Highlights/ Comments

• Indonesia Ministry of Transport has issued notice to 13 Indonesian airlines (including Indonesia AirAsia- IAA) to improve their balance sheet equity into positive territory and increase paid up capital to IDR500bn by end July 2015 or else risk the suspension of their airline operating permits. The move was to ensure that local airlines have sufficient capital to maintain reasonable safety standards, in accordance with Law No.1/2009 on aviation.

• As at end 1Q15, IAA’s total equity stands at -IDR3tn (RM860m) with paid up capital at IDR180bn. IAA would need further injection of at least RM1bn (including additional paid up capital of IDR320bn or RM90m).

• Currently AirAsia (AAB) is in talks with Indonesia government to solve the issue. Note that AAB has previously announced IAA restructuring exercise. Details: 1)Increase share capital of IAA to US$100m (from US13.8m), an increase of US$86.2m (RM330m or IDR1.1tn). AAB contributes RM162m (to convert existing loans to IAA into equity injection) for its 49% stake. 2)Issue convertible bonds up to US$150m (RM570m or IDR 2tn) to new investors. 3)IPO exercise with a targeted value of US$700m market capitalization.

• Given the detailed capital restructuring plan and combined with IAA huge influence in tourism industry (IAA commands the largest market share in international air travel segment in Indonesia), we are least concern on the potential suspension of IAA’s operating permit. We are confident on a favorable outcome of AAG’s talk with Indonesia government.

• Furthermore, all the affected airlines – including LionAir (subsidiaries Batik Air and Cardig Air) are likely to make appeals to the government, potentially for a more reasonable (longer) time to adhere to the rulings.

• Our valuation of RM3.11 is not affected by the exercise, given that our SOP is based on P/E valuation. In the worst case scenario, we would exclude IAA valuation of RM0.13.

• In terms of earnings, AAB may need to recognize losses of RM162m for its portion of capital injection under the restructuring plan. In the worst case scenario - IAA being scrapped (highly unlikely), AAB has to impair its receivables related to IAA, amounting to RM1.4bn (50sen/share).

Risks

• World crisis (ie. War, terrorism and epidemic outbreak); surge in jet fuel price; US$ appreciation; weak air travel demand; and high speed train infrastructure between Singapore and Pulau Pinang.

Forecasts

• Maintained forecast for now, pending further information from AAG close to dead line at 31st July 2015.

Rating

• Buy

Positives

• 1) Sustaining lowest cost LCC operator in Asia with largest network and strong brand name; 2) Low jet fuel price; 3) Increasing ancillary income; and 4) Routes rationalization of major competitor MAS.

Negatives

• 1) Higher cost of living faced by consumers (from GST implementation); and 2) Regional air-demand slowdown and political issues.

Valuation

• Maintained to BUY with TP of RM3.11 based on unchanged 10% discount to SOP.

Source: Hong Leong Investment Bank Research - 8 Jul 2015