Time For Bottom Fishing
We find the sharp selldown on AIRA’s shares excessive as we see a positive FY14 earnings outlook, bolstered by easing competition and cost efficiencies kicking in once KLIA2 opens for operation. Hence, we maintain our BUY call and MYR3.70 FV, based on a 12x target FY14 P/E. At the current FY14 P/E of 7.1x, we view the stock as a bargain.
Selling pressure. AIRA’s share price has retreated by about 12% since the low cost carrier released its 9M13 results. We think the selldown has been excessive and was, in part, exacerbated by the US Federal Reserve’s move to start scaling back on its quantitative easing (QE) programme. We note that AIRA’s foreign shareholding has fallen to 49% as at end-November from 52% in 1H13. In our opinion, the selldown by foreign shareholders may have bottomed, noting that the previous low in late Nov 2012 was 49%.
What’s brewing at Malindo Air. Recent news reports said Malindo Air’s owners – Indonesian billionaire Rusdi Kirana (Lion Air owner) and National Aerospace Defence & Industries (NADI) – have fallen out, and that the latter may pull out from the business. We note that Malindo Air has denied any conflict among its shareholders.
Competitive pressure eases. We expect 2014 to remain a challenging year as Malindo Air continues to spread its wings, but we think the carrier may ease up on the aggressive price competition due to its high cost structure. Carriers in Malaysia are likely to focus on cost savings in FY14, but this is not new for AIRA, as cost control is instilled in its corporate culture. Should both Malindo Air and Malaysia Airlines (MAS MK, NEUTRAL, FV: MYR0.30) adopt a more conservative approach in their expansion plans and pricing strategies, this will limit the downward pressure on AIRA’s yields.
Promising earnings outlook, BUY maintained. We believe the earnings outlook remains promising for AIRA as competition wanes and as its cost structure improve further when KLIA2 commences in FY14. We maintain our BUY call on AIRA, with our FV intact at MYR3.70, based on an unchanged FY14F target P/E of 12x vs its current FY14 P/E of 7.1x. Incorporating the market cap of the group’s listed entities and valuing its unlisted Indonesia unit at 10x, the Malaysian unit’s earnings are valued at an FY14 P/E of only 5.2x.
Selldown overdone. AIRA’s share price was bashed in the recent selldown, and has fallen by 12% since it announced in November its 9M13 earnings, which we had highlighted were better than we anticipated given the intense competition. Thanks to the airline’s focus on cost control, we note that its EBITDA has risen 2.8% YTD. Hence, we are of the view that the selldown was unjustified, and was partly sparked by market nervousness over further QE tapering by the US Federal Reserve. The selling resulted in AIRA’s foreign shareholding shrinking to 49% from 52% in 1H13. Based on past trends, we think the selldown may have bottomed, as 49% was the lowest foreign shareholding in AIRA back in Nov 2012 when its share price was hovering at around MYR2.90.
What’s going on at Malindo Air. Recent news reports said Malindo Air’s owners – Indonesian billionaire Rusdi Kirana and its local JV partner, NADI – have fallen out, and that this may result in the latter exiting the business. However, we also note that Malindo Air recently denied that there was any shareholding conflict between the two shareholders. We believe that NADI may have been unhappy that Lion Air did not send its fleet to AIROD Malaysia for maintenance, repair and overhaul (MRO) as agreed under the MRO deal between the two partners. AIROD is a subsidiary of NADI.
Should NADI pull out, Lion Air will need to find a new local investor to maintain Malindo Air’s air operator’s certificate (AOC) to ensure it remains in operation. Although a change of local ownership will not affect the AOC, this may, however, impact Malindo’s air service licence (ASL). An ASL is mandatory in order to operate scheduled services, without which the only service that Malindo Air will be allowed to offer would be charter aircraft services or an unscheduled flight service.
The Present Competitive Environment
Competition is on the wane. We expect 2014 to remain a challenging year as Malindo Air continues to spread its wings, but we think the carrier will be less aggressive due to its high cost structure. We also believe Malindo Air is still incurring losses, as we notice that its airfare discounts have narrowed considerably and it has cut back the capacity on some routes. In some instances, Malindo Air’s flights were cancelled and consolidated into the next flight to ensure sufficient loads. We understand that this is already the norm for Lion Air in its home country of Indonesia.
All said, the delivery of Malindo Air’s fleet so far (it currently has six narrow-bodied aircraft) has been below its initial target of 12 aircraft. The carrier has also adopted a new strategy of expanding to regional routes, such as Indonesia, Bangkok and India, as opposed to competing for a share of the domestic market in view of the stiff competition. Comparatively, MAS appears to be sticking to its aggressive pricing strategy, but we are of the view that this is a greater concern for AIRA.
AIRA to benefit as competitors get serious on cost discipline. We believe FY14 will be a year in which carriers will cut costs to improve their profitability. However, this is nothing new for AIRA as the cost awareness has long been imbued in carrier’s corporate culture. More importantly, should Malindo Air and MAS get more conservative in their future expansion plans and pricing strategies, the downward pressure on AIRA’s yields will dissipate.
KLIA2 to be a catalyst for AIRA. Premium passengers who have been hesitant to depart from the LCCT, due to the inconvenience and the uncomfortable environment, will likely change their minds when KLIA2 opens. Moreover, the rail link between the main KLIA terminal, KLIA2 and Kuala Lumpur’s KL Sentral station will also lure premium passengers to AIRA, given the carrier’s higher flight frequencies and punctuality. This will be positive in providing upside to overall passenger yields.
In fact, AIRA has taken the opportunity to offer a “Hi Flyer” scheme tailored to the needs of business and premium passengers that provides the flexibility of flight timing and express boarding. We understand that this extra service offering has led to strong take-ups from the business community.
Capacity outlook. YTD, AIRA has taken delivery of 11 aircraft (five delivered in Dec 2013 alone), which is in line with our assumption of an average of six new aircraft for FY13. We conservatively expect AIRA to take delivery of four aircraft in FY14 and three in FY15.
In total, the AirAsia Group is expected to take delivery of 31 aircraft, although most would be deployed to its associates. As such, AIRA will reap the benefits of higher lease rental income, which we assume would grow by 18% and 10% for FY14 and FY15 respectively. With loads expected to hover at 78% for FY14-FY15 (down by 1ppt from our FY13 assumption), we expect AIRA to see its revenue passenger km (RPK) grow by 7% and 5% respectively. This is a fairly conservative assumption.
Yield outlook. While there may still be pressure on airfare yield, which we expect to drop by 1% y-o-y in FY14, this will be mitigated by the higher ancillary revenue that AIRA is expected to rake in, notably from the recent revision of its baggage weighing structure and new ancillary initiatives launched, such as “Hi Flyer” (which will make full-year impact in 2014) and new “Fly Thru”, pairings as new route offerings from its associates.
AIRA’s baggage revision and stricter passenger inspection of cabin luggage have enabled the carrier to garner the highest baggage revenue per pax collected in 3Q2013 of RM21.30/passenger. This could come in substantially stronger in the
Other new initiatives include onboard Wifi and more onboard duty-free inventories. All in, we expect AIRA’s overall yields to come on lower by a mere 0.4% (to 18.67 sen/RPK) and 1.1% (to 18.45 sen/RPK) for FY14 and FY15 respectively. This will see the carrier posting revenue growth of 7.7% and 5.1% respectively. In 9M13, AIRA saw its overall yields drop 4.3% YTD to 18.3 sen/RPK (3QFY13: -9.7% y-o-y to 18.05 sen/RPK).
Setting up new domestic hubs. AIRA will also focus on building new hubs such as in Kota Bahru and Penang, which have recorded better than expected loads. This will allow the carrier to fly to more new routes and improve aircraft utilisation as well as improve yields.
Higher earnings from associates moving forward. AIRA collectively booked in total earnings of MYR28.4m from associates in 9M13 vs MYR17.5m in FY12. This was largely due to its exit from Japan, as well as improved profitability at Expedia and AirAsia CAE Academy. Moving into 2014, we expect associate earnings to improve to MYR160m (from MYR88m in FY13) due to higher contribution from Thai AirAsia and Indonesia AirAsia, as well as lower losses from the Philippines.
Jet fuel. Jet fuel prices have been relatively flat, and moving forward, we expect it to remain so in FY14, although a slight increase in FY15 could be expected. Hence, we do not see higher jet fuel prices posing a significant threat to AIRA’s earnings.
KLIA2 to further bring down costs. We are also positive on the commencement of KLIA2 in relation to improving aircraft turnaround vs the current congestion at LCCT. AIRA believes its costs will continue to improve on potentially lower fuel burn when KLIA2 opens. Furthermore, the automated baggage handling system installed at the new airport – and the recently implemented self-baggage tagging system – are expected to lead to lower ground and baggage handling costs.
Reducing flight distance to lower fuel consumption. In its efforts to improve efficiency, AIRA will be the first carrier in Malaysia to fly the Required Navigation Performance Authorisation Required Approach (RNP-AR APCH) flight paths. Adoption of RNP-AR APCH can potentially shorten the flight distance of an aircraft and, hence, reduce fuel burn. This procedure will also help air traffic controllers reduce events such as flight delays as well as alleviate air traffic congestion. AIRA has been collaborating with GE Aviation and DCA on the nationwide flight path programme since 2012 to improve operating efficiency at 15 local airports.
Highly sensitive to yields. Carriers’ earnings are highly sensitive to yields. For a one sen change to our base-case yield assumption, earnings would swing by MYR20.4-20.8m for FY13/FY14 and MYR11.4m for FY15. This approximates to roughly 3/2% and 1% in earnings respectively.
Cost sensitivity. With jet fuel costs accounting for 44% of AIRA’s total costs given its low cost model, a USD1 revision in jet fuel price from our base case assumption of USD130 for FY13/FY14 and USD135 for FY15 would change our earnings by some MYR15-18m (or 2% of earnings).
Valuation and Recommendation
Maintain BUY. We maintain our BUY call on AIRA with our FV intact at MYR3.70, premised on an unchanged target FY14 P/E of 12x. Including the market cap of its listed entities and valuing its Indonesia unit at 10x, the Malaysian unit’s FY14 earnings are valued at a P/E of only 5.2x. AIRA is currently at an attractive FY14 P/E of 7.1x vs peer average of 11.4x (a 38% discount), and its long-term historical average of 9x. To add to its allure, the stock also offers a dividend yield of 3.3%.