We maintain our BUY call on AirAsia with an unchanged RM3.39 FV. Excluding Thai AirAsia's value - reflected in Asia Aviation's market cap - the low cost carrier (LCC) is trading at a cheap 7.7x FY13 PE. The extra attractions are the upcoming listing of AirAsia X, Tune Insurance and Indonesia AirAsia, which will help crystallize this undervalued Malaysian LCCs's valuations. We deem recent concerns over upcoming competition from Malindo denting AirAsia's profits over-rated. BUY.
Bonjour Toulouse. We recently visited Airbus' main headquarters and manufacturing facility in Toulouse, France at the invitation of AirAsia's management, along with other sell side analysts in conjunction with the delivery of Airbus' first sharklet-tipped wing aircraft to AirAsia. Amid a promising longer term outlook for global aviation, Airbus believes that global demand for aircraft will continue to be strong, going by its improving orderbook. The leading aircraft manufacturer expects revenue passenger kilometer (RPK) to soar 150% by 2031 to 12.8 trillion from 5.1 trillion in 2011, essentially doubling the global aircraft fleet by then. This represents a potential pipeline of 28,200 aircraft valued at USD4trn by 2031.
Competition intensifies. The emergence of Malindo Airways will no doubt intensify competition in the low cost segment and pressure yields going forward, but just like in the past, yields do eventually recover. Although the new low cost carrier (LCC) has articulated plans to expand to 100 aircraft within the next decade, we think that its scale of operation in the first year would still be small, and any attempt to offer airfare discounts would not have that much impact on AirAsia, even if some yield compression may be expected.
The latest on Malindo. There are rumors that Malindo's major shareholder, NADI, is reluctant to pour more capital into its JV. Nevertheless, despite these rumors, we understand that the company is currently still recruiting cabin crew and pilots, with the first batch of 20 fresh pilots expected to come on board this month while some first officers and captains have started work. However, due to this JV's limited capital, we gather that Malindo is imposing a fee on new CPL (commercial pilot licence) holders with B737 NG Type rating who are interested in becoming pilots. Charges are estimated at USD30,000 for the first 500 hours, with no salary. These we view as a sign of financial constraint.
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KEY HIGHLIGHTS
Bonjour, Toulouse! We recently visited Airbus' main headquarters and manufacturing facility in Toulouse, France at the invitation of AirAsia's management, along with other sell side analysts. The visit was organized in conjunction with the delivery of Airbus' first sharklet-tipped wing aircraft to AirAsia, also Airbus' first sharklet aircraft customer. Airbus, a leading maker of commercial aircraft, is a core business subsidiary of European Aeronautic Defence and Space Company N.V. (EADS), a global pan-European aerospace and defence corporation and leading global defence and military contractor. Airbus' manufacturing facility in Toulouse is the final assembly line for its commercial aircraft, for which the input manufactured parts are mostly shipped from other Airbus manufacturing sites in Europe and globally. Another major final assembly line is also located in Tianjin, China. The aircraft maker is looking to set up a major final assembly line for its A320s in Alabama, United States, to pitch for more market share against its leading competitor, Boeing. During the plant tour, we visited the assembly lines of the A380 and A320, including a preview of its latest line-up, the A350 XWB, due to be delivered to its first customer in mid-2013. XWB is short for extra-wide body, a wider aircraft than A380 but with only level, unlike the A380 which has 2 levels. The A350 will be the first Airbus with both fuselage and wing structures made primarily of carbon fibre-reinforced polymer, and is said to be more fuel efficient than the Boeing 787 Dreamliner and the larger Boeing 777.
Is an aircraft over-capacity looming? Airbus believes that global demand for aircraft will continue to be strong, going by its improving orderbook. The leading aircraft manufacturer expects revenue passenger kilometer (RPK) to increase by 150% by 2031 to 12.8 trillion from 5.1 trillion in 2011, doubling the global aircraft fleet by then. This is a potential pipeline of 28,200 new aircrafts with a total market value of USD4trn by 2031. The regions where aircraft demand is burgeoning are China, India, Middle East, Africa and Asia, collectively representing a total population of 6bn, where RPK is expected to grow at a 6% CAGR up to 2031. This will exceed the 4% RPK growth seen in Western Europe, North America and Japan, which has a combined population of 1bn. Air traffic has been doubling every 15 years and will continue to go up in tandem with rising welfare and urbanization, which will in turn increase the propensity for air travel. As many are now wondering if the trend of rising production and orders for aircraft will lead to over-capacity, Airbus pointed out that there is demand for 28,200 new aircrafts, of which more than 10,000 are to replace ageing fleets.
AirAsia gets world's first sharklet-tipped wing aircraft. Sharklets, as Airbus calls them, are essentially winglets that have been fitted in aircraft since the 80s, mostly by Boeing. A sharklet is a fin-like airfoil protruding from the tip of an aircraft's wings which works to boost a wingtip's lift by smoothening the air flow across the upper wing near the tip and reducing the lift-induced drag caused by wingtip vortices, thus improving the lift-to-drag ratio. AirAsia has just received its first shaklet-tipped wing aircraft. These 2m long Sharklets tips are made from lightweight composites that bring about improved wing aero dynamics, thus reducing fuel burn by an estimated 4%, as well as emissions. It will also boost range by 100 nautical miles or bolster payload capability by up to 450 kg. The sharklets are manufactured by the Korean Air Group's Korean Air Aerospace Division. The list price of an A320 averages USD88.3m, and according to an airline forum, the additional cost for an optional sharklets is an extra USD1m.
Achieving fuel economy. The fuel mileage for operating aircraft is clearly cheaper than driving a car given that aircraft are air-borne. With the addition of 10 aircraft in 2013, we estimate that AirAsia's fuel savings of 4% per aircraft will work out to be about RM1.32m per aircraft per annum. Assuming a full fleet of 64 aircraft with sharklets, this will represent a significant RM78m. A fleet of newly delivered aircraft has proven to save on fuel burn, as exhibited in Figure 1 below. According to AirAsia, as it took delivery of more new aircraft, the LCC achieved a fuel efficiency of 2.62 litres per passenger per 100km, which is significantly better than the 2.72 litres per passenger per 100km it achieved back in 2009. The A320 is believed to be the most economical in the Airbus family, and more superior to the jumbo A380 of 3 liters per passenger per 100km. Compared with jet commercial aircraft, turboprops offer better fuel economy given their low optimum speed of below 700 km/h - below the optimum speed of the A320's 828 km/h - which results in it taking a longer time to reach its intended destination. This is because the jet velocity of the propeller (and exhaust) is relatively low. However, the lower optimum speeds for turboprops essentially reduce drag and hence cuts fuel costs, estimated to be only equivalent two-thirds of the cost of a typical jet commercial aircraft. As propeller fan (propfan)-powered aircraft offer more fuel efficiency, this has given rise to new interest to develop this technology to be utilized commercial jets. For instance, Airbus haspatented aircraft designs with twin rear-mounted counter-rotating propfans, which will likely be fitted in its new future aircraft.
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Enlarging its fleet. Last month, AirAsia announced a new order of 100 aircraft, including 36 A320s with Sharklets. This new order will ensure that AirAsia continues to have a strong footing in the ASEAN market in expanding into new routes and adding frequency to its existing network. AirAsia has a combined cumulative order of 475 single-aisle aircraft from Airbus, comprising 264 A320neo and 211 A320s. A total of 28 A320s will be delivered to AirAsia, of which 10 will be for Malaysia and seven for Thailand, nine for Indonesia and two for Japan. In addition, AirAsia X plans to add seven new aircraft. As of now, AirAsia has a fleet of 103 aircraft, of which 64, 27 and 22 aircraft are in Malaysia, Thailand and Indonesia respectively, with ages averaging 4.2, 2.9, 3.3 years. With AirAsia's burgeoning appetite for aircraft, half of the LCC's orders will be for progressive fleet replacement, which will likely happen starting 2017-2018 given that its oldest aircraft is currently eight years old. It is crucial for airlines to maintain a young fleet to sustain their low cost model by keeping maintenance and fuel costs as low as possible. For the company's fleet acquisition, AirAsia will utilize a combination of debt finance and operating leases.
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Can AirAsia outdo the Lion? Lion Air currently operates a total of 89 aircraft averaging 4.8 years old, having ordered 331 aircraft from Boeing for the upcoming years. In terms of size, AirAsia's cumulative order of 475 aircraft to be delivered up to 2025 will still make it the bigger LCC of the two. Lion Air's attempt to encroach into the Malaysian market with the setting up of Malindo - a JV with NADI, a Malaysian military MRO contractor - will certainly see competition intensify. Malindo will commence operation as early as March 2012 with a target fleet of 12 aircraft in the first year and gradually expand to 100 aircraft within the next decade. The key routes Malindo is eyeing in the immediate term are AirAsia's most profitable domestic KL- East Malaysia; Kuching and Kota Kinabalu routes. We think that as the 10 aircraft to kick start the first year of operation will be gradually delivered, any impact on AirAsia's overall yields will be mild given that the LCC is already flying 14 times and 12 times daily to both Kota Kinabalu and Kuching respectively. The high number of frequencies has secured flight slots for AirAsia at the respective airports, thus leaving little room for Malindo. While a price war may ensue if competition intensifies, we see Lion Air has not been aggressive in its promotions in Indonesia. Malindo may adopt the same thinking, with it starting off with a small fleet, its discounts may not be too aggressive.
Update on Malindo. There are rumors that Malindo's major shareholder NADI is reluctant to pour a large amount of capital into the J. Nevertheless, despite these rumors, we understand that recruitment of cabin crews and pilots is ongoing, with the first batch of 20 fresh pilots coming in this month while some first officers and captains have started work. However, due to the JV's limited capital, we gather that Malindo charges a fee for any new CPL (commercial pilot licence) holder with B737 NG Type rating who is interested to become pilots. Charges are estimated to be USD30,000 for the first 500 hours, with no salary. A type rating is a licence to fly a certain aircraft type that requires additional training beyond the scope of the initial licence and aircraft class training. This could be a sign of Malindo and Lion Air facing some financial constraints. We understand that AirAsia does not adopt this practice as it usually bears the cost of type ratings in exchange for a six-year bond. In the case of cadets, we understand that AirAsia provides some kind of financing scheme.
Maintain BUY. We maintain our BUY call on AirAsia, with an unchanged RM3.39 FV. Excluding Thai AirAsia's value - reflected in Asia Aviation's market cap - the LCC is trading at a cheap 7.7x FY13 PE vs its peer average 12x. The extra attractions are the upcoming listing of AirAsia X, Tune Insurance and Indonesia AirAsia, which will help crystallize this undervalued Malaysian LCC's valuations. We deem recent concerns over upcoming competition from Malindo denting AirAsia's profits over-rated. BUY.