We initiate coverage on the Aviation sector with a positive view given huge scope of growth in the Indian market. We believe that Low Cost Carriers (LCCs) will do well in the long term given attractive fares, low turnaround time (40% less) and tight control over costs. Notwithstanding near-term turbulence, rising air penetration rates, expanding middle class income and induction of fuel and cost efficient aircrafts (15% fuel savings) will enable profitable growth in coming years. We believe any industry consolidation can increase market share and profitability of strong incumbents like IndiGo and SpiceJet. We recommend a Buy on IndiGo and SpiceJet with a Target Price  of Rs 1,420 and Rs 107, respectively.

*India presents structurally a robust demand scenario: India is the fastest growing aviation market with domestic passenger traffic CAGR of  20% over the past five years. With an air penetration rate of 0.1 trips per capita (one of the lowest in the world) & GDP per capita above $1,500 in 2014, India is likely to imitate high growth recorded by China post 2004. On the back of strong GDP growth, domestic air traffic is expected to grow at 17% CAGR over FY18-24E as travelers shall increasingly prefer air travel on the back of increasing affordability and narrowing gap between air fares and rail fares. This coupled with the governments focus on stimulating regional traffic through the UDAN scheme shall encourage air travel to/from smaller towns & cities.

*However, Industry faces near-term turbulence: Demand for air travel is highly elastic with little pricing power for Airlines. In addition, Airlines have insignificant control over major input costs like Aviation Turbine Fuel (30-40% of sales) and volatile USD/INR (60-70% cost $ denominated) which in turbulent times can dent margins and profitability. Historically it has been observed that airlines have best pricing power when demand and supply grows in a band of 11-15%, any deviation from this band usually results in weakening of yields. Given that airports operated at 93% of their passenger handling capacity in FY18, slow pace of Airport infrastructure development can drag growth rates.

*Industry consolidation can improve pricing power: The environment of high costs and low fares is putting severe pressure on the finances of airlines especially for an FSC like Jet Airways or Vistara, given higher cost structure as compared to a LCC like an IndiGo or SpiceJet. This coupled with the precarious balance sheets of most airlines in India, one cannot rule out consolidation in terms of fleet/route rationalization or a merger in the near term which will bring back some pricing power in the industry.

*LCCs to dominate the sky: Leveraging the benefits of operating on a simplified and low cost structure, LCCs offered low fares proposition to the price elastic Indian travelers. From virtually having no share in the market in FY05, today LCCs ~command 66% of the domestic market. We remain bullish on LCCs prospects and expect them to continue gaining market share in the domestic market on the back of increased air penetration (4x to 0.4 annual trips capita by 2037) and rising middle class income.

InterGlobe Aviation

We initiate coverage on InterGlobe Aviation Ltd (INDIGO) with a Buy as we believe it shall emerge stronger from the current environment of high costs and low yields given its strong balance sheet, high operating efficiency and industry leading cost structure. Leveraging the robust domestic feeder network further strengthened by foray in regional markets, INDIGO is well placed to embark on the next phase of growth by expanding its international network. With ~400 aircrafts to be delivered over the next decade, we expect INDIGO to continue outperforming the industry with ASK, Revenue and PAT growing at a CAGR 22%, 23% and 7% respectively over FY18-21E. We value the stock at 8.5x FY21E adj. EV/EBITDAR given superior balance sheet with ~Rs117bn in net cash & cash equivalents, high operational efficiency (87% PLFs, average aircraft utilization rates of 11+ hrs) and strong growth potential. Buy with a target price of Rs. 1,420 (21% upside from CMP)

SpiceJet

We initiate coverage on SpiceJet (SJET) with a BUY given its strong presence in the high yielding regional market will enable strong growth and margin improvement. With a strong order book of fuel efficient aircrafts, long term maintenance contracts and the overhang of dilution behind it is best placed to benefit from the growth witnessed in the aviation market. We expect a CAGR of 21%/11% in Revenue/EBITDAR respectively over the next three years and value the stock at 8x FY21E adj. EV/EBITDAR. Initiate with a Buy and TP of Rs107.