The outbreak of COVID-19 has substantially affected Asia’s air travel demand (particularly China, Hong Kong and Singapore). AAGB is currently suffering low load factor and yields, while we do not expect meaningful recovery within the next 6 months. The impact on AAX is even more worrying given the weak balance sheet of the airline, and AAGB may need to step in to support AAX. Moreover, the ongoing scandal allegations on both top executives of AAGB have created more uncertainty. Nevertheless, the drop in oil price has provided some cushion to the deteriorating outlook of the group. We maintain HOLD on AAGB with lower TP: RM1.16 (from RM1.42) based on 30% discount to SOP: RM1.66, following the cut in earnings for FY20 (-74.9%) and FY21 (-28.9%).

COVID-19 affecting air travel. The recent outbreak of COVID-19 in China, affecting other 27 countries around the world has raised alerts by WHO (World Health Organisation) on the severity of the new virus. China has locked down several cities and provinces in bids to contain the virus while several countries have scrutinized their border movements. AAGB is being badly affected by a drastic drop in air travel demand as governments have imposed various bans and restrictions on air flights while people are reluctant to travel. We understand that AAGB has been cancelling flights for China sector while suffering low load factor for other sectors. At the moment, global health experts are still analysing the virus and developing the vaccines. We expect AAGB to re-adjust its capacity to more domestic and India sectors (limited number of cases) and postpone the delivery of aircrafts in 2020. We believe any recovery of air travel demand will at earliest, only be realised in 3Q20.

AAX’s loss making. We are relatively concern on AAGB’s 13.7% investment in AAX, with weak balance sheet and cash position. As at 9M19, AAX has cash of RM401m with a total debt of RM6,254m (inclusive of RM5,930m lease liabilities), of which RM806m was categorized as short term debt (inclusive of RM749m lease liabilities). For 9M19, AAX registered negative operating cashflow of RM200m (operating cash – lease payments), while its current positive cash position was sustained from its sales and leasebacks contract amounting to RM909m proceeds. We expect AAX’s loss making operation to worsen by the COVID-19 outbreak in 2020, and hence AAGB may need to step in to provide support to AAX.

Alleged scandal. Recently, AAGB has been embroiled in an alleged scandal where British authorities said Airbus SAS paid USD50m (RM220m) for the sponsorship of a racing team owned by the former’s top officials in return for an order of 180 planes (later changed to 135). Following which, Tan Sri Tony Fernandes and Datuk Kamarudin Meranun had stepped down from their executive roles for “2 months or a period that the company may deem fit”. This is to facilitate a full and independent inquiry by AAGB (appointed BDO Governance Advisory to assist in the investigation). Both founders are viewed to be the crucial factor in driving AAGB into today’s success. With this ongoing episode, we reckon that investors are likely to place discounts towards AAGB at least in the near term, given the leadership uncertainty, perceived or otherwise.

Decline in oil price. On a more positive note, global oil price has dropped to US$55/bbl (brent) due to the outbreak of COVID-19 affecting China’s demand for oil. Similarly jet fuel price has also trended down to US$63/bbl (from recent US$ 82/bbl), which will lower down AAGB’s operational costs, partially cushioning the impact of lower yields and declining load factor. However, AAGB has already hedged up to 72% (potentially higher by now) of its 2020 jet fuel requirements at brent oil price US$60/bbl.

Forecast. Cut earnings for FY20 and FY21 by 74.9% and 28.9% respectively, following cuts in the yields and load factors, partially cushioned by lower jet fuel costs.

Maintain HOLD with SOP-derived TP: RM1.16, (from RM1.42) based on unchanged 30% discount to SOP: RM1.66, following the cut in earnings. We have carried forward our valuation for Malaysia operation into FY21 as we believe FY20 will be affected by the outbreak of COVID-19, before full recovery in FY21. We have also lowered down our valuation for all other associates. Our new TP: RM1.16 implies 15% discount to AAGB’s book value of RM1.38 as at 9M19.

Source: Hong Leong Investment Bank Research - 17 Feb 2020