In this post, I will talk about airline businesses, they are one of the most classic cyclicals prone to fluctuations in crude oil prices and prevailing economic circumstances. When crude jumps suddenly during an economic expansion phase, airline tend to lose money as there is plenty of competition around and generally the lowest cost provider defines the ticket pricing. This goes on a while until someone goes bankrupt (shock in supply) leading to higher ticket prices benefitting the incumbants (eg: Jet bankruptcy in March 2019 benefitting incumbants). I will try and illustrate this with Indigo, Southwest airlines and Ryan air with data taken from tikr.
For Indian conditions, the low cost carriers like Indigo tend to make net profit margins > 10% in good times when crude prices are in check and economy is expanding (like 2010, 2017) and goes down to 0 or negative in bad times when there is a crude price shock (like 2012-13) or a general demand shock (like now).
The same applies to Southwest airlines. We can see low margins after 9/11 and the 2003 recession, 2008-09 financial crisis. These rebound in good times.
For the world’s leading low cost airline Ryan air, here are the margins. Its incredible that they do upto 20% net profit margins in good times. Indigo promoters have repeatedly said that they want to get to the same margin profile as Ryan air.
How does market value this business over time?
Indigo has been valued upto 2.5x EV/sales (translating into normalized P/E of 25x) in good times and multiples derate to 1x EV/sales (normalized P/E of ~10x) in bad times.
Here are the numbers for Southwest.
Here are the numbers for Ryan air. Market has given them valuations upto 4x EV/sales because of their very low cost structure translating into higher earnings. Again similar trend as Indigo and Southwest.
Contrary to popular perception, airline can be a good busines if managed diligently. Southwest airlines has been one of the best compounding stories in US. Since 1995, here are the returns for Southwest (after this corona crisis). For Ryanair it has been incredible, with 15% (in USD) CAGR since 1997 (excluding dividends).
Disclosure: Invested in Indigo (position size here)