We downgrade Aviation from OVERWEIGHT to NEUTRAL. While we like Malaysia Airports Holdings Berhad (MAHB) as an attractive play on the propensity for air travel in the region due to rising per capita income, the stock has risen 32% over a 52-week period and is currently trading at rich valuations of 26x on FY19E EPS and 22x on FY20E EPS. However, there is potential earning or rating upgrade catalysts upon the release of the final consultation paper on the implementation of Regulated Asset Base (RAB) in early October. Separately, AirAsia is expected to face near-term tough operating environment of intense competition, higher operating costs due to the sale-and-lease-back of aircrafts and sustained high jet fuel price over the medium term. AIRASIA, our TP is RM1.70 based on 10x FY20E EPS, at a discount to average forward PER of 11x of global peers to reflect AirAsia’s relatively smaller market capitalization. TP for MAHB is RM8.70 based on 22x FY20E EPS, which is at a 20% discount to regional peers average to reflect MAHB’s relatively smaller market capitalization.

Malaysia Airports Holdings Berhad (MAHB) is well-entrenched because (i) of its monopolistic position as an airport operator in Malaysia, while (ii) earnings downside in the aeronautical segment under the operating agreements is protected. The government of Malaysia and MAHB signed operating agreements on 12 February 2009 which provide a framework for the airport operations. A key component under the operating agreements lies in the Marginal Cost Support Sums (MARCS) system which would compensate MAHB for reduction in aeronautical (Passenger Service Charge or ‘PSC’) resulting in PSC rate being lower than the benchmark rate as per the OA due to governmental instructions. MAHB continues to register steady passenger traffic (including ISG) growth of 7.5% for YTD 8M19 (+9.2% for Malaysian operation and +3.1% for Turkey operation YoY-Ytd), which we believe is on track to meet our target of 4.3%.

Tough operating environment for AirAsia. The group expect load factors to remain solid and fares to hold steady in 2H19. 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 for 40% of total cost) and its planes 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 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. Hedging is in place for FY19-21 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.

RAB framework a potential re-rating catalyst for Malaysia Airport. MAHB is an attractive play on the stronger demand for air travel and airlines’ expansion initiatives but without the direct risk exposure to rising fuel prices. Recall, MAVCOM’s third consultation paper release of RAB which proposed a WACC of 10.88% compared to MAHB’s 12.7% but higher than consensus of 8%, and a preliminary approved CAPEX of RM5.0b under the first review period (RP1) from Jan 2020-Dec 2022. This means that under RP1, MAHB has to ensure no cost overrun on its capex programme and targets set by Mavcom are not exceeded.

Downgrade from OVERWEIGHT to NEUTRAL. While we like Malaysia Airports Holdings Berhad (MAHB) as an attractive play on the propensity for air travel in the region due to rising per capita income, the stock has risen 32% over a 52-week period and is currently trading at rich valuations of 26x on FY19E earnings and 22x on FY20E earnings. There is potential earning or rating upgrade catalysts upon the release of the final consultation paper on the implementation of RAB in early October. Separately, AirAsia is expected to face near-term tough operating environment of intense competition, higher operating costs due to the sale-and-lease-back of aircrafts and sustained high jet fuel price over the medium term.

Source: Kenanga Research - 4 Oct 2019