• Recapitalising IAA to lift IAA out of negative equity

• Swapping related party debt to perpetual securities

• All of IAA’s prior losses have been accounted for

• IAA is likely to turn profitable in 4QFY16

• Maintain our BUY call with TP of RM3.45

Phase 2 of recapitalising IAA. AirAsia Berhad (AirAsia) is moving ahead with phase 2 of recapitalising its 49% associate Indonesia Airasia (IAA) which has negative equity of IDR2.2t (RM727m). The purpose of the recapitalisation exercise is to comply with a directive by the Directorate General of Civil Aviation of Indonesia (DGCA), failing which could mean a suspension of IAA’s operations.

Swapping debt into convertible perpetual securities. The exercise entails Airasia converting IDR3t (RM1b) of related party borrowings owed by IAA into convertible perpetual securities, similar to Airasia’s previous subscription of IDR2t (RM620m) in October 2015. As of 3QFY16, the amount owed by IAA to Airasia stood at IDR3.6t (RM1.2b). Thus, the conversion of this debt to equity would be the most expeditious route in lifting IAA out of negative equity position, compared to a cash injection which would require financing arrangements and various approvals.

No one-off losses for Airasia. Airasia would not be required to recognise any prior accumulated losses from IAA this time around as all of IAA’s prior unrecognised losses have been accounted for. In the previous exercise in 3QFY15, Airasia recognised -RM625m being 49% of IAA’s accumulated losses. IAA’s 51% shareholder PT Fersindo Nusaperkasa took the remaining hit.

IAA is showing encouraging signs of a turnaround. In 3QFY16, IAA recorded a core net loss of RM3.3m which is a significant reduction over 3QFY15’s RM26m loss. Meanwhile, IAA is expected to be profitable in 4QFY16 helped by strong demand due to year end holidays and an improvement in average fares. Airasia would be recognising a 49% share of IAA’s profits or losses under the equity method. We believe that Airasia would be seeking to recoup its investments in IAA via an IPO.

Maintain our BUY call with TP of RM3.45. Our TP is pegged to a forward PE multiple of 8.5x FY17 EPS. Our positive view on Airasia is premised on: 1) robust travel demand coupled with moderate airline capacity expansion; 2) monetisation of AAC with potential for special dividends; 3) progress in turning around of IAA and PAA. Meanwhile, potential risks to our call are terrorist incidents and a sharp reversal in the prices of jet fuel.

Source: MIDF Research - 19 Dec 2016