We continue to keep our NEUTRAL recommendation for the aviation sector due to: (i) challenging operating environment, and (ii) suspension of Visit Malaysia Year 2014 campaign due to the recent MH370 incident; despite the regional low-cost carriers’ recent move in adjusting fleet expansion plans in order to better curb the overcapacity situation in Southeast Asia. However, we still favour AirAsia Bhd (AIRASIA, OP; TP: RM3.01) given its strong capability to withstand competition due to its innovative ways in reducing cost and also ability to maintain its 20% dividend payout ratio of net operating income policy. Our TP of RM3.01 for AIRASIA is based 11x FY14 PER which implies a c.30% discount to its peer average of 15.7x coupled with the fact that AIRASIA provides the highest dividend yield of 2.5% as compared to its peer average of 1.7%. Hence, this time around we prefer AIRASIA over Malaysia Airports Holdings (AIRPORT, OP; TP: RM9.44) due to the potential delay in the opening of KLIA2. Subsequently, while we maintain our UNDERPERFORM call on MAS, we have reduced our TP from RM0.27 to RM0.16 based on 6.9x FY14 EV/EBITDA as we widened our FY14 losses by 44% to RM807m after factoring the sequence of unfortunate events that struck MAS recently.

Softer set of results for airlines. In FY13, airlines under coverage namely Malaysian Airline System Bhd (MAS) and AirAsia Bhd (AIRASIA) reported results that were below our expectations, while airport operator Malaysia Airports Holdings Bhd (AIRPORT)’s earnings performance was pretty much within expectations. The major letdown in earnings by MAS which saw its loss widening from RM773m to RM1.2b was mainly due to higher-than-expected operating costs. As for AirAsia, the main deviation from our expectations was due to our overly aggressively assumptions on RASK assumptions of 17.7 sen vs its full-year actual RASK of 16.4 sen.

Active fleet capacity management. According to CAPA, the Southeast Asia LCC scene is poised to see another 18% growth in capacity, adding another 88 aircrafts to the existing 573 aircrafts into the region by end of 2014 with another 4 more carriers to be launched namely Thai AirAsia X, Thai VietJet Air, NokScoot and Indonesia AirAsia X. However, we are still optimistic with the short haul carriers and expect yield on the domestic front to stabilise due to: (i) the new start-ups and added capacity are mostly wide bodies that is catered for medium/long haul, (ii) LCCs in the region like AirAsia, Jetstar Asia, Tigerair Mandala slowing down on their fleet expansion plan with Tigerair Singapore following suit. To recap, Tigerair Singapore has placed an order for 37 Airbus A320 aircraft worth USD3.8b at list prices recently, taking delivery of the planes from 2018 to 2025 but canceled its existing order for nine Airbus A320 aircraft, which was part of a larger order agreed in 2007 that is scheduled for delivery in 2014 and 2015.

Visit Malaysia 2014 campaign shelved, but… Recently, Putrajaya suspended the Visit Malaysia 2014 campaign especially in China, out of respect for the families of the passengers and crews that was on board flight MH370. While we were negatively surprised with Putrajaya’s unprecedented but understandable move, it could possibly hamper its foreign tourist arrival target of 28.8m. However, we believe that the local travel scene would still be resilient due to high domestic travel demand spurred by the intense competition between airlines. To recap, AIRPORT has seen 20% growth in domestic passenger movements in 2013 from 34.4m to 41.3m as compared to a single-digit growth of 4% in 2012. Hence, we still prefer airlines like AIRASIA as we believe that it is able to outlast the other players due to its cost structure and extensive domestic routes.

Maintain NEUTRAL. While we maintain our NEUTRAL recommendation on the aviation sector due to the recent sequence of unfavourable events coupled with the uncertain opening date for KLIA2, we still believe that domestic demand for travel remains resilient driven by reasonably cheap airfares arising from the competition between airlines. Hence, AIRASIA would be our preferred pick over AIRPORT this time around given its strong capability to withstand competition due to its strong focus in reducing cost and also ability to maintain its 20% dividend payout ratio of net operating income policy. Currently, AIRASIA is only trading at 9x FY14 PER which is at c.42% discount to its peer average of 15.7x coupled with a targeted dividend yield of 2.5% as compared to its peer average of 1.7%. As for MAS, we reiterate our UNDERPERFORM call with a further reduced TP from RM0.27 to RM0.16 based on unchanged 6.9x FY14 EV/EBITDAR following our revised loss assumptions taking into account the unfortunate events that have struck the company lately.

Source: Kenanga