- We re-affirm our HOLD rating on AirAsia (AA) at unchanged fair value of RM2.80/share following the release of 1Q13 results. 1Q13 core earnings of RM160mil were within our expectation (21% of our full year estimate) but accounted for just 18% of consensus. Operating margins were down 1pp YoY to 19.6%. Core yields were down 7% YoY if we exclude fuel surcharges (See Chart 1) while gross yields were up 1.3% mainly driven by surcharge and fees (1Q12 minimal surcharge implemented).

- It seems as if AA is sacrificing yields to maintain traffic growth – early signs of impact of new competition. In fact, since 4Q12, core yields have seen deep contraction i.e. from +1.2% to +2.4% over 1Q12 and 3Q12 to between -4.4% in 4Q12 and a deeper -7% YoY in 1Q13. Recall that AA started accelerating aircraft intake for its Malaysian ops since 4Q12 ahead of new competition.

- More importantly, loads slipped despite the sharp contraction in core yields. Core load factor (based on actual passengers carried) dropped 3pp YoY to 77.9%, while reported load factor (includes no-shows) saw a 1pp drop YoY to 79%. The impact of core yield deterioration and lower load factor was however buffered by higher ancillary per pax (+6% YoY to RM42/pax) and lower CASK (-5% YoY ex-fuel). RASK (ex-ancillary income) was down by 2% YoY.

- Management intends to maintain fuel surcharge, though we believe this will likely be dictated by competitors’ moves. Group has locked in 44% of fuel requirement at USD123/barrel (vs. spot price of circa USD116/barrel) which could mean some hedging losses going forward. The easing in fuel price (-8% YTD) could trigger competitors to lower fuel surcharge to gain traffic in a tough market environment. Our projections model in average jet fuel price of USD125/barrel (FY13-14F).

- AA is shrugging off competition from Malindo as Malindo is combining and cancelling certain flights. Our channel check suggests that Malindo is experimenting with the different time slots to maximise loads currently. The massive core yield contraction over the past 2 quarters is not fully reflective of competition yet (Malindo only started flight in end-March) and is largely the dilution impact of AA flooding additional capacity into key domestic routes to East Malaysia ahead of actual competition. As Malindo’s fleet grows (from 2 in June to 12 by year-end and 24 by end-FY14F) and accounts for a larger proportion of AA’s capacity, we see more pronounced risk of yield deterioration. AA cannot afford to lose traffic as this will have detrimental impact on its ancillary income, which accounts for 17% of revenue and up to 50% of earnings, on our estimates. Every 0.5sen drop in yields impacts FY13F earnings by 17%.

Source: AmeSecurities