Unfazed  by  competition.  We  believe  the  entry  of  Malindo  will  not  pose  a  threat  to AirAsia's expansion plans  as  it  has  been  pushing  for  early  delivery  of  its  aircraft  orders. While passenger yields could take a hit as the new entrant chips away some of its market share,  we  believe  the  impact  on  AirAsia  would  be  fairly  minimal.  Newcomer  Malindo's small  fleet, and  thus small scale  of operation,  would  give  it  little  room  to  offer  its  fares  at steep discounts.  Meanwhile,  Malaysia AirAsia's will utilise the increased capacity from 10 new  aircraft  to  boost  the  frequency  of  existing  routes  (89%  of  the  seats),  as  well  as  add new routes (11%). The group has secured the financing to buy new aircraft for 2013 at an attractive low interest rate of about 3% p.a.  

Our  assumptions.  We  expect  the  10  new  aircraft  joining  the  fleet  by  end-2013  to  boost AirAsia's capacity by 13%. This is premised on an unchanged load factor of 78%. We have incorporated our estimated yield contraction of 5 sen (or 2.7% y-o-y) following the entry of Malindo,  which  we  think  would  only  make a  minimal  impact  on  AirAsia's yields in  view  of the former's small scale  of  operation.  Our  forecast  for  a  jet  fuel  price  of  USD140/bbl  for FY13 and FY14 remains unchanged vs the average forecast cost of USD135/bbl for 2012. All in, although we see a revenue dip due to lower yields, this does not change our latest estimated  FY13  earnings,  thanks  to  the  airline's improved  economies  of  scale  from operating  a  bigger  fleet.  However,  in  view  of  intensifying  competition  in  the  upcoming years, we are trimming AirAsia's FY14 earnings by 4%.  

Still  a  BUY.  We  maintain  our  BUY  call  on  AirAsia,  at  an  unchanged  FV  of  RM3.39, premised  on  a  11x  PE,  which  is  still  below  the  12x  average  among  its  global  low  cost carrier  peers.  At  the  current  9x  FY13  PE  -  after  stripping  off  its  stake  in  Thai  AirAsia  as reflected by Asia Aviation's market cap - AirAsia makes for an attractive Buy.

We  showcased  AirAsia  and  Asia  Aviation  (FV:  THB6.63)  at  our  Asean  Corporate  Day Conference  in  Singapore  earlier  this  week.  There  was  overwhelming  response  to  the meeting  with  Management,  attracting  the  highest  number  of  registrations  from  about  30 buy-side/fund managers from 22 different funds/houses. The key takeaways of the meeting
are:

Undeterred  by  competition.  The  entry  of  Malindo  will  in  no  way  hinder  AirAsia's expansion plans, as the latter has been pushing for early for delivery of its aircraft. While passenger yields could bit a hit as Malindo may chip away some of AirAsia's market share, we believe the impact would be fairly minimal. As we have reiterated, Malindo's small fleet and hence small scale of operations will give it little room to offer steep fare discounts. We understand that Malindo intends to start operation in March with two aircraft, progressively beef  up  its  fleet  to  12  by  year-end,  and  subsequently  increase  by  an  average  10  aircraft over  the  next  few  years.  As  far  as  poaching  is  concerned,  we  gather  that  no  pilots  have been pinched from AirAsia although about 10 cabin crew have left for Malindo, which is still on a recruitment drive. A check on its website, http://www.malindoair.com/, shows that the airline has yet to offerany promotions for early bird bookings.

Malaysia  routes  to  focus  on  higher  frequency.  Some 89% of the capacity increase for Malaysia  after  the  10  new  aircraft  join  the  fleet  will  be  allocated  to  additional  frequencies while  the  remaining  11%  will  be  for  new  routes  to  Indonesia  and  Thailand.  Additional frequencies  from its  Kuala Lumpur  hub  will  be  to  Bangkok,  Kota  Kinabalu,  Sibu,  Kuching and  Johor,  while  the  Johor  hub  will  see  more  frequent  flights  to  Kuching,  Sibu,  Miri  and Penang. Financing for aircraft acquisitions has been secured for 2013 at an attractively low interest rate of approximately 3% per annum.

Thai  AirAsia  to  benefit  from  Don  Muang  move.  Thai  AirAsia's incoming 7 aircraft will see it adding more frequencies to China and Indo China of which it is also looking to fly a couple more  new  cities in  China.  Of the  7 aircraft,  5  will  be  carried  into  its  balance sheet with the remaining as operating leases. Management guided that gearing is unlikely to go beyond 2x. Similar to Malaysia AirAsia, the allocated proportion for frequency increase and new  route  expansion  is  90%  and  10%  respectively.    Thai  AirAsia  targets  to  10m passengers  this  year  in  line  with  our  forecast.  The  recent  move  to  Don  Muang  has  given room  to  improve  its  operating  efficiencies  further  on  shorter  aircraft  turnaround  time  to reduce  fuel  wastage.  Furthermore,  cost  cuts  will  also  be  boosted  by  the  reduction  in aircraft parking and landing charges.  Passenger feedback has been generally positive due to  the  move  to  Don  Muang  airport  given  its  closer  proximity  to  the  city.  We  have  a  BUY rating on Asia Aviation with a FV of THB6.63 of which we had upgraded it recently on the basis of higher adjusted EV /EBITDAR multiples from 11.7x.
 
Expansion plans for Indonesia. Meanwhile, Indonesia AirAsia will have a higher capacity increase allocated to new routes, at 50% allocation of the total new capacity added from its incoming 9 aircraft this year as it opens a new hub in Makasar (Sulawesi). Immediate term expansion  plans  is  to  focus  on  destinations  outside Jakarta  due  to  the  airport  congestion carriers are facing coupled by the intensifying competition. Indonesia AirAsia does not aim to aggressively expand its market share on routes that it competes head on with Lion Air as there is still a lot of room to grow organically by improving loads on its existing routes as it  intends  to  triple  its  ticketing  distribution  network  from  the  current  1000  points  to  3000 points. The ticketing agency structure will be a low cost setup which will not be done jointly with Batavia after aborting its earlier proposed acquisition.

The smaller babies. For AirAsia's new associate setups, Japan and the Philippines will be
adding  3-4  and  1-2  aircraft  respectively,  while  AirAsia  X  is  looking  to  add  7  wide  body
aircraft  as  it  aims  to  triple  frequencies  its  Australia  sectors  and  doubling  them  for  Japan
and Korea and chartering flights for pilgrimage services. AirAsia's X increasing fleet bodes
well as a passenger feeder into other AirAsia's short haul network.  On  the  other  hand
AirAsia's non-airline  associate,  Expedia,  is  expected  to  continue  its  profitability  growth
momentum.
 
Update  on  upcoming  IPOs.  Indonesia  AirAsia's  upcoming  IPO  listing  is  scheduled sometime  in  2H  2013  and  hopes  to  raise  roughly  USD200m  to  strengthen  its  balance sheet.  At  a  conservative  estimated  earnings  forecast  of  RM41.2m  for  FY14,  its  potential market cap could range RM450m to RM530m premised at 11-13 x forward PE.  AirAsia X's IPO  is  also  likely  to  happen  this  year  too.  However,  due  to  its  balance  sheet  constraint  , Management guided that it is unlikely that Indonesia AirAsia will put in another aircraft into its balance sheet until FY14 at the very earliest.

Acquisitions  and  new  hubs.  Due to stiff competition and limited landing slot availability, AirAsia's Philippines associate  is  facing  a  challenging  situation  indeed.  One  shortcut  to quickly  overcome  this  is  to  acquire  another  carrier.  The  media  reported  sometime  in September last year that Zest Airways could be a likely acquisition candidate for AirAsia to expand  its  market  share.  Zest  Airways  operates  11  A320s  in  its  fleet  which  makes  it  an ideal candidate for AirAsia as a full fleet operator of A320s. AirAsia continues to eye other countries that it could paint the sky red as its new hub but preferring to start up fresh with a local partner which doesn't necessarily have to be from the aviation sector. We understand that discussions are ongoing for a possible new hub in India which was hinted by Tony's twitter  update  and  the  presence  of  reporters  from  India  in  the  media  briefing of AirAsia's first  delivered  sharket  tipped  wing  aircraft.  India  is  the  biggest  market  for  commercial aircraft  manufacturers  after  China  given  the  rising  middle  class  and  urbanization  rate. Korea is also another potential market that it is eyeing though this is old news for investors.

Adjusting  assumptions,  higher  earnings  projected.    We  present  our  assumptions overleaf and the changes made which we still think are fairly conservative. We foresee that with 10 aircrafts by end 2013 (previously only 7), capacity growth is expected to be at 13% (previously  1%)  as  we  think  most  of  the  aircraft  deliveries  will  be  done  in  the  2H.  This  is premised on an unchanged load factor of 78% assumption compared to FY12 although we have  reduced  FY14  load  factor  to  77.5%.  Our  yield  contraction  of  5sen  (or  2.7%  y-o-y, which  is  higher  than  our  previous  forecast  of  2%)  has  already  factored  in  the  entry  of Malindo which we reckon would make minimal impact to hurt AirAsia's yields due to the former's small scale of operations. Our  forecast  for  jet  fuel price  of  USD140/bbl  for  FY13 and  FY14  remains  unchanged  versus  the  average  forecast  cost  of  USD135/bbl  for  2012 (actual average is USD129/bbl). All in, revenue is reduced due to the lower yields fetched but  these  latest  inputs  see  no  changes  in  earnings  for  FY13  on  the  back  of  improved economies  of  scale  from  operating  a  higher  number  of  aircraft  fleet.  However  FY14 earnings  estimate  is  trimmed  down  by  some  4%  as  competition  intensifies  further  in  the coming years.

Maintain  BUY.  We  maintain  our  BUY  call  on  AirAsia,  at  an  unchanged  FV  of  RM3.39, premised on 11x PE. This is still below the global sector low cost carrier peers' average of 12x. We like AirAsia's resilient business low cost carrier business that taps into the growing middle income segment, as well as its expanding associates' earnings potential. Reflecting its stake in listed Asia Aviation's market cap, AirAsia is trading at a cheap 9x PE versus its peers' historical  average  of  10x  and  12x. We  are  now  promoting  AirAsia  as  a  tactical  top pic for the short term among our Malaysian aviation coverage. This is on anticipation of its 4Q earnings surprising on the upside. The group's upcoming IPOs will further crystalize its valuations, which we estimate a RNAV of RM4.00-RM4.20.

Source: OSK