INVESTMENT HIGHLIGHTS

• AAX reported a normalised net loss in 1HFY19

• Load factor flat at 81.0% due to a lower capacity base

• Nonetheless, fuel expenses declined -12.5%yoy despite the rise in jet fuel price

• Network rationalisation will enable stronger focus in key markets in addition to the high density short haul routes

• Revise earnings downwards to take into account of the more conservative yield growth

• Maintain NEUTRAL with a revised TP of RM0.19 per share

A whopping quarterly loss. AAX reported a net loss of -RM207.1m in 2QFY19 (+4.4%yoy). Excluding exceptional items such as deferred taxation, loss on disposal from the sale and leaseback of three aircraft and foreign exchange losses, AAX recorded a normalised net loss of – RM114.1m. This brings the cumulative 1HFY19 normalised net loss of – RM144.2m (>100%yoy), missing ours and consensus’ expectations by a variance of more than 10%. The negative variance was due to the substantial increase in financing costs following the MFRS16 adoption. We expect the effect to be until end of FY19 when a new base is established.

Revenue declined on lower passengers carried. Revenue in 1HFY19 dropped -6.4%yoy to RM2.18b due to a -6.0%yoy decline in passengers carried. Subsequently, ancillary revenue dropped by -4.7%yoy but still maintained a robust contribution to total revenue, at 19.0%. Looking ahead, AAX will boost a stronger take-up of ancillary offerings especially with the expected introduction of WIFI onboard the fleet. While the freight services segment was lower at -5.4%yoy in 1HFY19, we opine that revenue will improve following the Teleport’s (AirAsia Group’s logistics arm) shift to higher margin contracts.

Load factor maintained at the expense of lower fares. In line with the drop in revenue and lesser passengers carried, both RPK and ASK fell in 1HFY19. The -6.4%yoy decline in RPK outstripped the -5.1%yoy drop in ASK for 1HFY19. This was caused by the capacity management and operation of shorter stages routes compared to last year. The destinations involved were Gold Coast and Taipei. As such, capacity to Gold Coast posttermination of Auckland in February 2019 was reconciled, in line with AAX’s goal of network optimisation. The consolidation of capacity explains the ability of AAX to maintain a healthy load factor of 81.0% for 1HFY19.

Impact of fuel price was tamed. The average sector length was little changed at 9,441km but fuel expense declined by -6.2%yoy despite the +6.1yoy% increase in Singapore jet kerosene price in 1HFY19. The reduction in fuel expenses indicates that AAX’s conservative hedging strategy is bearing some fruit. For FY19, the average hedge ratio is ~65.0% at an estimated jet fuel price of USD78.3pb. However, AAX’s RASK-CASK spread for the same period was in a negative territory, with CASK exceeding RASK by a higher quantum of 0.45sen in 1HFY19 compared to 0.23sen a year ago as the percentage drop in revenue was slightly higher than the percentage drop in fuel costs. On a longer term, we opine that risks related to fuel costs will be tempered by the swap of existing A330ceos to the more fuel efficient A330neos, earliest by the end of 2021 which enables approximately 11.0% additional fuel savings.

Future prospects. For the remainder of the year, the number of passengers carried will be supported via the addition of high density short-haul routes done through code sharing with AirAsia Group such as from Kuala Lumpur to Singapore(14 weekly flights). This will also help to drive the aircraft utilisation from the current 14.3 hours per day to around 16 hours per day. Moreover, the network rationalisation undertaken in 1HFY19 will allow AAX to strongly focus in its key markets such as Northern Asia, India and Australia while letting other routes in infancy to grow naturally. Nevertheless, we opine that this may come at a cost of average base fares which are under pressure following the increase in capacity in the key markets.

Downward adjustments to near term earnings. We are revising down our earnings forecasts for FY19 and FY20 to RM17.9m (previously RM68.7m) and RM65.6m (previously RM74.4m) respectively. This is taking into consideration of a more conservative yield growth due to the lesser-than-expected passengers carried in 1HFY19.

Target Price. We revised our target price to RM0.19 per share (from RM0.22 previously) following the adjustment in earnings. Our TP is derived via pegging our FY20F EPS of 1.58sen to a target PER of 12.0x, which is the average PER of regional low cost carrier peers.

Maintain our NEUTRAL call. We maintain our view of AAX’s ability to record profit for FY19 albeit at a marginal level given the tough operating and regulatory environment. This could be possible through various cost reduction initiatives and better capacity utilization mentioned earlier. However, this could be weighed down by the pressure on yields. We opine that passenger growth in Malaysia to remain intact despite the departure levy which is expected to take effect in September 2019 as the levies gazetted are lower than regional peers such as Thailand and Hong Kong. As for low cost carriers such as AAX, the percentage of departure levy from the total ticket price is still immaterial at 1.5% on average for normal fares. Although the percentage is slightly higher at 3.7% for premium flatbed passengers, it is important to note that seats for this class constitute less than 5% of total seats offered for sale. Meanwhile, the adoption MFRS 16 will be a headwind in the next coming years as the majority of AAX’s fleet are leased. Nonetheless, AAX is expected to gain from lower amount of interest beyond the fifth year of the lease term. A rerating catalyst for AAX would be a favourable review in the passenger service charges by the Government. All in, we maintain our NEUTRAL call with an adjusted TP of RM0.19 per share (from RM0.22 per share).

Source: MIDF Research - 23 Aug 2019