We continue to reiterate our NEUTRAL recommendation on the sector, as we do not see any near-term catalyst that could excite the sector, especially when passenger traffic growths are expected to remain subdued for the rest of the year. However, we are still keeping our OUTPERFORM call on AIRASIA with an unchanged Target Price of RM1.86 as we believe that AIRASIA will continue to benefit from the low jet-fuel cost and also yield improvement from associates. As for AIRPORT, we are keeping our UNDERPERFORM call with a lower Target Price of RM5.90 based on SoP, due to consecutive quarter earnings disappointments.

Low jet-fuel costs continue to drive airlines’ performance. In 2QCY15, the two aviation stocks under our coverage, namely AIRASIA and AIRPORT, continued to report mixed results where AIRPORTcontinued to disappoint us and the market due to higher-than-expected operating costs stemming from its high staff costs due to another round of “one-off” salary adjustments. On the flip side, AIRASIA’s reported earnings were well within expectations as they continue to enjoy the benefits of lower jet fuel costs.

YTD share price performance. As at our cut-off date of 25thSeptember 2015, AIRASIA’s share price has plunged by 53%, mainly due to foreign selling coupled with the concerns over the profitability of its associates, i.e. AirAsia Indonesia and AirAsia Philippines. That said, AIRPORT did not perform any better than AIRASIA in the same period registering negative returns of 19%, which we believe was partly due to foreign selling coupled with disappointing results due to higher-than-expected operating costs arising from high staff costs.

Passenger traffic growth inline. On a cumulative basis, as of end-Aug15, AIRPORT registered total passenger traffic of 74.2m (inclusive of SGIA) (+5.7%, YoY) which was within expectation, making up 69% of our full-year passenger traffic estimates of 107.5m. For its Malaysian operations, AIRPORT registered passenger traffic of 55.7m (+2.0%, YoY) which was also within expectations, making up 66% of our full-estimate of 84.9m passenger traffic. While its passenger traffic numbers are coming inline with our expectations, we deem that AIRPORT has to do better to improve its passenger traffic growth and strive to reduce its operational costs stemming from the operations at KLIA2, else we do not see any catalyst for AIRPORT in the near-term.

AIRASIA, what’s next? While AIRASIA did relatively well in their 2QCY15 performance as compared to AIRPORT, we believe that AIRASIA will still need to iron out profitability issues coming from its associates, i.e. AirAsia Indonesia, and AirAsia Philippines. To recap, AIRASIA made an announcement recently that they will be subscribing to 49% of the Perpetual Capital Securities (PCS) totalling to IDR2.1b (c.RM620.0m) issued by AirAsia Indonesia by converting debts owed by AirAsia Indonesia into equity, while the remaining 51% will be undertaken by its local party or a new investor in Indonesia. In the short-term, we are quite positive with AIRASIA’s move as it would temporarily resolve the negative equity issue in AirAsia Indonesia, which will allow them to continue their operations in Indonesia. Post subscription to the PCS, AIRASIA would be expecting to equity account for a loss of RM474.0m for the cumulative unrecognised losses from AirAsia Indonesia. We believe that the next catalyst for AIRASIA would be its ability to turn around its associates, i.e. AirAsia Indonesia and AirAsia Philippines by breaking even in 4Q15, as we believe that the market is still skeptical with management’s guidance on breaking even by year-end.

NEUTRAL maintained. Post2QCY15 reporting season; we downgraded our Target Price for AIRPORT to RM5.90 with an unchanged UNDERPERFORM call (previously, RM6.18) after we lowered our FY15-16 earnings estimates for AIRPORT. Meanwhile, we are still keeping our OUTPERFORM call on AIRASIA with an unchanged Target Price of RM1.86 based on 1.32x FY15E PBV after taking into consideration the potential impairment impact from the amount owed by its associates as we believe that AIRASIA will continue to benefit from low jet-fuel cost and also the improvement in yields from its associates. We are keeping our NEUTRAL call on the sector as we believe that passenger traffic growth is likely to remain subdued for the rest of the year due to the previous air travel tragedies coupled with the lack of near-term catalyst for the sector except for low jet fuel prices that will continue to drive the airlines’ profitability.

Source: Kenanga Research - 7 Oct 2015