Yields sink as MAS turns up heat
AirAsia’s 1H13 core net profit was below expectations, accounting for only 23% of our full-year estimate, against a typical 35-40%. This was due to an 11% yoy decline in base yields during 2Q13, substantially worse than our previous forecast for a 2% decline for 2013 as a whole.
We maintain Outperform but cut our FY13-15 core EPS forecasts 14-19%, lowering our yield assumptions as competition in the Malaysian aviation space steps up. We also increase loss forecasts for AAP and assume a weaker RM but raise estimates for IAA. Our target price is reduced, still based on the sector average 11x CY14 P/E. Long-term re-rating catalysts include AirAsia’s structural growth despite competitive challenges.
Highlights of 2Q13
We were disappointed with the 2Q13 results as Malaysia AirAsia’s (MAA) core net profit dropped 25% yoy even though jet fuel prices fell 7%. MAA cut its base fares 11% yoy in response to a 20% cut in MAS’s average domestic fares and a 6% cut to its international fares during 2Q13. MAS had priced aggressively to fend off the Malindo threat. MAA also discounted to stimulate demand in the run-up to the 5 May general elections. Despite the lower fares, the load factor did not budge, suggesting weak demand and heavy competition. On the associates side, TAA’s and IAA’s earnings grew 63-85% yoy but AAP’s losses were unchanged and AAJ’s losses more than doubled yoy. All associates combined produced a net loss for 2Q13, albeit slightly lower yoy.
MAS and Malindo culprits
MAS’s strategic objective in 2013 is to increase the utilisation of its fleet and grow capacity even if it comes at the expense of yields. Its domestic and international capacity increased 19-20% yoy during 2Q13, necessitating deep cuts to its fares. Malindo’s flights to East Malaysia also added new capacity. We note, however, that from now until year end, the pace of capacity increase should moderate, leading to a slower pace of expected yield declines.
AAP to take a bashing
Even though we raise our forecasts for IAA, this will be more than offset by a substantial rise in AAP losses as fuel taxes have increased.
Yield pressure linked to substantial capacity injection
The 2Q13 conference call was hosted by Tan Sri Tony Fernandes together with his management team. The Q&A session only lasted five minutes so there is not much to report, except that AirAsia assured analysts that the worst of the yield declines are likely to be over. Our analysis of forward capacity suggests that this could be true.
Why did yields decline? The Malaysian yield environment deteriorated in 2Q13 for the following reasons:
• The run-up to the general elections held on 5 May saw many Malaysians postpone their travel plans as many were keen to remain in the country to vote. As a result, AirAsia had to stimulate demand with lower fares.
• Malindo started operations in May 2013 and although AirAsia initially claimed that Malindo had no impact on its yields, AirAsia’s key competitor MAS aggressively matched Malindo’s pricing and, in the end, also forced a response from AirAsia.
• Over and above Malindo’s presence, MAS also expanded its domestic and international capacity 19-20% yoy during 2Q13 and priced aggressively to fill that capacity with international fares cut 6% on average and domestic fares down 20% yoy.
As a result of the above, Malaysia AirAsia (MAA) cut its 2Q13 average base fares 11% yoy and this negatively affected profits. MAA’s core net profit fell from RM130.3m in 2Q12 to RM97.6m in 2Q13, a 25% decline despite jet fuel prices falling 7% yoy from US$133/barrel in 2Q12 to US$124/barrel in 2Q13.
Ancillary income/passenger rose yoy due to a depressed base.
Average total revenue/passenger declined by a lower 7.5% yoy and this was due to ancillary income/passenger rising 6.3% yoy, which partially offset the 11% yoy fall in base fares during 2Q13. As much as we would like to give AirAsia credit for this increase in ancillary spending, the yoy improvement in ancillary income/passenger was due entirely to the easy base-year comparison. Recall that MAA had cut baggage check-in fees back in March 2012 in an attempt to increase the take-up rate but reinstated the original baggage check-in fees four months later in late-June 2012 when MAA realised that passengers did not check in more luggage just because baggage check-in fees were lower. As a result of this temporary cut in baggage check-in fees, the 2Q12 ancillary revenue/passenger was depressed and this was why per passenger ancillary income rose 6.3% yoy for 2Q13. What is disconcerting is the fact that ancillary income/passenger actually fell 7% qoq from RM42/pax in 1Q13 to RM39/pax in 2Q13, suggesting that demand was weak and MAA had to price its fares low during 2Q13 in order to attract the marginal passenger, who was unlikely to spend very much on ancillary products and services.
PLF did not budge, suggesting weak demand and plenty of alternatives. Despite MAA cutting its base fares by 11% yoy, the passenger load factor (PLF) remained unchanged at 80% during 2Q13, suggesting that passengers were spoilt for choice in an environment where MAS, Malindo and MAA were all injecting capacity. We analysed a selection of routes to East Malaysia where Malindo introduced capacity from March and saw that between January and August, total seat capacity had increased 36.3% yoy, which was likely to have been too substantial for the market to absorb all at once. MAA’s market share declined 9.8% pts as a result from the start of the year.
2H13 yield pressures likely to moderate. We note, however, that between August and December, total seat capacity will actually decline 5.6% from 102,369 seats/week to 96,648 seats/week and MAA’s market share will consequently rise by 3.2% pts to 57.4%. This was driven by Malindo cutting back capacity on Kuching and Miri and withdrawing completely from Tawau.
We think that Malindo is feeling the heat from MAS’s aggressive capacity and price response and also from AirAsia’s defensive price posture and is withdrawing from selected domestic routes due to larger-than-expected losses. In a recent interview with the Centre for Asia Pacific Aviation, Malindo CEO Mr Chandran Rama Muthy said “We don’t want to put so much capacity in domestic, where the pie is smaller”, and then proceeded to say that it will focus on international expansion from here on, with a new route launch to Dhaka on 28 August 2013, followed by likely expansion into India (Delhi, Mumbai, Kochi, Tiruchirappalli) and Indonesia (Jakarta, Medan, Bali, Batam).
Some of these routes, like Dhaka, Delhi, Mumbai and Batam, are not served by MAA, whereas virtually every domestic route is served by MAA. As such, reorientation of Malindo’s capacity expansion to international destinations is likely to ease the quantum of overall yield pressure on MAA, although we are under no illusion that yield pressure will at anytime, over the next few years, stop even for a moment.
Another point to note is that MAS, during its recent 2Q13 results conference call, said that its capacity expansion during 1H13 was driven by the combination of two factors – (1) the deployment of additional aircraft deliveries, and (2) the increase in the utilisation of its existing fleet from 10 hours/day to 11.7 hours/day. We believe that the second factor accounted for more of its capacity increase than the first. Importantly, MAS said that since it was now happy with its level of aircraft utilisation, capacity expansion going forward will largely be coming from additional aircraft deliveries. This suggests that the pace of MAS’s capacity expansion will slow from 2H13 onwards.
It could slow even more if MAS decides to get rid of the 23-odd B737-400s still being deployed within domestic Malaysia, accounting for one-third of its narrowbody fleet. If a decision is taken to retire these permanently from 2014, the domestic yield environment in Malaysia may even improve next year from a bashed-down 2013.
Our assumptions. We have factored into our model a 4.5% yoy drop in AirAsia’s base yields in 2013 (from a previous assumption of a 2% decline), followed by another 4% decline in 2014 (due to Malindo’s expansion overseas but potentially offset by better yields within domestic Malaysia) and a further 3% yoy decline in 2015. Despite ASK capacity expansion of some 10-15% yoy for MAA, the yield declines are likely to keep MAA’s core net profit for 2013 flat at RM783m but down 5% yoy in 2014 to RM747m and down a further 3% in 2015 to RM727m. In the immediate 2H13 period, we are factoring in a 3.5% yoy average base fare decline, which is slightly better than the 4.3% yoy decline we saw in 1H13, due to the reasons mentioned above.
Associates: a mixed bag of fortunes
The associates as a whole contribute next to nothing to the AirAsia group, recording a small core net loss of RM8.3m as their contribution to AirAsia in 2Q13. This comprised a relatively large RM22m profit contribution from 45%-owned Thai AirAsia (TAA), a small RM8m profit contribution from 49%-owned Indonesia AirAsia (IAA) and an even smaller RM2.5m profit contribution from 50%-owned AACOE, which is the pilot/crew training school. More than offsetting the above are RM9.6m losses attributed to AirAsia’s 40% stake in AirAsia Philippines (AAP), a final RM26.3m loss from 49%-owned AirAsia Japan (AAJ) and smaller losses from the online travel agency JV with Expedia and the loyalty-card JV with Tune Money called BIG. AAJ was sold to ANA for RM80.5m during 2Q13, realising an exceptional disposal gain of RM78.3m for AirAsia, and will be closed down shortly. Hence, we do not expect further losses from AAJ in the coming periods.
AAP is hugely problematic and the qoq rise in losses to RM9.6m (40% portion) is going to look good compared to the losses it will suffer from 2H13 onwards. As we have elaborated in depth in our recent Cebu Air report (PDF), fuel uplifted for international flights was subjected to a tax hike of around US$30/barrel from July 2013 onwards. This will hit AAP very badly because 67% of its ASKs are allocated to international routes, although it will not hit its 85%-owned subsidiary Zest Air as much as Zest is primarily a domestic carrier
TAA is doing very well, with RPK expansion of 25% yoy during 2Q13. Even though underlying yields fell 4% yoy, RASK rose 1.9% yoy as strong demand for TAA’s flights saw PLF rise 4.4% pts yoy and more than offset the lower yield. With aggressive market share expansion, TAA should increase its domestic market share by 6.6% pts and international market share by 2.4% pts between its April 2012 IPO and December 2013. This solidifies TAA’s relative competitive strength. Given the strong inflows of tourists into Thailand, we think that TAA will continue to see rapid growth in the years ahead. For more details, please see our 2Q13 results report on Asia Aviation, dated 8 August 2013 (PDF).
IAA is doing reasonably well under the circumstances given that Lion Air is the dominant LCC in Indonesia but profits remain very small relative to TAA, even though IAA’s fleet of 24 planes is just five short of TAA’s 29 planes. IAA reported a razor-thin core net profit margin of just 3.7% for 2Q13 as it is still in a heavy investment phase in terms of building up its domestic routes. ASK capacity and RPK demand rose 28-30% yoy in 2Q13. RASK rose an impressive 11% yoy, partly because the average sector length fell 15% yoy as new domestic routes were launched. However, this capacity increase was matched by a large increase in costs, with the net result being very small profits. IAA is also disadvantaged by structurally high fuel costs in Indonesia, averaging US$134/barrel in 2Q13 vs. just US$124/barrel for MAA. We think that IAA will need more time to build up the size of its profits and profit margins before it can be successfully listed.
Valuation and recommendation
We maintain our Outperform rating on AirAsia, with a reduced target price of RM3.45 on the back of 14-19% core EPS cuts due to the weaker-than-expected yield environment in Malaysia. Our target price basis remains 11x CY14 P/E, which is the sector average. We adjust our core net profit estimates for MAA based on the following assumption changes:
1. We cut our FY13 base yield assumption and now expect it to drop 4.5% yoy instead of 2% previously.
2. Our average ringgit assumption is weakened from RM3.05:US$1 to RM3.15 for our forecast period.
3. Conversely, we are now using a spot jet fuel price of US$125/barrel compared to US$130/barrel previously.
In addition, we make the following changes to our associate contributions:
1. The losses contributed by PAA are now raised significantly from RM30m loss in 2013 to RM70m loss and from RM10m loss in 2014 to RM60m loss.
2. Conversely, IAA’s contributions have been increased from RM35.8m to RM36.7m for 2013 and a more substantial increase from RM38m to RM50.9m for 2014 on the back of its improving performance.
We continue to forecast an unchanged RM40m loss contribution from AirAsia India (AAI) in 2014, followed by another RM30m loss contribution, even though we note that the recent financial results of airlines in India indicate worsening losses due to aggressive discounting. The Centre for Asia Pacific Aviation recently noted that “the current yield environment is particularly poor, with July yields down approximately 18-20% relative to the April-June quarterly average” and also that “the discounting appears to have been in vain as it has failed to stimulate the market”. The 15% depreciation of the rupee over the past three months will also add to the difficulties for AAI once it is launched by end-2013. While we recognise that there are no powerful near-term catalysts for AirAsia’s share price over the next half-year, we like the fact that AirAsia’s valuations are attractive even after our downward revision to earnings and that AirAsia will likely continue its structural growth despite competitive challenges.
Publish date: 22/08/13