Deccan Aviation: Accept

Shareholders of Deccan Aviation can tender their shares to the open offer being made at Rs 155 per share by Kingfisher Radio, UB Overseas and UB Holdings. Deccan Aviation has achieved impressive revenue growth on the back of strong expansion in passenger traffic and a rising share of low-cost carriers in the domestic aviation market. However, the company's losses at the operating level have continued to widen due to aggressive fleet and network expansion amidst a highly competitive environment.

There is little clarity at this juncture on when the company may turn in positive per share earnings. There is also considerable uncertainty about the likely business model and strategy that may be pursued for Deccan Aviation, after its acquisition by the UB group. It may, therefore, be prudent for shareholders to use the open offer to encash their holdings.

Profitability under pressure

As India's leading low-cost airline, Air Deccan connects over 65 domestic destinations through 332 flights with a fleet of 43 Airbus 320s and ATRs. The airline has about a 22 per cent share in the domestic passenger traffic. Deccan Aviation's revenues have grown from Rs 62.9 crore in 2003-04 to Rs 1,627 crore in the nine months ended March 2006-07. Over the same period, profitability has deteriorated, with the company moving from marginal profit of Rs 6 crore to loss of Rs 173 crore at the operating level. High fixed costs on account of fleet acquisition and a sharp spike in fuel costs, amidst pressure on air fares with the advent of new entrants are key reasons for the company's deteriorating profitability.

In this context, the recent consolidation moves in the sector, with Jet Airways acquiring Air Sahara and the Indian Airlines- Air India merger, could endow domestic carriers with greater pricing power. However, the benefits from such consolidation to Air Deccan could be restricted on two counts. Relying as it does mainly on price-sensitive travellers to drive growth and maintain viable utilisation levels, Air Deccan may have limited headroom to hike fares without impacting its yields. Intense competition from new entrants such as IndiGo and Go Air and aggressive capacity additions among low cost carriers could also set a cap on very sharp or sustained fare hikes in this segment.

Early turnaround?

Though the preferential allotment of equity to the UB group will bring in cash of Rs.545 crore, it also expands the equity base required to be serviced. Any savings on fixed/maintenance costs due to synergies with Kingfisher Airlines and a route rationalisation exercise between the two providers could also aid an early turnaround of Air Deccan's operations. However, Kingfisher Airlines is itself a recent entrant to the sector and its latest available financials (March 2006) show significant operating losses. Therefore, it is difficult to say if, and when, the benefits of synergies from its alliance with Kingfisher, will flow to investors in Deccan Aviation.

Shareholders should, however, note that the offer price does not seem to factor in possible gains from a turnaround in Deccan Aviation's operations. The offer price of Rs.155 is at a 8.3 per cent premium to the stock's current market price and values the company at an enterprise value of about Rs 2,800 crore, which is about 1.7 times yearly revenues.