We maintain our NEUTRAL call on the sector due to the uninspiring passenger traffic growth arising from the three air tragedies related to local air carriers.The tepid passenger traffic does not bode well for AIRPORT (UP; TP: RM6.77). However, we are upgrading AIRASIA to OUTPERFORM albeit with a lower Target Price of RM2.55 based on 11.0x FY15E PER (previously MP; TP: RM2.90 based on 12.5x FY15E PER). Our applied 11.0x FY15E PER is based on a lower valuation basis of -0.5SD of its 5-year forward average (previously, 5-year forward average) which is also close to its trough levels after taking into consideration of potential threats from new entrant FlyMojo and generally weaker travel sentiment. Furthermore, the share price has been severely bashed down 18.0% since the beginning of the year, and we strongly believe that the lower jet fuel cost and slight recovery in yields would be able to mitigate the weak passenger traffic in 1Q15 due to the lack of promotional activities after the QZ8501 incident.

Disappointing results, despite strong quarter.For 4QCY14, 2 aviation stocks under our coverage, namely AIRASIA and AIRPORT, reported disappointing results, largely due to higher-than-expected operating costs, financing costs and lower-than-expected passenger traffic. Generally, 4Qs tend to be the strongest quarter for the aviation industry. However, this time around, both companies registered flattish to declining performance bogged down by high operating expenses. AIRASIA’s 4Q14 core net profit was flattish (QoQ, +1.0%), while AIRPORT’s 4Q14 core net profit recorded a seemingly 28x leap QoQ, but it was mainly due to the change in depreciation method based on unit production instead of straight-line method previously. That said, AIRPORT would have registered a core loss of RM0.7m based on the old depreciation method.

YTD share price performance. As at our report cut-off date on 20 March 2015, AIRASIA’s share price took a beating, registering negative returns of 18.0% due to the disappointment in earnings coupled with the flight of foreign funds. As a result, its foreign shareholding has come off from its historical peak of 62.9% in January-15 to 60.9% in March-15. On the flip side, AIRPORT had performed relatively well with an 8.7% gain despite the disappointment in results, which we believe could be due to the subscription of its rights issuance exercise undertaken by management to raise up to RM1.3b for the acquisition of the remaining 40.0% stake in SabihaGocken International Airport (SGIA).

Uninspiring passenger traffic growth. On a cumulative basis for Feb-15, AIRPORT registered total passenger traffic of 16.7m (inclusive of SGIA) (+0.6%, YoY). The total passenger traffic of 16.7m was still softer than expected, as it only accounted for 15.3% of our full-year passenger traffic estimates of 109.3m. The weaker-than-expected passenger traffic was mainly dragged down by the decline in passenger traffic from its Malaysia operations, and slower-than-expected passenger traffic growth from SGIA. For its Malaysian operations, AIRPORT registered a disappointing passenger traffic of 13.1m (-3.0%, YoY), as it only made up 15.0% of our full-year estimate of 86.7m passenger traffic. Its international and domestic passenger traffic saw declines of 4.2% and 1.8%, YoY, respectively. The negative growth on its international segment was mainly due to the decline in passenger traffic from China (due to Chinese New Year), while the travel demand from the domestic-end remains fairly weak due to rising living costs and also the lack of promotional activities from AIRASIA due to the QZ8501 incident. As for SGIA, while it continued to register passenger traffic growth of 15.7%, YoY to 3.6m for Feb-15 (cumulative), it still came below our expectations as it only made up 16.0% of our full-year passenger traffic estimates of 22.6m.

Upgrading AIRASIA to OUTPERFORM. While AIRASIA might have disappointed on its FY14 performance due to higherthan- expected fuel cost arising from hedging losses and 1Q15 results are also expected to be weak due to slower-thanexpected traffic, we are upgrading AIRASIA to OUTPERFORM but with a lower Target Price of RM2.55 based on 11.0x FY15E PER (previously, MARKET PERFORM; TP: RM2.90 based on 12.5x FY15E PER). Our applied 11.0x FY15E PER is based on a lower valuation basis of -0.5SD of its 5-year forward average (previously, 5-year forward average) which is also close to its trough levels as after taking into consideration the potential threats from a new entrant i.e. FlyMojo and weaker market sentiment. We are calling an OUTPERFORM on AIRASIA albeit with a lower Target Price of RM2.55 premised on the following:(i) slower passenger traffic risk to be mitigated by lower jet fuel costs and slight recovery in yields, and (ii) AIRASIA is a strong contender in the region which is unlikely to be affected by FlyMojoin the long run, as we believe that new airlines may be disadvantaged in pricing competition due to higher start up and operational costs. That said, FlyMojo would not have a direct competition with AIRASIA unlike Malindo as it would be operating from Senai International Airport and Kota Kinabalu Airport coupled with the fact that that they would be catering for the niche and premium market vis-à-vis AIRASIA’s mass market.

Maintaining NEUTRAL.We maintain our NEUTRAL call on the sector due to the uninspiring passenger traffic growth due to the three Malaysian-related air tragedies that does not bode well for AIRPORT (UP; TP: RM6.77). However, we are upgrading AIRASIA to OUTPERFORM albeit with a lower Target Price of RM2.55 as the share price has been severely bashed down 18.0% since the beginning of the year, and we strongly believe that lower jet fuel cost and slight recovery in yields will be able to mitigate its weak passenger traffic in 1Q15 due to the lack of promotional activities post the QZ8501 incident.

Source: Kenanga Research - 6 Apr 2015