INVESTMENT HIGHLIGHTS

• FY18 performance expected to be in the red

• Volatility in oil price, a lingering challenge

• Focus in core markets, to benefit AAX in the long run

• Downgrade to NEUTRAL

• Target price adjusted to RM0.26

Losses could widen in 3QFY18. Recall that AAX’s net profit slumped into the red in 1HFY18, as a result of elevated fuel cost. On average, fuel price came in +33.7%yoy higher from USD54.6/b since December 2017. Largely, this was attributable to the anticipated US sanctions on Iranian oil exports, shale bottlenecks and Venezuelan turmoil. As such, we are expecting price to remain volatile. This will elevate the downside risk of fuel cost especially for airlines, as it account to a large percentage of opex.

AAX’s cost structure remains a challenge. Despite AAX’s attempt to further squeeze out savings from ex-fuel costs, fuel price increase remains a major encumbrance to earnings. We expect it to remain in the near term as the move to increase yield continue to be challenging. Notably, we have to make allowance for the introduction of new routes, whereby fare prices are typically given heavy discounts. Although this is positive to enhance presence and connectivity, we have to be cognizant of the short-term pressure it has on seat sales revenue.

Making provision of temporary setbacks. The current environment serves as a proving ground for AAX to firm up its long-haul low-cost business model. Its ability to sustain earnings in the long run would be largely driven by the continuous improvement in cost structures and the generation of meaningful revenue in new routes. While these are already in the works, we believe an adjustment to our earnings forecasts is necessary. Note that fuel consumption accounted for the largest portion of the group’s overall expenses at 35.0-38.0%. From our sensitivity analysis, we estimate that every +1.0% rise in fuel price; will impact net operating profit by -12.0%.

Earnings adjusted lower. Accordingly, we adjusted our earnings forecasts lower to take into account the elevated fuel price for FY18 and FY19. This is based on our average fuel price assumption of USD85/b (from USD79/b previously) for both fiscal years respectively. We expect AAX to record losses this year, while we adjust FY19 by -34.4% lower.

Downgrade to NEUTRAL. Based on the changes made, our TP is adjusted lower to 26.0sen. This is pegging its

FY19 EPS to PE of 8.5x. Despite the cloudy outlook for the rest of FY18, we are expecting AAX to return to profits in FY19. This could be possible through further cost cutting initiatives, better capacity utilization and stable fuel environment. Although we are downgrading the stock due to short term headwinds, we remain encouraged by AAX’s long-term prospect that is tied to the strategic plan of 1) further reduction in CASK; 2) stronger focus in core markets. This will be supported by AAX’s gradual shift to modern fleet operation via the purchase of new generation aircrafts.

Source: MIDF Research - 11 Oct 2018