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Aviation: higher crude oil prices make for cloudy skies
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Aviation: higher crude oil prices make for cloudy skies

When crude oil prices are flirting with $70 per barrel, investors in aviation companies should start biting their nails. The adjacent chart shows fuel costs expressed as a percentage of operating revenue for InterGlobe Aviation Ltd (running the IndiGo airline), Jet Airways (India) Ltd and SpiceJet Ltd for the half year ended September 2017. The proportion is substantial and that"™s why higher crude oil prices spell trouble for aviation companies, as they are a risk to profitability.

However, there are some comforting elements at play this time around. According to Ansuman Deb, an analyst at ICICI Securities Ltd, the threat from rising crude oil prices is relatively less pronounced this time because the airlines still have pricing power considering that average fare for low-cost airline"”IndiGo and SpiceJet"”are about Rs4,000.

"However, if crude rally sustains in the long run, one can expect some hit on profit margins," he said, adding that even as airlines can pass on higher crude oil prices to consumers, airlines wouldn"™t like to sacrifice passenger growth rates for fares.

To be sure, the forthcoming December quarter results are not expected to show the impact of higher crude oil prices. But watch out for the March quarter when higher fuel costs are likely to make the going difficult.

"As we move into the seasonally weak 4Q, we expect a) moderation in industry load factors by 200bps to 84%; or b) moderation in yields to keep the load factors intact," wrote analysts from SBICAP Securities Ltd in a report on 1 January.

According to the brokerage firm, a 20% increase in aviation turbine fuel prices would require an average increase of 7-7.5% in passenger yields. "Despite the strong capacity addition in recent weeks, we believe the record industry level PLF (passenger load factor) provides enough room to absorb the incremental capacity and maintain healthy PLFs (83-85%) to sustain current yield improvement," it added.

However, profitability will start getting adversely affected once passenger growth starts to slow substantially. According to the Directorate General of Civil Aviation, passengers carried by domestic airlines over January-November 2017 increased 17% year-on-year. So far as passenger growth is reasonable, things should not turn too ugly unless of course, crude oil prices rise through the roof. In the near term, December quarter results should bring some cheer. After all, it is a seasonally stronger quarter and this time, demonetisation provides a favourable base…

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