November 13, 2007| Aviation

Initiating Coverage

SpiceJet (MODLUF)
Jet set go …
SpiceJet is one of the focussed low-cost carriers (LCC) in India. We believe the airline is best positioned to breakeven given its low costs and improving yields in a changing industry scenario. It plans to ramp up its fleet size, a move that would help it manage costs more effectively. We initiate coverage on the company with an OUTPERFORMER rating.

Current price Rs 51 Potential upside 33%
Analyst Name

OUTPERFORMER
Siddhartha Khemka
siddhartha.khemka@icicidirect.com

Time frame 12 months Potential upsidemonths Time frame 12 13%

Target price Rs 68 Time Frame 12-15 months

Ember Pereira

ember.pereira@icicidirect.com Sales & EPS trend
2500 2000 Rs crore 1500 1000 500 0 FY06 FY07 Net Sales FY08E EPS (RHS) FY09E 4 3 2 1 0 -1 -2 -3 -4

LCCs transform industry dynamics
The advent of low-cost carriers (LCCs) has revolutinised Indian aviation. The Centre for Asia Pacific Aviation (CAPA) has predicted the domestic traffic, currently at 35.3 million passengers, would grow at 25%-30% annually until 2010, taking the overall market to more than 70 million passengers.

Lowest cost among peers
SpiceJet follows the pure LCC model. This has helped it achieve the lowest cost in the industry – its per unit cost is 20% lower than peers in the LCC segment, and 40% lower than players in the full-service carrier (FSC) segment. We believe this would help it achieve breakeven ahead of others in an improving yield scenario.

Fleet expansion to help achieve breakeven
We expect the company to post profits at the net level by FY09E as an optimal fleet size is achieved, and fixed costs are absorbed over a higher capacity (ASKM). It has unveiled a phased capacity expansion plan which will see the addition of 15 aircrafts by FY10E, and another 8 in FY11-12E, taking its total fleet size to 34 aircrafts.

Stock metrics Promoters holding Market Cap 52 Week H/L Sensex Average volume

12.91% Rs 1,227 crore 68 / 36 18,908 494,811

Valuations
Globally, LCCs trade at a premium over FSCs because of the sustainability of their business model, and greater reach among masses. SpiceJet is currently in a growth phase and yet to achieve an optimal size. We believe the company is set for a turnaround given the growth in the Indian aviation sector and its cost leadership. We value the stock at 4.5x it FY09E EV/EBIDTAR with a 12-15 months price target of Rs 68, an upside potential of 33%. Exhibit 1: Key Financials Year to March 31 Net Sales (Rs crore) Net Profit (Rs crore) EPS (Rs) P/E (x) Price/Book (x) EV/EBIDTAR (x) EV/EBIDTA (x) NPM (%) RoNW (%) RoCE (%)

Comparative return metrics Stock return 3M SpiceJet -11% 8% Deccan Airlines 13% Jet Airways

6M 15% 33% 14%

12M 20% 38% 33%

FY06 419.62 -47.29 -2.57 -19.88 -73.64 116.30 -38.53 -11.27 370.41 -10.25

FY07* 640.44 -67.38 -2.80 -18.22 6.65 -47.75 -23.25 -10.52 -36.50 -10.07

FY08E 1340.09 -5.94 -0.25 -206.66 6.87 7.53 195.66 -0.44 -3.32 -0.38

FY09E 2140.34 69.78 2.90 17.59 4.94 3.10 12.38 3.26 28.09 14.09

Price trend
120 100 Share Price (Rs) 80 60 40 20 0 Feb-06 Dec-05 Dec-06 Feb-07 Oct-05 Oct-06 Jun-05 Jun-06 Aug-05 Aug-06 Jun-07 Aug-07 Oct-07 Apr-05 Apr-06 Apr-07

Absolute Sell Target Price

Absolute Buy

Source ICICIdirect Research, *FY07 10 months year, FY06 ending 30-June

ICICIdirect | Equity Research

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Rs

Company Background
SpiceJet is the second largest low-cost airline in India. The company was originally promoted by the SK Modi Group under the name ModiLuft. It was acquired by Royal Holding Services (Kansagra family) in 2000 and restarted operations in May 2005. SpiceJet flies a single aircraft type fleet (Boeing 737), which allows for greater efficiency in maintenance, and supports its low-cost structure. Currently, it has a fleet of 14 Boeing 737-800 aircrafts in single-class configuration with 189 seats. It flies to 15 destinations, and plans to include two more by next month. The airline’s new fleet of aircraft is backed by cuttingedge technology, and infrastructure. It has maintenance support from KLM and state-of-the-art technology from world leaders like Star Navigation, Russel Adams and Tech Log. SpiceJet has a partnership with Navitaire, the world’s renowned low-cost support system for reservations and revenue management for providing ebooking and e-ticketing services.

Shareholding pattern Shareholder Promoters Institutional investors Other investors General public Promoter & Institutional holding trend
30 25 20 15 10 5 0 Q3FY07 Q4FY07 Q1FY08 16.9 12.9 12.9 24.4 24.3 25.7

% holding 12.91 28.44 42.34 16.31

28.4

12.9

Q1FY08

Promoters (%)

Institutional investors (%)

Exhibit 2: Global LCC model (Common size statement) Year ending Passenger revenue Ancillary revenue Revenue Staff costs Fuel & Oil Airport & handling charges Maintenance, materials & repairs Marketing, distribution & other costs Total Cost EBITDAR Aircraft rentals EBITDA Depreciation Interest expense PBT & Other Income Other Income PBT Tax PAT
Source: Respective company filling, ICICIdirect Research

Southwest 31-Dec-06 96.30 3.70 100.00 33.59 23.53 5.45 5.15 14.59 82.31 17.69 1.74 15.95 5.67 1.41 8.87 -0.18 8.69 3.20 5.49

RyanAir 31-Mar-07 83.81 16.19 100.00 10.13 31.00 21.14 1.88 5.75 69.89 30.11 2.60 27.50 6.42 3.70 17.38 2.78 20.16 0.69 19.47

EasyJet 30-Sep-06 91.89 8.11 100.00 18.78 23.44 23.94 6.76 9.89 82.81 17.19 8.23 8.96 1.69 1.49 5.79 2.19 7.98 2.17 5.81

31-Mar-07 94.57 5.43 100.00 13.35 54.56 9.39 10.49 16.49 104.28 -4.28 21.35 -25.62 0.91 0.67 -27.20 16.31 -10.89 0.16 -11.05

SpiceJet 31-Mar-08 94.34 5.66 100.00 8.73 47.38 8.25 8.72 14.96 88.04 11.96 17.97 -6.01 0.61 0.32 -6.94 6.47 -0.47 0.09 -0.56

31-Mar-09 93.90 6.10 100.00 8.49 45.56 7.26 7.81 13.07 82.19 17.81 15.26 2.55 0.55 0.14 1.86 1.91 3.77 0.50 3.26

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INDUSTRY OVERVIEW
Boom in Indian travel industry
India is one of the fastest growing tourism destinations in the world. The World Travel & Tourism Council has estimated that India's tourism economy will emerge as the world’s 3rd fastest growing over 2007-16, growing at over 8% per annum in real terms. Robust economic growth, higher disposable incomes, and growth in tourism & business travel, are the major demand drivers.

LCCs transform industry dynamics
The advent of low-cost carriers (LCCs) has revolutionized the Indian aviation industry. Corporate travellers have historically formed the majority of the domestic air travel market in India. However, the emergence of LCCs has resulted in middle-income people and self-employed shifting from premium class travel in trains to air travel. The number of domestic air passengers grew at a healthy 38.5% with 35.3 million passengers flying in FY07 against 25.5 million in FY06. The Centre for Asia Pacific Aviation (CAPA) has predicted that the domestic traffic would grow at 25%-30% annually until 2010, taking the overall market to more than 70 million passengers. Aircraft manufacturer Boeing has raised its 20-year market forecast for Indian commercial aircraft purchases to $86 billion from $72 billion last year. Exhibit 3: Domestic air passengers increasing (in millions)
80 70 60 50 40 30 20 10 0 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08E FY09E FY10E

CAPA has predicted domestic passenger traffic would grow at 25%-30% annually until 2010

Source: CMIE, CAPA, ICICIdirect Research

Domestic passenger traffic, which increased at a CAGR of 4% over FY97-04, has moved into high growth trajectory with a 30% CAGR during FY04-07. We expect a 26% CAGR in demand for domestic air travel over the next 5 years.

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LCCs – best positioned to capture the growth
LCCs operate on a distinct low-cost model, without any frills or additional services, which allows them to charge low fares compared to a full-service carrier (FSC). Besides the veritable ‘no-frill’ cost benefit, LCCs also use other cost efficient techniques like single passenger class, standardised fleet and direct ticketing (selling directly to customers via Internet and/or call center). Exhibit 4: LCC v/s FCS Features LCC SpiceJet Fleet type Standardised fleet (B737-800s)

FSC Jet airways

Advantage

Mix of turboprops, narrow-body Maintenance, training & wide-body aircraft (ATRs, and service is simpler B737-400/700/800/900, A330, and cheaper B777) B737-800 (dual) 28 seats in business class & 126 seats in economy class 30-45 minutes 10.7 hrs per day

Number of seats 189 economic per aircraft class Turnaround time 20-25 minutes Flying hours per day Flights per day per aircraft Avg. employees per aircraft Ticket form 12 hrs per day

Higher yield per aircraft LCCs are set to benefit from the high growth in the Indian aviation sector

High aircraft utilization, higher revenues per aircraft, High yields Fixed cost distributed over more flights Lean structure – lower personnel cost Lower cost ($2 as compared to $8 for paper ticket)

8 flights

6.5 flights

146

176

100% e-tickets

Paper and e-ticket (74%)

Distribution model

Focus on direct distribution avoiding agents

Primary use of agents for ticket Lower commission cost distribution

Source: Company, Jet Airways filings, ICICIdirect Research

A LCC is able to contain costs in areas that are under the control of the airline. Things like fuel ciost, airport handling & navigation, and maintenance charges are beyond the control of an airline. The ability of LCCs to offer tickets at lower prices has made them popular in India, where consumers are very price sensitive.

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Consolidation to result in increase in fares and yields
Recently there has been a consolidation in the domestic aviation sector. From a fragmented sector with more than 10 players, today there are 3 major players, and a couple of other smaller players in the LCC space. These three together have a combined market share of around 80%. Exhibit 5: Competitive scenario Market share (%) 29.4 Jet + JetLite Kingfisher + Deccan 28.9 Air India + Indian 19.8 Indigo 8.4 SpiceJet 8.3 Others 5.2

Fleet size 86 (66 + 14) 75 (31 + 44) 132 (77 + 55) 12 13 14

The top three players together have a combined market share of around 80%

Source: Market share – DGCA, fleet – Industry, ICICIdirect Research

We believe consolidation would help the industry, which was hitherto plagued by low yields and excess capacity. These large groups have already initiated a route–rationalisation exercise, which will help in pulling out excess capacity from sectors that are susceptible to heavy discounting. Consolidation has also triggered rationalisation of fleet expansion plans. We expect average yields in the industry would go up by around 5%-10% over the next few quarters, which will help pure LCCs like SpiceJet to achieve early breakeven.

Infrastructure development to aid growth
The key challenge to sustain growth is infrastructure. The government has taken a number of measures to boost airport infrastructure for the country. India allows 100% foreign direct investment (FDI) in green-field airport projects. It has opted for a Public-Private partnership (PPP) model, and has already started for restructuring and modernization of the airports at Delhi and Mumbai, and for setting up green-field airports at Bangalore and Hyderabad. Further, a modernisation plan for 35 non-metro airports has also been unveiled. The anticipated investment in airport development during the 11th Five Year Plan (2007-11) is over Rs 40,000 crore. Exhibit 6: Airport development program Airport Particulars Restructuring/ Modernisation for Delhi, Mumbai world class airports Chennai, Kolkatta Bangalore, Hyderabad, Goa, Pune, Greenfield airports Navi Mumbai, Nagpur (Hub) & Greater Noida Upgradation 25 selected airports Modernisation / Improvement 55 airports
Source: Committee on Infrastructure, Govt. of India

Indicative cost (Rs crore) 15,000 5,000 10,000 7,000 3,000

Government plans to invest Rs 40,000 crore during the 11th five-year plan to improve airport infrastructure in India

We feel that these initiatives would structurally benefit the industry in the longterm though medium term concerns regarding infrastructure would persists.

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INVESTMENT RATIONALE Focused player in the LCC segment
SpiceJet re-commenced operations in May 2005. It follows a pure LCC model – single aircraft type, point-to-point service, and quick turnaround time for higher asset utilisation – which has been successful globally. It has positioned itself as a niche player focusing on profitability rather than chasing market share. Low-cost airlines like Southwest Airlines (based in Dallas, Texas, US), RyanAir (Europe's largest LCC, headquartered in Dublin, Ireland) and EasyJet (based in London) have shown sustained profitability over the years. Exhibit 7: Profitable LCCs Southwest Year ending 31-Dec-06 RoE 7.6 Load factor 73.1 EBITDAR Margin 17.7 Net Margins 5.5

RyanAir 31-Mar-07 15.8 82.0 30.1 19.5

EasyJet 30-Sep-06 10.1 84.8 17.2 5.8

LCCs like Southwest Airlines, RyanAir & EasyJet have shown sustained profitability

Source: Respective company filling, ICICIdirect Research

Focus on profitable routes
SpiceJet operates most of its flights between profitable metro routes to optimise its load and yield (average revenue per passenger). It currently operates from 16 destinations with more than 700 flights a week. 56% of these flights originate from Delhi, Mumbai, Hyderabad and Bangalore. During FY07, Delhi and Mumbai accounted for around 40% of the total domestic air traffic in the country. Exhibit 8: SpiceJet’s top destinations Number of flights per week Airport Delhi 136 Mumbai 98 Hyderabad 83 Bangalore 77 Ahmedabad 57 Chennai 56
Source: Company, ICICIdirect Research

56% of its flights originate from Delhi, Mumbai, Hyderabad and Bangalore

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Rationalised operations
SpiceJet focuses on a few destinations, and maximises frequencies between them. This helps the company amortise the fixed costs of setting up bases at airports over a larger number of seats. At present, the airline operates from16 airports, and plans to increase the number to 18 by the end of FY08E, and further to 22 by FY09E. Exhibit 9: Number of destinations to increase
25 20 15 11 10 6 5 0 FY05 FY06 FY07 FY08E FY09E
34 30 23 17 11 3 FY05 6 26

22 18 14

Source: Company, ICICIdirect Research

Phased capacity expansion
SpiceJet has unveiled a phased capacity expansion plan to meet its growth objectives. It started operations with a fleet of 3 aircrafts, which it has now increased to 14. It plans to add another 12 by FY10E, which will take the total to 26. During the time when the domestic market was mired by over capacity and fierce competition, SpiceJet was able to increase its market share, while maintaining its load factor. With an average age of 2 years, its fleet is also among the youngest in the country. Exhibit 10: Planned fleet expansion
40 35 30 25 20 15 10 5 0 FY06 FY07 FY08E FY09E FY10E FY11E FY12E

SpiceJet plans to expand its fleet significantly

Source: Company, ICICIdirect Research

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Pure LCC model -- helps achieve lowest cost per unit
SpiceJet follows the pure LCC model used globally. This has helped it in achieving the lowest cost in the industry. Its per unit cost is 20% lower than other LCC competitors, and 40% lower than players in the FSC segment. Going ahead, we expect the cost per unit to reduce further on account of fleet expansion, which would absorb the high fixed cost over a larger base. Exhibit 11: Cost comparison with domestic peers SpiceJet Year ending 31-Mar-07 Revenues (Rs crore) 640.44 Total Operating Expenses (Rs crore) 667.85 ASKM (crore) 310.97 Revenue per ASKM (Rs) Operating Cost* / ASKM (Rs) Operating Cost* / ASKM (ex fuel) (Rs) Exhibit 12: Global peer cost comparison Southwest Year ending 31-Dec-06 2.69 Revenue per ASKM (Rs) 2.21 Operating Cost*/ASKM (Rs) Operating Cost*/ASKM 1.58 (ex fuel) (Rs) 2.06 2.15 1.02

Deccan 30-Jun-07 1774.55 2049.11 757.80 2.34 2.70 1.41

Jet Airways 31-Mar-07 7057.78 6434.67 1759.80 4.01 3.66 2.28

Cost leadership gives it an edge over peers

Source: Respective company filling, ICICIdirect Research (* excludes lease rentals)

RyanAir 31-Mar-07 2.5 1.75 0.97

EasyJet 30-Sep-06 3.76 3.11 2.21

SpiceJet 31-Mar-07 2.06 2.15 1.02

Source: Respective company filling, ICICIdirect Research (* excludes lease rentals)

SpiceJet’s model
SpiceJet’s strategy is to provide safe, reliable travel at low cost from point-topoint by maximising the efficiency of all resources, keeping processes simple, and without incurring expenditure on components which do not support the basic function of travel.

Single aircraft type
The airline has a single aircraft type fleet, the Boeing 737-800, which allows for greater efficiency in maintenance, and supports its low-cost structure. The airline has a fleet of 14 new-generation Boeing 737-800 aircrafts with advanced technology and added features like blended winglets. The 737-800 is the most technologically advanced airplane in the single-aisle market. With a new wing and more powerful engines, the 737 can fly higher, faster and farther than previous models. The advanced-technology ‘Blended Winglets’ allows the airline to save on fuel, extend range, carry more pay-load and reduce engine maintenance costs. A standardised aircraft fleet helps the airline reduce costs incurred on maintenance, spares inventory, pilots training, engineering, and supervisory activities. The 737-800s can spend more hours flying, as the new jets do not need to spend much time in maintenance.

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High seat density
SpiceJet’s aircraft are configured in a single economy class having 189 seats, which is among the highest in the industry. This is possible as the airline focuses on maximum space utilisation for generating more revenue per aircraft. SpiceJet accommodates 21% more seats than a dual (business and economy) configuration. With costs like fuel, lease, maintenance remaining same per aircraft, its per-seat costs comes down by around 20%. Exhibit 13: General seat configuration among airlines in India Airline Jet Airways Kingfisher Indian Deccan Indigo Go Air SpiceJet Aircraft type B737-800 A320 A320 A320 A320 A320 B737-800 Class Dual Single Dual Single Dual Single Single Single Single Number of seats Business Economy 28 126 175 20 114 174 20 125 180 180 180 189 Total 154 175 134 174 145 180 180 180 189

Highest seating capacity among any domestic carrier

Source: Respective company’s website, ICICIdirect Research

Direct distribution of tickets
The airline sells its tickets via the Internet or call centre route. This helps it bypass travel agents who work on commissions, and expensive GDS (global distribution system) employed by FSC for ticket reservations. The mechanism also helps in reducing working capital requirements as the company receives the money in advance prior to travel. There are no receivables, and also controls bad debts. Overall it helps the company cut its distribution costs by 10% of the revenues.

High aircraft utilisation
A carrier aiming for the lowest possible cost of operation has to develop a schedule that would give a high annual utilisation of each aircraft in its fleet. Such a policy will lower cost as the fixed costs of the aircraft ownership or lease rentals can be spread over higher quantity of output (ASKM). Exhibit 14: Highest aircraft utilisation (hours)
14 12 10 8 6 4 2 0 Jet Airways Southwest SpiceJet RyanAir EasyJet Deccan 12.0 11.6 11.3

10.7

9.8

9.7

Source: Respective company filling, ICICIdirect Research

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SpiceJet has been consistently reporting high aircraft utilisation (around 12 hours a day), in line with international benchmarks. This is possible because of its high on-time performance (82% within 15 minutes) and a low turnaround time of 20-25 minutes as compared to 40-45 minutes takes by FSC. No loading of meals or complex cargo and faster check-in system helps in reducing turn around time. Overall it reduces fixed cost absorption by 15-20%.

Consolidation to result in stabilisation of yields
The Indian aviation industry has undergone through a major consolidation with the market leader Jet Airways acquiring Sahara Airlines, Kingfisher taking a stake in Deccan Airlines, and the government-owned Air India and Indian Airlines merging. Post consolidation, these three together have a combined market share of around 80%. Earlier, airlines used to sell huge inventory of tickets at low or near zero prices (Re 1/- to Rs 9/- base fare per ticket) to attract traffic and gain market share. With consolidation, the large players have shifted their focus on profitability from market share. As a result, the yields per ticket have been improving and the practice of heavy discounting has declined. SpiceJet, which has the lowest cost in the industry, will be the first beneficiary, when the yields start improving. We expect the yield (average revenue per passenger) for SpiceJet to stabilise at the current levels of Rs 2,430 for this financial year, and improve to around Rs 2,700 in FY09E. This will bring in the break-even at EBIDITA levels. Exhibit 15: Sensitivity to yields Yields fall by 10% Rs 2185 40.1 3.4 (127.9) 38.7 Rs 2430 195.0 10.1 (96.1) 7.6 Base Estimate Rs 2429 160.3 12.0 (7.5) 8.9 Rs 2700 381.1 17.8 69.8 3.4 Yields rise by 10% Rs 2670 266.4 18.0 98.8 4.9 Rs 2970 567.2 24.1 235.7 2.0

Average yields set to improve from Rs 2,430 per passenger in FY08E to Rs 2,700in FY09E

FY08E

FY09E

Yield assumption EBITDAR (Rs crore) EBITDAR margin (%) PAT (Rs crore) EV / EBIDTAR Yield assumption EBITDAR (Rs crore) EBITDAR margin (%) PAT (Rs crore) EV / EBIDTAR

Source: ICICIdirect Research

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Load factor to be maintained above industry average
Ever since its launch, SpiceJet has maintained the highest load factor in the industry. In FY06, the company achieved a PLF (passenger load factor) of 86%, which declined to 78% in FY07. Heavy discounting by airlines led to this decline, even as SpiceJet continued to sell fewer tickets at very low prices. Addition of new fleet by the company and increase in the overall industry capacity also laid pressure on load factor. Going forward, we expect the company to maintain PLF in the range of 74%-75% relatively higher than industry levels of 65%. Exhibit 16: Sensitivity to passenger load factor (PLF) PLF fall by 400 bps FY08E PLF assumption 70% EBITDAR (Rs cr) 93.9 EBITDAR margin (%) 7.4 PAT (Rs cr) (60.4) EV / EBIDTAR 15.9 FY09E PLF assumption 72% EBITDAR (Rs cr) 283.2 EBITDAR margin (%) 13.9 PAT (Rs cr) (17.5) EV / EBIDTAR 4.9
Source: ICICIdirect Research

Base Estimate 74% 160.3 12.0 (7.5) 8.9 76% 381.1 17.8 69.8 3.4

PLF rise by 400 bps 78% 216.5 15.4 48.8 6.3 80% 479.0 21.3 157.0 2.5

Crude price hike offset by fuel surcharge
Airline companies in India have adopted the internationally-tested method of passing on the cost of rising fuel prices to customers through fuel surcharge. SpiceJet has also been pro-actively increasing its surcharge in line with the industry to pass on the effect. This not only helped the company in avoiding a direct hit on its bottom-line, but also in improving the overall yields. Going forward, we expect the airline companies to continue with this surcharge and increase it in line with any rise in their fuel costs. Exhibit 17: ATF prices and corresponding fuel surcharge
50000 45000 40000 Rs / KL 35000 30000 25000 20000 Mar-05 Mar-06 Mar-07 Jul-05 Jul-06 Jan-05 Nov-05 May-05 Jan-06 May-06 Nov-06 Sep-05 Jan-07 Jul-07 May-07 Nov-07 Sep-06 Sep-07 1600 1400 1200 RS / ticket 1000 800 600 400 200 0

Cost of rising ATF prices, passed on to the customers by way of fuel surcharge

Fuel surcharge (RHS)

Delhi

Mumbai

Chennai

Kolkata

Source: IOC (Prices at 4 Metros including Sales Tax for domestic airlines), Company, ICICIdirect Research

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Aviation Turbine Fuel (ATF) forms a major part of the overall cost for airlines in India. It accounts for 40%-50% of total operating costs, the highest in the world. ATF prices in India are 60% higher than international prices. The major component of the ATF prices is taxes (see Exhibit 18), which account for 53% of the base price. ATF prices in India are based on the "International Import Parity Prices", and directly linked to the benchmark of Platt's publication of FOB Arabian Gulf ATF prices (AG); and do not relate to the actual cost of producing ATF in India. ATF prices for domestic operations also include freight charges from the Gulf to India, customs duty of 10% ad-valorem (which adds up to an effective rate of approx 20% inclusive of the CVD and cess), domestic transportation and other charges, excise duty of 8.24% (including cess), sales tax (levied by state governments) averaging across the country at 25% as add-ons to the AG prices, besides the oil companies' marketing margin, and throughput charges paid to the Airports Authority. Exhibit 18: Break-up of fuel costs Base price Custom duty (incl of CVD & cess) Excise duty Sales tax and surcharge Total taxes Marketing Margin Throughput, transportation & other charges Retail price
Source: ICICIdirect Research

Rs / litre 25.00 5.00 2.00 6.25 13.25 5.50 2.50 46.25

% to base price 20 8 25 53 22 10

Rationalisation of taxes on ATF can bring huge saving in cost for airlines

Sensitivity analysis
In our estimates, we have assumed ATF prices would increase to Rs 45 per litre in FY09E from Rs 44 per litre (as on Nov 1, 2007). Any further rise in the fuel prices will have a negative impact on our estimates. Exhibit 19: Sensitivity ATF prices ATF price fall by 10% Rs 37.5 227.4 16.9 59.5 5.9 Rs 40.5 478.6 22.4 156.6 2.6 Base Estimate Rs 41.7 160.3 12.0 (7.5) 8.9 Rs 45 381.1 17.8 69.8 3.4 ATF price rise by 10% Rs 46 98.7 7.4 (69.2) 15.1 Rs 49.5 283.6 13.3 (17.0) 4.9

FY08E

FY09E

ATF price assumption EBITDAR (Rs crore) EBITDAR margin (%) PAT (Rs crore) EV / EBIDTAR ATF price assumption EBITDAR (Rs crore) EBITDAR margin (%) PAT (Rs crore) EV / EBIDTAR

Source: ICICIdirect Research

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Fleet expansion, funding on track
SpiceJet has unveiled a phased capacity expansion over FY08-FY12. From a fleet of 11 aircrafts at the end of FY07, it plans to add 15 by FY10E, and another 8 in FY11-12E, which will take its total fleet size to 34. The company has already secured financing arrangement for the next phase of its expansion. In December 2005, it raised US$ 80 million through an FCCB (foreign currency convertible bonds) issue, proceeds of which are being utilised for the Pre-Delivery Payments (PDP) of first ten aircrafts. The subscribers to the bond issue include Goldman Sach, and Istithmar, the private equity arm of Government of Dubai. The company also has a sale and lease back arrangement with Babcock & Brown Aircraft Management and Nomura Babcock & Brown, for all 16 aircrafts to be purchased during 2007-09. The deal is valued at over US$ 1.1 billion based on the manufacturer’s list prices. Further, in January 2007, the company raised US$ 67 million (Rs 297 crore) through preferential equity allotment to strategic investors like the Tata Group, Istithmar, KBC Financial Products (UK) and BNP Paribas. Exhibit 20: Equity funding Investor US$ million Tata 18 Istithmar 31 BNP Paribas 15 KBC UK 3 Total 67
Source: Company, ICICIdirect Research

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RISK AND CONCERNS
Rising ATF prices
Rising global crude prices result in higher ATF prices. This would impose a threat to the profitability of airlines. Over the last year, ATF prices have increased by 20%. ATF being the largest single cost element (accounting for over 40% of the total operating cost), any significant rise in its price, will impact the company’s bottom-line significantly. Also, the high tax structure on ATF need to be rationalised so as to make Indian carriers globally competitive.

Inadequate infrastructure to have a negative impact
The aviation industry is currently facing huge infrastructure constraints. Over 40% of the passenger traffic is concentrated in the two main airports of Delhi and Mumbai. Both the airports have inadequate capacities to handle aircraft and passenger movement. This along with limited terminal capacity, increased congestion, outdated infrastructure, inadequate ground handling systems and poor passenger amenities have a great impact on the operations of airlines. Further, for a total fleet size of 310 aircrafts in the country, there are only around 250 parking bays. Though the government has initiated plans for infrastructural developments, any delay in infrastructure development would aggravate the problem.

Availability of skilled personnel
Rapid growth in the industry has led to a sustained shortage of pilots and other trained personnel in the industry. This is aggravated by the high gestation period (more than 3 years) required for acquiring a commercial pilot’s license. The training period for a cabin crew ranges from 6 months to one year. This shortage is driving the cost of high-skilled staff. Also, the limited availability of the required ground & maintenance staff could adversely affect growth plans of the company.

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FINANCIALS
Exhibit 21: Key assumptions Average fleet Average stage length (km) Block hours (hrs) ASKM (crore-km) Passenger Load Factor (%) Average Yield (Rs) Fuel cost (Rs/ litre) Passenger carried (million) Revenue /ASKM (Rs) Cost/ASKM ex fuel cost (Rs) Cost /ASKM (Rs) Rupee Dollar exchange rate (Rs)
Source: ICICIdirect Research

FY07 8.1 900 12 311 78 2328 37.4 2.3 2.06 1.46 2.59 44

FY08E 13.5 888 12 624 74 2429 41.7 5.2 2.15 1.26 2.28 39

FY09E 19.3 915 12 896 76 2700 45.0 7.4 2.39 1.24 2.33 38

Revenues set to surge
SpiceJet’s revenue are likely to increase at a CAGR of 83% from Rs 640 crore in FY07 to Rs 2,140 crore in FY09E on the back of capacity addition, high load factor and higher yields. In light of the increasing capacity in the industry and increase in SpiceJet’s own fleet, we expect the average load factor to remain at a low of 74% in FY08E, and then stabilise at 76% in FY09E. Exhibit 22: 83% CAGR in revenues over FY07-09E
2500 2000 Rs crore 1500 1000 500 0 FY06 FY07 FY08E FY09E

Revenues to increase at a robust CAGR of 83% over FY07FY09E

Source: Company, ICICIdirect Research

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Break-even to be achieved by FY09E
We expect the company to post profits at the net level by FY09E, as the optimal fleet size is achieved and fixed cost being absorbed over a higher capacity (ASKM). From a net loss of Rs 70.7 crore in FY07, it is likely to turnaround and post a net profit of Rs 69.8 core in FY09E. Net margins are expected to improve to 3.3% in FY09E from a negative margin of 11% in FY07. Exhibit 23: Net profit/loss and NPM
80 60 40 Rs crore 20 0 -20 -40 -60 -80 Net Profit NPM (%) (RHS) FY06 FY07 FY08E FY09E 6 4 2 0 (%) -2 -4 -6 -8 -10 -12

Source: Company, ICICIdirect Research

EBITDAR, EBITDA margins to improve
SpiceJet posted a loss of Rs 27.4 crore at the EBITDAR level in FY07, which is expected to improve to a profit of Rs 160.3 crore in FY08E and Rs 381.1 crore in FY09E. EBIDTAR margins are likely to improve from a negative of 4.3% in FY07 to a positive of 17.8% by FY09E, on back of higher yields, cost efficiencies and rationalization of operations. EBITDA margins will improve from negative of 25.6% in FY07 to 2.6% in FY09E. Exhibit 24: Increase in EBITDAR, EBIDTA margins
20 15 10 5 0 -5 -10 -15 -20 -25 -30 FY06 FY07 EBIDTAR margins (%) FY08E EBIDTA margins (%) FY09E

Source: Company, ICICIdirect Research

(%)

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VALUATIONS
At the current price of Rs 51, the stock is trading at a market cap-to-sales ratio of 0.9x FY08E sales and 0.6x FY09E sales. On an EV/EBIDTAR (earnings before interest, depreciation, tax, amortisation & aircraft rentals) basis, the stock is available at 8.9x FY08E earnings and 3.4x FY09E earnings. Globally, LCCs trade at a premium over FSCs as evidenced by higher EV/EBITDA and price/earnings multiples (Exhibit 20). Considering the fact that SpiceJet is currently in a growth phase, and is yet to achieve an optimal size, the stock trades at a discount to a FSC like Jet Airways, which is currently trading at an EV/EBIDTAR of 12x its FY07 earnings. We believe the company is set for a turnaround given the growth in the Indian aviation sector and its cost leadership. We value the stock at 4.5x it FY09E EV/EBIDTAR (a discount of 40% over Jet’s FY09E EV/ EBIDTAR of 7.5x). We rate it an OUTPERFORMER with a 12-15 months price target of Rs 68, an upside potential of 33%. Exhibit 25: Peer comparison (Estimates for FY09E) Market Cap Revenue Company Price (Rs cr) (Rs cr) SpiceJet 51 1227 2140 Deccan 147 1441 3867 Jet Airways 825 7122 13843
Source: Consensus Estimates, ICICIdirect Research

LCCs trade at a premium over FSCs because of the sustainability of their business model, and greater reach among masses.

PAT (Rs cr) 70 -108 275

EPS 2.9 -10.7 28.3

P/E 17.6 22.7

EV / EBITDAR 3.4 2.5 7.5

EV / EBITDA 13.8 -162.1 8.9

ROE 28.3 15.6

ROCE 13.8 7.9

Exhibit 26: Global valuation matrix (US$million) (latest financial year) Airline Mkt Cap Sales PAT OPM P/E Full service carriers Singapore Airlines 13503 9262 1360 9.6 9.0 British Airways 11021 16062 549 7.5 13.1 Low-cost carriers Southwest 12624 9086 499 10.3 21.6 RyanAir 12141 2869 559 21.1 20.7 EasyJet 3779 2914 169 6.3 21.0 SpiceJet 196 142 -15 -19.1 Source: Bloomberg, ICICIdirect Research

RoE EV/EBITDA 14.9 14.2 7.6 19.2 10.2 6.7 5.1 7.1 12.3 14.7 -

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FINANCIAL SUMMARY
Profit and Loss Account (Rs crore) Year to March 31 FY06 FY07* FY08E FY09E Net Sales 419.62 640.44 1340.09 2140.34 % Growth 52.62 109.24 59.72 Total Expenditure (ex lease rentals) 408.47 667.85 1179.76 1759.23 EBITDAR 11.16 -27.40 160.33 381.11 Operating profit -66.01 -164.11 -80.50 54.47 Other Income 32.33 107.84 86.67 40.81 EBIDTA -33.68 -56.27 6.17 95.28 EBIDTA margin (%) -8.03 -8.79 0.46 4.45 Depreciation 8.16 5.85 8.23 11.79 EBIT -41.83 -62.12 -2.06 83.49 Interest 4.16 4.27 2.71 3.05 PBT -46.00 -66.38 -4.77 80.44 Taxation 1.29 0.99 1.17 10.67 PAT -47.29 -67.38 -5.94 69.78 % Change YoY 77.7 42.5 -91.2 -1275.0 Shares O/S (crore) 18.43 24.07 24.07 24.07 EPS (Rs) -2.57 -2.80 -0.25 2.90 (Note: FY06 year ending June-06, *FY07 - 10 months year ending 31-Mar-07)

83% CAGR in revenues over FY07-09E

Breakeven to be achieved at net level by FY09E

Balance Sheet Year to March 31 Sources of Funds Equity Share Capital Reserves & Surplus Secured Loans Unsecured Loans Current Liabilities & Provisions Total Liability Application of Funds Net Block Capital WIP Investments Cash Trade Receivables Loans & Advances Miscellaneous Expenditure Total Asset

FY06 184.34 -197.11 359.64 61.09 163.79 571.75 49.06 362.89 0.00 63.43 7.12 79.88 9.37 571.75

FY07 240.65 -56.07 357.18 74.97 687.15 1303.88 48.38 694.35 81.22 351.05 13.50 115.38 0.00 1303.88

FY08E 240.65 -62.01 312.00 45.33 492.90 1028.87 80.15 291.00 56.22 376.62 23.86 201.01 0.00 1028.87

(Rs crore) FY09E 240.65 7.77 304.00 40.33 170.16 762.90 88.36 0.00 36.22 392.03 32.25 214.03 0.00 762.91

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Cash Flow Statement Year to March 31 Opening Cash Balance Profit after Tax Misc Expenditure w/off Dividend Paid Depreciation Provision for deffered tax Cash Flow before WC Changes Net Increase in Current Liabilities Net Increase in Current Assets Cash Flow after WC Changes Purchase of Fixed Assets (Increase) / Decrease in Investment Increase / (Decrease) in Loan Funds Increase / (Decrease) in Equity Capital Net Change in Cash Closing Cash Balance

FY06 28.97 -41.42 14.08 0.00 8.16 0.00 -19.19 70.85 16.00 35.66 (366.73) 0.00 306.60 58.93 34.46 63.43

FY07 63.43 -70.74 -12.74 0.00 5.85 0.00 -77.64 523.36 41.89 403.84 (336.63) (81.22) 11.43 290.20 287.61 351.05

FY08E 351.05 -5.94 0.00 0.00 8.23 0.00 2.29 -194.25 96.00 -287.95 363.35 25.00 -74.82 0.00 25.57 376.62

(Rs crore) FY09E 376.62 69.78 0.00 0.00 11.79 0.00 81.57 -322.74 21.41 -262.59 271.00 20.00 -13.00 0.00 15.41 392.03

Ratio Analysis Year to March 31 EPS (Rs) Book Value (Rs) Enterprise Value (Rs. Crore) EV/Sales (x) EV/EDITDAR (x) EV/EBIDTA (x) Market Cap to sales (x) Price to Book Value (x) Operating Margin (%) Net Profit Margin (%) RONW (%) ROCE (%) Debt/ Equity (x) Current Ratio Debtors Turnover Ratio Fixed Assets Turnover Ratio

FY06 -2.57 -0.69 1297.45 3.09 116.30 -38.53 2.24 -73.64 -8.03 -11.27 370.41 -10.25 -32.96 0.92 58.94 8.55

FY07 -2.80 7.67 1308.43 2.04 -47.75 -23.25 1.92 6.65 -8.79 -10.52 -36.50 -10.07 2.34 0.82 47.44 13.24

FY08E -0.25 7.42 1208.03 0.90 7.53 195.66 0.92 6.87 0.46 -0.44 -3.32 -0.38 2.00 1.33 56.15 16.72

FY09E 2.90 10.32 1179.62 0.55 3.10 12.38 0.57 4.94 4.45 3.26 28.09 14.09 1.39 3.96 66.36 24.22

The stock is available attractive valuations.

at

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ANNEXURE
Glossary
Term Aircraft utilisation ATF Available Seat Kilometres (ASKM) Average stage length Block hours Cost per ASKM Description Represents the average number of block hours operated per day per aircraft for the total aircraft fleet Aviation turbine fuel Represents the aircraft seating capacity multiplied by the number of kilometres the seats are flown Represents the average number of kilometres flown per flight Refers to the elapsed time between an aircraft leaving an airport gate and arriving at an airport gate Represents total cost less cargo revenue net of commissions, excess baggage, other income and non-operating revenue including interest income, divided by the ASKMs Earnings before interest, taxation, depreciation and amortization excluding Non-operating Revenues and excluding any adjustments to profit Earnings before interest, taxation, depreciation, amortisation and aircraft rentals (fixed), excluding Non-operating Revenues and excluding any adjustments to profit Revenue passenger kilometres expressed as a percentage of available seat kilometres. Represents the total number of fare paying passengers flown on all flight segments (excludes passengers redeeming their frequent flyer miles). Represents the number of kilometres flown by revenue passengers Net Passenger Revenue divided by ASKMs. Average revenue earned per passenger

EBITDA

EBITDAR

Seat Factor Revenue passengers

Revenue Passenger Kilometres (RPKM) Revenue per ASKM Yield

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RATING RATIONALE ICICIdirect endeavours to provide objective opinions and recommendations. ICICIdirect assigns ratings to its stocks according to their notional target price vs current market price and then categorises them as Outperformer, Performer, Hold, and Underperformer. The performance horizon is 2 years unless specified and the notional target price is defined as the analysts' valuation for a stock.

Outperformer: 20% or more; Performer: Between 10% and 20%; Hold: +10% return; Underperformer: -10% or more.

Harendra Kumar

Head - Research & Advisory ICICIdirect Research Desk, ICICI Securities Limited, 2nd Floor, Stanrose House, Appasaheb Marathe Marg, Prabhadevi, Mumbai – 400 025 research@icicidirect.com

harendra.kumar@icicidirect.com

Disclaimer
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