We are maintaining our NEUTRAL recommendation for the aviation sector at this juncture albeit an exciting year ahead (i.e. Visit Malaysia Year 2014 and the highly anticipated opening of KLIA2) as we believe that the competition between airlines continues to intensify as price war continues. However, we still favour AirAsia Bhd (AIRASIA, OP; TP: RM3.51) given its strong ability to withstand competition due to its innovative ways to reduce cost and its clear focus on its target market around Asia Pacific, which are largely driven by low-cost travellers as compared to business travelers. Hence, we maintain our OUTPERFORM recommendation on AIRASIA with an unchanged Target Price of RM3.51 based on 11x FY14 PER and upgrade Malaysia Airports Holdings (“AIRPORT”) to OUTPERFROM with a higher target price of RM9.44 based on SOP valuation.

A mixed bag of marbles. For 3QCY13, AIRASIA (OP; TP: RM3.51) and AIRPORT (MP, TP: RM8.67) results were well within our expectations. While MAS (MP; TP: RM0.32) results were largely disappointing and surprising, albeit registering a very strong set of operational numbers with its passenger load factor soaring to a historical high of 85.8%. The main drag on MAS earnings was due to lower-than-expected yields as a result of highly aggressive promotional fares and its inability to further reduce its Cost per Available Seat-Kilometer (CASK). Its total yield saw a greater decline as compared to the reduction in costs. Its total yield declined 11.2% from 36.6sen/rpk to 32.5sen/rpk while its CASK was only reduced by 5.1% from 27.9 sen to 26.5 sen.

Looking back to 2013. Generally, 2013 was an eventful year for the aviation industry. The year started off with the entry of hybrid airline Malindo Air, which somewhat changed the competition landscape between Low-Cost Carriers and Full Service Carriers like AIRASIA (OP; TP: RM3.51) and MAS (MP; TP:RM0.32), listing of AirAsia X Bhd (AAX, Not Rated) the long-haul low-cost carrier coupled with an additional 25 planes order on top of its initial order of 26 planes, rights issue exercise by MAS and the proposed acquisition of the 40% stake in Sabiha Gocken International Airport located in Turkey by AIRPORT (MP, TP: RM8.67) from GMR Group (Not Rated).

… moving forward to 2014. Overall, we should see more excitement in the aviation industry in 2014 given that it will be Visit Malaysia Year 2014 (VMY 2014) whereby the government is targeting 28.8m foreign tourist arrival, a 17% growth as compared to 2011. Despite being a promotional year for Malaysia, we still believe that price war between airlines would still be imminent as airlines would use this chance to gain market share or stimulate more demand. Hence, we strongly believe that airlines that have a strong concentration on its cost structure like AIRASIA would definitely have a better advantage as low-costs equals to low-fares while the key beneficiary from VMY 2014 and the price war between airlines would be AIRPORT, which is due to implement a tariff hike on its Passenger Service Charge (PSC) and the highly anticipated opening of KLIA2 on May 2, 2014.

KLIA2 the game changer for LCCs. We strongly believe that the opening of KLIA2 would be highly beneficial to the LCCs as it could provide better traveling experience for travelers in terms of comfort and convenience given its better infrastructures, i.e. aerobridges, automated baggage handling system coupled with the Express Rail Link (ERL) connectivity to KLIA2. The better traveling and transit experience could possibly translate into higher travel demand with the LCCs.

All eyes on KLIA2 opening. Given the recent news flow on the potential delay on KLIA2, UEM Construction Sdn Bhd and Bina Puri Sdn Bhd had issued a statement that they are striving to ensure the physical completion of works and would be able to obtain Certificate of Completion and Compliance (CCC) for its portion by Jan 31, 2014 before the Operational Readiness and Airport Transfer (ORAT) process could commence on Feb 1, 2014. Hence, we strongly believe that any delays in obtaining the CCC by Jan 31, 2014 could possibly have a knee-jerk reaction to AIRPORT’s share price as it could signal another round of delay for the opening of KLIA2. However, we are upgrading recommendation for AIRPORT from MARKET PERFORM to OUTPERFORM with a higher Target Price of RM9.44 based on SOP valuation with a higher targeted 22x PER to its Malaysian operations FY14E earnings (previously, 20x PER) due to Visit Malaysia Year 2014. We believe AIRPORT is the key beneficiary to the intense competition between airlines and also tariff revision for its PSC charges.

Source: Kenanga