The aviation sector has been severely affected by Covid-19 in 2020, as countries implemented social distancing measures, lockdowns and closed borders, resulting to a significant restrain on air travel. We expect a prolonged impact of Covid-19 (further impeded by recent implement of MCO 2.0), especially on international travel, affecting the profits and margins of the sector. Nevertheless, we assumed a low base rebound of +64.1% YoY for passenger movement in 2021 (still 50% below 2019 levels), after a drastic drop of -75.5% in 2020. Maintain UNDERWEIGHT rating on aviation sector with SELL recommendations on AAG (TP: RM0.37) and MAHB (TP: RM4.65).

Disappointing passenger demand in 2020. While 3Q20 has shown some positive signs of domestic air travel recovery, the situation turned sour towards 4Q20, as Malaysia experienced a 3rd wave of Covid-19 since Sept. The Malaysian government has since tightened border control and movement control orders in several states, while the public are advised to stay at home and avoid crowded places. The sudden drastic drop in air passenger traffic signifies the high risk faced by the aviation sector in view of the current pandemic. For 2020, MAHB experienced a substantial drop of -75.5% YoY in passenger traffic in Malaysia, which was relatively within our assumptions of -74.8% YoY for 2020.

2021 may not be bright. The recent positive developments of the vaccines and Malaysia government securing supply for c.40% of its population has been relatively positive to the sector, as investors placed hope on air travelling to resume in the near future. However there will likely be hiccups from both supply (vaccines from the Efficacy-3 hogged mainly by high income nations) and demand (“wait and see” approach to getting jabbed). We expect Malaysia to achieve an immunization level of 20% of population by end-2021. As such, we expect that Covid-19 will still very much be around in 2021 (Economics & Strategy). Moreover, the recent implementation of stringent MCO 2.0 measures across Malaysia has further impeded the hopeful recovery of air travel, given the fast spread of 3rd wave of the pandemic. Bulk of Malaysians (as well as other nations) will likely still have to contend living in this “new normal” i.e. limited travel and continued cross border restriction in place for 2021. For 2021, we are imputing conservative assumption of +64.1% low base recovery in MAHB’s Malaysia traffic (see Figure #2), assuming recovery in 2H2021.

Lower international mix. Currently, only domestic travel is allowed with restrictions/conditions in place, while international travel remains close (unless selectively with approval). Currently governments are still exploring the potential for flights (international travel) between restricted countries (i.e. travel bubbles), depending on the severity of Covid-19 in respective countries. Regionally, there are some countries i.e. India, Indonesia, Bangladesh, Pakistan and Philippines (worldometers), which have been experiencing alarming number of Covid-19 cases, while Japan, Malaysia, Myanmar, South Korea, Sri Lanka, Hong Kong and Thailand are recording increasing numbers of new cases in recent months. Hence, we do not anticipate a smooth recovery to international air travel in the near term. With the lower international travel mix, both airlines and airport operators will lose out, as international travel command higher spending power and operational leverage, and hence higher margins. Moreover, domestic based airlines will have to operate competitively just for a piece of the now smaller domestic segment (given the limited flight opportunity for international segment).

Survivability of local airlines. Back in Malaysia, domestic based airlines are facing profitability and cash flow liquidity issues, severely affected by Covid-19 pandemic and implementation of restricted movement (including border closure) leading to a drastic drop in air passenger traffic (2020: -75.5% YoY). All the airlines are currently undertaking restructuring exercises involving cost-cutting (including retrenchment/furlough/lower salary), renegotiating with suppliers, requesting for debt haircut and raising new funds (equity and borrowings) in order to survive this difficult period.

While MAVCOM has projected a few scenarios (see Figure #6), we believe the overall outcomes are relatively negative to the aviation sector, as these scenarios highlighted the severe degree of impact to the sector within one year (or less). As we expect continued limited demand for air travel in the near term in 2021, the sector will continue to face liquidity risk and subsequently liquidation risk without any support from the government.

Higher jet fuel cost. In line with the movement in global crude oil price, jet fuel price has dropped to a low of USD22bbl in May 2020 and has since rebounded to now USD55/bbl at the start of 2021 (averaged USD46/bbl in 2020). Our O&G analyst expects average crude oil price (Brent) to trade averaging USD55/bbl for the full year 2021, indicating jet fuel price to average at USD58-60/bbl in 2021. Jet fuel cost historically constitutes c. 40% of AirAsia Group (AAG) operating cost structure. Hence, airlines’ operation costs will be affected by the higher jet fuel costs in 2021.

RM against USD and EUR. We expect RM to appreciate further against USD to average 4.00 level in 2021 (vs. average of 4.21 in 2020). A stronger RM is overall positive to the airlines (i.e. AirAsia Group and AirAsia X), given the 40-60% (under normal environment) of operating costs is denominated in USD. On the other hand, RM to depreciate against EUR to average 4.9075 level (Bloomberg forecast) in 2021 (vs. avg 4.7956 in 2020). MAHB will recognise lower translated expected losses in RM term from ISGA (denominated in EUR).

Stock Recommendations

AirAsia Group. We maintain our SELL recommendation on AAG with unchanged TP of RM0.37, based on 1x P/B tagged to FY20 BVPS. The on-going uncertainty of Covid-19 as well as the “new normal” is affecting consumer behavior in air travel demand within its geographical operations. The gradual opening of domestic and international routes is expected to introduce stiff competitions among airlines, as they now compete for a smaller market pie in order to maximize their fleet utilization. There is a further risk of AAG’s capital raising exercise (cash calls) in order to ensure sufficient liquidity as well as to recapitalise its fast deteriorating capital position.

Malaysia Airports. We maintain SELL recommendation on MAHB with higher TP: RM4.65 (from RM4.15) based on DCFE. We believe the current share reflects an optimistic scenario on travel recovery due to optimism of vaccine development. However, we expect MAHB to continue face weak passenger traffic in 1H21 (recent implementation of stringent MCO 2.0 measures across the country) and only to gradually recover into 2022-23 (provided effective vaccination program in the region to reach meaningful levels by mid-2022 with opening of country border in the region, and no further risk of evolvement of the virus strain).

Source: Hong Leong Investment Bank Research - 15 Jan 2021