We maintain our OVERWEIGHT rating on the aviation sector premised on: (i) AIRASIA’s high passenger load factors driven by stronger travel demand and additional capacities 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 in addition to a 35-year extension in Operating Agreement (OA) for their Malaysia Operations. Over 1QCY17, AIRASIA’s share price has improved 20% as the sale of AAC comes closer to fruition with a potential round of special dividends – anticipated to be concluded by 2H17. AIRPORT’s share price was also up 13% likely due to the extension of OA for Malaysian operations for another 35 years, which greatly reduced amortization charges coupled with the robust Malaysia passenger traffic YTD. As of 2M17, AIRPORT’s total passengers traffic (both Malaysia and Turkey) were up 6.3% YTD – in line with our target. We maintain our OUTPERFORM rating for both AIRPORT and AIRASIA based on unchanged TP of RM7.42 and RM3.82, respectively.

Results Recap. In 4QCY16, stocks under our coverage (AIRASIA, AIRPORT) registered decent performance with AIRASIA coming in line with estimates while AIRPORT was above due to lower amortisation charges arising from new OA extension kicking in from 4Q16 instead of FY17 as expected earlier.

Decent share price performance. Over 1QCY17, AIRASIA’s share price improved 20% likely due to the news flow from the disposal of AAC and the potential special dividends to be dished out by 2H17 (refer below for more). Meanwhile, AIRPORT’s share price was up 13% likely due to the extension of OA for Malaysian operations for another 35 years, which greatly reduced amortization charges coupled with the robust Malaysia passenger traffic YTD.

AIRPORT’s passenger growth estimates. AIRPORT’s total passenger movement for Malaysia and Turkey registered growth of 6.3% YoY-YTD (till February 2017) in line with our estimates of 6.3% (our targets of +6.0% for Malaysia and +7.0% for Turkey). However, on individual country basis, we note that growth was mainly supported by its Malaysian operations, which were up 9.9% while Turkey was down 5.5%. Malaysian operations passenger growth remains robust supported by improved load factors from strong travel demand and new foreign airlines and MAB operating at increased frequencies. Meanwhile, Turkey’s travel statistics remain subdued, still reeling from the bombing incidents and travel threats, which have severely affected their international passenger growth, registering monthly negative growth rates since June 2016. For now, we keep our 6.0% and 7.0% estimates unchanged for Malaysian and Turkey, respectively, pending a review on March 2017 Passenger traffic before deciding whether to trim Turkey estimates. Should we cut our FY17E Turkey estimates to 3% growth (from 7%), we note that this would lower our FY17E CNP by c.10%. That said, we note that the impact might be cushioned as we might have an upward revision towards our Malaysia passenger growth target considering the stronger-than-expected travel demand in Malaysia YTD.

AIRASIA, extending its wings. In FY17, AIRASIA is looking to expand their aircraft fleet by a net growth of 27 planes; Malaysia +7, Thailand +6, Indonesia +2, Philippines +3, India +6 and Japan +3. Apart from the increase in fleet size, AIRASIA is also targeting a higher aircraft utilization rate from 12 hours to 14.5 hours. While we are expecting a significant boost to existing capacity, we believe AIRASIA is able to maintain healthy load factors of >85% backed by: (i) strong travel demand, coupled with their (ii) extensive route options with optimal frequencies. However, we do expect some yield pressure from its increased capacities and competitions from other airlines. While yields might be pressured arising from the increase in capacity, we remain confident that they should be able to maintain its RASK leveraging on the use of technology, i.e. data mining/dynamic pricings enabling them to mitigate the yield pressures through increased ancillary income from more targeted marketing/sales – which they have targeted RM55/pax in FY17 and RM60/pax by FY18 (vs RM48/pax in FY16). Despite the rising fuel costs, we believe AIRASIA’s fuel risks are greatly minimized as c.80% of its FY17 fuel is hedged at USD59/barrel comparable to FY16’s average effective fuel costs of USD56/barrel. While FX (USD/MYR) might be a concern as well, we note that AIRASIA’s FX risks are partially mitigated through: (i) ticket sales which are 37% denominated in foreign currency, and (ii) 47% USD borrowings for planes hedged at 3.2 USD/MYR. Our analysis indicates that a 10.0 sen depreciation of MYR against USD would decrease FY17E CNP by 2.6%.

Leaner AIRASIA operations post disposal of AAC. Post disposal of AAC, AIRASIA is expected to lose their stream of leasing income by c.RM400m in FY17 (lowering FY17E CNP by 29% to c.RM1.0b) which we believe would be compensated by a round of special dividends. The AAC disposal is expected to fetch a price tag of USD1.0b-1.2b (equivalent to RM4.4b-5.3b) which comprise: (i) AAC’s 29 existing aircrafts plus another 7 planes yet to be novated into their books – bringing it to a total of 36 aircrafts, (ii) 38 AIRASIA’s planes to have a sale and leaseback done with AAC, i.e. AIRASIA will sell 38 planes to AAC for c.USD1.2b-1.3b and lease them back from AAC, (iii) portfolio of 14 spare engines from AIRASIA worth c.USD93m, and (iv) an option for AAC’s prospective buyer to take up to 30% of planes from AIRASIA’s 399 plane order-book (299 A320neo’s and 100 A321neo’s yet to be delivered by Air Bus). Assuming a 100% stake sale of AAC at USD1.0b (USDMYR of 4.4), a 80% dividend pay-out would translate to RM1.05 of dividend/share. However, we have yet to factor this in into our estimates as the final amount and portion of the stake sale remains uncertain. We are positive on the monetisation of AAC as this would allow AIRASIA to lighten its balance sheet from current 1.3x (as of 4Q16) to c.0.9x and allow it to fully focus on its airline business.

Maintain OVERWEIGHT for Aviation sector. For AIRPORT, we maintain our positive stance, as we believe the newly improved PSC structure coupled with the extension of Operating agreement would provide better earnings visibility for the group. Hence, we believe our current valuations of 1.58x FY17E PBV, based on +0.5SD above its 5-year historical mean, is fair despite the poor Turkey passenger growth due to travel threats which we believe will eventually recover citing the recovery of Malaysian domestic air travel and the return of China travellers post the triple air tragedy in 2014. Maintain OP call with an unchanged TP of RM7.42 for AIRPORT. Meanwhile, we expect AIRASIA to continue registering high load factors post fleet expansion on the back of strong travel demand coupled with their dynamic pricing of tickets. We make no changes to AIRASIA’s OP call with an unchanged TP of RM3.82 based on 9.0x FY17E PER (5-year Fwd. Average) as we believe that it will be a good time for investors to accumulate underpinned by the prospect of special dividends. Maintain OVERWEIGHT recommendation on the sector.

Source: Kenanga Research - 28 Mar 2017