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  • May 10, 2018 - Looking Beyond the Colourful Prism of This Airline Company

Looking Beyond the Colourful Prism of This Airline Company

May 10, 2018

Interglobe Aviation ltd.

It operates India's largest passenger airline: Indigo.

Not long ago, it was considered the blue-eyed boy in the aviation sector.

And quite rightly so.

To lead a sector plagued with so many problems - government regulations, volatile fuel prices, intense competition - is no small feat.

And it did it profitably.

Now the aviation sector is not a favourite of ours. It has seen many players bite the dust. Even those that survived, struggle to remain afloat.

But Indigo has defied the odds. It is the most profitable airline in India.

Its secret sauce lies in its low-cost carrier (LCC) business model.

You see, the company doesn't own most of its aircraft. Instead it follows the 'sale and leaseback' model.

Under this model, it places bulk orders for a single aircraft variety. Thus, it gets a big discount from the manufacturer.

On delivery, Interglobe Aviation immediately sells the aircraft to leasing companies and then leases them back again. This helps the company maintain a young fleet of the latest aircraft, lowering day-to-day operating and maintenance costs.

As on 31st March 2018, the company had a fleet of 159 aircraft out of which 136 are on operating lease and the balance 23 are company-owned.

Backed by profitable operations, Interglobe Aviation's strategy of low fares, on-time flights, and a hassle-free experience was a huge success in economy air travel. This helped it to establish its brand in a cost-conscious country like India.

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Therefore, when the company came out with its IPO in November 2015, investors finally got an opportunity to own a well-managed airline.

But can operational efficiencies alone guarantee long-term wealth creation?

No.

The Oracle of Omaha, Warren Buffett, gives equal importance to management quality.

In his 2007 letter to shareholders Warren Buffett wrote...

  • "Charlie and I look for companies that have
    a) a business we understand;
    b) favorable long-term economics;
    c) able and trustworthy management, and
    d) a sensible price tag.

Despite having an efficient business model, Interglobe's track record in capital allocation was questionable.

It paid hefty dividends to promoters prior to listing.

And most of the funds raised through the issue was used to pay off debt instead of being used in the business.

Moreover, in the past one year, Indigo's strength in operations and customer service have also come under the scanner.

It all started with the manhandling of a customer by the Indigo security staff last year. Initially the company tried to downplay it citing security concerns. But after a public outcry and a probe by the Ministry of Civil Aviation, it had to apologise.

This was followed by glitches in Pratt and Whitney engines in its new aircraft. Several flights had to be grounded. These incidents have dented its image.

These issues are not grave by themselves. However, being in the aviation business, it is important to proactively work towards keeping the customer satisfied and safe in the skies. The management's firefighting measures to restore confidence came with a delay. This also led to the unceremonious exit of its Chief Executive Officer recently.

We believe, Interglobe Aviation needs to work hard to earn back the respect of customers as well as shareholders.

The redeeming factor is that the company has embarked on the route to correct its business strategy.

Interglobe's sale and lease back model will no longer have the benefit of being 'asset light' in nature. New accounting norms, that become effective in 2019, require lease rentals be counted as debt during the lease period.

So Interglobe Aviation is slowly transitioning towards outright purchase of aircraft. In FY18, the company purchased six aircrafts using its internal cash reserves.

Hopefully, with the new CEO gaining confidence of customers and shareholders, this company can build a good track record in management quality.

Madhu Gupta

Madhu Gupta (Research Analyst), ValuePro has a post graduate degree in both physics and finance. Having worked with India's leading economic research agency, she has a natural flair for numbers and analytics. She brings with her a near-decade long rich experience in the field of finance. A firm believer of the principles of value investing, she looks for robust businesses with durable competitive advantages.


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1 Responses to "Looking Beyond the Colourful Prism of This Airline Company"

Pradeep Kumar Nair

May 14, 2018

Madhu

Who is the new CEO of Indigo? I thought Rahul Bhatia is only playing interim CEO role

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Equitymaster requests your view! Post a comment on "Looking Beyond the Colourful Prism of This Airline Company". Click here!

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