Investment Highlights

• We maintain our BUY call for AirAsia despite cutting our FY19F forecast by 29% and reducing our FV by 16% to RM3.04 (from RM3.63). We believe value has emerged for AirAsia following an almost 20% correction in its share price from a peak of RM3.29 on 21 Feb 2019. Our new FV is based on 10x FY20F EPS, at a slight discount to an average of 11x of key global peers Ryanair and Southwest Airlines largely to reflect AirAsia’s relatively smaller size.

• Our earnings downgrade is largely to reflect: (1) higher jet fuel price assumptions of US$79–89/bbl in FY19-21F (vs. US$76/barrel previously); and (2) higher ex-fuel cost structure as a result of the sale and leaseback of its fleet (generally, it is costlier to lease vs. own an aircraft).

Key highlights from our recent engagement with the company are:

1. AirAsia is substantially shielded from high fuel costs in FY19–20F via hedging, but it is vulnerable to sustained high crude oil prices beyond FY20F. The group has hedged 52%, 40% and 4% of its fuel requirements in FY19–21F at US$63.41/bbl (Brent), US$59.89/bbl and US$59.23/bbl respectively.

Having considered AirAsia’s current fuel hedge positions and our house view on Brent in 2019–2021 of US$65/bbl, US$72.3/bbl and US$74.5/bbl, we now assume in our forecasts jet fuel prices of US$79/bbl, US$82/bbl and US$89/bbl in FY19–21F. For every US$1 increase in our jet fuel price assumption, AirAsia’s FY19F earnings will be reduced by 3.9%.

2. Having laughed all the way to the bank with a 40 sen per share special dividend in 2018 (funded with proceeds from the sale and leaseback of 84 aircraft), we believe AirAsia’s shareholders will have to be mindful that AirAsia’s ex-fuel cost has since substantially increased, given the cost of leasing an aircraft is substantially higher than owning it.

To recap, AirAsia in March 2018 sold 84 of its aircraft to BBAM Ltd Partnership (BBAM) for US$1.2bil (RM4.6bil) and leased back 79 of them. Subsequently, in December 2018, it announced another sale and leaseback deal involving 25 aircraft worth US$768mil (RM3.2bil) with Castlelake LP. Our forecasts assume EBIT margin in the low teens after the sale and leaseback deals, vs. the low 20s AirAsia achieved in FY17 (prior to the deals).

3. AirAsia is mindful of the intensifying competition in the regional aviation market over the short term with capacity expansion from key rivals particularly, Malindo Airways which is reported to be adding 10–15% new capacity in 2019. No helping either is the economic slowdown in China that could hurt outbound tourists from China. In 2018, excluding Singaporean tourists (which are largely day trippers by land), Chinese tourists made up of 19% of Malaysia’s total tourist arrivals, vs. 17% in 2017.

AirAsia will continue to do what it does best to stay relevant, i.e. to further reduce cost. It plans to cut its headcount by 10% by closing all its call centres by June 2019 (part of its digitalization plan). Other cost reduction initiatives in its pipeline include automation at airports to reduce ground staff, route rationalization, capacity management, cutting marketing expenditure, etc.

AirAsia is also actively engaged with its technology partners (eg. Google, Airbus [Skywise] & Palantir) to integrate machine learning, artificial intelligence (AI) and big data into its business to improve operations and efficiency. AirAsia plans to boost its fleet by 18 to 244 by end-FY19, translating to a seat capacity growth of around 10%. The group is confident on maintaining its average load factor of 85% achieved in FY18. Our forecasts assume a slightly more conservative load factor of 83% due to the intensifying competition and China’s slowdown as mentioned.

• We believe value has emerged for AirAsia after the recent correction in its share price. AirAsia is a good proxy to the growing low-cost air travel market in the region, underpinned by rising per capita incomes and a young demographic. Its strong market presence (in terms of the number of routes, and frequencies for each route) enables it to compete effectively against its rivals (both low-cost and full-service). It has struck a chord with investors with its plans to monetise some of its auxiliary businesses and assets, including its leasing arm and ground-handling unit, which could translate to special dividend payouts to shareholders.

Source: AmInvest Research - 5 Apr 2019