The aviation sector has been severely affected by Covid-19, as countries implemented social distancing measures, lockdowns and closed borders, resulting to a significant restrain on travel plans. We expect a prolonged impact of Covid-19, especially on international travel, affecting the profits and margins of the sector. We do not expect the sector able to take advantage of the drop in jet fuel prices due to existing hedges, while being further dragged by RM depreciation. Maintain UNDERWEIGHT rating on Aviation sector with SELL recommendations on AAG (TP: RM0.48) and MAHB (TP: RM4.35).

Declining passenger demand. The outbreak of Covid-19 has severely affected global demand for air travel as countries implemented social distancing measures, lockdowns and closed borders, resulting to a significant restrain on travel plans. Based on MAHB statistics, passenger traffic dropped drastically in 2Q20 (see Figure #1). Like many other countries, Malaysia government has only allowed domestic air travel for now, as the control of Covid-19 has achieved satisfactory status. However, the government is still evaluating the decision in opening up international travel, for it cannot risk a new wave of imported cases. We have pen in a decline of 47.8% YoY passenger traffic in 2020, and expect a rebound of 63.2% YoY (due to low base) in 2021. However we only expect full recovery in 2022, where passenger numbers will normalise back to pre Covid-19 levels.

Lower international mix. As of today, only domestic travel is allowed with little limitations. Airlines have been relocating their capacities into domestic from international. Currently governments are still in negotiations to allow flights (international travel) between countries (i.e. travel bubbles), depending on the severity of Covid-19 in respective countries. We note that regionally, there are many countries i.e. India, Indonesia and Philippines (worldometers), still recording increasing new cases of Covid-19. We do not anticipate a smooth recovery to international air travel in the near term as long as vaccine has not been developed. With the lower international travel mix, both airlines and airport operators will lose out, as international travels command higher spending power and provide higher margins.

RAB uncertainty. The much talked RAB structure has not been implemented until today (was initially targeted by 1 Jan 2020). We expect further postponement to the implementation as the RAB will raise the effective passenger tariff charges continuously (see Figure #3). The tariff hike will not be a popular measure given the severely affected aviation and tourism industries, while the ailing national airline MAS is still undergoing restructuring exercise. Moreover, the government is strategizing towards encouraging domestic tourism as international travel is unlikely to recover in the near term. Without RAB structure in place, airport development will continue to face funding constraints, which will be negative to MAHB.

Locked in jet fuel cost. In line with the slump in global crude oil price, jet fuel price has dropped to USD40-45/bbl (from previous year of USD70-90/bbl). Our O&G analyst expects average crude oil price (brent) to trade at around current level of USD43/bbl to average USD44/bbl for the full year 2020. Jet fuel cost historically constitutes c. 40% of AirAsia Group (AAG) operating cost structure. However, we do not expect AAG to fully benefit from the YoY drop in jet fuel prices, as the group has substantial fuel hedges (more than the expected requirement for 2020, given the significant cut in flight capacity) at brent price USD61.41/bbl. AAG is restructuring 70% of its fuel hedges with its counter-parties, including a carry forward into 2021.

Source: Hong Leong Investment Bank Research - 20 Jul 2020