We maintain our UNDERPERFORM call on AIRPORT, which is currently working relentlessly to meet the criteria for QoS set by MAVCOM to avoid financial penalty. Its valuations are also stretched. On the airline front, operating environment in the region remains challenging due to high fuel price environment coupled with stiff competition from other players. Our Top Pick call on AIRASIA is a tactical move banking on the announcement of special dividend in 4Q18 and its ability to maintain decent profitability compared to its peers amid the high fuel environment. In the longer run, we are anticipating more changes made to the aviation industry as the transport ministry is working closely with both MAVCOM and the stakeholders, i.e. AIRPORT and AIRASIA to drive the sector to the next frontier which might prompt us to upgrade the sector back to OVERWEIGHT in the future. To recap, we downgraded the sector from OVERWEIGHT to NEUTRAL in our 2QCY18 results review and we continue to reiterate the same stance.

3Q18 share price performance. Over 3QCY18, AIRASIA’s share price remains flattish with a marginal decline of 1.6% while AIRPORT’s share price increased by 2.4%. We believe that the marginal movements in share price for both stocks are largely due to lacklustre sector news flow as the transport ministry is still in the midst of doing a study on the future development for Malaysia’s aviation space.

AIRPORT’s traffic, banking on stronger fourth quarter. AIRPORT’s 8M18 passengers (including ISG) registered growth of 4.8% (+2.7% for Malaysian operations and +11.5% for Turkey operations) YoY-YTD. While the growth seems to be lagging behind our full-year growth assumptions of 8.5% (+8.0% for Malaysian operations, +10.0% for Turkey operations) due to weaker growth from its Malaysian operations, we deem that it is still on track to meet our target, banking on stronger months ahead especially from international travel. Our 8.0% growth estimate for Malaysia is premised on further international growth from China, India and other South East Asian countries due to: (i) visa relaxations, and (ii) increased capacities by local and foreign carriers, especially AIRASIA, for their plan to increase more capacities in both domestic and international routes. Note, our sensitivity analysis indicates that for every 1ppt (from current 8%) decline in Malaysian passenger growth forecast, it will drag earnings lower by 1.5% (or RM6m).

Racing to deliver better services. To recap, MAVCOM has stepped in to regulate the quality of service in KLIA and KLIA2 with the objective to improve passenger comfort at airports; failure to comply would result in a financial penalty of up to 5% of aeronautical revenue. As such, AIRPORT has increased their planned CAPEX to RM600-700m for FY18-19 to upgrade their infrastructure, i.e. trains, baggage systems and toilets. For Sept 2018, AIRPORT must ensure the following criteria to be met :- (i) cleanliness of washrooms, (ii) availability of ramp wifi service, and (iii) cleanliness of staff washrooms. Firstly, we must laud MAVCOM for their Quality of Service framework and AIRPORT’s relentless effort in complying to those standards as we have definitely experienced a major improvement at KLIA2 during our recent travel experience where its washrooms are constantly dry and clean while the waiting time for baggage has reduced significantly as we did not have to wait more than 10 minutes to receive our bags upon exiting from the customs check point. Hence, we believe that the risk of AIRPORT facing a financial penalty in September would be low, but continue to maintain our UNDERPERFORM call on the stock due to the lack of fresh catalyst.

Innovation, a key to survival. AIRASIA is unfazed with the rising fuel trend and has proven to be able to look out for opportunities to grow its business amid the adversities they have faced in the past; we believe that the key to its successes is innovation. Going forward, management is looking to further grow its business through its ancillary business (i.e. RedCargo, Ourshop, Baggage, Big Loyalty, Santan) apart from raising ticket prices and capacity expansion. On the cost front, they continue to leverage on technology for centralised procurement, increase automation at airports to reduce ground staff and route rationalisation strategy by suspending non-profitable routes and grow its profitable top routes. Hence, we believe that AIRASIA would weather through this challenging operating environment where oil price is on the rise better than any players in the region.

Tactical pick. In line with AIRASIA’s promise to dish out special dividends at least once every two years, we are positive on AIRASIA’s plans to continue unlocking assets. To recap, they announced a 13.0 sen interim dividend in 1Q18 arising from their proceeds from previous disposals. While we reduce our FY18-19E earnings by 14-25% on the back of a higher jet fuel in which we raise our FY18-19E average jet fuel assumptions to USD86.7-80.0/bbl (previously, USD80.0-.70.0/bbl) and a lower TP of RM4.05 (previously, RM4.80), we still opt to choose AIRASIA as one of our Top Pick as a tactical play this time around. We are anticipating that they would announce a special dividend from the sales proceed of its leasing arm AAC, where we are expecting a special dividend of 78.0 sen. Hence, we maintain our OUTPERFORM call on AIRASIA with a lower SoP-driven Target Price of RM4.05 which we ascribed 9.0x FY19E PER to its earnings and included the anticipated special dividend of 78.0 sen.

Maintain NEUTRAL. For now, we are maintaining our NEUTRAL call for the sector due to our UNDERPERFORM call on AIRPORT, due to the lack of re-rating catalyst at this juncture, especially when AIRPORT is working relentlessly to meet the criteria for QoS set by MAVCOM to avoid financial penalty. Its valuations are also stretched. On the airline front, operating environment in the region remains challenging due to high fuel price environment coupled with stiff competition from other players. Our Top Pick call on AIRASIA is a tactical move banking on the anticipated announcement of its special dividend in 4Q18 and its ability to maintain decent profitability compared to its peers amid high fuel environment. In the longer run, we are anticipating more changes in the aviation industry as the transport ministry is working closely with both MAVCOM and the stakeholders, i.e. AIRPORT and AIRASIA to drive the sector to the next frontier which might prompt us to upgrade the sector back to OVERWEIGHT in the future. To recap, we downgraded the sector from OVERWEIGHT to NEUTRAL in our 2QCY18 results review and we continue to reiterate the same stance.

Source: Kenanga Research - 4 Oct 2018