What Happened?

The tension in the Middle East has been contained from escalating into a full-blown war after the world superpowers urged Israel and Iran to exercise caution and refrain from pursuing any emotionally charged decisions that would destabilise the region. Nonetheless, Israel and Iran stand ready for any eventuality and have activated their air defence systems to defend incoming explosive drones and missiles after a series of terrible events post Hamas attack on Israel on October 7. In a series of tit-for-tat actions that followed, Israel attempted to wipe out Hamas from Gaza and occupied territories but faced stiff retaliation not only from the latter but also from Iran’s proxies in Syria, Lebanon, Iraq and Yemen.

On April 1, an Israeli airstrike destroyed the Iranian embassy in Damascus, Syria killing 16 people. Among them were seven Islamic Revolutionary Guard Corps members, including two generals. Iran retaliated with an arsenal of more than 300 drones and missiles targeted directly at Israel on April 13, but to no avail, as 99% of them were intercepted by Israel, the US and their allies. In respond to that, Israel carried out a limited drone strike against the city of Isfahan last Friday and the Iranian’s air defence system shot them down.

What Did World Leaders Say?

The world leaders urged calm after Israel’s drone attacks, hoping to deescalate tensions in the middle east.

US: Secretary Blinken said Washington was not involved in any offensive operation and reiterated the G7’s call for de-escalation.

China: China opposed any behaviour that may further escalate tensions.

EU: President Ursula von der Layen urged all sides to refrain from further action, saying it is “absolutely necessary” for the middle east to stay stable.

Iran: The foreign minister said it was not a strike, downplaying Isfahan drone attack, and Tehran has no plans for retaliation.

Israel: Israel neither claimed responsibility nor commented on the drone attack.

Flight to Safety Mode

The rise in geopolitical tension has hurt investor confidence, prompting them to be cautious and pursuing a flight to safety approach by avoiding affected countries or sectors. For Malaysia, which is 5,900 kilometers from the warzone, we reckon the impact would be indirect and insignificant. Specifically on the transportation sector, we do not see any immediate threats to earnings unless the tit-for-tat exchange turns out to be a full-blown war between Israel and Iran, and their allies.

Shipping

At this juncture, we incline to believe that shipments of goods would remain fully operational but the cost of shipment is expected to rise due to geopolitical risk. After many incidents of shipping attacks in the Red Sea and the subsequent re-routing of cargos around Africa early this year, the cost of shipping has increased sharply (refer to report dated 16 Jan 2024). Four months later, the latest world container index has retreated to $2,719 from recent peak $3,964 (Figure 1). Having said that, it remains elevated if compared to Jan-24’s US2,000 levels.

Following the attacks between Israel and Iran, major shipping liners are on high alert again when transiting the Arabian Gulf and Western Indian Ocean as the Persian Gulf and Strait of Hormuz is very likely to be in the same situation now as the Red Sea. The Strait of Hormuz currently handles almost 30% of the world oil trade.

As far as share price is concerned, the performance of major shipping liners was mixed last week as investors are taking a wait-and-see approach. Also, we believe the muted performance fully reflects the sentiment in the Middle East, which have already been hit by the Gaza war and Red Sea crisis. Having said that, if there are any higher scale attacks on Israel and Iran later, we believe the shares of shipping liners would respond in tandem with the rise in global shipping costs.

Aviation

The impact on aviation can be seen from several Middle Eastern countries, including Jordan, Iraq and Lebanon, which have temporarily closed their airspace. That said, we reckon that airlines have already prepared for it as most of the airlines have suspended or cancelled their flights to Israel when the war on Gaza broke out on Oct 7. On Iran attack last Friday, Iran closed its airports in Tehran, Shiraz and Isfahan and airlines have changed flight paths, cancelled some flights, diverted others to alternate airports or returned to departure points, according to Reuters. These countries have reopened their airspaces and resumed flight operations shortly after the attack.

In Malaysia, no direct flights available to Israel and Iran but there are connecting flights in India, Dubai or Abu Dhabi offered mainly by Emirate, Etihad, Qatar Airways, Salam Air and Air Arabia. So, we opine that the direct impact on Capital A would be relatively small compared to major airlines in the Middle East. For Malaysia Airports’ (MAHB) wholly-owned subsidiary, Istanbul Sabiha Gokcen International airport (ISG) which contributed to 14% of MAHB’s revenue in FY23, the impact is insignificant too as Iranian passengers constitute less than 1% of total seat capacity of ISG, according to MAHB.

Oil Price Fear

Oil price was volatile last Friday, surging to a high of US$90.75/b (Brent Crude) as the news broke out but retreated to US$87.55/b on closing when Iran viewed it as a nonevent and did not plan to retaliate. We are watching the oil price closely as any unfavourable price movement can distort the recovery trend in demand. In our opinion, the overwhelming demand for air travel in this region after the implementation of visa-free entry in China means the fuel surcharge imposed by Capital A currently would remain intact. In other words, the increase in fuel cost will be passed on to passengers by raising airfare. As such, we do not think the surge in oil price will affect margins this time around unless there is an exorbitant rise in jet fuel price that will affect the demand. In our forecast, we assume crude oil to be around USD85/b and for every USD1.00 increase in fuel, our earnings estimates for Capital A will be reduced by 15.4% without any cost pass-through.

No Immediate Threat

We reiterate our view that there is no immediate threat to corporate earnings for the transportation sector unless the tit-for-tat has turned out to be a full-blown war between Israel and Iran, and their respective allies. With the limited country exposure, we continue to believe the sector earnings would grow by 68%, thanks to the robust trade activities and overwhelming demand for air-travel, which are spurred by the state of US and China economies. According to IMF report, US and China’s economies are expected to grow by 2.7% and 4.6 %, respectively in 2024.

In the event of an all-out war, global trade disruption is inevitable and would have a profound effect on the global supply-chain. As such, we continue to think that thirdparty logistics (3PL) in Malaysia will play an important role in strengthening the overall supply-chain management. The 3PL operators enable various warehousing processes, procurement and distribution of raw material, a unification between freight and customs and expedite shipment of goods. Importantly, the additional cost of having the 3PL service is insignificant if compared to the cost of operation disruptions, which is unbearable.

Recommendation

We raise Airport’s target price further to RM10.60 (RM9.94) and maintain Hold recommendation. The increase in target price is to reflect the buoyant sentiment underpinned by the new operating agreement signed with the government and rumours about privatisation. Meanwhile, for Capital A, we put our recommendation under review with unchanged target price of RM0.77, pending the announcement of restructuring plan this week. We reiterate our neutral stance on the sector. Top pick is Westports (Buy, TP: RM4.26) as the company is one of the beneficiaries of influx of FDI in Malaysia as well as the new concession agreement, which bodes well for its future earnings growth.

Source: TA Research - 24 Apr 2024