AirAsia’s 2Q18 saw encouraging passenger growth but was dragged by significantly higher average fuel cost leading to core net profit falling below our expectation. However, we continue to like AirAsia as the best-in-class LCC amid a structurally favourable operating environment regionally and its attractive valuations. We reiterate our BUY call with a lower TP of RM4.10, based on 10x 2019E target PER.

Core Profit Underwhelms Amid Healthy Topline Growth

AirAsia’s 2Q18 core net profit of RM366m (>100% yoy) brought 1H18 core net profit to RM626m (+42% yoy), although below our expectations at 44% of our full-year forecast. Revenue for the quarter rose 10% yoy amid seasonally lesser travel period as capacity increased by 17%. Influx of capacity eased seat load factor by 3ppt to 86% as average fare was 3% lower yoy, translated into lower RASK of 3% yoy to 14.83 sen. Geographically, growth was spearheaded by Philippines growing 33%. While Malaysia sailed to a robust 2Q18 11% yoy growth, Indonesia’s underwhelming 3% revenue contraction was due to prolonged volcanic activities. (This note marks the transfer of analyst coverage)

Fuel Cost Suppresses Margins

Margins for the quarter contracted 9.4ppt to 21.6% as CASK rose to 13.77 sen, up 4% yoy. This was primarily attributed to 29% higher average fuel at USD89bbl vs USD69bbl in 2Q17. Margin erosion is likely to persist going forward as AirAsia has only hedged 12% of 2018 fuel requirement at USD69/bbl. Positively, an uptick in maintenance and leasing was offset by suppressed staff cost, resulting in lower CASK ex. fuel by -2% yoy. Associates performance, Thailand and India combined contribution fell into losses of –RM46m (vs. 1Q17: RM5m). Meanwhile, increasingly challenging operating conditions saw competitors, Malindo and MAS reduce weekly flights by 37% and 9% respectively. It could enhance AirAsia’s seat load factor going forward.

Maintain BUY With a Reduced 12-month TP of RM4.10

We trim FY18-20E earnings by 5%-11%, factoring in revisions to our jet fuel price assumption. We maintain our Buy with a reduced TP of RM4.10 (from RM4.36 previously) based on an unchanged 10x 2019 PER. We remain positive on AirAsia for i) well sustained demand and high load factors across its operating markets and ii) potentially attractive special dividend due for an announcement in 3Q18. Key downside risks are higher fuel costs and prolonged disruption to Indonesia operations.

TAA and IAA Widen Losses

TAA saw ASK grow by 14% yoy thanks to the net addition of 5 aircrafts in 2Q18 relative to 2Q17. While AirAsia did not disclose TAA’s RASK, it appears RASK may have declined given load factor and average fares slipped -1ppt and -5% yoy respectively. Against lower RASK, CASK would have rose in tandem with higher fuel cost. These factors combined saw operating loss –THB654m in 1Q18 from THB238m in 1Q17. Unlike TAA, India AirAsia (IAA) saw ASK spread widen thanks to rapid capacity addition amid increasing brand awareness. However, given the rapid capacity addition, operating losses widened to INR516m in 1Q18 from INR242m. Management expects these two associates to breakeven in FY19 onwards.

Source: Affin Hwang Research - 3 Sept 2018