INVESTMENT HIGHLIGHTS

• Blip in first quarter earnings

• Capacity additions will eventually contribute to earnings

• AAX had a decent quarter operationally

• We are seeing green shoots appearing for IAAX

• Merger with Airasia Berhad is not imminent

• We downgrade AAX to NEUTRAL with TP of RM0.50

Blip in first quarter earnings. AirAsia X’s (AAX) 1QFY17 core net profit of RM33m missed both ours and consensus forecasts, representing just 12% of ours and 14% of consensus numbers. The shortfall was mainly due to 1) narrowing RASK-CASK spread and 2) exorbitantly high effective tax rate of 68%. The latter arose following mark-to-market losses on fuel hedging derivatives which were not tax-deductible.

We are not too discouraged by the blip in earnings. We assess that the earnings miss was largely a result of robust capacity expansion, which, ceteris paribus would deliver more pronounced benefits down the road as 1) demand expands further, driving up RASK and 2) aircraft are utilised more efficiently, driving down CASK.

Operationally, AAX fared decently in the first quarter:

1. ASK, RPK and Load factors - AAX added capacity (ASK) of+29%yoy in 1QFY17, which exceeded the rate of increase in 2016 of +26%. Demand grew enthusiastically, with RPK rising +33%yoy leading to a +2ppt gain in load factors which stood at 84%. 2. Average fares - Amid the robust expansion in ASK to grow its market share, average fares fell only slightly by -4%yoy which is not alarming, in our view. The decline in average fares is not indicative of major discounts given to encourage ticket sales. 3. RASK-CASK spread - RASK (yields) fell -6%yoy following the decline in average fares and an increase in ASK. On the other hand, CASK improved only marginally by 1%yoy. This led to a narrowing of AAX’s RASK-CASK spread, and hence a contraction in EBIT margin by -6ppt yoy

Green shoots appearing for IAAX. IAAX had temporarily suspended its operations since September 2016, with its fleet of 2 A330 aircraft being wet leased to Airasia Berhad. This month, IAAX is scheduled to relaunch its operations from its Denpasar base in Bali to 1) Narita and 2) Mumbai (via KL). Having previously served routes to Australia which faced tough competition, IAAX’s focus will now shift toward North Asia (fewer LCCs ploughing the route) and India (routes served by rivals MAB and Malindo).

Still on expansion mode. AAX reiterated plans to increase its ASK by 25-30% in FY17 with increased utilisation of its fleet, notably daytime slots which are underutilised. Management highlighted that there would be no more wet leasing operations in 2017, even during the softer 2Q and 3Q period. Instead, frequency increases and new routes would be prioritised. To note, AAX would be making its inaugural flight to Honolulu (via Osaka) in June.

Merger with Airasia Berhad not imminent. In clarifying on his interview with Focus Malaysia, Group CEO, Datuk Kamarudin Meranun expressed his dismay over the headline which suggested that a merger between AAX and its 14% shareholder Airasia Berhad was being revisited. On the contrary, he highlighted that the Airasia Group is merely exploring ways to enhance shareholders’ value. A merger, as with various other corporate exercise proposals is one of many possible ways in achieving this goal.

Downgrade to NEUTRAL from BUY with lower TP of RM0.50 (from: RM0.56). We cut our FY17 and FY18 earnings forecast by 15% and 14.5% respectively as we increase our operating expense assumptions. We roll-forward our valuation to FY18 EPS, pegged to an unchanged forward price-to-earnings ratio of 8.5x and derive our new target price of RM0.50. AAX’s share price has gained a healthy return of 48.6% year-to-date, just shy of our previous target price of RM0.56. We believe that AAX is fully valued for now

Source: MIDF Research - 24 May 2017