AAG has converted 253 A320NEOs (186 seats) order to the larger A321 NEOs (240 seats) with first delivery by end 2019, which will further improve AAG’s costs structure and efficiency. The larger A321 NEOs address AAG’s strong passenger demand (high load factor) with issues of landing slot limitation. While the proposed RAB structure is expected to have nega tive impact on AAG in 2020, we believe the impact will be cushioned by AAG’s improving cost structure and ability to price-in the higher costs to its large customer base. In relation to China Eastern Airlines’ LCC expansion towards ASEAN market, we are not overly concern as AAG has the leading competitive advantage. We maintain our BUY recommendation with unchanged TP: RM3.35 (based on 10% discount to SOP: RM2.72 + 90sen dividend).

Larger A321 NEO in place. AAG has upsized its future fleet deliveries, converting 253 orders for the A320 NEOs to the larger A321 NEOs version. To date, AAG has placed orders for 239 A320s (delivered 224) and 353 A321 NEOs (first delivery by end 2019). We are positive on the conversion, as the larger A321 NEOs will enable AAG to offer higher capacity in response to ongoing strong demand across its network and limitation on airport landing slots. A321 NEO boasts a capacity of up to 240 seats configuration (vs. current 180-186 seats in A320). Currently, AAG has been achieving high load factor rate of 85-90% and occasionally chartering in larger A330s (377 seats) from AAX during peak period in order to meet the high passenger demand. Furthermore, A321 NEOs will enable further cost-savings (per seat basis) and ensure AAG’s leading competitiveness in the market.

RAB structure. Based on the latest release of consultation paper by MAVCOM, AAG seems to be slightly negatively affected for the required higher return for MAHB under the proposed RAB structure. Based on MAHB’s proposal (pre-tax WACC 12.7%, which is higher than MAVCOM cap at 10.88%), AAG will be affected by the higher PSC tariffs (exception to the lower KLIA2 int’l PSC tariff) and higher aircraft landing and parking charges in 2020. On the other hand, based on MAVCOM’s proposal (pre-tax WACC 10.88%), the higher KLIA2 PSC tariffs will be partially offset by the lower PSC tariffs in other airports. We believe that the negative impact will be cushioned by AAG’s continuous improvement in cost structure and its ability to price in higher costs to its large passenger base of 35m pax per annum (MAA only). Over the longer term, we opine that AAG tends to benefit from the cap in the airport charges under RAB structure (vs. guaranteed rate increase based on inflationary rate in every 5 years under current OA).

Increasing competition. Competition within the airline industry has never been dull, as existing regional FSCs struggle to protect their market shares while LCCs strive for market shares. Recently, China Eastern Airlines announced that it plans to reposition its China United Airlines subsidiary (currently a local LCC) as a regional LCC expanding into Japan, Korea and South East Asia. Within three to five years, China United will have a fleet of about 80 aircrafts (currently 51 737s), enough to handle multiple new destinations outside China. We note that China United is the first China-based LCC to officially announce to expand network into South East Asia market. We believe AAG has the leading advantage in terms of market branding, price competitiveness, innovation and costs structures, which have been proven over the years, with its ever expanding fleets, increasing market share and earnings growth.

AirAsia 3.0. Innovation and flexibility are the keys for AAG’s success. Management continues to adapt to new technologies and ideas in order keep AAG ahead of its competitors. Leveraging on the group’s strengthening core airline business and integration of digitalization, management is creating new business platforms to build new revenue stream, expand user base and improve user engagement and experience, which will eventually further enhance the group’s earnings. 3 key business platforms to be introduced/enhanced: 1) AirAsia.com website; 2) BIGPay (digital banking and money application); and 3) Teleport (cargo & logistics).

What’s next after 90 sen special dividend? Post the special 90 sen dividend (ex date 30 Jul 2019), we believe management has the ability to sustain its target for a special dividend for every 2 years, as AAG still has maturing assets to be monetized, including MAA and fleet deliveries for the next 2 years (amounting to 50 A320s and A321s). The investments in the new business platforms may take 5 years to mature before any potential monetization exercise.

Forecast. Unchanged.

Maintain BUY with unchanged SOP-derived TP: RM3.35 as we account for the attractive special dividend payout of 90sen/share. We remain positive on AAG’s outlook, given: 1) high load factors; and 2) higher yield and ancillary/other income.

Source: Hong Leong Investment Bank Research - 25 Jun 2019