We maintain our OVERWEIGHT rating on the aviation sector premised on: (i) AIRASIA’s low fuel costs, better yields and passenger load factors driven by stronger travel demand coupled with the sale of their leasing arm Asia Aviation Capital, and (ii) an improved earnings outlook for AIRPORT buttressed by the newly suggested PSC structure that will equalize PSC charges at all airports in Malaysia. Since our last report cut-off date, AIRASIA’s share price was up 11% from the outperformance of its 2Q16 results and the news flow on the sale of their leasing arm while AIRPORT was up 7% likely from the newly suggested PSC rates. As of 8M16, AIRPORT’s passenger traffic for Malaysian operations was up 3.3% above our 3.0% estimate while Turkey operations only registered 6.8% growth vis-à-vis our 10% target. We keep our Turkey passenger traffic estimates unchanged despite registering below our estimates as we are banking on a seasonally stronger 4Q16 and the potential recovery in passenger traffic as negative news flow begins to subside. On a side note, we issued an On Our Radar report on AirAsia X (AAX) dated 28/9/16 with a Trading Buy call with TP of RM0.49 premised on a turnaround story and their undemanding valuations. Meanwhile, we maintain our OUTPERFORM rating for both AIRPORT and AIRASIA based on unchanged TP of RM7.33 and RM3.82, respectively.

Mixed bag of results for 2QCY16. In 2QCY16, stocks under our coverage (AIRASIA, AIRPORT) registered a mixed bag of results with AIRASIA outperforming our expectation for the second consecutive quarter as we had previously overestimated our cost assumptions. Meanwhile, AIRPORT disappointed due to the higher-than-expected depreciation and taxation cost.

AIRASIA rallied and pulled back… As at our previous cut-off date at 30th June 2016 (RM2.60), AIRASIA’s share price peaked at RM3.25 on the 18/8/2016 and pulled back to RM2.88 level on our cut-off date on 15/9/2016 (+11%). We believe the share price peaked mainly due to: (i) 2Q16 results outperformance, and (ii) new flows on the sale of their leasing business Asia Aviation Capital (AAC) being valued at USD1.0b and potential special dividend to be announced once the sale materializes in 4Q16/1Q17. Meanwhile, the pullback was likely due to the equalization of PSC charges in all airports in Malaysia to be officially announced in 4Q16 – effectively hiking up KLIA 2 international and domestic PSC charges by 128% and 12%, respectively. AIRPORT’s share price bottomed in July to RM5.81 as their Turkey operations were affected by a bombing and military coup causing passenger traffic to deteriorate. However, the share price had since recovered and closed +7% on our cut-off date (previous cut off price of RM6.12) which we believe is due to the new PSC structure mentioned above which could potentially generate higher revenue.

AIRPORT’s passenger traffic review. As of 8M16, AIRPORT’s total passenger movement for Malaysian and Turkey operations registered growth of 3.3% and 6.8% YoY-YTD, respectively. While Malaysia’s passenger growth came in above our 3.0% estimate, Turkey was below our 10% target. We believe Malaysian passenger growth will likely meet our expectation or potentially outperform being supported by the stronger travel demand from international traffic, introduction of new routes and increased flight frequencies from airlines with improved load factors. However, its Turkey operations at ISG airport continued to remain weak registering negative YoY growths of -2% to -5% for months June to August. While we note there are downside bias towards our 10% ISG target, we decide to make no changes to our passenger growth estimates as we are banking on the seasonally stronger 4Q coupled with the potential recovery in passenger traffic as earlier negative news flow in Turkey has subsided.

Still Positive on AIRASIA. For 4QCY16, we expect AIRASIA to continue its good run underpinned by: (i) low fuel cost environment, (ii) improving yields from better ancillary income, (iii) improving load factors on stronger travel demand and (iv) sale of their leasing arm, AAC. Despite the newly implemented PSC rates which will raise KLIA2 international PSCs by 128% – possibly deterring travellers, we believe it is highly unlikely as the impact would be minimal towards AIRASIA as most of AIRASIA’s international flights are flown towards the ASEAN region which will fall under the new RM35 ASEAN segment (PSC effectively only up by RM3 or 9%) – allowing AIRASIA to keep their competitive pricings (refer to our previous report dated 26/9/16 for more).

Turnaround Story – AirAsia X. We had issued an On Our Radar note on AirAsia X (AAX) on the 28/9/16 with a Trading Buy call with TP of RM0.49 based on 8.0x FY17 PER. We believe AAX is set to turn around from their unprofitable past underpinned by: (i) the low fuel environment, and (ii) enhanced yields and load factors through increasing frequency to the North Asia route coupled with further improvements in ancillary income through the introduction of premium lounge, making Tune insurance and in-flight entertainment available in all markets. With regard to the hike in PSC charges, we are not overly concerned given that AAX had proven to be able to raise their average fare by RM88/pax in 1H16, while charting an impressive passenger growth of 21%, YoY. We note that AAX is currently trading at an undemanding valuation of 6.3x vis-à-vis other low cost carriers’ average of 9.3x.

Maintain OVERWEIGHT for Aviation sector. We had recently upgraded AIRPORT to OUTPERFORM (26/9/2016) with higher TP of RM7.33 based on +0.5SD 5-year historical Fwd. PBV of 1.58x as we believe the new PSC structure to be officially announced in 4Q16 will equalize PSC charges in KLIA Main and KLIA 2 and provide an improved earnings outlook. We believe further upside on AIRPORT’s TP lies with a faster-than-expected recovery for their ISG operations as the negative news fades away. For now, we maintain AIRPORT’s OUTPERFORM call with unchanged TP of RM7.33. On the other hand, we believe AIRASIA is ready to chart yet another strong quarter ahead supported by the low fuel cost and improving load factors/yields. Hence, we reiterate our OUTPERFORM call with unchanged TP of RM3.82 for AIRASIA based on 9.0x FY17 PER. All in all, we maintain our OVERWEIGHT call for the aviation sector.

Source: Kenanga Research - 5 Oct 2016