The aviation sector has been severely affected by Covid-19, as countries implemented strict 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. Maintain UNDERWEIGHT rating on Aviation sector with SELL recommendations on AAG (TP: RM0.56) and MAHB (TP: RM4.88).

Suppressed passenger demand. The recent outbreak of Covid-19 has again affected Malaysia air travel market as FMCO/ECMO being implemented. Based on government plan, interstate travel (including air travel) will only be considered when we enter into Phase 4, targeted by Nov-Dec 2021. It was unfortunate that current situation pans out similar to our risk assessment on the sector outlook at the starting of the year. Similarly, other regional countries are also facing similar situation. Judging from the current developments, we expect domestic travel within ASEAN countries will remain suppressed until end-2021 and only gradually recover by mid-2022 with international border opening up at the same time and to only potentially enjoy meaningful recovery towards end-2022/mid-2023.

Lower international mix. Based on track records, governments will only allow for gradual opening of domestic travels when the pandemic (considered) has become under control. On the other hand, the opening of international borders policy is heavily dependent on governments’ confidence on each other’s covid-19 measures, only after respective countries domestic cases has become under control. Thus far, we have not seen successful instances of border opening between countries within Asia-Pacific. We note that regionally, there are still many countries recording high number of new cases of Covid-19 (despite the acceleration of vaccination programs) and also increasing concerns of the more deadly and infectious new virus variants. We note that Asia-Pacific governments in general have lower risk tolerance (as compare to US and European). Hence, we do not anticipate a smooth recovery to international air travel in the near term. With the lower international travel mix, airport operators will lose out, as international travels command higher spending power and provide higher margins. Similarly, majority of airlines have been relocating their capacities into domestic segment and hence stiff competitions with limited flight deployment by the respective airlines (low asset utilization).

Liquidity. During current crisis, it is utmost important to ensure strong balance sheet and enough cashflow for the day-to-day operations until the sector recover from the pandemic (potentially by mid-end 2022). In recent 1QFY21, MAHB has reported a relatively healthy balance sheet position with RM6.9bn shareholders’ equity, RM1.6bn cash, RM107m short term debt and RM23m short term lease liabilities. We do not foresee the need for MAHB to raise cash via cash call exercises even if the crisis prolong until mid-2022. Conversely, AAG has proposed rights issue of 7-years RCUIDS (redeemable convertible unsecured Islamic debt securities) with free detachable warrant to raise up to RM1bn cash. As forewarned by the management, the RM1bn will only serve as interim measure to address the near-term cash flow requirements of AAG, and more exercises/actions still need to be done to improve the group’s financial performance in the longer term. Based on 1QFY21, AAG reported -RM1.6bn shareholders’ equity (excluding -RM2.6bn MI), RM448m cash, RM847m short term debt level and RM4.0bn short term lease liabilities.

RM movement. RM has appreciated against USD, but depreciated against EUR considerably since starting of 2021. Our economist expects RM/USD to average 4.10 in 2H21 (vs. 4.10 in 1H21 and 4.04 in 2020), while Bloomberg consensus estimated RM/EUR to average 4.92 in 2H21 (vs. 4.94 in 1H21 and 4.77 in 2020). A stronger RM/USD is overall positive to the airlines (i.e. AirAsia Group and AirAsia X), given the 40-60% of normalised operating costs is denominated in USD. On the other hand, MAHB will suffer from higher losses in ISGA (denominated in EUR) will be translated into larger losses in RM term.

Stock Recommendations

Malaysia Airports. We maintain SELL recommendation with unchanged TP: RM4.88 based on SOP (from DCFE). MAHB is expected to remain in the red in the near term, as the hopeful recovery of air travel (especially in Malaysia) remains a concern. Nevertheless, management has secured enough liquidity until 2021-2022.

AirAsia Group. We maintain our SELL recommendation on AAG with unchanged TP of RM0.56, based on 8x PE tagged to FY23 EPS. While we are positive on the group’s progress in the development of AirAsia Digital and the potential listing of the unit in US stock -exchange, we reckon its aviation segment is still in dire situation. We remained concern on the current negative equity position and the proposed cash call exercise, while there is still on-going uncertainty on Covid-19 as well as the “new normal” affecting government’s decision to allow air travel within its geographical operations.

Source: Hong Leong Investment Bank Research - 14 Jul 2021