Is Spicejet stretching its income?
(Quora moderation took my earlier post down, hence publishing this on LinkedIn again.)
A little while back I had attempted to write a small piece on the complexity of the airline business and cover in brief about how different airlines operate across the world. Here’s a link to the earlier post:
Coming to SpiceJet.
It was still early days for me as an active investor in the stock market in 2015, Spicejet was on the verge of collapse (almost an another Kingfisher in the making), the stock price had come down to almost 12 rupees a share and Ajay Singh was ready to be the “Turnaround Guy”. Rakesh Jhunjhunwala picks up a stake at 19/20 rupees a share and the stock ends the year in triple digits. The airline does not collapse and another Kingfisher episode is stopped from happening. Brilliant story.
But this is not about 2015. Cut to 2019.
Spicejet procures most of its aircrafts from Boeing, unlike Indigo which gets most of its aircrafts from Airbus.
Let’s start with Boeing.
Boeing has been engrossed in a myriad of controversies right from their controversial accounting method of the “unit cost accounting” to their 737 Max fiasco.
Boeing was able to convince the SEC in the USA (SEC is the equivalent of SEBI in USA) to get the “unit cost accounting” method approved whereby they were able to significantly defer the cost of their aircraft developments (acceptable in normal accounting methods / parlance). Everyone was comfortable till this point as long as this was applied to costs. Things got a little uncomfortable when they could do the same with their Revenues!
Basically, the SEC allowed Boeing to recognize revenues based on their expected order book and future expected earnings provided they delivered the aircraft over the next 5–10 to even 15 years. This was as good as building a house made of cards.
Then came the 737 Max controversy which landed Boeing in deep, deep trouble. It basically got all the existing aircraft grounded and made the potential order book of Boeing - worthless giving them a significant hit to future profitability and existence. Along with it, came a host of lawsuits putting significant question mark on their going concern.
Cut to Spicejet.
Spicejet has been successfully flexing its muscle with the DGCA to get swifter clearances for acquiring leases on Jet’s planes (after Jet Airways went down), profitable time slots and the close nexus of Mr. Singh with the who’s who in New Delhi is not something which is a secret. ET Prime wrote a detailed piece on this talking about how Spicejet is trying really hard to get a leap ahead of Indigo.
Is Spicejet cooking it’s books?
Spicejet owns 13 Boeing 737 Max aircraft in its fleet. As a result of the global ban, these aircraft remain grounded.
Now comes the interesting part.
This is an excerpt from their June 2019 quarterly earnings release which was the first Operational quarter after the March 2019 global ban of the Boeing 737 Max.
Rs. 114 cr. recognized as Other Income.
September 2019 earnings release.
Rs. 178 cr. recognized as Other Income (YTD Rs. 291 cr.).
December 2019 earnings release.
Rs. 246 cr. recognized as Other Income (YTD Rs. 537 cr.).
Ind AS 18 (The erstwhile AS9) clearly state the first principle of recognizing Revenue in the books of accounts.
“Revenue is recognized when it is probable that future economic benefits will flow to the entity and these benefits can be measured reliably.”
Being in the world of Finance, we have all heard of Contingent Liabilities but this right here is clearly a case of Spicejet recognizing Income in the form of a “Contingent Asset”. Here’s what Para 33 of Ind AS 37 states:
Contingent assets are not recognised in financial statements since this may result in the recognition of income that may never be realised. However, when the realisation of income is virtually certain, then the related asset is not a contingent asset and its recognition is appropriate.
So what did the auditors, SRBC (EY) do?
They qualified their report.
June 2019
September 2019
December 2019
However, the overall opinion of the Auditors’ have not been qualified except for the item of “Other Income” as described above.
Spicejet has issued the following note which has found an “Emphasis of Matter (EOM)” in the Auditors’ report.
Auditors’ EOM:
Let’s take a look at Spicejet’s financials:
Source: screener.in
The trailing 12 month loss arrives at Rs. 71 cr. If we remove the impact of Other Income which Spicejet has been aggressively accounting for, the figure shall stand at a loss of whopping 600 cr. And of course, we shall see a similar recognition in Q4.
Conclusion
Given the range of lawsuits occurring around Boeing and with the Presidential elections in the USA around the corner, mind you Ted Cruz was grilling the Boeing CEO in one of the hearings, the outcome of the hearing can swing to any direction. Moreover, there have also been talks doing the rounds about a bailout package for various airlines in the USA on account of the Covid - 19 situation.
Keeping the above mentioned factors in mind, it is still a tremendously big risk lying in Spicejet’s books of accounts which cannot be ignored.
If you’re willing to take the risk, feel free to invest.
On the positive side, crude prices have softened to mutli-decade lows, airline industry in India has been in consolidation mode, more airports are getting linked under the Udan scheme and more and more Indians have started travelling by air compared to other traditional modes like railways, buses and cars.
(I am not a SEBI registered Investment Advisor, please do your own due diligence before investing.)
Sources:
https://www.bseindia.com/xml-data/corpfiling/AttachHis/e02dc037-94ab-43fd-8e9c-d10bce2974cf.pdf
https://www.bseindia.com/xml-data/corpfiling/AttachHis/8d5624d9-1a46-4a21-9e4b-3df7b04a16f0.pdf
https://www.bseindia.com/xml-data/corpfiling/AttachHis/20190252-e9c0-4eac-8bfd-aeb34e6c0e8b.pdf