We upgrade our aviation sector call to OVERWEIGHT (previously NEUTRAL) premised on: (i) AIRASIA’s low fuel cost, better yields and load factor supported by stronger travel demand coupled with lower earnings risks from associates, and (ii) recent dip in AIRPORT’s share prices. Since our last report cut-off date, AIRASIA’s share price has increased 38% on the back of 1Q16’s results outperformance while AIRPORT’s share price dipped 4% likely dragged by the recent bombing incident in Turkey. Nonetheless, AIRPORT’s passenger growth is deemed in-line with our target which we have decided to keep unchanged at 3.0% and 20.0% for Malaysian and Turkey operations, respectively. We still expect AIRASIA to fare better against AIRPORT, benefitting from the low fuel cost and improvements in load factor and yields. Hence, we have chosen AIRASIA to be among our Top 10 picks for the first time this coming quarter. In light of the drop in its share prices coupled with intact fundamentals, we upgrade our call for AIRPORT to OURPERFORM with an unchanged target price of RM7.11 while keeping AIRASIA’s (OP; TP: RM3.41) call and TP unchanged.

Aviation 1QCY16 results surpassed expectations. In 1QCY16, both stocks (AIRASIA and AIRPORT) within our coverage registered better-than-expected results. AIRASIA’s stellar performance was driven by better-than-expected yields due to the recovery in ticket prices, higher load factor and lower fuel cost. Meanwhile, AIRPORT’s performance was lifted by lower financing costs.

AIRASIA continued its rally… As of our last cut off at 25th March 2016 (RM1.81), AIRASIA’s share price continued to increase by another 38% while YTD, it registered a whopping 95% gain. We believe AIRASIA’s good run was fuelled by: (i) 1Q16 results outperformance coupled with associates results showing improvement, (ii)new placement of shares taken up by Tony and Kamarudin, which help support share prices at the RM1.84-level (refer to CU dated 29/4/16), (iii) buying interest for their leasing business arm (Asia Aviation Capital)being valued at USD1.0b in which Tan Sri Tony Fernandes disclosed that an interested buyer had offered USD800m for 80% stake, and (iv) buying interest from foreign investors. Meanwhile, AIRPORT’s share price was down4% (last cut off price of RM6.34) due to the bombing incident in Ataturk Airport, Turkey which indirectly dragged AIRPORT’s share price due to their wholly-owned ISG Airport.

AIRPORT’s passenger growth on-track... For FY16, AIRPORT management is expecting passenger growth of 2.5% for their Malaysia operations and 15% for Turkey. We are slightly more optimistic, expecting growth of 3.0% and 20.0% for AIRPORT’s Malaysia and Turkey operations, respectively. YTD (till May), Malaysian passenger traffic growth is in-line with our expectations registering 3.1% growth. We believe Malaysian passenger growth will meet our expectations or potentially over perform, buttressed by the stronger travel demand from international traffic and introduction of new routes coupled with increased flight frequencies from airlines with improved load factors. Despite the rising security threats in Turkey which caused ISG’s passenger traffic growth to weaken (registering 15.4% growth YTD against our 20.0% estimate), we deem growth as in-line and decide to keep our estimates unchanged at this juncture, expecting a recovery from its international passenger traffic number as we observe a slight recovery in May which registered YoY growth of 1.8% for its international traffic growth vis-à-vis April’s negative growth of 2.5%.However, should its passenger traffic numbers fail to see any improvements by 3Q16 from the recent bombing at Ataturk Airport, we may look to trim our growth assumptions to 15% (from 20%) for ISG. That said, AIRPORT management has shown confidence through better growth direction with their ‘Runway To Success’ programme and promised more consistent reporting with lesser major FV adjustments going ahead.

Airlines still the pick over airport…For 3QCY16, we are still expecting AIRASIA to fare better than AIRPORT and continues its good run underpinned by: (i) low fuel cost, (ii) improvement in yields, (iii) improved load factor underpinned by strong travel demands, and (iv) better contribution from its associates arising from better fuel costs, which further reduces its earnings risk from associates. However, the existing risk for AIRASIA would be the abrupt hike in DCA charges by 10x as proposed previously, which we understand the Ministry has staggered it over an undefined period. The first 1-fold hike which was implemented on 15 April 2016 has minimal impact to our estimates as we have already factored it in. However, we remain negative on the hike decision and remain cautious on timing of an interval of the hike implementations as a further 9x hike could negatively impact our earnings forecasts.

Upgrade to Overweight with AIRASIA chosen as Top 10 Pick! We believe AIRASIA is ready to chart another strong quarter ahead supported by the low fuel cost coupled with improved load factor and yields driven by strong travel demand, especially from China. Hence, we reiterate our OUTPERFORM call with an unchanged TP of RM3.41 and have chosen AIRASIA to be within our Top 10 picks for 3QCY16. This would be the first-time AIRASIA is chosen as our Top Pick. We value AIRASIA at 9x FD FY16 PER based on -0.5 SD @ 3-year average Fwd. PER. Meanwhile, with valuations intact for AIRPORT, we upgrade AIRPORT to OUTPERFORM (previously MARKET PERFORM) with an unchanged TP of RM7.11 (1.52x FY17E PBV @ 5-year Fwd. Avg.)in light of the drop in share price due to the recent bombing at Turkey’s Ataturk Airport. We note that even if we had trimmed our ISG passenger growth to 15% (from 20%), AIRPORT’s TP would only decrease slightly to RM7.08, which still warranted an OUTPERFORM call based on FY17 PBV of 1.52x. Consequently, we upgrade our sector call to OVERWEIGHT.

Source: Kenanga Research - 12 Jul 2016