How to analyse airline stocks

"The world has changed for airlines", said the legendary investor Warren Buffett as his company sold its entire stake in the four airline companies owned by it. COVID has badly hit the airline companies. Meetings that earlier required in-person presence are now being conducted via video conferencing and tourism travel continues to remain dismal due to fear of catching the virus along with border restrictions in various parts of the world.

However, forecasters of the industry are divided. While one camp feels that substantial part of business travel will permanently be replaced by internet calls, the other camp feels that the practice of meeting in person will return along with travel and tourism as the world emerges from COVID. While the battle over the future of airline stocks rages, as investors we need to first understand the key metrics used to analyse airline companies before we think about investing in them.

Airline companies can be broadly classified into two categories; Low cost carriers and full service carriers. Low cost carriers have lower fares and fewer frills, while full service carriers have complimentary meals, various cabin options (economy, business), and loyalty programs. Indigo can be categorized as a low cost carrier whereas Air India as a full service airline.

The metrics
One look at Interglobe aviations' (Indigo airlines) investor presentation can leave the readers scratching their heads because of all the 'ASKs'. On top of that, there are terms like load factor, EBITDAR (instead of EBITDA) and others. Let's understand some of these terms in order to better understand airlines.

ASK (available seat kilometer): It is an indicator of capacity available with the airline. It is calculated by multiplying the number of seats available on board with the distance to be flown by the airline. For example, suppose 'XYZ Airlines' operates Boeing 737-800 aircraft with a capacity of 200 seats from Mumbai to New Delhi. The distance between the two airports is around 1,148 km, which means ASK for the airlines is roughly 2,30,000 seat km (1148 X 200).

RPK (revenue passenger kilometer): It is the measure of an airlines' traffic. It reflects how many of an airline's available seats were actually sold. It is calculated by multiplying the number of seats booked by passengers with the distance flown by the airline. Taking from our previous example, let's say only 100 passengers boarded that Mumbai-New Delhi flight. Then, the RPK would be 1,14,800 passenger km (1148 X 100).

Load factor: Have you observed that every Mumbai-Delhi flight looks really crowded while a route like Delhi-Bhuj seems to be always sparsely booked? This is because the Mumbai-Delhi route has a higher load factor than Delhi-Bhuj. The load factor is the measurement used by companies to understand how filled its planes are. It is calculated by dividing RPK by ASK. SpiceJet had an industry leading load factor of 73.1 for Q2FY21 which means that 73 per cent of its fleet capacity was booked for the quarter.

Yield (passenger ticket revenue/revenue passenger kilometer): Yield is a unit economics indicator depicting the revenue earned by the airline from each passenger per kilometer. While booking a last minute ticket, we end up paying a higher price. The higher price is a result of the airline trying to increase its yield. It is calculated as total revenue generated from ticket sales divided by RPK.
For Indigo, the yield for Q2FY21 stood at Rs 4.53, which meant the airline charged Rs 4.53 to each passenger for flying a kilometer.

RASK (revenue per available seat kilometer): Revenue per available seat kilometer is measured by taking an airline's revenue in a particular period and dividing it by ASK (available seat kilometer). It is a unit measurement stating the revenue earned by the airline on each seat (empty or filled) per km flown in the given period. For Indigo, the RASK was 3.24 in Q2FY21, which means the company made a revenue of Rs 3.24 on each seat per km flown (That's certainly cheaper than your next Uber ride).

Difference between RASK and yield? The definitions of RASK and Yield look similar, yet there is a slight difference. While RASK is calculated for the complete capacity of the airline, yield is calculated only for the booked capacity.

CASK (cost per available seat kilometer): Just like RASK gave us the revenue the airline makes on each seat per kilometer flown, CASK tells us how much it costs an airline to fly one seat per kilometer. It is calculated by dividing the total expenses in a particular time period by ASK (available seat kilometer).

Indigo had a CASK of Rs 4.58 in Q2FY21, and we know that its RASK was only Rs 3.24 for that time period. This means that the company lost Rs 1.34 (RASK-CASK) on each seat per kilometer in Q2FY21.

What is the 'R' in EBITDAR?
We do understand that EBITDA (earning before interest, tax, depreciation and amortization) is a measure of calculating operating profit for businesses. But while analysing airlines, we add R, which stands for rents/restructuring costs, to EBITDA. This practice exists because rental costs (comprising lease rentals for aircrafts and engines) vary greatly among airlines. This is because of the many different ways in which they choose to finance their fleets (lease or direct ownership).
However, EBITDAR has lost most of its essence as changes in lease accounting in FY20 have led companies to account for lease rentals under interest and depreciation head now instead of rental head. Hence, the use of age old EBITDA is becoming more relevant in the airline industry.