We reiterate our NEUTRAL rating on the AVIATION sector, due to the lack of near-term excitement and catalyst coupled with a seasonally slower quarter ahead. We continue to choose AIRASIA (OP; TP: RM3.01) as our preferred pick in the sector given that its foreign shareholding has declined to a low of 47% (historical low at 43% due to September-11 incident then which we think is unlikely to be repeated) vis-à-vis its high of 49% back in January-14, while MAS remains an UNDERPERFORM due to its inability to turn around and widening losses. As for AIRPORT, we downgraded it to MARKET PERFORM (previously, OUTPERFORM) with a lower Target Price of RM8.63 as we believe that the market has already priced in most of its positive news flow back in 1H14.

1QCY14 results round up. Generally, the results for the aviation stocks under coverage like AIRASIA and AIRPORT came in within our expectations, except for MAS which saw its losses widened from RM330.5m to RM455.9m, YoY due to lower-than-expected yields arising from the decline in fuel surcharges and other income.

Passenger traffic still experiencing double-digit growth. Year-to-date up till May, AIRPORT recorded a healthy passenger traffic growth of 13.5%, YoY, handling c.34.1m passenger traffic. The overall growth was well supported by the strong growth in domestic passenger traffic, which increased by 14.6%, YoY from 15.1m to 17.4m. On the international front, AIRPORT still managed to register double-digit growth of 11.7% on its international traffic. Post-MH370 incident, MAS’ international passenger numbers have been on a declining trend. Hence, we would expect AIRPORT’s international traffic to grow at a slower pace, given that the MH370 incident has cast a negative impact on the China market coupled with some capacity cutbacks from foreign carriers.

Improvements in airfares. Apart from fuel cost and currency, we also saw some minor improvement in yield for the airlines in 1Q14 from 4Q13 due to better fares arising from capacity cutbacks/route rationalisation from other airlines. AIRASIA saw 4% improvement in its 1Q14 average fares of MYR135/pax as compared to RM130/pax in 4Q13, while MAS’ average fare in 1Q14 also improved by 8.3% from MYR494.0/pax to MYR535.2/pax boosted by better international fares.

Jet fuel price remains steady. Since the beginning of the year, jet fuel prices had been relatively steady, trading at an average price of USD121.5/bbl in 1Q14 and at USD120.6/bbl in 2Q14 while the Malaysian Ringgit (MYR) has seen some strengthening against US Dollars (USD) in 2Q14 to MYR3.23 versus MYR3.30 in 1Q14. We view the steady jet fuel prices and the strengthening of MYR as boons for the airlines as most of their costs are denominated in USD, especially jet fuel and interest costs.

Slow & Quiet 3QCY14. While we have seen improvements in traffic numbers, airfares and also currency, we are expecting a slow and quieter 3QCY14 after an ‘eventful’ 1HCY14 given: (i) it is a seasonally slower quarter for the sector and (ii) we expect minimal news flow for the sector given that it is a Ramadan month. The exception is MAS where we expect some news flow regarding MAS’ restructuring plan/potential privatisation as MAS’ balance sheet might not be able to last them till 2015 assuming that the staggering losses in 1Q14 persists. At current levels, MAS’ share price has a 36% downside to our Target Price of RM0.14 which is pegged to 1.1x FY14 Price-to-Book which we deem that the risk-reward ratio as totally unfavourable at this juncture. Hence, we reiterate our UNDERPERFORM recommendation on MAS.

NEUTRAL maintained. Due to the lack of near term excitement and seasonally slow quarter ahead, we reiterate our NEUTRAL recommendation on the sector. While we maintain our recommendation and Target Price for AIRASIA (OP; TP: RM3.01) and MAS (UP; TP: RM0.14), we are downgrading AIRPORT from OUTPERFORM to MARKET PERFORM with a lower Target Price of RM8.63 (previously, RM9.44) as we believe that market have already priced in the “excitement” over the opening of KLIA2 and acquisition of the 40% stake in Sabiha Gocken Airport. Currently, we value AIRPORT’s Malaysian operations based 13x FY14 EV/EBITDA (previously, 22x FY14 PER) at +1SD to its 3-year average that is also inline with its peer average. We have also switched our valuation method from PER to EV/EBITDA as we believe that it is much more reflective of AIRPORT’s valuations as its earnings might be distorted from the higher depreciation arising from KLIA2 and also its concession period (refer overleaf for Sum-of-Parts table). Amongst the three stock under our coverage, we still prefer AIRASIA as its foreign shareholding had came off to a low of 47% (historical low at 43%, due to September-11 incident which we think is unlikely to be repeated) vis-à-vis its high of 49% in the beginning of the year coupled with the fact that it could benefit from the steady jet fuel prices and strengthening of MYR currency against USD.

Source: Kenanga