Qantas announced to the Australian Exchange last week thatit  was terminating its possiblepartnership with MAS to setup a premium airline as  the two were not able to reach mutuallyagreeable commercial terms. Qantas' CEO, Alan Joyce, said Asia remained apriority for the Qantas Group and it will continue to explore opportunities in theregion, including joint ventures and alliances. Separately, the union workforceof MAS has bypassed  management to meetthe Prime Minister a couple of weeks ago, urging him to  review the share swap deal between the mainshareholders of MAS and AirAsia. It is understood that the Prime Minister isseriously looking into the matter. A key official in AirAsia says that it isprepared to part ways should it become a problem for the Prime Minister,although its CEO, Tan Sri Tony Fernandes, has denied any plans to scrap thecollaboration. Officials at Khazanah and the Prime Minister's Department aredeterminedto ensure that the collaboration remains on course. 

Another blow for MAS.Sponsorship at risk? The announcement came as a surprise to us as we hadassumed that negotiations on setting  up a regional premiumcarrier between MAS and Qantas would eventually be concluded despite the delaysin finalizing the partnership. With Qantas ending talks for a potentialcollaboration, a key concern is whether Qantas could pull out of itssponsorship of MAS in joining the oneworld alliance as this would be deemed acompetitive threat since Qantas no longer sees Malaysia as a potential hub forits Asian premium airline. But with Qantas reaching a dead end for now (as ithas ran out of options on partnerships), we reckon Qantas will continue to be thesponsor  of MAS as  the former will still ultimately benefit fromthe traffic feed generated. With no partnerships at hand, MAS faces toughheadwinds in its expansion plan to setup a short-haul regional premium carrieras this would mean  that  it would have to rely on its own balancesheet to for fleet acquisition.

Why the deal didn'tgo through. Although the reason of the termination was never disclosed, wereckon  it could be largely due tothe  amount of assets  that MAS is required to inject into thepartnership. Qantas has indicated that it would want to spend as little aspossible on new jets, which probably put off MAS  which has its own set of problems in acquiring new aircrafts too.

Qantas faces deadend. With Singapore Airlines already having an established partnership with Virgin, it remains to be seenwhich airline can be Qantas' new partner for its Asian premium carrier. Apossible partner could be Thai Airways, which is now concentrating onstrengthening its presence in Asia, and given that it also has plans to establisha regional carrier of its own called Thai Smile. However, we think the chances forthis to happen are still slim, noting that there is a difference in the targetmarket as Thai Smile Air intends to serve the market gap that exists betweenthe low cost carrier and the full service segments. We also don't thinkIndonesia's national flagship carrier, Garuda Indonesia could be a potentialpartner of Qantas as geographically serving the lucrative Chinese market wouldstill not be feasible for flights exceeding 6 hours on the former's upcomingdelivery of A320s. Furthermore, Garuda is still the dominating carrier in termsof international destinations (other than ASEAN per se), and what the Indonesiancarrier needs is  wider  access to Europe and North America  after being slapped with numerous  bans back in 2007'2009.  With no viable  options at hand for Qantasto revive its International Business, it appears to be at a dead end for now.

Share swap to bereversed? While the cries of the union workforce of MAS over the need toprotect jobs are felt by the Prime Minister, we have reiterated that the keylow hanging fruit for MAS to pick lies in trimming its excessive workforce (MAShas some 20,000 employees vs AirAsia's 9,000 and SIA's 21,000). Furthermore, withroutes between AirAsia and MAS already rationalized as well as key employeesfrom AirAsia  being deployed to MAS, wethink the unraveling of the share swap deal inked last year would not bode wellfor the Malaysian corporate scene. Aside from scrapping the share swap deal,rumours are abound that the union is requesting MAS (in  an attempt to protect jobs) to abort its  plans to start a new premium  short-haul carrier (and instead focus onFirefly) as well as abort  its pannedentry into the oneworld alliance. We think any reversal of the share swap ishighly unlikely but we do not discount this possibility entirely.

Malaysia Airports'potential volume feeder fizzles out. With MAS and Qantas  both ending  partnership talks,Malaysia Airports  will lose theopportunity  to tap into  higher feeder traffic  arising from being  a key operating hub for Qantas' Asia-basedpremium carrier. Nonetheless, this will have no impact to our BUY call on thecompany as we are fairly optimistic on the airport operator's ability to expand its retail revenue significantly once the KLIA2 is fullyoperational over the medium to long term. In addition, the completion of therecent private placement exercise  thatraised some RM616mm  which was  taken up by both local and foreign investorscould instill confidence  in thelonger-term prospects of KLIA2. Previously, there were concerns from some quarters over the possibility of alukewarm response to the private placement since the higher capex allocationfor KLIA2 was announced.

SIA potentiallysustaining its premium market share. With Qantas reaching a dead end inestablishing anAsia-based regional premium carrier, this would bode well forSIA in retaining its market share in the premium segment which has beendeclining over the recent years due to the intensifying competition from other regionalfull service carriers.

Maintain OVERWEIGHT.With SIA (FV: SGD12.47), AirAsia (FV: RM4.57), Malaysia Airports (FV: RM7.53) andTiger (FV: SGD0.87) in our list of BUYs, we maintain our OVERWEIGHTrecommendation on the aviation sector. Given concerns  over their weakening balance sheets amidintensifying competition, we maintain our sell calls for MAS (FV: RM0.90) andTHAI (FV: THB21.13).  Our OVERWEIGHT callis largely centred on the activities of passengers downtrading to low costcarriers, hence benefiting the likes of AirAsia and Tiger as well as MalaysiaAirports as it stands to take advantage of the potential higher revenue arisingfrom  travellers spending more moneyin  airports. While  SIA will continue to face headwinds from the intensifyingcompetition, we think that its valuation is appealing as we continue to believeits share price has bottomed  out  and considering the fact that its balance sheet remains solid  with a high net cash level to weather anydownturn. With our overall sector call driven by the low cost segment, wecontinue to have AirAsia as our TOP BUY in the aviation sector.

Source: OSK188