We maintain neutral on sector. We like Malaysia Airports Holdings Berhad (MAHB) as an attractive proxy to the propensity for air travel due to rising per capita income. MAHB is well-entrenched because of its (i) monopolistic position as an airport operator in Malaysia, while (ii) earnings are protected from downside in the aeronautical segment under the operating agreements. However, AirAsia is expected to face near-term tough operating environment on intense competition, and higher operating costs due to accounting treatment for aircrafts under sales and leaseback arrangements. AirAsia’s TP is RM1.70 based on 10x FY20E EPS, at a discount to average forward PER of 11x of global peers to reflect its relatively smaller market capitalization. TP for MAHB (OUTPERFORM) is RM9.90 based on 22x FY20E EPS, which is at a 20% discount to regional peers’ average to reflect its relatively smaller market capitalization. Reiterate Neutral on sector.

Malaysia Airports Holdings Berhad (MAHB) is well-entrenched because of its (i) monopolistic position as an airport operator in Malaysia, while (ii) earnings are protected from downside in the aeronautical segment under the operating agreements. A key component under the operating agreements is 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.

Malaysia Airports register a solid 3QFY19. The recently concluded 3QFY19 results season for both AirAsia Group and Malaysia Airports Holdings came in contrasting fashion. Malaysia Airports Holdings delivered 9MFY19 earnings which were above expectations due to better-than-expected results from Turkey underpinned by maiden 3QFY19 profit at International Sabiha Gokcen resulting in narrowing losses. However, AirAsia’s 3QFY19 earnings were hit by low fares at Malaysia and Thailand, lower yields and higher cost where CASK (+11%) rose faster than RASK (+1%) and exacerbated by adoption of MFRS 16 and sale and leaseback programme which drove maintenance and overhaul costs higher.

Tough operating environment for AirAsia. The group expect load factors to remain solid and fares to hold steady despite nascent signs indicating that higher industry supply of seats is potentially outstripping passenger demand growth which are leading to competitive fare war. We note that the maintenance costs spiked up in 3QFY19 (+118% YoY) due to accounting treatment for the aircrafts under sales and leaseback arrangements which also contributed to the hike in CASK. Specifically, 3QFY19 earnings was dragged down by CASK (+11%) which rose faster than RASK (+1%) due to higher staff costs, provisions for maintenance and overhaul (+>100%), user charges and other operating expenses, due to the increase in operations, as well as the impact of adopting MFRS16. 9MFY19 core net profit came in at RM247m hit by: (i) stiff price competition in the Malaysian market, (ii) challenging operating environment in Thailand and India due to low pricing by competitors and higher CASK, respectively, (iii) sale and leaseback programme which requires AirAsia to make provisions or expense off maintenance provisions rather than capitalising and amortising over the useful life of the major overhaul, and (iv) the adoption of MFRS 16 requiring operating leases to be capitalised on the balance sheet, with the right-of-use assets depreciated and interest expense recognised.

RAB framework hanging in the balance?. We highlight that the RAB has yet to be implemented of which we have yet to impute into our earnings model. Malaysia Aviation Commission (MAVCOM) reaffirmed the implementation of Regulated Asset Base (RAB) model framework-led tariff on aeronautical charges or Passenger Service Charge (PSC) for Malaysia Airports Holdings Berhad (MAHB) and reiterated its stance of having statutory right to set the PSC due to be implemented for FY20 to FY22 with a WACC of 10.88%. Under the RAB, capex of RM4bn (previously RM5b) and lowered traffic assumption for 2018- 2022 CAGR of 4.9% (vs. 5.7% in June consultation paper), regulated revenue per pax is raised from RM42.90 to RM43.50 for regulatory period of year 2020 till end 2022. Bulk of the capex estimated at 70-80% is earmarked for KLIA 1 and 2. The implementation of RAB in early-2020 is the key re-rating catalyst; if this falls through, we expect MAHB to negotiate for higher MARCS compensation. The Ministry of Transport has confirmed that the cabinet has decided to dissolve MAVCOM and transfer its functions to the Civil Aviation Authority of Malaysia (CAAM) which could put a brake to the implementation of RAB. However, despite the uncertainties, we believe a delay in the RAB framework would delay expansion needs for some airports including KLIA’s main terminal (baggage handling and aero trains).

Reiterate Neutral. We like MAHB as an attractive play on the propensity for air travel due to rising per capita income. MAHB is well-entrenched because its earnings in the aeronautical segment under the operating agreements are protected from downside 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. TP for MAHB is RM9.90 based on 22x FY20E EPS, which is at a 20% discount to regional peers’ average to reflect MAHB’s relatively smaller market capitalization. Reiterate Outperform on Malaysia Airport.

Source: Kenanga Research - 6 Jan 2020