JP Morgan grounds aviation stocks

Peter Negline of JP Morgan shares his views on where the Indian aviation industry is headed. He doesn't see the aviation industry moving towards profitability any time soon. He sees no signs of rational pricing emerging in aviation.

While his price target for Deccan Aviation is Rs 50 by the end of 2007, he feels that the rally in Deccan Aviation is not justified by fundamentals.

He states that he would not buy any Indian aviation stocks at this stage, and would prefer airline companies trading at 1x book value.

Excerpts on CNBC-TV18's exclusive interview with Peter Negline:

Why are you concerned about the Deccan Aviation stock?

We are concerned about the industry as much as the stock. The industry is very crowded where there are no margins. We don't know of anybody making money in the domestic market at all. We don't see the condition improving in the near term, given the rate of cash being destroyed, we are certainly worried about the prospects of some of the carriers.

Deccan has raised through asset sales and other transaction, cash that will help them survive through near term that probably being in next year or so beyond that we remain worried unless some rational behavior in the industry.

Hopes are being raised recently that maybe people are slowly moving or veering away from irrational behavior on the pricing front because prices went up a little bit for the low cost carriers of late. Do you think this industry still has a chance of sorting out those issues and can still move towards profitability?

No, we don't think it will move towards profitability in the near term. The airline industry is inherently seasonal. A week ago or so, a couple of major players announced 3-4 per cent fare increases. If I recall, about this time last year, Jet Airways announced more than 10 per cent increase and the stock rallied dramatically and that really didn't count so much in the end.

The notional prices might rise inspite of what the real price is and it's the matter of what the cost is doing in the meantime. I still feel that there is way too much competition and there are still too many people chasing for the lowest price in the market. So in our view and from all the evidence we monitor, there are no signs at all of rational behavior emerging.

On a relative basis, in a market like India, which model strikes you as more interesting - a low cost carrier or a carrier like Jet?

There is no simple answer to that question. A low cost airline can easily make a lot of money. There are other good examples of that in other jurisdictions, similarly in the full service side. We think that the Indian market is very large. It has substantial but long-term potential to grow.

There is room for carriers in both ends of the spectrum. It is just the matter of how well managed they are, how well they are executed, but at this stage, despite all the efforts of the various players, we don't see much potential.

You have got a December 2007 price target of Rs 50 for Deccan Aviation, which is nudging Rs 150 now. How did you arrive at that price?

It's priced on a bottom up fundamental valuation. I am certainly happy to admit at this stage that we have got the market wrong or got that stock wrong specifically. But in terms of the industry structure and the cut-throat brutal dynamics of the market place, I don't think we have that wrong. I think there is plenty of evidence to support our concerns there.

I think that the rally in the stock has certainly been significant, and has been well ahead of many of its peers. I am not sure whether it's fundamentally based, I think it's based more on a level of optimism of some investors that they will be take every potential - the potential for deregulation that allows foreign airlines to invest in the local market. We think that optimism is unfounded but anyway, the investors are speaking with their money, I suppose that speaks for itself for the moment.

So would you say that this is just a bounce and after this seasonal rally, the stock will go back to where it came from?

Deccan Aviation have raised cash through various transactions that will support them in the near term. Some people may view that differently from our point of view. As far as we are concerned, they have sold the last remaining asset they have.

The cupboard is bare and once that cash is consumed, and at the rate at which they are burning cash in the September quarter of more than Rs 2 billion in the quarter, they can't tolerate too many wrong consecutive quarters like that or they will be back in trouble again. This optimism is based on potential changes in the aviation policy or M&A activity.

Unless that emerges very quickly, we think that the stock is heading over. At the moment, the stock is trading about 6 times its historical book value. We think there is going to be any M&A activity in an industry where conditions are so difficult; you rather buy or invest in airline at 1 time its book value, not 6 times book value. That is one of the reasons why we think if rational behavior returns, it will positively result in rational valuation that should bring the stock down quite a bit.

At this point in time, from the three listed entities available - Jet, Deccan and Spice Jet, would you buy any of them?

No, we wouldn't be buying any of the stocks at this stage. I think they have reached the sensible fundamental valuations level on one hand and I don't see the industry rationalising. As soon as we know someone is going to collapse, I think that will be the time we want to buy. Unfortunately, I hope that will be an '07 event but I don't have extremely high level of confidence that it will happen, it could drag beyond that even.