Period  2Q14/1H14

Actual vs. Expectations AirAsia reported its 1H14 results yesterday and its core earnings of RM152.4m was way below expectations, accounting for only 20% and 25% of our full-year forecast and that of the street, respectively. We believe the disappointment was mainly due to higher-than-expected operating costs (i.e. fuel, maintenance and depreciation).

Dividends  No dividend was declared, as expected

Key Results Highlights YoY, 1H14 core earnings saw a major decline by 49% to RM152.4m despite a marginal 3% growth in revenue to RM2613.4m. The decline in earnings was mainly driven by higher operational cost that saw an increase of 8% to RM2308.3m whereby fuel and depreciation costs which make up a major proportion of its total operational cost increased by 9% and 12%, respectively, due to higher fuel prices and new fleet additions. On a positive note, AirAsia managed to improve its ancillary revenue by 4% to RM42.2/pax, providing some cushion on the impact of lower average fare that was down 8% to RM131.8/pax in 1H14.

 QoQ, its 2Q14 core earnings fell sharply by 80% to RM25.8m also due to the reasons mentioned above i.e. fuel cost (+10%) and depreciation cost (+22%). That aside, AirAsia also registered a loss of RM8.8m vis-à-vis a profit of RM16.3m in 1Q14 on its JCE and associates whereby Thai AirAsia was the main drag as it recorded losses for the quarter due to the political unrest in Thailand. In 2Q14, its ancillary revenue remains flattish at RM42.3/pax while its RASK (sen) was down 6% to 15.4sen.

Outlook  The overall sector remains highly challenging due to intensive industry competition amid negative newsflow arising from a pandemic scare and geopolitical unrest which would continue to have a negative impact on traveling sentiment. While we are still hopeful to see some recovery in yield for the airlines as MAS will be undergoing a major restructuring process, we opine that it would take at least another six months before airfare stabilises.

 Hence, we believe that AirAsia’s management is working towards the right albeit challenging direction to improve its ancillary revenue up to RM50/pax through the introduction of more ancillary products and also actively manage its capacity by deferring more Airbus delivery or to sell off more aircrafts.

Change to Forecasts However, we are lowering our FY14-15E earnings estimate by 32% and 26% to RM517.4m and RM623.3m, respectively, as we have factored in higher operational cost.

Rating Downgrade to MARKET PERFORM

 We are downgrading AirAsia to MARKET PERFORM as we believe that the operating environment would remain highly challenging given that the travel sentiment has been badly affected by various incidents, i.e. MH370, MH17, political unrest in Thailand, EBOLA and etc.

Valuation  Lowered our TP to RM2.47 based on 11x FY15 PER that is 20% discount to its peer average of 13.8x (previously 11x FY14 PER) as we roll forward our valuation coupled with the downward revision in earnings.

Risks to Our Call Sharp decline in airfares on intensified price war.

 War, global political risk, pandemic.

Source: Kenanga