We believe 2023 will be earnings positive for Aviation sector after 2022 showing turnaround signs. The sector will benefit from the increasing air travel demand (especially international segment as recently Japan, South Korea, Taiwan and Hong Kong have re-opened while China could potentially reopen in 2023) and higher availability of operating aircrafts to cater for the higher demand. Furthermore, the recent depreciated USD and declined jet fuel prices will improve the sector’s profitability. Maintain OVERWEIGHT with BUY recommendations on CapA (TP: RM0.88) and MAHB (TP: RM7.75).

Sustaining recovery trend. Since Malaysia fully reopened its national borders and relaxed travel requirements in Apr 2022 (transitioned to endemic stage), we have seen a strong recovery of air travel demand. The recovery was further aided by regional ASEAN counterparts also embarking on reopening at the same time. Malaysia’s overall air travel has recovered back to 69.0% for domestic, 58.8% for ASEAN and 43.0% for International (ex-ASEAN) in Nov 2022 vs pre-pandemic levels. With the recent border reopening by South Korea, Japan, Hong Kong and Taiwan, we expect further acceleration of international air travel demand in coming months. Airlines are rushing to re-instate their fleets (subject to air worthiness after a long shut down since early 2020) as well as rehiring of staffs in order to meet the strong demand recovery.

2023: Charging ahead. Judging from the current developments, we expect Malaysia’s 2023 air travel demand to charge upwards near to pre-pandemic 2019 levels. The growth will be mainly driven by the International segment, given the recent border reopening by South Korea, Japan, Hong Kong and Taiwan as well as China potentially by mid-2023 (recently relaxed Covid-19 restrictions). We also have seen countries starting to be more aggressive in promoting their respective tourism activities. We have imputed a growth of +61.2% for 2023, up to 85.8% of pre-pandemic 2019 level.

Improving international mix. As foretold during the start of 2022, domestic travel would be first to recover as domestic travel policy is easier to implement and within the control of the government. As more countries reopened since 2Q22 (especially ASEAN), we have seen strong catch up for regional ASEAN travel demand, and only followed by International – non ASEAN (see Figure #1) and improving international travel mix (see Figure #3). For 2023, we expect growth to be mainly driven by international travel segments, further accelerating improving international travel mix, benefiting the overall Aviation sector given that international travel command higher spending power and provide higher margins.

Liquidity. Since the pandemic in 2020, the overall Aviation sector has suffered huge setbacks with record losses. Nevertheless, the sector has been able to sustain their cash liquidity over the period and will be able to ride on the expected recovery of air travel demand in 2023. In latest 3QFY22 results, MAHB reported a relatively healthy balance sheet position with RM6.1bn shareholders equity, RM3.8bn cash, RM2.2bn short term debt and RM24.5m short term lease liabilities. MAHB continued to register a positive operating cash-flow of RM416.9m for 9MFY22 despite the reported RM215.0m losses. On the other hand, CapA was still in a weak financial position, with -RM7.1bn negative shareholders equity position, RM415.4m cash, RM1.3bn short term debt and RM4.4bn short term lease liabilities. CapA nonetheless, was able to turnaround its operating cash-flow to positive RM65.6m, despite the huge losses RM2.7bn for 9MFY22.

Risk of Covid-19. While there have been on-going concerns on new variants/sub-variants of the Covid-19 virus, we have seen governments and the public becoming more receptive of having to live with the virus in endemicity. In general, there is now higher awareness and increasing embracing of vaccination requirements. Governments will continue to adopt a balanced approach in promoting economic growth and public healthcare. Hence, as we move into 2023, we believe that strict lockdowns will be a thing of the past for most parts of the world.

Receding jet fuel price. Jet fuel price has eased downwards to now USD100/bbl (after hitting high USD160/bbl in June 2022) in tandem with the weakening global crude oil prices. A weakened jet fuel price is generally positive for Aviation sector, as jet fuel cost contribute to 30-50% of airlines operating cost structure. The lower jet fuel cost will also allow for cheaper air ticket pricing, therefore increasing air travel demand. Based on our expectation of brent crude oil price to average USD85- 90/bbl in 2023, the indicative jet fuel price would be USD100-120/bbl (vs USD125/bbl in 2022).

RM movement. RM has recently appreciated against USD to RM4.40/USD level and EUR to RM4.60/EUR. Our economist expects further appreciating RM/USD to average 4.34 in 2023 (vs. 4.40 in 2022), while Bloomberg consensus estimated an appreciating RM/EUR to average 4.70 in 2023 (vs. 4.62 in 2022). A stronger RM/USD is overall positive to the airlines (i.e. Capital A and AirAsia X), given that 40-60% of normalised operating costs is denominated in USD. On the other hand, MAHB will benefit from higher translated expected profits in ISGA (denominated in EUR).

Stock Recommendations

We maintain an OVERWEIGHT rating on Aviation sector as we expect continuing air travel recovery into 2023. We believe the worst is over for the sector following 2022’s turnaround, while 2023 will be a growth year for the sector. Four major catalysts for the sector in 2023:

1. Strong recovery for international travel given the recent reopening of Japan, South Korea, Hong Kong and Taiwan, and potentially China by early 2023;
2. Higher Availability of Aircrafts and Staffs to Take Advantage of the Higher Air Travel Demand;
3. Easing of Jet Fuel Prices;
4. Weakening of USD Against Regional Currencies.

We Have BUY Recommendations for MAHB (TP: RM7.75) and CapA (TP: RM0.88).

Malaysia Airports. Maintain BUY recommendation with unchanged TP: RM7.75, based on SOP. We have seen MAHB reporting lower losses over the quarters and is expected to breakeven in 4QFY22, driven by the improving air travel demand and international air travel mix for both Malaysia and Turkey operations. We expect FY23 to be a profitable year given the expected higher air travel demand and higher airlines’ capacities (reinstating their fleets back to pre-pandemic levels).

Capital A. Maintain BUY recommendation with unchanged TP: RM0.88, based on unchanged 8x FD PE tagged to FY24 EPS. While CapA has not shown meaningful lower losses in the past quarters (affected by depreciated RM/USD, surge in jet fuel prices and higher repair and maintenance charges to reinstate aircrafts), we do expect a better FY23 given the improved situation of RM/USD, jet fuel prices and full 205 fleet of operating aircrafts by mid-2023 (103 aircrafts as at 3QFY22), enabling the group to take advantage of the increasing air travel demand. Nevertheless, the group is still under PN17 status. Management plans to distribute in specie Aviation Group to shareholders, which will subsequently be acquired by AAX (to be renamed as Aviation Group) through a share swap exercise to maintain listing status. Hence existing shareholder of CapA will subsequently own shares in CapA (aviation services and travel fintech) and Aviation Group (airlines).

Source: Hong Leong Investment Bank Research - 23 Dec 2022