Tell-tale signs of intense competition, higher operating costs due to the sale-and-lease-back of aircrafts and sustained high jet fuel price are pointing towards a tough operating environment over the medium term. Downgrade FY19E/FY20E net profit by 46%/32%. Our TP is cut from RM2.20 (SoP-based) to RM1.70 based on 10x FY20E EPS. Downgrade our call from OP to MP.

Tough operating environment ahead. There are nascent signs indicating that higher supply of seats is potentially outstripping passenger demand growth which are leading to competitive fare war. Recall, 2Q19 load factor was commendable (2Q19 load factor at 85%, versus 86% in 2Q18). However, the higher supply of seats, coupled with competitive pressure have capped AirAsia’s RASK (revenue per ASK) growth at 4% YoY, which far trailed the 15% growth in CASK (cost per ASK). Separately, we expect a tough operating environment over the short to medium term due to the sustained high jet fuel price (accounts 40% of total cost) and planes which are now leased vs. owned previously. We note that the maintenance costs spiked up in 2Q19 (+105% YoY) due to accounting treatment for the aircrafts under sales and leaseback arrangements which also contributed to the hike in CASK. As such, we expect tough operating environment to persist over the medium term. We expect maintenance cost to be higher than expected in 2H19 upon gradual disposal of the group’s remaining 39 aircrafts as at June 2019 to 5 by end 2019. Elsewhere, the sustained weakness in MYR vs. USD could impact the group’s earnings because 70% of operating cost is USD-denominated.

High jet fuel cost sustained, accounts for 40% of total cost.

Hedging in place for FY19-21F but for Brent, rather than jet fuel. The group have also hedged 70% and 85% of fuel requirement for 3Q and 4Q 2019 at average Brent hedge prices of US$62/bbl and US$60.77/bbl, respectively and hedged 73% for FY20 at USD60.22 per barrel and FY21 19% at USD59.45/bbl. The Brent price of crude oil is currently trading at US$64/bbl, and has averaged around US$62/bbl so far in the 3Q. However, jet fuel is up 14% YTD to USD75.7/bbl.

Outlook. The group expect load factors to remain solid and fares to hold steady in 2H19. However, we expect tough operating environment to persist in 3Q19 and 4Q19 no thanks to: (i) high maintenance cost due to accounting treatment for aircrafts under sales and leaseback arrangements, and (ii) sustained high fuel jet price. The group planned a net fleet growth of 20 aircraft across AOCs. AirAsia expects to receive its first A321neo in November which is more fuel efficient, has longer range on top of additional 50 seats. The group will continue its focus on digital initiatives. Teleport (logistics business) is expected to see encouraging growth due to efforts to seek tie-ups with different airlines, as well as SMEs. AirAsia.com is being developed as a full-fledged onestop travel and lifestyle platform whilst BigPay will be rolled out in multiple markets in ASEAN.

Slashed our FY19E/FY20E forecasts by 46%/32%. The downgrades are mainly due to: (i) higher maintenance cost assumption, (ii) higher aircraft lease cost, and (iii) raised jet fuel price assumption.

Downgrade from OP to MP. Correspondingly, our TP is cut from RM2.20 to RM1.70 based on 10x FY20E EPS (+0.5SD above 5-year historical forward mean), which is at a discount to average forward PER of 11x of global peers like Ryanair and Southwest Airlines to reflect AirAsia’s relatively smaller market capitalization. Downgrade from OP to MP. Risks include lower-than-expected RASK and higher-thanexpected fuel costs, and higher-than-expected operating costs.

Source: Kenanga Research - 24 Sept 2019