Conference call addresses receivables concerns. The conference call started off straight with Q&A session with investors and analysts to address the concerns on its accounting methods and so-called transparency issue, especially on its aircraft leases to its associates and also growing concerns on its balance sheet whereby the amount due by its associates has ballooned up to a staggering amount of RM2.4b in FY14 as compared to RM1.3b back in FY13 and the ability of its associates to pay back.

What are these amounts owed by associates? The receivable sum of RM2.4b is the amount owed by its associates, mainly AirAsia Indonesia (IAA) and AirAsia Philippines (PAA); it comprises of loan advancement from AIRASIA, finance expenses, brand licensing fees, aircraft leases payable. These amounts due by its associates ballooned by almost 2x from RM1.3b back in FY13, as IAA and PAA failed to be profitable due to challenges in the local market, i.e. intense price competition and high operational costs, i.e. jet fuel. As of FY14, 50% of this amount of RM2.4b owing to AIRASIA were past due but not impaired by management in view that it is recoverable.

Main concerns and measures by management. In the conference call, the amount of RM2.4b owed by its associates in FY14 and AIRASIA’s ability to get its payback from its associates was the concern of most participants of the conference call. Management reiterated their strategy in raising fresh funds at its associate’s level by raising its share capital by USD100.0m for IAA and PAA, and pre-IPO funding by seeking fresh investors to raise USD100.0m for each associate by subscribing to convertible bonds (CB) issued by IAA and PAA respectively, raising a total of USD300.0m from both of its associates. That said, management also addressed investors and analysts concern should they fail to secure fresh funds for IAA and PAA, they are still confident in recovering these receivables over a longer period of time as they would expect both of these associates to be cash flow positive in 2H15.

How bad can it get? We came up with three potential scenarios and the theoretical impact on its FY15E balance sheet entails the impairment on these receivables from its associates. In our view, the worst-case scenario is if they fail to secure fresh funding while its associates remain cash flow negative over FY15. If so, we would likely need to impair RM1.57b worth of receivables from associates (refer to Scenario 2), which would erode our FY15E BV/share by 27% to RM1.41, implying a PBV of 1.18x based on last price. (Kindly refer overleaf for our scenario analysis on the potential impact to its valuation.)

Asia Aviation Capital. On its aircraft leasing, we believe that AIRASIA is heading towards the right direction by setting up a leasing house, namely Asia Aviation Capital (AAC), to manage its fleet of 128 aircrafts in the future. Furthermore, management's disclosure of AAC profitability on its 1Q15 results for the first few aircrafts transferred as this has provided much more clarity and transparency on its leasing business to its associates. That aside, should AAC reach an optimal size AIRASIA could opt for a listing in the future. We like this because it would provide a better picture of its leasing business going forward.

Maintain OUTPERFORM. In our view, it is still too early to judge AIRASIA’s ability in securing fresh funding from new investors. We are neutral to positive on its associates, especially on PAA as it has seen tremendous improvements in performance in 1Q15 given that its losses narrowed by 39% YoY. As for IAA, we are still monitoring this associate closely as its 1Q15 performance has worsened with its losses increased by another 17% mainly plagued by the QZ8501 incident. However, management remains positive on IAA and confident of breaking even by year-end, as they will be reducing its capacity on its domestic end (-4 aircrafts) and focus on the international market. Hence, we are reiterating our OUTPERFORM call on AIRASIA with a lower Target Price of RM1.86 based on 1.32x FY15E PBV (recall that our previous TP of RM2.55 was based on 11x FY15E PER or 1.32x PBV), after factoring in the potential impairment of RM1.6b in our Scenario 2 analysis. Furthermore, we need to highlight that since its listing, AIRASIA has achieved an impressive feat of aggressive growth over the years to what it is today with only one placement to date; not many airlines can boast such internal funding capabilities for a highly CAPEX intensive industry. 

Source: Kenanga Research - 19 Jun 2015