INVESTMENT HIGHLIGHTS

• Benefits of sale and leaseback in terms of lower interest cost to be felt in the long run

• Higher maintenance expense as a result of increased standard of return obligation to be contained via digitalisation initiatives

• Teleport’s investment in EasyParcel will increase the utilisation rate of AAGB’s aircraft belly space to around 20%

• Immediate headwinds from MFRS 16 to be moderated by prudent fuel hedging policy

• Revise earnings slightly upwards after imputing lower Brent crude oil price forecast for FY19

• Maintain BUY with revised target price of RM3.29 per share

Benefits of sale and leaseback to be felt in the long run. Recall, the group recorded a 1QFY19 normalised net profit of RM104.6m (- 72.9%yoy), missing ours and consensus’ expectations by a variance of more than 10%. The negative variance was due to the substantial increase in finance costs following the MFRS 16 adoption. Nevertheless, it is noteworthy that the impact of combined depreciation and interest will be more than the amount of operating lease (based of pre-MFRS 16 adoption) during the earlier portion of the lease. As such, we expect AAGB will benefit from lower amount of combined depreciation and interest beyond the fifth year of the lease term.

Impact of increased maintenance expenses to be contained via digitalisation initiatives. Post-MFRS 16 adoption, higher standard of return obligation increased as more of AAGB aircrafts undergo a sale-and-leaseback transaction. As a result, overall maintenance and overhaul expenses increased by +63.8%yoy in 1QFY19. Looking ahead, AAGB’s digitalisation strategy is expected to propel cost rationalisation via various alternatives. Operationally, AAGB has partnered with Airbus and Palantir to establish an integrated Big Data platform which includes forecast of predictive maintenance and efficient scheduling of parts with a potential saving of USD0.04m per aircraft per year.

More synergies expected from Teleport. Teleport, AAGB’s logistics arm recorded a revenue of RM101m for the quarter staying on track to meet its annual revenue target of RM400m. We opine that this would be achievable due to the arrangement with Oman Air to provide customers with access to Oman Air’s network covering Africa, the U.K. and Europe. Meanwhile beyond FY19, we believe that the USD10.6m (roughly 2.5% of AAGB’s retained earnings as of 31 March 2019) investment by Teleport and its venture capital firm, Gobi Partners in EasyParcel will further increase its utilisation rate of its aircraft belly space to around 20%. This would be made possible via the expansion of EasyParcel’s offerings for SME customers through Teleport’s network of more than 100 cities and cargo capacity exceeding 1m tonnes. We opine that the full accretion of this investment will be realised in FY21.

Immediate headwinds from MFRS 16 to be moderated by prudent hedging policy. Recall that the impact from rising Brent crude oil price in 1QFY19 was moderated by AAGB’s increase in its average hedge ratio of ~54% in FY19, compared to just ~15% in FY18. We expect more benefits of AAGB’s hedging policy to be realised in 2QFY19 following the average -8.0%yoy drop in the Singapore jet kerosene price during the same quarter, effectively bringing the Singapore jet kerosene price lower by -6.1%yoy on average for 1HFY19. In addition, Brent crude prices have been hovering around USD60pb to USD70pb in the recent months while we have revised downwards our FY19 forecast from USD75pb to USD70pb. This coincides with the International Energy Agency’s (IEA) cut in 2019 global oil demand forecast and the expectation that OPEC demand will fall to 28m barrels per day in 1QCY20. Therefore, we have imputed a lower jet fuel price assumption than the USD90pb previously.

Impact to earnings. We are taking into account of the lower jet fuel assumption following MIDF Research’s downward revision of the average Brent crude oil price in FY19. As a result, our earnings forecast for FY19 and FY20 has been adjusted upwards to RM814.9m (+4.8%) and RM998.7m (+2.4%) respectively.

Target price. We revised our target price to RM3.29 per share (from RM2.92 previously) following the upward revision in our earnings forecast. Our target price is also derived via pegging our FY20F EPS of 29.9sen to a target PER of 11.0x (previously 10.0x) which reflects the 12-month trailing PER of AAGB’s regional peers. However, we must note that our target price will be adjusted 90sen lower after the ex-dividend date on 29 July 2019, which will be inline with the adjustments made to its share price then.

Maintain BUY. We continue to like Air Asia as the company continues enhance its cost structure, along with its efforts of rationalising revenue and cost via digitalisation efforts. Our positive outlook on the AAGB also hinges on: 1) its more prudent hedging policy 2) stable operations with added capacity and 3) continuous improvement to derive higher values per km flown. Based on our previous analysis for MAHB (BUY; TP:RM9.43) in our report dated 15 April 2019, we opine that the proposed international departure levy to not have much impact on Air Asia’s passenger growth. All in, we maintain our BUY call

Source: MIDF Research - 17 Jul 2019