MALAYSIAN AIRLINE
Joining the LCC race
BUY (Unchanged)
Price RM2.12
Fair Value RM3.50
52-week High/Low RM2.60/RM1.80
Investment Highlights
• We maintain our BUY rating on Malaysian Airline System Bhd (MAS) with an unchanged fair value of RM3.50/share – following an analyst briefing yesterday. Our valuation continues to peg MAS at P/BV of 1.8x, at par to historical average.
• MAS’ wholly owned unit, Firefly, announced plans to acquire a fleet of 30 B737-800 between 2011 and 2015 to enable it to penetrate into the low-cost carrier (LCC) segment. Operations will start with the high-yielding Peninsular-East Malaysia routes to Kota Kinabalu and Kuching from KLIA, from mid-January onwards. Firefly will likely remain domestic focused in the foreseeable future, targeting an 80:20 cut between domestic and regional capacity within the next 2 years (which is when almost half of its planned fleet would have been delivered).
• Firefly’s initial strategy is to “cherry pick” lucrative domestic routes, tap on the under-capacity in connecting flights for the domestic market and leverage on its parent’s international connectivity via code sharing. As an indication, 20% of AirAsia X’s traffic feed into AirAsia’s regional routes.
• With the jet aircraft, Firefly’s claim of the lowest unit cost in the country (at an estimated 11.2sen/RPK versus AirAsia’s 11.7sen/ASK) - by virtue of a higher number of seats per aircraft (189) versus largely A320s (180 seats) operated by peers - allows it flexibility in terms of pricing.
• While we would expect a certain extent of yield dilution at MAS arising from traffic cannibalisation i.e. from full service yields of 24sen/RPK to LCC yields of 15-16sen/RPK (i.e. 30%-40% lower based on AirAsia’s existing systemwide yields), the latest development is positive as MAS’ LCC foray plugs existing revenue leakage to competitors.
• However, we prefer AirAsia Bhd for exposure to an LCC play given AirAsia’s far superior route network and fleet size, which enables it to better tap the growing regional demand and provides it the critical mass (in terms of passenger base and website traffic) to enable it to capitalise on ancillary initiatives. AirAsia trades at par to MAS in terms of forward PE, but at a 30- 40% discount to LCC peers.
• We are longer-term positive on MAS’ LCC strategy as it enables the group to claw back some market share that was lost to AirAsia, but value enhancement is not likely to materialize within the next 12 months due to initial losses expected to be incurred from new routes for between 1 and 2 years.
• Nonetheless, we like MAS for its: (1) massive fleet replacement story which will lead to significantly lower cost, (2) its status as a laggard in terms of valuation and share price performance versus regional peers, as well as (3) potential earnings turnaround over the next 12 months.
FORAY INTO THE LCC SEGMENT
Firefly to buy 30 B737-800s for LCC market. Below are key takeaways from the analyst briefing yesterday:
_ Itching to join the LCC hype?
MAS’ 100% owned unit, Firefly, announced plans to acquire its first fleet of jet aircraft (B737-800) to enable it to penetrate into the low cost carrier (LCC) market. Under its Phase 1 expansion, the group plans to build up the B738 fleet to 30 aircraft between 2011 and 2015, where deliveries will be frontloaded (see Table 1). Firefly currently operates a fleet of seven ATR 72—500s (turbo props) from Subang airport, deployed mainly on domestic routes within a 1-hour flight range.
Orders for the B737-800s have yet to be firmed up and chances are Firefly may utilise MAS’ existing B737-800 options for some of its purchases. To recap, MAS has firmed up orders for 35 B737-800s, which comes with an option for another 20 aircraft of the same type.
Firefly’s fleet will operate strictly a point-to-point network and single class fleet, similar to existing short-haul LCC peers. Between 13 and 20 aircraft, which will be delivered by 2012-13, will be secured via an operating lease, resulting in a minimal capital layout, but typically higher operating cost. Leases for four out of 6 expected deliveries in 2011 have already been secured.
Going by its expansion plans up till 2015, we do not foresee Firefly attempting to outgrow larger peer, AirAsia. The latter currently operates 50 A320s for its Malaysian operations and this will grow further to 76 aircraft by 2015 – which will be more than double Firefly’s fleet during the same period.
_ Domestic focus over foreseeable future
Firefly will kick start its jet aircraft operations with the Peninsula-East Malaysia crossing routes. From 15 January 2011, Firefly will operate 2x daily from KLIA to Kota Kinabalu and 2x daily KL-Kuching flights. Meanwhile, from 24 January 2011, frequencies will be increased to 3x daily for KL-KK flights and 4x daily KL-Kuching flights. These routes will be operated by two leased B737-800s.
More destinations will be announced as Firefly takes further aircraft deliveries in 2011 and we anticipate more routes involving East Malaysia from KL and potentially from Singapore to other parts in Malaysia – given strong traffic flows on these routes.
We note that these initial routes are higher yielding routes due to the lack of alternative transportation. Our chat with AirAsia in the past underlines this fact – AirAsia’s top three highest yielding routes by sequence are: (1) KL-Kota Kinabalu; (2) KL-Kuching; (3) KL-Singapore.
While the B737-800 attains flight range of up to 5,665km i.e. able to serve India and China markets, Firefly will remain focused on domestic routes for the foreseeable future. Over the next 2 years, management foresees an 80:20 division between domestic and regional capacity outlay – despite the fact that almost half its total orders would be delivered by 2012.
Management indicated that Firefly gets to “cherry-pick” higher yielding routes to operate in the near future, which should provide it with strong revenue base and a core network, before further expansion. The idea is for Firefly to tap on the existing under-capacity in the local domestic routes.
Case in point, flights from Europe typically arrive early on the morning (local time) but there are very few connecting flights to other destinations in the country during this specific period. Firefly’s initial strategy is to fill in this gap during its initial stages of growth before undertaking more competitive regional routes. At present, however, there is no plan for MAS to give up any of its local routes to Firefly.
_ MAS’ connectivity gives Firefly a competitive edge
Firefly’s route network, as an independent LCC, will be far smaller than AirAsia, but on a positive note, it will be able to tap on MAS’ existing robust international traffic. Currently, MAS’ feeder traffic that flows to Firefly is relatively small, but as an indication, 20% of AirAsia X’s traffic feed into AirAsia’s regional flights. Bear in mind that MAS’ international traffic is six times the size of AirAsia X’s and MAS entails much better long-haul connectivity than AirAsia X.
To further seal the feeder traffic to Firefly, management indicated that Firefly will embark on codeshare arrangements with MAS for connecting flights to local destinations. Should this strategy work out, we would not rule out Firefly expanding in a big way into the ASEAN region in the future to further expand the hub and spoke network that MAS is creating for the LCC arm. For the international markets, Firefly will need to negotiate for its own landing rights.
_ Operating out of KLIA
Firefly will be operating out of the main terminal at KLIA given the congestion at the LCCT and its planned codeshare arrangements with MAS. Despite using aerobridges, management indicated that Firefly will still strictly maintain a 30-minute aircraft turnaround time. The downside, however, is that Firefly will have to bear more expensive airport charges at KLIA versus the LCCT. Passenger service charge is 50% (or RM3) higher than the LCCT’s charge of RM6 per pax for domestic flights. For international flights, passenger service charges at KLIA’s main terminal go as high as RM51/pax versus LCCT’s RM25/pax.
Nonetheless, we note that an additional RM3 charge (for domestic flights) is negligible versus benefits that passengers attain from: (1) aerobridge usage; (2) more comfortable airport; (3) better connectivity given the larger number of airlines operating out of KLIA. To note, two other major LCCs currently operate out of KLIA, namely
Tiger and Jetstar.
_ Lowest unit cost in Malaysia
Firefly’s B738 aircraft will entail 189 seats per aircraft – circa 9 seats (or 5%) more than a typical A320 configuration of 180 seats.
Due to the higher number of seats per aircraft – Firefly is expected to manage lower unit cost than AirAsia, which operates a full A320 fleet for its Malaysian operations. As an illustration, AirAsia reported CASK of circa11.7sen in its recent 2QFY10 results.
Our back of the envelope calculation suggests that Firefly’s unit cost will likely be 5% lower than that of AirAsia’s – at 11.2sen/ASK. This is purely coming from a higher seat count per aircraft, all else being equal. The lower than peer unit cost should allow Firefly flexibility in managing pricing. Firefly is targeting a similar ancillary income contribution to the industry’s, i.e., circa 18% of total revenue and RM43/pax based on AirAsia’s 2QFY10 numbers. For a start, Firefly’s ancillary initiatives include the typical in-flight meals, checked-in baggage charges, excess baggage allowance, travel insurance, priority seating and priority baggage.
_ Ancillary income
From our meetings with AirAsia in the past, its top ancillary revenue contributors are priority seating, food & beverage, baggage charges as well as insurance. Based on our checks, Firefly’s baggage charge is similar to AirAsia’s i.e. at RM20 for a 15kg allowance while meals are priced cheaper at RM9/meal versus AirAsia’s predominantly RM12/meal.
OUR VIEWS
We gather that although Firefly’s existing turboprop operation is profitable, it will face initial losses from the new jet aircraft routes, which typically take 1-2 years to break even.
While we would expect a certain extent of yield dilution at MAS arising from traffic cannibalisation i.e. from full service yields of 24sen/RPK to LCC yields of 15-16sen/RPK (i.e. 30%-40% lower based on AirAsia’s existing systemwide yields, the latest development is positive as MAS’ LCC foray plugs existing revenue leakage to competitors, particularly AirAsia.
However, in our opinion, investors are better off with AirAsia for exposure to LCC play given its far superior route network and fleet size, which enables it to better tap the growing regional demand and provides it the critical mass (in terms of passenger base and website traffic) to enable it to capitalise on ancillary initiatives. AirAsia trades at par to MAS in terms of forward PE, but at a 30%-40% discount to LCC peers.
We are longer-term positive on MAS’ LCC strategy as it enables the group to claw back some market share that was lost to AirAsia, but value enhancement is not likely to materialise within the next 12 months due to initial losses expected to be incurred.
Nonetheless, MAS remains a BUY in our books with an unchanged fair value of RM3.50/share, pegging the group at P/BV of 1.8x, at par to historical average. We like MAS for its: (1) massive fleet replacement story which will lead to significantly lower cost, (2) its status as a laggard in terms of valuation and share price performance versus regional peers, as well as (3) potential earnings turnaround over the next 12 months.
Source/转贴/Extract/Excerpts: AmResearch
Publish date:09/11/10
