Friday, September 6, 2013

Overweight call on airline sector stays

Overweight call on airline sector stays
By RHB Research Institute
Overweight (maintained)

THE airlines we cover generally saw a seasonally weaker second quarter as loads weakened owing to lower-than-expected demand amid aggressive capacity expansion.

Among the carriers that saw improved loads quarter-on-quarter (Malaysia Airlines, Garuda and AirAsia), yields were sacrificed to boost passenger volume.

All carriers except Thai Airways and AirAsia X (AAX) saw double-digit growth year-to-date (ytd) in first half of 2013 in terms of available seat kilometre (ASK) and revenue passenger kilometre (RPK).

Thai Airways increased its RPK by just 6.2% ytd due to the weak recovery in its long-haul destinations while AAX’s RPK dipped slightly, but this was somewhat distorted as the airline was still serving the routes before these were fully discontinued.

In second quarter of financial year 2013, the yields of the airlines dipped.

MAS suffered the biggest drop as its yield fell by 10.6% ytd due to intensifying domestic competition with the emergence of Malindo Air and new foreign carriers.

AirAsia’s yield also declined by 2.7% ytd.

Meanwhile, AAX was the only outperformer, raking in a higher ytd yield of 9.9% since it rationalised its routes last year to focus on core markets, and its yield from mature routes increased.

With the exception of Nok Airlines (Nok), Thai carriers, Thai Airways and Thai AirAsia (TAA) managed to maintain their yields (which were flat) due to resilient domestic demand.

Nok’s yield dipped 8% ytd, no thanks to stiff competition on its primary routes despite the stronger yields generated from its feeder routes.

Of the seven airlines we cover, first half financial year 2013 earnings for Nok, Garuda, and Thai AirAsia came within our estimates. Earnings estimates for the remaining four airlines were downgraded due to their dismal results.

AirAsia operations in Malaysia performed within expectations, although associate losses dragged its bottomline and missed our estimate.

MAS’ performance was widely expected to be disappointing, due to its sharp yield deterioration, while Thai Airway’s wider losses in second quarter financial year 2013 (+48% year-on-year) came as a negative surprise.

The latter’s first half financial year 2013 earnings shortfall against our estimates largely stemmed from yields being much lower than we anticipated due the strengthening Thai baht, higher staff costs following the union strike in early 2013 and higher advertising expenditure.

Jet fuel costs (after local currency conversion) in second quarter financial year 2013 were generally weaker by an estimated 10% q-o-q, 7% y-o-y and 3% ytd (for first half financial year 2013).

Despite the weaker jet fuel price, the overall cost per ASK rose slightly from an increase in non-fuel costs, notably on staff and advertisement expenditure spending.

The current respective local currency depreciation from the exodus of funds on concerns of the Fed tapering down its asset purchase programme – will boost our carriers’ toplines but this will be more than offset by the higher jet fuel cost.

Long-haul carriers like AAX, Thai Airways and MAS would see higher yields and passenger demand due to the weakening local currency, since air fares and vacation costs would be perceived as cheap by foreigners.

However, the higher jet fuel charges, which are typically paid in US dollars, would likely more than offset the overall positive impact of higher revenue churn.

Debt will also be affected by currency risks, as funding for some aircraft purchases are mostly done in US dollar terms.

We also note that financing is typically structured by foreign banks. Most sensitive to currency risks, in our view, are carriers with a low earnings base such as Thai Airways, MAS and AAX.

Thai AirAsia would be the least affected as it has no foreign borrowings exposure on its balance sheet.

The outlook for the Malaysian carriers we cover will continue to be challenging due to stiff competition from Malindo Air – although we think AirAsia has done fairly well in cushioning the downside impact on its yield.

Furthermore, Malindo Air seems to be shifting its focus to expanding to regional routes – which suggests that it is likely to underperform its profitability target.

In Thailand, we understand there will be two more new carriers that will offer scheduled passenger services, of which one is City Airways, which has already established its presence in charter flights with AAX and is also setting up a hub in the country.

Meanwhile, in Indonesia, Garuda continues to grow its market share for both domestic and international routes due to its award-winning high-quality services – as evidenced by its upgrade in global airline ranking.

Save for Singapore Airport Terminal Services, airports and ground handlers in our coverage – Airports of Thailand (AOT), Malaysia Airports Holdings and Cardig Aero Services – posted earnings that were well within our estimates, driven by resilient passenger growth and higher non-aeronautical revenue.

Following the earnings cut in second quarter financial year 2013, we make no changes to our earnings estimates.

We maintain our “overweight” call on the airline sector.

We foresee resilient demand, while the recent selldown in the market presents bargain-hunting opportunities for long-term investors.

Our top pick is Nok due to its attractive valuation relative to peers, coupled with its zero borrowings.

Furthermore, the under-appreciated low-cost carrier has an attractive financial year 2014 price-earnings multiple of 6.8 times and an implied financial year 2014 dividend yield of 7.4%.

Publish date: 06/09/13

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