capita grew by 5% CAGR). In June 2007, United Breweries Holdings Ltd (UBHL), the promoter company of KAL, which holds 60.6% stake in the carrier, entered the low-fare air travel market by acquiring a 26% stake in Deccan Aviation Ltd (operator of Air Deccan). The deal was valued at Rs 546 crore (Rs 155 per share, which was at a premium of ~10% to the market price of Deccan Aviation). Further, UBHL acquired an additional 20% stake in Deccan Aviation at an investment of Rs 420 crore (an open offer to acquire 27,094,024 equity shares of Deccan Aviation at a price of Rs 155 per share) in August 2007. Finally, UBHL merged its holding company KAL with Deccan Aviation on June 2008 after acquiring another 3% stake in the latter. The merger was a share-swap deal where KAL’s shareholders were allotted three fully-paid equity shares (Rs 10 per share each) of the new entity for every seven equity shares (Rs 10 per share each) held in KAL. During FY09, the scheduled air transport services of the new entity (which included the commercial airline division of erstwhile KAL and scheduled air transport services of Deccan Aviation Ltd) was demerged into a separate company, which retained the name Kingfisher Airline Ltd (KAL) while non-scheduled services of erstwhile KAL were transferred to another company, Kingfisher Training and Aviation Services Ltd (KTASL).



Exhibit 2: Pre-merger analysis

(year ending June 2007)

Particulars Deccan Aviation Ltd KAL

Revenues (Rs Crore) 1,622 NA

EBITDA (Rs Crore) -678 NA

PAT (Rs Crore) -416 NA

Fleet size 39 25

Pax market share (%) 18.4% 10.2%

Source: DGCA, Company, ICICIdirect.com Research

KAL, headquartered in Mumbai, has staff strength of 7,590 employees (March 2010).

Exhibit 5: Kingfisher’s pax traffic (in lakh)

15.6

16.3

16.5

16.4

26.1

26.7

27.8

24.9

25.9

26.8

28.1

12.8

13.2

2.9

1.6

0.2

0.7

0.7

1.4

1.5

0

6

12

18

24

30

Q1FY

08

Q2FY

08

Q3FY

08

Q4FY

08

Q1FY

09

Q2FY

09

Q3FY

09

Q4FY

09

Q1FY

10

Q2FY

10

Q3FY

10

Q4FY

10

Q1FY

11

(in L

akhs

)

Domestic Pax International Pax

Source: DGCA, ICICIdirect.com Research

Exhibit 3: Domestic market share (FY10)

Paramount 1.8%

G oA ir5.1%

SpiceJet12.5%

Indigo 14.4%

NA CIL17.3%

K ingf isher 23.3%

Jet L ite 7.5%

Jet A irw ays18.1%


Exhibit 4: Domestic market share (Q1FY11)

Paramount 0.3%

G oA ir5.9%

SpiceJet13.2%

Indigo 16.2%

NA CIL16.7%

K ingf isher 21.1%

Jet L ite 7.9%

Jet A irw ays18.6%


The acquisition of Air Deccan led to a 1.6x jump in domestic pax traffic in Q3FY09



Investment Rationale Strong turnaround expected in domestic pax traffic during FY10-12E…

After witnessing a decline of 13.2% YoY in domestic pax traffic during July 2008-June 2010 (Q2FY09-Q1FY10), the Indian aviation sector reported a strong turnaround with a growth of 23.4% YoY to 478.4 lakh passengers during July 2009-June 2010 (Q2FY10-Q1FY11). In our view, pax traffic will continue to grow at a robust pace during FY11E-12E driven by an improving economic environment (GDP expected to grow at a CAGR of 7.5% according to RBI’s conservative estimates), higher demand from budget travellers due to rising income levels (GDP per capita expected to grow at a CAGR of 6%) and stable crude oil prices (US$87 per barrel in Q4FY12E vs. the high of US$124 per barrel in Q1FY09).

Further, the government’s plan to invest about Rs 49,200 crore towards airport infrastructure and connectivity improvement during the Eleventh Plan (2007-12) is expected to provide a significant boost to the growth of pax traffic in India. As a result, we forecast the domestic pax traffic will grow at 14.1% CAGR in FY10-12E (vs. decline of 11.1% YoY in FY09).

Exhibit 6: India’s domestic pax traffic (in lakh)

112 104116 112 114

89 95 97107

122 118133

119138 133

150134

156 150

106

0

30

60

90

120

150

180

Q1FY

08

Q2FY

08

Q3FY

08

Q4FY

08

Q1FY

09

Q2FY

09

Q3FY

09

Q4FY

09

Q1FY

10

Q2FY

10

Q3FY

10

Q4FY

10

Q1FY

11

Q2FY

11E

Q3FY

11E

Q4FY

11E

Q1FY

12E

Q2FY

12E

Q3FY

12E

Q4FY

12E

(Pax

in la

khs

)

-60

-40

-20

0

20

40

60

(%)

Pax traffic (LHS) Growth YoY (RHS)


…but Kingfisher lags in the race

We forecast KAL’s domestic market share will decline to 20.5% in Q4FY12E (vs. 25.9% in Q1FY10) primarily due to the increasing popularity of LFCs in the domestic market (LFCs market share to increase to 45.6% in Q4FY12E vs. 38.5% in Q1FY10). We believe LFCs will be the preferred mode of air travel during the next two or three years due to the high price elasticity of demand (consumers are likely to opt for low cost travel as the economy comes out of the slowdown). Also, we expect LFCs to add more new aircraft (17 new aircraft by LFCs in FY10-12E vs. eight by FSCs that includes KAL, Jet Airways and National Aviation Company of India Ltd, NACIL) in order to improve their domestic and international presence. This is since most of them will finish the mandatory five years of domestic operations in the next one or two years (IndiGo and Paramount have sought approval from the government to start international operations while SpiceJet has already received permission from the government in May 2010). Consequently, we estimate KAL’s domestic pax traffic growth (7.1% CAGR in FY10-12E) to be lower than the sectors’ (14.1%).

Domestic pax traffic is expected to grow at a 14.1% CAGR during FY10-12E driven by the strong macroeconomic growth, robust demand for budget travel and stable crude oil prices…

KAL’s market share is expected to decline to 20.5% in Q4FY12E (vs. 25.9% in Q1FY10) due to increased competition and customers’ preference for low cost travel…



Exhibit 7: Domestic pax traffic (in lakh) – Sector vs. KAL

252

358

444 395453 523

589

12 33 58 86105 109 121

0

150

300

450

600

750

FY06 FY07 FY08 FY09 FY10 FY11E FY12E

(Lak

hs)

0

5

10

15

20

25

(%)

Sector - LHS KAL (Domestic) - LHS KAL market share (%) - RHS

Source: Company, ICICIdirect.com Research

With Jet Airways (India’s largest FSC) converting nearly 70% of its total capacity into Jet Airways Konnect (low cost service), we expect KAL to face increased competition in the domestic market. Jet Airway’s market share is estimated to increase to 26.5% in Q1FY11 vs. 24% in Q1FY10. Although KAL has also imitated Jet Airways’ strategy through its low cost service, Kingfisher Red (~65% of the total capacity at the end of Q4FY10), we believe the former has lost the first mover advantage and is expected to trail Jet Airways in terms of market share (KAL’s market share is estimated at 20.5% in Q4FY12E vs. 26.5% for Jet Airways). Consequently, we expect KAL’s domestic revenue passenger per kilometre (RPKM), a measure of demand, to grow at a slower rate during FY10-12E (7.1% CAGR vs. 14.1% for the sector and 16.7% for Jet Airways).

Exhibit 8: Market share of domestic players

0

20

40

60

80

100

Q1FY

07

Q2FY

07

Q3FY

07

Q4FY

07

Q1FY

08

Q2FY

08

Q3FY

08

Q4FY

08

Q1FY

09

Q2FY

09

Q3FY

09

Q4FY

09

Q1FY

10

Q2FY

10

Q3FY

10

Q4FY

10

Q1FY

11E

Q2FY

11E

Q3FY

11E

Q4FY

11E

Q1FY

12E

Q2FY

12E

Q3FY

12E

Q4FY

12E

(%)

KAL Jet Airways (Excl Jet Lite) LFCs* NACIL Other players

Source: DGCA, ICICIdirect.com Research, LFCs - Indigo, SpiceJet, JetLite and GoAir, Other private players include Air Deccan, Paramount and MDLR, NACIL – National Aviation Company of India, which operates Air India and Indian Airlines



Exhibit 9: RPKM (in crore) – KAL (Domestic and International)

302

514

958859 886

985

55

204

352 380

0

200

400

600

800

1,000

1,200

FY07 FY08 FY09 FY10 FY11E FY12E

(Cro

re)

KAL RPKM (Domestic) KAL RPKM (International)


Load factor to improve to 77.3% in FY12E…

KAL’s load factor rose to 71.8% in FY10 (vs. 64% in FY09) primarily due to an improvement in the demand environment, capacity rationalisation undertaken (fleet size reduced to 69 aircraft in FY10 vs. 77 in FY09) and increased focus on budget travel (~80% of total flights under the low-cost service Kingfisher Red in Q4FY10).

Due to the aggressive fleet reduction programme, KAL’s domestic capacity, as measured by available seats per kilometres (ASKM), declined by 20.8% YoY in FY10 (vs. increase of 97.4% in FY09). With the further reduction in the number of aircraft in Q1FY11 (66 aircraft) and deferral of new aircraft addition plans by the management, we estimate the domestic ASKM will decline by 2.1% YoY in FY11E. In our view, KAL will benefit from the current demand-supply equilibrium in the sector as major FSCs such as Jet Airways and NACIL (who were aggressively expanding their fleet size during FY05-08) have also shelved their fleet acquisition plans for the next 8-12 months. Consequently, we estimate KAL’s load factor will rise to 76.2% in FY11E and 77.3% in FY12E.

Although KAL’s management has announced plans to add 10 new aircraft in FY12E (six Airbus 320 and four Airbus 330), ~40-50% of these aircraft are optional (delivery based on market conditions). We believe the management’s expansion plans are aggressive considering the high debt on the company’s balance sheet (~Rs 7,414 crore at the end of Q4FY10) and large outstanding fuel bills, which, in unison, pose a significant cash flow problem for the company. In our view, KAL will face difficulty in funding its proposed aircraft acquisition plan in light of the completely eroded net worth and continuing negative operational performance. Consequently, we expect KAL to add only one or two new aircraft in FY12E.

KAL’s capacity rationalisation and higher focus on budget

services will drive the overall load factor to 77.3% in FY12E vs. 64% in FY09)



Exhibit 10: ASKM (in lakh) and load factor (%)

443

755

1,5841,767

1,4801,626

0

400

800

1200

1600

2000


(Cro

re)

50

60

70

80

90

100

(%)

KAL ASKM (LHS) Load Factor (RHS)

Load Factor - Dom* (RHS) Load Factor - Int* (RHS)

Source: Company, ICICIdirect.com Research,* Dom – Domestic, Int - International

…but growth in pax yields to remain under pressure

We expect KAL’s yield, measured by operating revenue per RPKM, to grow at 6.6% YoY to Rs 5.1 in FY11E due to the low base effect, improvement in domestic pax traffic and strong performance in Q1FY11 (~4% YoY increase in yields to Rs 5). However, the carrier is expected to face increased difficulty in raising its yields primarily due to shifting of ~65% of the total capacity towards low cost services (yields similar to other LFCs vs. 10-15% higher yields for Jet Airways Konnect service of Jet Airways) and rising competition from major LFCs such as IndiGo, SpiceJet and Paramount. Exhibit 11: Trend in yields

5.05.2 5.2

4.85.1 5.2

2.0

3.0

4.0

5.0

6.0


(Rs)

Operating Revenue per RPKM


Jet Airways scores over KAL in terms of EBITDAR margin

A significant improvement in the domestic demand environment coupled with strong operational efficiencies led Jet Airways to report higher EBITDAR margin (18.7% in FY10) vs. KAL (3.8%). Jet Airways’ robust operational performance was primarily driven by higher load factor (77.4% in FY10 vs. 71.8% for KAL) and block hours per flight (1.9 vs. 1.5 for KAL) although KAL performed better than Jet Airways in terms of flights per aircraft. In our view, the delayed focus on the low cost travel market was the primary reason for the lower load factor witnessed during FY10.

KAL’s yields will remain under pressure during FY11E-12E



Exhibit 12: Comparison of EBITDAR (Rs crore) and EBITDAR* margin (%) – KAL vs. Jet Airways

1,3631,008

184

2,221

659194

-303-189 -622-369-1000

0

1000

2000

3000

FY06 FY07 FY08 FY09 FY10

(Rs

Cror

e)

-30

0

30

60

90

(%)

Jet Airways - LHS KAL - LHS

Jet Airways Margin - RHS KAL Margin - RHS

Source: Company, ICICIdirect.com Research, EBITDAR – Earnings before interest, depreciation and amortisation, and rentals (EBITDAR helps in comparing airlines by discarding the distortions created by different depreciation policy and aircraft financing method used by the individual airlines)

Exhibit 13: Comparison of aircraft utilisation – KAL vs. Jet Airways (including Jet Lite) Parameters

FY08 FY09 FY10 FY08 FY09 FY10

Load Factor (%) 68.1 63.0 71.8 69.2 67.8 77.4

Block hour per flight (hrs) 1.5 1.5 1.5 1.7 1.9 1.9

Flights per aircrafts 5.5 5.6 5.5 4.3 4.3 4.2

KAL Jet Airways


EBITDA margin to turn positive in FY12E

KAL continues to generate operational losses (EBITDA margin of -17.7% in FY10) despite the significant margin improvement of other domestic players, Jet Airways (8.9% in FY10 vs. -6.6% in FY09) and SpiceJet (1.2% FY10 vs. -24.8% in FY09). Negative margins have persisted despite cost cutting initiatives undertaken by the company such as staff rationalisation (employee costs down 16.4% YoY in FY10) and improved operational management (other operating costs down 2.1% YoY). In our view, negative EBITDA margins were due to:

• Decline in operating revenues by 3.3% YoY in FY10 was due to the market share loss by KAL (22.7% in Q4FY10 vs. 27.5% in Q4FY09) to Jet Airways and other domestic LFCs such as IndiGo, SpiceJet and GoAir

• Delivery costs of ~Rs 400 crore from the premature termination of agreements for aircraft taken on operating lease

• Loss of Rs 240 crore due to grounded aircraft

We expect KAL’s EBITDA margin to turn positive in FY12E (2.3%) contributed by the sustained topline growth (18.9% CAGR in FY10-12E), improvement in load factor (77.3% in FY12E vs. 64% in FY09) and continuation of cost cutting initiatives by the company. Cost cutting initiatives include discontinuation of loss-making routes (Bangalore-London, Colombo-Bangalore, etc) during April-December 2009, lower cost on operating leases (renewal of existing operating leases at a discount of 20%) and higher aircraft utilisation (better than the sector leader, Jet Airways), leading to improvement in the load factor.

EBITDA margin expected to turn positive in FY12E



Exhibit 14: KAL EBITDA margin (%)

-43.5-50.2

-34.5

-17.7

-3.3

2.3

-60

-40

-20

0

20


(%)

EBITDA margin (%)


KAL’s earnings highly sensitive to changes in fuel prices

KAL’s earnings are highly susceptible to a rise in crude oil prices as fuel costs account for nearly 40% of the total operating expenses for the company. Based on our sensitivity analysis, we estimate that a 10% change in average jet fuel prices either way will lead to 16.7% and 45.3% volatility in EPS in FY11E and FY12E, respectively. (We have assumed average jet fuel prices of 59.1 cents per litre (CEP) and 62.5 CEP in FY11E and FY12E, respectively, which is based on our crude oil forecasts).

Exhibit 15: Sensitivity of KAL’s EPS with jet fuel prices Change in average jet fuel prices (%)

FY11E FY12E

10 -34.5 -22.4

0 -29.5 -15.4

-10 -24.6 -8.4

Change in EPS (Rs)

Source: EIA, ICICIdirect.com Research

Exhibit 16: Cost per ASKM (Rs) and breakeven load factor (%)

5.3

4.03.0

1.7

2.8 2.8 2.6 2.5

4.12.9

4.4

4.0

0.0

2.0

4.0

6.0

8.0

10.0


(Rs)

0

20

40

60

80

100

(%)

Cost per ASKM (LHS) Cost per ASKM - W/o Fuel (LHS) BE LF* (RHS) BE LF* - W/o Fuel (RHS)

Source: Company, ICICIdirect.com Research, *BE LF – Breakeven Load Factor (%)

Earnings are highly susceptible to changes in jet fuel prices



KAL’s outstanding fuel dues present cash flow problem

With the slowdown witnessed in the domestic economy and high fuel prices in early 2009, major domestic players such as NACIL, Jet Airways and KAL faced a significant increase in the outstanding fuel bills in FY09. Although NACIL and Jet Airways were able to decrease their outstanding dues to Rs 473 crore (vs. Rs 1312 crore in FY08) and Rs 760 crore (from Rs 1266 crore in FY08), respectively, Kingfisher reported only a marginal decline in its dues (Rs 950 crore vs. Rs 1030 crore in FY08). As a result, KAL’s creditor days increased significantly to 397 days in FY09 (vs. 167 days in FY08). Exhibit 17: KAL’s creditor days

91

167

397 397

496

566

0

200

400

600


(Day

s)

Creditor days


In our view, KAL will face increasing difficulty in paying its outstanding dues as the company is burdened with significant debt (~22x increase in interest cost during FY08-10), has completely eroded its new worth and continues to report a decline in profitability (EBITDA margin of -17.7% in FY10 vs. 8.9% for Jet Airways). Major domestic oil companies such as Indian Oil Corporation (IOCL) and Bharat Petroleum Corporation (BPCL) have already put KAL under cash-and-carry arrangement (KAL has to pay upfront for immediate jet fuel requirements) after repeated failure by the company to pay its fuel bills on time (normal credit period followed by domestic oil companies is three to six months).

With rising pressure from the government (the oil ministry rejected the corporate guarantee worth Rs 500 crore that was issued by the promoter company UBHL to HPCL in March 2010), KAL paid Rs 63 crore (~10% of its outstanding dues) to HPCL when UBHL sold off its 10.2% stake in Aventis Pharma (investment gain of ~Rs 414 crore) in April 2010. Also, the carrier paid Rs 60 crore in May 2010, which reduced the outstanding bill towards HPCL to Rs 479.5 crore.

In a recent development, HPCL has decided to put KAL on cash-and-carry terms from August 2010, after the airline failed to submit a bank guarantee of Rs 250 crore by June 2010 as committed by the management. In our view, this situation can worsen to a serious cash flow problem as KAL is yet to come up with a plan to pay off its outstanding dues.



Exhibit 18: KAL’s unpaid fuel bills (Rs Crore) Company As the end of May FY10 (Rs Crore)

Hindustan Petroleum Corporation Ltd 479

Bharat Petroleum Corporation Ltd 314

Indian Oil Corporation Ltd 31

Total 824

Source: ICICI.direct.com Research

Balance sheet severely stretched

With a negative net worth and high borrowings of Rs 7,414 crore (Q3FY10), KAL has the weakest balance sheet in our coverage universe. Although the company has recently announced plans to raise fresh capital through GDR (in European markets) or rights issue, we believe the threat from unstable economies (especially Greece and Spain) will hinder KAL’s plan to raise capital from the European region. In our view, the company will proceed with the rights issue in the next few quarters in order to raise additional funds.

We have assumed that the company will be able to raise fresh capital worth ~Rs 446 crore (US$100 million) through a rights issue in FY11E. Although the additional capital falls short of the required amount (payment obligations of ~Rs 2,100 crore at the end of FY10), we believe the expectation of improved operational environment (EBITDA margin to turn positive at 2.3% in FY12E) and support from the holding company will help the company to improve its liquidity situation and reduce its debt burden. Consequently, we expect the net debt-to-equity ratio of the company to improve to -1.3x in FY12E vs. -2.1x in FY09. Exhibit 19: Comparative statement – Group companies

(Rs Crore) FY08 FY09 FY08 FY09 FY08 FY09 FY08 FY09

Revenues 403 403 4,628 5,468 1,561 1,929 1,656 2,470

EBITDA (515) (1,753) 1,070 770 185 227 81 88

PAT (1,003) (2,202) 301 (408) 54 46 40 28

Capital Employed 5,870 7,154 8,585 9,673 1,299 1,827 19 15

Total Networth 950 238 2,077 2,386 609 1,062 373 389

Interest Coverage (x) (1.3) (2.0) 1.8 0.9 2.0 1.3 4.2 1.9

MCFUBHL USL UBL

Source: Company, ICICIdirect.com Research, UBHL – United Breweries (Holding) Ltd, USL – United Spirits Ltd, UBL – United Breweries Ltd, MCF – Mangalore Chemicals and Fertilizers Ltd

Exhibit 20: Net debt-to-equity ratio

0.3

3.3

-2.1 -1.7 -1.4 -1.3

-6.0

-4.0

-2.0

0.0

2.0

4.0

FY 07 FY 08 FY 09 FY 10 FY 11E FY 12E

(x)

Net debt-to-equity


KAL’s highly leveraged balance sheet is likely to contribute to negative net margins in FY11E-12E



Exhibit 21: Interest coverage ratio

-22.3

-15.3

-2.6-1.0 -0.5 -0.1

-25.0

-20.0

-15.0

-10.0

-5.0

0.0

FY07 FY08 FY09 FY10 FY11E FY12E(x

)

Interest coverage ratio


KAL joins ‘Oneworld’ alliance

In June 2010, KAL signed an agreement with Oneworld alliance in order to boost its international operations as the agreement will enable KAL to enter into code-share agreement with the Oneworld’s member. Oneworld is a global network of 12 airlines that covers about 700 destinations and links around 550 airports across the world. This alliance is also expected to put the about 58 Indian cities (under KAL coverage) on the global list. The prominent members of Oneworld alliance include American Airlines, British Airways, Cathay Pacific, Finnair, Japan Airlines, Qantas, LAN Airlines and Royal Jordanian, etc.

KAL has already signed a code sharing agreement with British Airways and expects to become a fully-integrated member of the Oneworld alliance within the time frame of 18 months after the integration of IT systems, distribution processes and frequent flyer programmes with Oneworld’s other member airlines.



Risks and concerns

Delay in raising fresh capital We have assumed that KAL will raise fresh capital worth ~Rs 446 crore (US$100 million) through a rights issue in order to improve its liquidity position. Any delay in the capital raising process is likely to exert significant pressure on the liquidity position of the company. Further, the failure of promoter company (UBHL) to arrange funds for KAL will negatively impact the long-term viability of the company’s business.

Delay in payment of outstanding fuel dues

KAL’s inability to raise additional funds in order to pay outstanding fuel dues (worth ~Rs 824 crore at the end of May 2010) may create a serious cash flow problem, in case HPCL (KAL’s largest fuel provider) decides to put the carrier under cash-and-carry terms, resulting in immediate payment for all fuel requirements in future.

Delay in recovery of domestic economy India’s air pax traffic is highly dependent on macroeconomic growth (~1.5-2x GDP growth rate). Any delay in recovery of the domestic economy (due to the slower-than-expected recovery of western economies and contagion effect from unstable economies in the Euro zone region such as Greece and Spain) can negatively impact the growth of pax traffic in India.

Margin contraction due to higher crude oil prices With fuel expenses accounting for ~40% of KAL’s total operating expenses, a significant rise in crude oil prices can adversely impact the bottomline of the company. As a rise in fuel prices directly impacts customers (ticket price increases due to higher fuel surcharges), a higher-than-expected rise in fuel prices may force the customers to cut back on their travel expenses and choose a less costly mode of transport (railways, etc).

Oversupply situation likely in case of excess capacity addition With the revival of domestic pax traffic (14.7% growth in pax traffic in FY10 vs. 11.1% decline in FY09) and customer preference towards low cost travel, LFCs are planning to acquire new aircraft to boost their market share. Although we believe the sector can accommodate 6-7% growth in capacity addition in the present scenario, a slower-than-expected improvement in pax traffic and excess capacity addition by domestic players can lead to an oversupply situation in the sector, resulting in a decline in load factors.



Financials

Revenues to grow at 18.9% CAGR during FY10-12E

During FY10, KAL’s revenues declined by 3.3% YoY to Rs 5,068 crore despite a 14.7% YoY growth in domestic pax traffic. The lower topline was primarily due to market share loss by KAL (22.7% in Q4FY10 vs. 27.5% in Q4FY09). The market share loss was due to a delay in focus towards the low cost travel market, which has emerged as the preferred mode of air transport in the domestic market.

With the positive growth in the last four quarters (23.4% in Q2FY10-Q1FY11) and focus on improvement in pax-traffic and focus on budget travel (~65% of KAL’s capacity shifted to low cost service in Q4FY10), KAL’s revenues grew 28.9% YoY to Rs 1,641 crore in Q1FY11. We estimate KAL’s revenues will grow at 18.9% CAGR to Rs 7,162 crore during FY10-12E driven by the strong turnaround expected in domestic pax traffic (14.1% CAGR in FY10-12E) and stable fuel prices environment.

Exhibit 22: Revenues expected to grow at 18.9% CAGR during FY10-12E

5,068

6,4237,162

1,622 1,441

5,239

0

1,500

3,000

4,500

6,000

7,500


(Rs

Cror

e)

-75

0

75

150

225

300

(%)

Revenues Growth YoY


EBITDA to turn positive in FY12E

During FY10, KAL reported an EBITDA loss of Rs 899 crore vs. positive results by Jet Airways (Rs 1,062 crore) and SpiceJet (Rs 26 crore). The decline in operating revenues, premature termination of aircraft leases (loss worth Rs 400 crore) and loss due to grounded aircraft (worth Rs 240 crore) contributed to KAL’s negative EBITDA margin. We expect KAL’s EBITDA to turn positive in FY12E fuelled by sustained topline growth, stable fuel prices and cost cutting initiatives bearing fruit. Exhibit 23: Positive EBITDA expected in FY12E

-706 -724-899

-195

152

-1,807-2,000

-1,600

-1,200

-800

-400

0

400


(Rs

Cror

e)

EBITDA




Margin under pressure

During FY10, KAL witnessed a severe contraction in the net margin (-32.5%) primarily due to slower topline growth and high interest expenses (40.8% YoY to Rs 1,097 crore). We expect the net margin to remain under pressure in FY11E (-18.3%) and FY12E (-8.5%) due to the significant debt on KAL’s balance sheet (Rs 7,414 crore at the end of Q4FY10).

Exhibit 24: Slow recovery in margin during FY10-12E

-46.9

-32.5

-18.3

-8.5

-53.6

-1.0

-38.0

-22.0

-7.1

-26.5

-13.9

-41.1

-60.0

-50.0

-40.0

-30.0

-20.0

-10.0

0.0


(%)

EBITmargin Net margin


Net worth to remain negative in FY12E

In FY09, KAL’s net worth turned negative as a result of a significant decline in earnings and high interest obligations (debt of Rs 5,666 crore in FY09 vs. Rs 934 crore in FY08). Although we expect the company to raise ~Rs 446 crore (US$100 million) in FY11E, the amount will fall short of the required amount in order to improve its net worth.

Exhibit 25: RoCE (%) and net worth (Rs Crore)

385 199

-2,656

-4,303-5,075

-5,646

-8,000

-6,000

-4,000

-2,000

0

2,000


(Rs

Cror

e)

-100

-75

-50

-25

0

25

(%)

Net Worth - LHS ROCE - RHS




Valuations

KAL is India’s second-largest airline operator with a domestic market share of 21.1% in Q1FY11. Despite its increased focus on budget travel (~65% of capacity shifted to low cost services in Q3FY10), we believe the company’s market share will decline to 20.5% in Q4FY12E (vs. 25.9% in Q1FY10) primarily due to increased competition from sector leader, Jet Airways (shifted ~70% of capacity to low cost service, Jet Airways Konnect) and major LFCs such as IndiGo, SpiceJet and GoAir. Consequently, we expect KAL to continue to generate operational losses in FY11E. Furthermore, the large quantum of debt on KAL’s balance sheet will contribute to the negative net margins and negative net worth in FY11E. Other key risks for KAL include a higher-than-expected rise in crude oil prices, slower recovery of the domestic economy and delay in raising fresh capital in order to deleverage its balance sheet.

We have valued KAL on EV/sales basis as other multiples such as EV/EBITDA and price/book value were unsuitable due to the eroded profitability. The company is expected to generate positive EBITDA for the first time ever in FY12E.

At the CMP of Rs 55, the stock is currently trading at 1.3x FY12E EV/sales. The stock has underperformed the Sensex (by 22.8% YTD) and Jet Airways (by 37.6% YTD) due to its continued operational losses and failure by the management to infuse fresh capital, leading us to believe that investors are factoring the risk inherent in the stock. Although the expected amount of fresh capital (~Rs 446 crore/US$100 million) falls short of the payment obligation (~Rs 2,700 crore at the end of Q1FY11), we are of the opinion that further help from promoters may bring a positive surprise to the stock. We have valued KAL at FY12E EV/sales of 1.25x, at the adjusted mean of its Asian peers. We are initiating coverage on the stock with a REDUCE rating, deriving a target price of Rs 52 (downside risk of 5.5%). Exhibit 26: Valuation – KAL vs. Asian peers Major Asian Airlines EV/Sales (FY12E)

Kingfisher 1.3x

Jet Airways 1.3x

Air China 1.8x

China Eastern Airlines Co. 1.2x

China Southern Airlines Co. 1.0x

EVA Airways 1.2x

Cathay Pacific 1.2x

Korean Air 1.1x

Singapore Airlines 1.1x

Thai Airways International 0.9x

Median 1.2x

Mean 1.2x

Adjusted Mean** 1.2x

Source: Company, ICICIdirect.com Research, **Adjusted mean is used to remove extreme values, either minimum or maximum.

KAL valued at 1.2x FY12E EV/Sales, at the adjusted mean of its Asian peers



Table and Ratios Profit and loss statement

(Rs Crore)(Year-end March) FY07 FY08 FY09 FY10 FY11E FY12ENet Sales 1,622 1,369 5,187 4,713 5,973 6,694% Growth -15.6 278.8 -9.1 26.7 12.1Other Operating Income 0.0 72.1 52.4 354.8 449.6 468.6

Fuel Expenses 980 889 2,603 1,803 2,417 2,586% of Sales 60.4 64.9 50.2 38.3 40.5 38.6Personal Cost 252 246 824 689 654 661% of Sales 15.5 17.9 15.9 14.6 10.9 9.9Other Operating Expenses 1,097 1,030 3,619 3,476 3,547 3,762% of Sales 67.6 75.3 69.8 73.7 59.4 56.2Total Expenditure 2,328 2,166 7,046 5,967 6,617 7,010% Growth

Operating Profit -706 -724 -1,807 -899 -195 152% Growth -2.6 -149.5 50.2 78.4 178.3Depreciation 54 49 184 217 228 217EBIT -760 -773 -1,990 -1,117 -422 -65% Growth -1.7 -157.5 43.9 62.2 84.6

Interest 34 50 779 1,097 889 757Non-operation income 368 129 71 -205 141 251Profit before Tax -426 -695 -2,698 -2,418 -1,170 -571% Growth -62.9 -288.4 10.4 51.6 51.2Taxation 3 -494 -546 -771 -77 0

Net Profit -430 -200 -2,152 -1,647 -1,094 -571% Growth 53.4 -974.6 23.4 33.6 47.8



Balance Sheet

(Rs Crore)(Year-end March) FY07 FY08 FY09 FY10 FY11E FY12ELiabilities Equity Share Capital 135 136 266 266 370 370Preference capital 11 10 105 105 105 105Reserves & Surplus -540 -915 -6,135 -9,429 -11,522 -12,664Secured Loans 717 592 2,623 2,623 2,623 2,623Unsecured Loans 200 342 3,043 4,791 4,791 4,791Current Liab. & Prov. 482 667 3,496 4,509 5,830 6,553Deferred Liabilities & Others 0 30 364 -400 -477 -477Total Liabilities 1,005 862 3,762 2,465 1,720 1,301

Assets Gross Block 341 322 1,892 1,892 1,892 1,892Less: Acc. Depreciation 34 44 316 534 751 968Net Block 307 279 1,576 1,358 1,141 924Capital WIP 358 346 1,631 1,631 1,631 1,631Net Fixed Assets 665 625 3,206 2,989 2,772 2,555

Loans & Advances 160 200 1,436 2,083 2,668 2,997Cash 817 280 172 149 231 222Trade Receivables 35 27 230 222 265 299Inventory 62 49 147 102 140 155Investments & Other Assets 16 91 4 0 0 0Total Current Assets 1,090 647 1,989 2,556 3,303 3,673

Others - Goodwill 29 559 1,674 1,674 1,674 1,674Total Assets 1,005 862 3,762 2,465 1,720 1,301



Cash Flow statement

(Rs Crore)(Year-end March) FY07 FY08 FY09 FY10P FY11E FY12EProfit before Tax -416 -683 -2,686 -2,418 -1,170 -571Depreciation 44 37 172 217 228 217Other Non Cash expenses 10 12 12 0 0 0Diect Tax Paid 3 4 13 -6 77 0Interest Income 0 0 0 0 0 0Others 334 596 413 -1,097 -740 -506CF before WC Changes -699 -1,233 -2,928 -1,098 -279 152

Net Increase in CL 100 175 2,784 1,013 1,321 723Net Increase in CA 35 93 1,451 590 666 378CF after WC Changes -634 -1,152 -1,594 -675 376 498

Purchase of Fixed Assets -165 30 -2,854 0 0 0(Inc.)/Dec. in Investment 368 104 64 0 149 251CF from Investing 204 134 -2,791 0 149 251

Inc/(Dec) in Loan Funds 465 18 4,731 1,748 0 0Inc/(Dec) in Net Worth 580 3 -715 0 446 0Others -34 -50 -779 -1,097 -889 -757CF from Financing 1,011 -29 3,237 652 -443 -757

Op. Cash & CE 256 817 280 172 149 231Cl. Cash & CE 817 280 172 149 231 222FY10 figures are provisional.



Ratios (Year-end March) FY07 FY08 FY09 FY10P FY11E FY12EPer share data (Rs)EPS -31.7 -14.7 -80.9 -61.9 -29.5 -15.4Cash EPS -27.7 -11.2 -74.0 -53.8 -23.4 -9.6Book Value 26.3 13.4 -100.1 -162.0 -137.2 -152.6Operating Profit Per Share -52.1 -53.3 -67.9 -33.8 -5.3 4.1

Operating RatiosOperating Margin -43.5 -52.9 -34.8 -19.1 -3.3 2.3Net Profit Margin -26.5 -14.6 -41.5 -34.9 -18.3 -8.5

Return RatiosRoNW* -141.2 -68.6 NM NM NM NMROCE -79.6 -64.7 -96.6 -36.5 -15.5 -3.2

Valuation Ratios EV/EBITDA -2.1 -2.8 -3.9 -9.7 -44.5 56.9PE -1.6 -3.5 -0.6 -0.8 -1.7 -3.3EV/Sales 0.9 1.5 1.3 1.9 1.4 1.3Sales to Equity 4.2 6.9 -2.0 -1.1 -1.2 -1.2Market Cap to Sales 0.8 1.0 0.3 0.3 0.2 0.2Price to Book Value 2.0 3.8 -0.5 -0.3 -0.4 -0.3

Turnover Ratios Fixed Asset Turnover Ratio 149.6 166.6 225.7 231.5 169.4 139.3Debtor turnover 7.9 7.2 16.2 17.2 16.2 16.3Creditor turnover 55.2 108.3 199.5 152.1 200.7 218.5Cash to abs. Liab. 1.7 0.4 0.0 0.0 0.0 0.0

Solvency Ratios Debt/Equity 2.4 4.7 -2.1 -1.7 -1.5 -1.3Current Ratio 2.3 1.0 0.6 0.6 0.6 0.6Quick ratio 2.1 0.9 0.5 0.5 0.5 0.5*NM-Not meaningful as earnings & net worth are expected to remain negative in FY11-12



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Pankaj Pandey Head – Research [email protected]

ICICIdirect.com Research Desk, ICICI Securities Limited, 7th Floor, Akruti Centre Point, MIDC Main Road, Marol Naka, Andheri (East) Mumbai – 400 093

[email protected]

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