We maintain our OVERWEIGHT rating on the aviation sector on the back of 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. Over 2QCY17, AIRASIA’s share price improved 13% as the sale of AAC comes closer to fruition with a potential round of special dividends – expecting to be concluded by 2H17. Meanwhile, AIRPORT’s share price surged 27% likely due to: (i) inception of the Digital Free Trade Zone within KL Aeropolis, and (ii) potential stake sale in ISG (Turkey). As of 5M17, AIRPORT’s total passengers traffic (both Malaysia and Turkey) were up 9.0% YTD – in line with our 9.2% target. Maintain OP call with an unchanged TP of RM4.10 for AIRASIA. Given the correction of share price since our last downgrade report on AIRPORT, we upgrade AIRPORT back to MARKET PERFORM with an unchanged TP of RM8.38 as share price downside is largely covered.

1QCY17 Results Recap. In 1QCY17, stocks under our coverage (AIRASIA, AIRPORT) registered decent performance with AIRASIA (consolidated MAA, IAA and PAA) coming in line with estimates (21%) while AIRPORT was broadly inline (20%) as we expect stronger quarters ahead from: (i) recovery of Turkey market, and (ii) seasonality stronger 4Q.

Outstanding share price performance. Over 2QCY17, AIRASIA’s share price continued to improve, by 13%, buoyed by the anticipated disposal of AAC and the potential special dividends to be dished out by 2H17 (refer below for more). Meanwhile, AIRPORT’s share price surged 27% likely due to: (i) inception of the Digital Free Trade Zone, and (ii) potential stake sale in ISG (Turkey).

AIRPORT’s Turkey passenger growth momentum weakening? AIRPORT’s 5M17 total passenger movement for Malaysia and Turkey registered growth of 9.0% YoY-YTD in line with our estimates of 9.2% (Malaysian target growth of +10.0% for Malaysia and +7.0% for Turkey). However, on an individual country basis, we note that growth was mainly supported by its Malaysian operations, which were up 11.8% while Turkey was only up marginally by 0.6%. Malaysian operations passenger growth remains robust supported by improved load factors from strong travel demand buoyed by visa relaxations, currency advantage and various tourist promotional efforts coupled with new foreign airlines and MAB operating at increased frequencies. Meanwhile, Turkey’s travel statistics have shown improvement since March-17 registering positive growths of +4.1%, +8.1% and +0.3% running up to the month of May; as compared to negative growths since June-2016 as Turkey traffics were previously still reeling from the bombing incidents and travel threats. We believe the recovery is due to the stronger tourist arrivals post Turkey referendum boosting tourist confidence on the back of strengthening democracy in Turkey, which would deter military interventions like the coup in FY16. That said, we note that our Turkey growth target of +7.0% might have some downside risks given that May-2017’s growth of only +0.3% (International +1.9%; Domestic -0.4%) shows some slight weakness in passenger growth momentum (Turkey 5M17 growth at 0.6%). However, for now, we keep our 10.0% and 7.0% estimates unchanged for Malaysian and Turkey, respectively, pending a review on 1H17 passenger traffic before deciding 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%.

AIRASIA outlook remains attractive. For the rest of FY17, AIRASIA plans to further consolidate their remaining associates namely Thai, India and Japan Airasia into their accounts (currently consolidated Malaysia, Indonesia and Philippines). Cumulatively, they are 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. Recently, AIRASIA has also placed additional orders for 14 A320ceo aircraft; increasing their total outstanding aircraft order log to c.410 aircrafts. Apart from the increase in fleet size, AIRASIA is also targeting a higher aircraft utilization rate of 14.5 hours (previously 12 hours) which would be accretive towards ASK growth (+c.8.0% based on our estimates). While we are expecting the 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 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 pricing 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 75% of its FY17 fuel is hedged at USD59/barrel which we have factored into our assumption; comparable to FY16’s average effective fuel costs of USD56/barrel. While FX (USD/MYR) might also be a concern, we note that AIRASIA’s FX risks are partially mitigated through: (i) ticket sales, which are 37% denominated in foreign currency, and (ii) 50% 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.USD93.0m, and (iv) an option for AAC’s prospective buyer to take up to 30% of planes from AIRASIA’s c.410 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), an 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 it allows AIRASIA to lighten its balance sheet from current 1.3x (as of 1Q17) to c.0.9x (based on 80% special dividend pay-out) and focus on its airline business.

Maintaining OVERWEIGHT. Since our downgrade on AIRPORT to UNDERPERFORM (report dated 13th June 2017) due to its high trading valuations, AIRPORT’s share price has come down 6% from a high of RM9.28 to RM8.70 (based on our cut-off date of 23/6/2017). Given the correction in share price, we upgrade AIRPORT to MARKET PERFORM (from UP) with an unchanged TP of RM8.38 as the downside in share price is largely covered. We note that should we trim Turkey growth rate to a more achievable rate of +3.0% (from current target of +7.0), there will only be a slight adjustment towards AIRPORT’s TP of RM8.38 to RM8.35 based on the unchanged 1.74x FY18E PBV; whereby it is still within our stipulated MP range. Meanwhile, we expect AIRASIA to continue to register high load factors post fleet expansion on the back of strong travel demand coupled with their dynamic ticket pricing strategy. We make no changes to AIRASIA’s OP call with an unchanged TP of RM4.10 based on 9.0x FY18E 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 given that market weightage for counters under coverage has >10% upside.

Source: Kenanga Research - 5 Jul 2017