Investment Highlights

• Capital A (BUY, TP RM0.96) recently disclosed details of its planned exercise to dispose of its aviation business to a newly established entity, Air Asia Group (AAG). Pursuant to a transfer listing exercise which will see AAG assume the listing status of Air Asia X (Not Rated), the group will acquire all the aviation businesses from Capital A – Malaysia and four foreign operations: Philippines, Indonesia, Thailand, and Cambodia - via a purchase consideration comprising debt settlement and new share issuance worth a combined value of RM6.8bil (Exhibit 1).
  
  Capital A will retain its aviation services, logistics and digital businesses, as well as retain its intellectual properties and various licenses.
  
  There is no information memo or prospectus for now. For any major restructuring like this, shareholders’ approval is required by way of an Extraordinary General Meeting (EGM).
   

OUR VIEWS:

1. This corporate exercise essentially turns the companies into 2 types: a pure-play aviation services company and a low-cost carrier (LCC) airline. Although both are aviation plays, the drivers and risk factors are vastly different, providing an alternative investment opportunity for the discerning investor. 
    
2. Post-restructuring, Capital A is most accurately described as an aviation services company. Domestically, it is comparable to Pos Aviation (wholly-own subsidiary of POS Malaysia) as many of its core businesses overlaps. Globally, we can compare it to 3 other listed global companies: Singapore Airport Terminal Services (SATS SP, Not Rated), which happens to be Capital A's joint venture partner for its ground operations business; Cardig Aero (CASS IJ, Not Rated), and Saudi Arabia Airlines Catering (CATERING SA, Not Rated).
   
   As shown in Exhibit 3, these companies typically have a high valuation with a P/E greater than 20x. This is because of its high earnings visibility driven by traffic growth. Its operating costs are relatively stable, comprising of staff, raw materials, and depreciation and they are not affected by volatile foreign exchange rates and fuel prices. Furthermore, aviation services companies generate substantial free cash flow and are usually in a net cash position. However, there is uncertainty regarding how much debt is transferred to AAX, so the true balance sheet of Capital A postrestructuring remains unknown. Moreover, historical operating statistics of Capital A have mainly focused on the airline business, often neglecting the other ancillary businesses. Therefore, management must address these concerns for the market to accurately value the company. 
    
3. After restructuring, AAG operates as a LCC airline offering short-haul services across the Southeast Asian region, and medium-haul services to destinations across Asia and Australasia. Essentially, it has returned to its original form as a pure LCC, minus all the distortions of its extended businesses.
   
   LCCs have yet to regain their pre-pandemic momentum due to shifts in customer demand dynamics, inability to attract and retain existing staff, a narrowing cost gap against legacy carriers and a resurgence in popularity for full-service carriers. This is a global phenomenon and not specific to the challenges faced by the AirAsia Group.
   
   There are however some exceptions. Interglobe Aviation (INDIGO IN, Not Rated) of India is doing very well because 2 competitors went bankrupt (Go First, Jet Airways), and the next biggest airline, Air India, is undergoing a deep restructuring. Therefore, there is little in the way for Indigo to capture a significant market share and push for higher fares. Ryanair (RYA ID, Not Rated) and Norwegian Air Shuttle (NAS NO, Not Rated) are doing very well in Europe because competition is receding in key markets, and they have a steady growth pipeline supported by firm aircraft delivery slots, unlike competitors that are facing significant aircraft delivery delays and shortage of capacity.
   
   According to IATA, international traffic in Asia is at 85% of pre-pandemic levels with expectations for the gap to narrow by the end of 2025. The wide margin is primarily due to ongoing sanctions on Russia and strained relations between the US and China, resulting in international flights between these 2 nations operating at barely 33% of pre-pandemic levels.

Source: AmInvest Research - 8 May 2024