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The Pratt & Whitney (P&W) engine issues have aggravated, with parent company RTX Corporation expecting over 3,000 engine recalls for inspection (vs. earlier est. of over 1,200 engines). We estimate incremental impact on Indigo, under a worst-case scenario, to be 20-25 more aircraft on ground (AOG) at a time, on an average, for the next 3-4 years, from ~40 as of end of Jun-23. This implies ~20% total AOG on Indigo’s current fleet size. As per media reports, Indigo plans to add 20 A320ceos on damp lease in view of the upcoming peak travel season. We estimate damp lease margins to be ~10% lower vs. dry lease, although blended impact on net earnings is likely to be moderate at 6-7%. Indigo remains best-placed among peers to tackle the current challenges of engine issues and rising fuel prices. The upcoming travel season, as per our checks, is looking strong and expected yield recovery should offset cost pressures. We retain our BUY rating.

P&W engine issues linger on

P&W engines were initially impacted by high-pressure turbine hub issues, which resulted in 600 engine recalls by P&W up to CY26, while major recalls are scheduled by early CY24. This problem was further accentuated by powder metal contamination found in certain engine components, which initially necessitated over 1,200 engine recalls, while RTX Corporation’s current estimate stands at more than 3,000, spread over CY23-26, taking ~10 months’ inspection each. Currently, Indigo has ~136 aircraft using P&W engines, of which 45-50 aircrafts are grounded, as per media reports. We estimate Indigo to have ~65 AOG under the worst-case scenario. However, Indigo’s damp leasing plans of ~20 aircraft could provide support in the near term and deliveries from its existing order book with Airbus would also add up. We believe Indigo is better placed among peers through optimal leasing arrangements backed by Rs157bn free cash. The company’s dominant position should also aid in compensation.

Near-term fuel pressures visible

PSU OMCs have recently hiked domestic ATF price by 14% MoM for Sep-23 due to the increase in crude prices as well as jet fuel spreads. Brent is currently trading higher at ~USD93/bbl, thereby indicating another ~3% MoM hike for Oct-23. We estimate Indigo to report fuel cost/ASK of Rs1.7 in Q2FY24, while our FY24E estimate of Rs1.6 could turn out to be 10-12% higher at ~Rs1.8, assuming current prices prevail in H2FY24, although we believe jet fuel spreads could correct going ahead. For Indigo, a 5% higher ATF price leads to ~Rs28/share EPS loss, ceteris paribus.

Outlook and Valuation

Indigo remains well-poised to capture strong air traffic growth in India (12% CAGR over FY24-30), through maximization of destination-route mix as well as capacity additions. Indigo has a strong outstanding order book of over 980 aircraft (incl. the recently placed order for 500 aircraft) with Airbus and a target to double its fleet size by CY30. Further, Indigo is likely to keep benefitting from low competitive intensity. We value Indigo using the DCF method, with a TP of Rs3,000/share (14.8x Mar-25E target P/E (PBT) and ~20x tax-adj. target P/E). Key risks: Adverse currency/fuel prices, recession, stake sale, and operational issues. 

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