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2022: A year of two halves

* Omicron has significantly impacted demand, weakening the yield outlook and earnings prospects for Q4FY22

* Q3FY22 preview: we expect relatively better numbers but followed by challenges around Omicron and industry structure

* Maintain Hold rating on SJET, TP lowered to INR70 (INR82); Reduce rating on Indigo, TP edged up to INR1,615 (INR1,525)

Near-term outlook deteriorates demand could remain soft, recovery in the following quarter will depend on virus and as Omicron spreads: Domestic traffic has fallen by more than 45% in the last 10 days. Looking ahead, while Q1 CY22 (Q4FY22) vaccination developments. Although demand in both the previous COVID-19 waves took around 8-9 months to get back to ~80% of pre-COVID-19 levels, the peak levels of infections in the UK and South Africa this time were acute and brief but with a very mild impact, so the mood regarding travel is still fairly optimistic in Europe.

Before we turn too optimistic, another challenge looms… While demand recovery could resume in Q2 CY22, causing some optimism, that could be short-lived as two new airlines plan to start operations in H2 CY22. Also, Tata group is expected to take control of Air India soon after which it could consolidate its aviation business. So, the industry structure is set to fragment which could see the health of the industry deteriorate.

…that could weaken the yield outlook: Amidst all these challenges, investors are concerned about the yield outlook. The bulls think that there won’t be a fare war given that two strong airlines will be competing. While this argument has some merit, we think the fare war could be an obvious outcome of excess supply in the market. On our calculation, the industry could add 80-85 aircraft this year which could increase the gap between demand and supply, adding pressure on the load factor and yield.

Q3FY22 preview: We present our Q3 preview in this note. We forecast an INR3.1bn net loss at Indigo and INR1.7bn loss at SJET; so on a sequential basis the numbers should be much better. However, the key issues will be the trading environment and capacity outlook, neither of which looks too optimistic at the moment.

Lower SJET TP, higher Indigo TP: We have lowered SpiceJet’s TP to INR70 (from INR82) but we maintain our Hold rating. On Indigo, we edge up our TP to INR1,615 from INR1,525 but our Reduce rating remains unchanged.

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