Jet Airways: Valuation

July 1, 2013

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In the earlier article, we discussed the Etihad-Jet deal.  Etihad bought a stake in the Jet Airways by valuing the Jet’s market cap at ~$1.2B (Rs. 7000 Cr). Is this valuation correct? Let us check it out by conducting an independent valuation of Jet’s business. This is an exercise on fun basis.

Valuation is a process to identify the price at which an investor should be ready to buy Jet Airways. An important consideration in valuation is the value of the company wherein value is specified as a range and not a fixed value. For example, the value of Jet airways can be anywhere between 6000 to 7000 Cr. We will ascertain that this range is correct or not. Sometimes, value of the airline can be determined by demand and supply of similar deals in the market. We will avoid that route and value it independently.  

There are many methods to do valuation but here we will focus on the ability of the business to generate free cash flows and sustainability of the business in the long term. First, we will take up key questions that an investor should know and are discussed below.  Second, we will calculate the value of the business based on its business segments. In case of Jet airways, there are two segments – domestic and international. Domestic segment is unprofitable and may not be valued at current performance. However, international segment has turned profitable and we will value it. The calculations may be complicated for non-finance guys so you can ask your queries in comments section given below the article.

There are two key questions which an investor should ask before an investment. For Jet airways, they are as follows:  

1.       Can this airline generate free cash flow?

2.       Can this airline pay back its debt?

Let us look at these questions one by one and see how Jet airways do. You may or may not agree with this valuation and can make comments accordingly. For reference, you can check transcript of Q4 FY13 conference call – . Through this Q&A, I am going to discuss the average performance of the airline over last few years. (FY means financial year)

1.       Can this airline generate free cash flow?

Free cash flow for any firm is the cash flow available from its operations which can be distributed to its owners. This free cash flow is calculated after deducting capital expenditures and changes in working capital from net income. For simplicity, we would consider EBITDA (Earnings before interest, taxes, depreciation and amortization) for the Jet airways as a measure of the free cash flow. Average EBITDA as a percentage of sales for last five years is 13%. If you compare this to Southwest airlines, one of the best managed airlines in the world, then the average EBITDA/sales is 5.3%. You can imagine how well Jet airways did in comparison.      

It is clear that this airline can generate free cash flow.

2.       Can this airline pay back its debt?

The airline currently has a debt to the tune of $2.1 B (Rs. 10328 Cr). Out of this debt 75% is owing to aircraft and 25% is due to the working capital requirements of the business. This 25% working capital debt is perennial and will always exist for the firm. Rest 75% of the debt is a concern for any investor. The airline plans to pay back this debt through sale-lease back of the aircrafts. This means that the airline should sell its aircraft and then lease back these planes for operations. The capital received from the sale of plane can be used to pay back loans. The benefit of this model is twofold. First this should decrease the interest expense on debt used to buy the aircraft and second there will be no expense when airline wants to ground these planes. The company can pay back all of its loan by sale-lease back model in next 5 years. 

Through this analysis, we know that Jet Airways can be a debt free airline and has the ability to generate free cash flow. Plus, it has a niche in international travel market which cannot be easily destroyed. Hence it is sustainable. How much should be the value of this airline? In other words, what an investor should be ready to pay for its EBITDA or free cash flow?

We will value the company on its international segment alone.  We are not writing off domestic segment but we know that any projections on current values of domestic segment will be guess work. Plus, Jet is going to use domestic segment to fuel its growth in international segment. Since international segment constitutes roughly 60% of Jet Airways business, we can safely assume that its value will be equal to the current valuation of Jet.

Jet generated an EBITDA of $352 M from international operations in FY13. EBITDA is the proxy for free cash flow. The international segment is going to grow at the rate of 4-5%. This is a global growth rate in international traffic. The valuation of international segment of Jet airways comes out to be equal to $3.1 B based on free cash flow analysis.

On multiple basis, the airline transaction multiple, EV/EBITDA, is 11.3 times according to 2012 KPMG report. Now this means that the international segment is valued at 11.3 x $352 M = $3.9 B.

Hence the current enterprise valuation of Jet airways is anywhere between $3.1 to $3.9 B.

Let’s  take a conservative estimate of valuation at $3.1 B. Out of this valuation, if I remove the current debt of $2.1 B then the market capitalization of Jet Airways should be $3.1 B – $2.1 B = $1 B~5900 Cr. The current market cap is Rs. 4126 Cr. The company is undervalued at its current market capitalization.

In the next article, we will understand the perspective of Etihad’s valuation. We will discuss how Etihad should make much more than its investment in Jet.

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Devendra Mangani

Devendra Mangani

Devendra is working in curriculum development and assisting finance faculty at Sunstone. He has worked with RBC capital markets, an investment bank in Canada and global manufacturing organization in various roles.
He is a graduate from IIT Bombay and holds an MBA from Queen’s School of Business, Canada.

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