Investment Highlights

• We maintain HOLD on Capital A (formerly AirAsia Group) with an unchanged fair value of RM0.60/share, pegged to FY24F P/E of 5x at its FY18–FY19 pre-pandemic average.

• Our fair value still incorporates a 3% premium to account for an unchanged 4-star ESG rating (Exhibit 4), underpinned by the group’s continuous efforts to replace its air fleet with more fuel-efficient Airbus A321neos from 2024 onwards which is expected to reduce carbon emissions/seat by 20%.

• We widen FY22F losses by 8% on higher fuel cost assumptions and increased finance costs as Capital A’s 1HFY22 core net loss (CNL) of RM1.4bil (stripping off group’s forex losses of RM398mil, AirAsia Thailand associate’s forex losses of RM128mil, as well as RM44mil fair value gains on derivatives) was worse than expectations, coming in at 75% of our FY22F CNL and 97% of street estimates.

• However, our FY23F–24F earnings are unchanged, anchored by expectations of solid earnings recovery in the aviation division as air travel demand gradually picks up pace amid a higher global vaccinated population alongside relaxations of international travel restrictions around the world.

• YoY, Capital A’s 1HFY22 revenue grew tremendously by 3x to RM2.3bil, mainly driven by the increase in aviation revenue from higher number of carried passengers as well as raised average fares (Exhibit 3). However, 1HFY22 CNL moderately dropped by 7%, weighed down by higher operating expenses mainly from elevated fuel costs coupled with increased interest expenses.

• QoQ, 2QFY22 revenue rose 81% to RM1.5bil, again stemming from higher aviation revenue which more than doubled to RM1.4bil from RM629mil in 1QFY22. Sequentially, the aviation segment managed to return to profitability at the EBITDA level backed by a whopping 54%-point surge in EBITDA margin in tandem with the higher revenue.

• This also gave rise to a 45%-point QoQ increase in group EBITDA margin, which led to a sequential halving in 2QFY22 CNL to RM472mil. Looking ahead, we expect the aviation segment to continue delivering a solid recovery in earnings, propelled by higher carried passengers coupled with lower operating costs as shown in the consistent downtrend in costs per available seat kilometers (excluding fuel).

• Recall that Capital A has reintroduced fuel surcharges beginning March this year, which partially offset the increase in fuel costs. Additionally, given the demand recovery in international travelling, the group also expects lower fuel costs as it gradually adds flights with longer stage lengths that consume lesser fuel.

• In 2QFY22, the group ramped up seat capacity by 33% QoQ to 6.6mil seats with a higher operational fleet size of 90 aircraft (compared to 72 aircraft in 1QFY22). Moving forward, to support the surge in air travel demand for both domestic and international markets, the group plans to restore capacity to near pre-Covid levels and fully operate all aircraft by 2QFY23. This bodes well for earnings recovery in the aviation segment, paving the path for a subsequent turnaround in the group’s FY23F earnings.

• Meanwhile, its non-aviation operations, which accounted for 12% of 1HFY22 revenue, including Asia Digital Engineering (which provides aviation maintenance, repair and overhaul services), Teleport (end-to-end logistics) and Digital (AirAsia Super App and BigPay) segments, continued to grow at a rapid 21% YoY, as the company seeks to mitigate earnings volatility in the airline business.

• The company earlier received a clean audit opinion from Ernst & Young, thus removing material uncertainty on its going concern status. We understand that management is still on track in formulating PN17 regularisation plans (to be submitted by January 2023), which are not likely to involve proposals that will result in further share dilution. Despite a lack of clarity, we gather that potential restructuring initiatives may include spinning off its airline and digital divisions in the US stock market. At this juncture, we view depressed stock market sentiments around the globe to be a key hurdle for alternative listing prospects.

• Valuation-wise, the stock is currently trading at a fair FY24F P/E of 5x, close to its 2-year FY18–FY19 prepandemic average. Key downside risks include a further slowdown in air travel demand and escalation of competitive pressures within the airline industry.

Source: AmInvest Research - 29 Aug 2022