We are keeping our NEUTRAL call on the aviation industry at this juncture despite the fact that 4QCY14 is always the strongest quarter for airlines due to seasonality factor arising from year-end festivities and school holidays. The lack of excitement is due to the continuing flat yield for airlines and AIRPORT’s passenger traffic growth continuing to grow at a moderate pace affected by geopolitical events especially in the Middle East and Hong Kong. We might potentially look to downgrade the sector from NEUTRAL to UNDERWEIGHT should the current geopolitical events worsen. Currently, we have MARKET PERFORM call for both AIRASIA (TP: RM2.47) and AIRPORT (TP: RM8.06) while we had ceased coverage on MAS as we expect the delisting process for MAS to progress smoothly.

Disappointing 1HCY14. For 1HCY14, the results for the aviation stocks under coverage like AIRASIA and AIRPORT were disappointing while MAS’ result was within expectations even if its losses were still widening. AIRASIA and AIRPORT’s results disappointments were mainly driven by higher-than-expected operating costs. AIRASIA was bogged down by higher-than-expected fuel and maintenance costs while AIRPORT’s earnings saw a major hit as a result of higher-than-expected depreciation and financing cost arising from the opening of KLIA2.

YTD share price performance. At our cut-off date of 19th Sep 2014, AIRASIA’s share price had performed relatively well (+7.4%) as compared to AIRPORT that was down by 16.8% as the stock had been on a downtrend since the opening of KLIA2 which been a drag to its earnings performance due to higher-than-expected financing and depreciation costs.
Passenger traffic growth moderated. Year-to-date from Jan-Aug, AIRPORT’s passenger traffic growth moderated at 7.9%, YoY, handling c.54.6m passenger traffic as compared to a double digit growth of 13.5% YoY it charted for the period Jan - May. The moderation in growth was well within expectations due to the recent incidents like MH370 and MH17 that had cast a negative impact on the overall travel sentiment. Nonetheless, despite growing at a slower pace, AIRPORT still managed to record higher passenger traffic for both domestic and international segments that is still growing at 8.3% and 7.4% YoY, respectively.

Jet fuel price down in 3QCY14. Since the beginning of the year, jet fuel prices had been relatively steady, trading at an average price of USD121.5/bbl in 1QCY14 and at USD120.6/bbl in 2QCY14 but it went down by 3.5% to an average of USD116.4/bbl while the Malaysian Ringgit (MYR) continued to strengthen against US Dollars (USD) in 3QCY14 to MYR3.19 versus MYR3.23 in 2QCY14. While we view that 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, we note that the current operating environment remains highly challenging. Yield in airfares have not seen much improvements due to the stiff competition within the region especially in Thailand due to the domestic capacity expansion by Thai Lion Air while the overcapacity and intense competition in Singapore’s short-haul market also have not seen much improvements despite capacity cutback strategy adopted by most of the short-haul LCCs.

Ceasing coverage on MAS. As per our 3QCY14 strategy report, we highlighted the potential privatisation news flow for MAS whereby Khazanah had made a RM0.27 offer to minority shareholders through selective capital reduction. At the same time Khazanah also laid out its “restructuring” plan for MAS that involves: (i) a RM4.6b capital injection (after privatisation), (ii) a 30% cut in workforce, and (iii) review of routes and renegotiation of supply contracts and targeting to return to profitability by the end of 2017 which we believe would be an uphill battle for MAS in the next 3 years due to the current competitive landscape in the aviation industry arising from the intense competition by the Low-Cost-Carriers. However, we take this as positive news for the minority shareholders whom we urge to ACCEPT OFFER and we take the opportunity to cease coverage on MAS as we expect the delisting of MAS to progress smoothly.

NEUTRAL maintained. While 4QCY14 are generally the strongest quarter for airlines due to seasonality factor like year-end festivities and school holidays, we are still maintaining our NEUTRAL sector call as we believe that the yield for airlines will continue to be flat and AIRPORT’s passenger traffic growth continue to be moderate due to global geopolitical events especially in the Middle East and Hong Kong. We may look to downgrade the sector from NEUTRAL to UNDERWEIGHT should the current geopolitical events worsen as it would further hamper passengers traffic growth. Currently, we have MARKET PERFORM call for both AIRASIA (TP: RM2.47) and AIRPORT (TP: RM8.06).

Source: Kenanga