Highlights

Buffettology

Author: ZeroPointEnergy   |   Latest post: Sat, 16 Feb 2019, 11:42 PM

 

The Value of Airasia

Author:   |    Publish date:


Introduction

I am a fan of Warren Buffett, and I intend to get rich through investment like him (who doesn't).     The Investment methodology is called Buffettology.    In the following series of exercises, I would like to examine Airasia and different companies using Buffettology.     Its beneficial to answer these questions on your own, maybe you can get different answers.   

A.    BUSINESS TENETS

1.    Is the business simple and understandable?     

       Yes and No.    The core airline business is easily understandable.    Management also consistently provides very detail operational and financial information.    

       Other businesses such as BIGPAY, Rokki, eWallet are more complicated.   

       Basically Warren dislikes companies diversify, only investors do.    This is also the consensus of the academic world.   

2.     Does the business have a consistent operating history? 

       Yes.     Since listed in 2004, the company has been making increasing profits except the year 2008.    Revenue is growing at an amazing 23.7% compounded between 2005-2018.      Net Operating Income has been increasing at 25% p.a. compounded.   

3.     Does the business have favorable long-term prospects?

       Yes.      If Airasia can repeat the success in Malaysia in other ASEAN countries as well as ASIA countries, Airasia can grow 20 times larger than today.    

B.      MANAGEMENT TENETS

1.     Is management rational?

        The most important management act is allocation of the company's capital.    It is the most important because allocation of the capital, over time, determines shareholder value.   Deciding what to do with the company's earnings--reinvest in the business or return money to shareholders--in Buffett's mind, an exercise in logic and rationality.   

        Yes, Since listing in 2004 at RM1.40, Airasia has since distributed RM1.19 as dividend and special dividend.    Management also said to distribute special dividend every two years.      

2.     Is management candid with the shareholders?

        There are two parts in this, 1)    Does Airasia hide their problems in numbers?    Probably no.    2)    Does Airasia admit their mistakes?    Probably never.     3)    Does Airasia achieve what is promised?    Yes.    

3.     Does management resist the institutional imperative?

        Does management imitate illogical behaviours of other managers?   No.   

        (As an example, in the early years of Public Bank, it went into real estate too for a short period of time.    If Public Bank didn't stop, probably you won't s see it exist today.     )

C.      FINANCIAL TENETS

1.       "Focus on return on equity, not earnings per share.      "

          ROE is 24.4 for 2016, 23.4 for 2017, Maybe 29.38 for 9M2018.    

          8 is normal, 12 is good, more than that is amazing.     

          Note to say Airasia create another figure "Return on Capital Employed" which just means they take account of debts loaded to examine the real performance.   The figure is lower and meaningful.    

2.      Calculate "Owner's Earning" to get a true reflection of value.

         Warren Buffett says companies which are capital intensive needs to replace their asset (aircrafts) to stay competitive.    When he did his calculations on airline businesses years ago, he found out the Owner's Earning of Airlines businesses is negative (hence a zero sum game).    This just mean at that time airlines cannot get back their investments at the end of the aircraft's life cycle.    Few years ago, that number turns positive and Berkshire did invest in Airline businesses big time.   

          Although Airasia has very high aircraft utilisation rate (increasing from 12 to 15 hours) and bought the aircrafts much cheaper (because of its size of the order), Airasia is not much different in comparison.    Fortunately Airasia is selling its aircrafts and change into asset light mode.   

         Basically, Owner's Earning = Net Profit + Depreciation - Capital Expenditure.    

3.      Look for companies with high profit margin.

         The average gross margin for Airasia is around 21% over the period of 2005-2017.    Nothing spectacular.     However, Warren Buffett's concern is the managers of high-cost operations tend to find ways to continually add to overhead, whereas managers of low-cost operations are always finding ways to cut expenses.     Well, saving money is in Airasia's DNA.   In this regards, Airasia pass this tenet.   

4.      The One-Dollar Premise

         This is a quick test that can be used to judge not only the economic attractiveness of a business but how well management has accomplished its goal of creating shareholder value.    

          Say if a company makes RM1M, then the manager of the company will consider to distribute that RM1M as dividend or to repay debt or make new investment.     

          Too often in Bursa we see companies which makes lots of money but eventually the profit went into drain as management has wasted it.    

          Airasia on the other hand, has been increasing shareholder's fund from 952.9M in 2005 to 6710M in 2017 (Note:   1000M from TF and MK private placement).     That is slightly less than 18% growth per year.    Remarkable!

D.     MARKET TENETS

         After Warren Buffett studied all of the above, if the company pass the test, then he starts to value the business.    As we know, Warren likes to use Dividend Discount Model (DDM), and Discounted Cash Flow (DCF).    Theoretically in the longer-term, both methods equalises.    Warren uses long-term government bond rate as the discount rate.    Here, we use 3.5% only.   

         "Risk comes from not knowing what you do.     "     Therefore, in Buffettology, no risk premium is applied.   

         1.     What is the value of the business?

                 If I use Owner's Earning to calculate Present Value, then most years between 2005-2017 is making losses, but 2018 will be making 5 billion or so (because Airasia sold a lot of planes).    So, I will stick to the audited net income.    

                 Let's assume Tony Fernandes continue to work very hard, grows 15% profit a year (vs 25% historical), 10 years later finally Airasia is bigger than SIA in market cap, Tony retires. Airasia grows slower for 10 years @ 5%, then after another 10 years Flying vehicles takes over and Airasia stop to exist.   

                Present Value = RM28.92.   

         2.    Can the business be purchased at a significant discount to its value.   

         Buy at attrative price!!!!    Warren Buffett is only willing to pay 20% of the Present Value calculated above.    The remaining 80% is his "margin of safety".    

         Yes.    

 

SO, its a YES.   

 

Conclusion:    You will find most companies in Bursa cannot get through the test, if you think there are good companies which has a chance, let me know.    

 

 

 

 

 

 

 

 

 

 

 

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Labels: AIRASIA

Related Stocks

Chart Stock Name Last Change Volume 
AIRASIA 2.79 0.00 (0.00%) 3,230,300 

  6 people like this.
 
supersaiyan3 Great writing!

I guess some of the more honest companies deserve a deeper look.
17/02/2019 10:33
RainT Problem is beware of AirAsia

I have many accounting items and is volatile to oil price
17/02/2019 11:27
ChefSaham Airasia has an impressive hedging strategy against oil prices
17/02/2019 18:45
Shinnzaii Diversify also need to see diverse to which business activity mah...if the diversify business have create value to your core business then should be ok one...some diversify business also tricky because the cost is higher...hehe
18/02/2019 06:37
Springtime AA with 100million customers can think and twist on how to take an extra RM1 here and there from each customer would be enough to meet any extra costs or make extra money. Which other company in Msia has 100m cash paying customer? Genting? Banks? Telcos?
18/02/2019 06:58
Choivo Capital This is a good try. But its too surface level, and the reasoning is not deep enough.

You did not illuminate the audience on the real economic power of Airasia or whatever edge it has.

I look forward to your future pieces.
18/02/2019 14:58
newbie4444 2019 oil got hedged 100% when drop to 50+?
18/02/2019 15:04
(70B-SAPNRG-3Yrs) Philip How about BJTOTO, I dont think you can buy toto with credit. :) Isn't that an all cash business?

Is that a good business? Not necessarily.

I think author forgot to mention that until recently, Warren buffett has been avoiding airplane stocks like the plague.

Only recently has berkshire bought delta and southwest airlines due to massive consolidation in the industry to make it attractive.

The main problem with airlines is the fact that you can lose an entire plane, your business, factory and production area which is worth hundreds of millions of dollars in one single flight, with no idea what happened. The nasty surprise can be very nasty and will hit the company earnings for multiple quarters.

On top of that the main raw material is a very expensive ingredient which is subject to change on an immediate basis and affects bottomline on a huge basis, due to the fact that it is 70%+ of entire AirAsia costs, its major expenses.This is also a nasty surprise, should fuel prices spike suddenly. These 2 costs are not something that you can pass through to the customer.

Just these 2 surprises is the main reason why so many airline stocks have gone bankrupt throughout the years.

Buying airline stocks is not for the faint of heart.

Having said that, AA is a fantastic company that is the best performer in its entire industry, and is always searching for new ways to monetize the fact millions of people spend hours sitting in their planes with nothing to do and no where to go. I'm surprised Tony hasn't thought of starting up flight casinos in international air space for long haul flights.

It's just that you need to know the underlying risk in buying airline stocks. You cannot just see the happy times when all making money without knowing your risk potential for loss when bad things happen.

One big metric which you don't put in your thesis is the number of mechanical delays, failures, loss of life and crashes AA versus the competitors and industry. This is important because you need to realize the bigger scope of business of AA, the higher the rate of risk of dangerous, company affecting damage.

Just ask MAS airlines. How much was the reputation loss after MH370? How big was the drop in passenger turnover after the crash? How much many to save it?

Thoughts to ponder.
18/02/2019 15:11
(70B-SAPNRG-3Yrs) Philip If you think there is no risk premium in buying airline stocks, you are either joking or crazy...

>>>>
Therefore, in Buffettology, no risk premium is applied.


also, malaysia 10 year bond rate is at 4%-5%, so anything you buy better do than this. You can't apply US government bond rates in emerging markets in my opinion.
>>>>
Warren uses long-term government bond rate as the discount rate. Here, we use 3.5% only.
18/02/2019 15:30
Shinnzaii Posted by (S = Qr) Philip > Feb 18, 2019 03:11 PM

" I'm surprised Tony hasn't thought of starting up flight casinos in international air space for long haul flights. "

Good idea...hot air balloon aircraft casino also not bad...
18/02/2019 15:31
Jia Yi Young RM28.92??
18/02/2019 15:59
newbie8080 Present Value = RM28.92?
How do you derived this figure?
18/02/2019 18:58
PotentialGhost Perfect article
18/02/2019 19:38
Felicity On top of that the main raw material is a very expensive ingredient which is subject to change on an immediate basis and affects bottomline on a huge basis, due to the fact that it is 70%+ of entire AirAsia costs, its major expenses.This is also a nasty surprise, should fuel prices spike suddenly. These 2 costs are not something that you can pass through to the customer.

Philip,
May I know how did the70% come about?
18/02/2019 19:42
(70B-SAPNRG-3Yrs) Philip hi felicity,thanks for catching my error. I meant to say it is 30%+, or (2,821,124) as per 2017 entire operating expenses costs, the biggest and most major expense in its operation (8.3 billion). And something that is totally uncontrollable and unproducable by air asia , as hedging on the jet fuel spot futures can only go so far.

Note that the net profit for Air Asia in 2017 is 1,571,374. a 15-20% swing in jet fuel prices can hit the bottomline of Air Asia very heavily. something that we smile when crude oil prices is low, but we will rue when we realize it will be difficult to pass the costs down easily.
19/02/2019 11:04
Fabien Extraordinaire hi Phillip, what's ur take on Dialog? Any insights to share?
19/02/2019 14:23
(70B-SAPNRG-3Yrs) Philip Other than it is a storage company that charges on flat rate similar to yinson with a good growing profit with exposure to PIC I have totally no idea. I like how the rates are standardized with no relation to oil price per barrel (as compared to the negotiations of bumi armada and sapura), but I guess it will continue to do well in the future, it is in a niche market after all.
19/02/2019 16:52
(70B-SAPNRG-3Yrs) Philip This is the part where I become the oracle of Kota Kinabalu.

KUALA LUMPUR (Reuters) - Malaysia’s AirAsia X Bhd recorded its third consecutive quarterly loss on Thursday, dragged down by an impairment provision while rising fuel costs also dented its performance in the October-December period.he airline’s average fuel price rose 29 percent from $69 to $89 per barrel during the period.

>>>>

hi felicity,thanks for catching my error. I meant to say it is 30%+, or (2,821,124) as per 2017 entire operating expenses costs, the biggest and most major expense in its operation (8.3 billion). And something that is totally uncontrollable and unproducable by air asia , as hedging on the jet fuel spot futures can only go so far.

Note that the net profit for Air Asia in 2017 is 1,571,374. a 15-20% swing in jet fuel prices can hit the bottomline of Air Asia very heavily. something that we smile when crude oil prices is low, but we will rue when we realize it will be difficult to pass the costs down easily.
22/02/2019 06:07


 

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