Can AirAsia Continue to Gain Altitude?

The carrier is up 26% over the last month as fuel prices fall, but its affiliates continue to burn cash.

March 23, 2016

Photographer: Charles Pertwee/Bloomberg

AirAsia has been flying through turbulence for the last couple of years, but is Southeast’s biggest budget airline entering clearer skies?

The Kuala Lumpur-based carrier’s shares had been buffeted by the crash of Indonesia AirAsia flight 8501 in late 2014, accusations of accounting shenanigans and loss-making regional businesses. While AirAsia’s shares had been stuck in a holding pattern over the past five months, they have soared 26% over the last month after surprising investors with a return to profit. The stock has been lifted by analyst upgrades and higher price targets. But Barron’s Asia urges caution as AirAsia (ticker: AIRASIA.MY) still needs to bring its struggling regional associates to heel.

The improvement in AirAsia’s business was underscored by its fourth quarter earnings, which exceeded analyst expectations. Profits after tax soared to MYR554 million in the fourth quarter compared to a loss of MYR429 million a year earlier. The improved showing reflected a recovery in passenger numbers, with the airline’s load factor, which measures how full flights are, increasing from 78% to 85%. The company is also benefiting from the weaker Malaysian ringgit, which makes it cheaper for foreigners to visit the Southeast Asian nation. Also, Malaysians are skipping long-haul destinations like Europe and the U.S. and vacationing in the region instead.

The fall in oil prices to around $30 a barrel has also started to drip through to AirAsia’s bottom line. The airline hedges over half of its jet fuel requirements, which means it pays more than the spot price. Jet kerosene will cost AirAsia about $60 a barrel in 2016 compared to a spot price of around $40 a barrel. However, the fall in prices allowed AirAsia to remove the fuel surcharge it had been charging customers, which also helped lift passenger numbers on the fourth quarter.

That showing was enough to convince Hong Leong’s Daniel Wong to bump his target price up to MYR2.14 a share, meaning the stock offers about 22% upside. He’s upbeat on earnings improving in the next two years because of lower jet fuel prices and thinks AirAsia will also benefit from government initiatives to make Malaysia a more popular tourism destination. These include visa-free entry for Chinese tourists. AirAsia also stands to pick up passengers from floundering rival Malaysian Airline System, which has been paring its route network after two crashes and renationalization by the Malaysian government.

Another bull is MIDF Research’s Tay Yow Ken, who upgraded his target price to MYR1.94 a share. Tay says he was encouraged by signs of a turnaround in Philippines AirAsia, which reduced losses by more than 90% to USD2.5 million. More Chinese tourists visiting the sun-and-surf paradise of Boracay boosted average fares and load factors at the Filipino operation, he points out.

However, some of AirAsia’s associate airlines continue to flail. AirAsia doesn’t own these carriers outright because of tough foreign investment rules in several Southeast Asian countries, so instead has a 49% equity stake in each. Thai AirAsia is the only one currently in the black and in the quarter it booked a lower profit of USD15 million, down a third from a year ago. The Thai affiliate faces rising competition in one of the world’s hottest tourist markets: Carriers like Indonesia’s Lion Air and local airline Bangkok Airways are adding more routes and are particularly keen on capturing more of the Chinese market. Market saturation has pushed down fares though, with Thai AirAsia’s own average ticket prices down almost 20%.

The picture’s even gloomier for Indonesia AirAsia, where losses grew to USD79 million. The airline’s faced a string of setbacks, stretching back to the tragic loss of an aircraft in December 2014. Others include a threat by local regulators to ground the carrier for its messy finances. A recent decision by the Indonesian government to lower the floor for low-cost airlines’ ticket prices might also hurt if it leads to a price war between carriers. Indonesia is the biggest air travel market in Southeast Asia and within 20 years could be world’s sixth-largest. But AirAsia hasn’t made great in-roads here and is way behind locals Garuda (GIAA:ID) and Lion Air. It’s instead focused on trimming down its fleet and focusing on international routes out of the country. AirAsia last year recapitalized the Indonesia airline by issuing convertible securities and plans to do likewise with the Filipino associate. Chief executive Tony Fernandes wants both airlines to IPO within the next couple of years.

Adrian Ng, an analyst at Kenanga, says he still thinks 2016 will be a bumpy year for the airline. He says AirAsia should be more transparent when it comes to transactions between its Malaysian parent and regional associates if it’s to win over investors. AirAsia shares were hammered over precisely this last summer: A report by GMT Research alleged the carrier boosted its bottom line with lease and maintenance deals between the parent group and its associates. AirAsia’s denied doing so.

Despite the recent ascent in its share price, Barron’s Asia still thinks there’s better stock picks than AirAsia in the region’s skies – even at an undemanding valuation of less than seven times forward earnings. Analysts at Jefferies are positive on Chinese carriers, for one. Air China ( 753.HK ) and China Eastern Airlines ( 670.HK ) are both cheaper than AirAsia at about a 20%-30% discount to their asset values. Jefferies think both airlines should improve returns generated by shareholder equity on lower fuel costs and rising demand for domestic travel in China. Chinese airlines are also busy paying down their U.S. dollar denominated debt, which reduces FX risk from any further weakening in China’s yuan.