IndiGo's IPO: Non-operating income dominates profit, timing and valuation critical

NEW DELHI: How much should an investor pay for IndiGo stock? The no-frills carrier, which is planning an initial public offer ( IPO), has an astonishing earnings record, having consistently made a profit when rivals have posted losses and others have struggled to stay airborne.

While it’s no secret that the company has astutely combined blockbuster plane purchases with a sale-and-leaseback strategy, its draft share-sale prospectus offers a closer look at the numbers. Timing and valuation are critical, analysts said.

One analyst suggested the airline may be better off deferring its IPO by another two years when the India story is expected to get more upbeat. Others said the $4-billion valuation expectation may be on the higher side.

IndiGo’s profit since FY10 is dominated by non-operating income that includes income from investments and cash and non-cash income from aircraft and engine manufacturers, according to the draft red herring prospectus (DRHP) filed by the airline. It has earned Rs 3,174 crore as profit since FY10, while earnings from non-operating income amounted to Rs 2,789 crore or 88% of the total.

Significantly, the data also show operational profitability was strained in FY12 and FY14, when it posted a net income of Rs 140 crore and Rs 473 crore, respectively. Earnings from non-core operations wasRs 405 crore in FY12 and Rs 675 crore in FY14. In all other years since FY10, profit was higher than non-operating income. The carrier, which has 96 Airbus A320 planes with 180 more on order, has a lot of planes and not enough places to fly, an expert said.

“That IndiGo has had to rely on non-core earnings suggests to me that growth is not just hitting the buffers. It also (shows) that they have not figured out how to grow organically,” said Saj Ahmad, chief analyst at StratAero Research, a London-based aviation consulting firm. “It’s quite ridiculous to have a fleet of 100 or more jets and just 40-odd paltry routes — yield nosedives with frequencies and IndiGo is running out of options in India to grow frankly.”

Other earnings sources include interest income on fixed deposits, net gain of sale of investments, profit on sale of fixed assets, profit on redelivery of aircraft and miscellaneous income. The cash and non-cash incentives earned through engine and aircraft manufacturers have not been elaborated on by the airline in the DRHP.

Ahmad said the sale-and-leaseback strategy is a globally recognised model but for it to continue working, the carrier needs to fly more routes.

“It is a sustainable model if the airline expands and IndiGo is not,” said Ahmad. “Airlines like Flydubai, Jazeera Airways, Ryanair, Norwegian and Lion Air are just a few examples of airlines that follow the sale-and-leaseback model.”

The airline declined to respond to specific questions.

“As you are aware, we have just filed the DRHP with Sebi ( Securities and Exchange Board of India) and till we are listed on the stock exchanges, we need to adhere to strict publicity guidelines advised by the regulatory authorities,” it said in an email. “Request you to please refer to the DRHP for the information provided. We have no further comment beyond that.”

The company’s exceptional earnings record makes it a worthwhile investment and the share offer is likely to get a warm welcome, said Kapil Kaul, India CEO for the Centre for Asia Pacific Aviation (CAPA).

“In a market where airlines are making losses, IndiGo has been consistently profitable,” he said. “The airline has a brand, cash reserve, huge order book, commanding position at various airports and further growth. It is going to be the growth engine for domestic aviation. I think the IPO will be well received.”

The valuation appears excessive, said another analyst. “The company will always be valued in terms of operational performance and IndiGo’s valuation would only be a little higher than its peers ( Jet Airways and Spice-Jet) because the airline has been consistent with profit,” said Daljeet Kohli, head of research at IndiaNivesh Securities.

As reported by ET in April, Indi-Go invests its surplus in instruments other than bank deposits for better returns such as mutual funds over a short duration. The airline’s board raised its investment limit to Rs 5,000 crore fromRs 2,000 crore in March. Some analysts feel the airline may be better off deferring an initial public offer.

“Given the current state, we believe it may be likely that Indigo may capitalise just about $2 billion, or Rs 13,000 crore, from the market with an average floor price of Rs 120 to Rs 180 per share range given the current market challenges and risks associated with the airline business,” said Mark Martin, founder and CEO at Martin Consulting LLC. “Whilst the airline’s balance sheet clearly does look appealing, with fuel price being at its lowest level, world fuel prices are expected to rise by 2015 Q4 to the $75 a barrel range and this will burden the right side of airline P&Ls in times to come.”

Martin said Indigo should consider deferring its IPO to FY17 when the Indian economy is expected to make a turnaround against the backdrop of a more stable world market, the China recovery and the return of US investments to Asia.