INVESTMENT HIGHLIGHTS

• 1HFY19 normalised earnings below expectations

• Healthy load factors did not come at the expense of lower average fares

• Teleport to roll-out more platforms i.e., social commerce enabler to ensure large contribution for non-airline ancillary segment

• Prudent fuel hedging policy helped to contain the rise in fuel expense

• Earnings estimates tweaked to reflect higher costs related to maintenance, financing and also its non-airline ancillary segment

• Maintain BUY with revised target price of RM2.08 per share

Below expectations. The group recorded a 2QFY19 normalised net loss of –RM81.0m (>-100%yoy). This brings the cumulative 1HFY19 normalised net profit to RM21.3m (-97.0%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 MFRS16 adoption which is more than we had expected, coupled with higher maintenance expense which saw higher provision for engine overall with higher number of leased aircraft. We expect the effect to be felt until end of FY19 when a new base is established.

RPK growth slightly outgrew expansion in ASK…. The group’s 1HFY19 revenue was up by +12.7%yoy to RM5.8b. The robust growth was due to another record breaking number of passengers carried in 2QFY19 of 12.8m which was supported by the festive seasonality factor around ASEAN. As a result, the number of passengers carried in 1HFY19 grew by 17.9%yoy to 25.4m. With strong growth in passengers carried, the 14.6%yoy growth in RPK to 31,444m outpaced the ASK growth rate of 14.1%yoy in 1HFY19.

….which helped maintained a healthy load factor. As such, the load factor in 1HFY19 remained robust at 87.0%. This was despite the 17.8%yoy increase in capacity via strategic addition of new routes and increased frequencies for both domestic and international routes for AAGB’s AOCs and net addition of 22 aircraft. More importantly the strong load factor did not come at a cost at a lower average fares but in fact there was a +0.6%yoy increase for 1HFY19.

‘Teleporting’ to better growth in freight services. The increase in passengers which contributed to higher 1HFY19 ticket sales of +18.6% to RM4.4b, also resulted in airline related ancillary income revenue to grow by +12.8%yoy. After including non-airline ancillary segments such as Teleport, Airasia.com, RedBeat Ventures and Bigpay, total ancillary grew by +40.3%yoy. Most of the contribution for non-airline ancillary revenue came from Teleport and we expect it will reach its target of given revenue recorded was RM212.4m in 1HFY19. Performance of Teleport in 2HFY19 will be enhanced by the launch of ‘teleport.social’, a platform enabling sellers on social media to integrate with Teleport’s logistics infrastructure.

Prudent hedging policies ahead to mitigate oil price volatility. The group experienced a rise in opex, partly attributable to the +15.5%yoy increase in aircraft fuel expenses amidst capacity expansion in 1HFY19. Nevertheless, the increase was not as profound as in 1HFY18 when fuel expenses increased by +26.9%yoy. The lower magnitude of increase in aircraft fuel expenses occurred despite the +6.1%yoy jump on Singapore jet kerosene in 1HFY19, indicating that AAGB’s conservative hedging strategy is bearing fruit. For FY19, the average hedge ratio of AAGB is ~65.0% at a Brent crude oil price of USD63.3pb of compared to just ~15.0% in FY18. In addition, AAGB’s older fleet will be replaced with new A320neo and A321neo in November 2019. These aircrafts have advanced fuel efficient technology which will lead to an estimated fuel savings of 15% by FY20, translating into lower cost per seat as it has 50 additional seats.

Impact to earnings. Aside from that, we have also taken into consideration of: (i) the burgeoning financing and maintenance costs following the adoption of MFRS16 and higher number of leased aircraft; and (ii) the higher operating expenses incurred to roll-out the non-business airlines. As a result, our earnings forecast for FY19 and FY20 has been adjusted downwards to RM564.9m and RM633.0m from RM814.9m and RM998.7m respectively.

Target price. We revised our target price to RM2.08 per share (from RM2.39 previously) following the downward revision in our earnings forecast. Our target price is derived via pegging our FY20F EPS of 18.9sen to an unchanged target PER of 11x. The target PER is premised on AAGB’s regional peers which are trading at a 12-month trailing PER of 11x on average while AAGB is trailing at a PER of 6.2x which we opine is unwarranted given the company’s position as ASEAN’s leading low cost carrier.

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. Meanwhile, the adoption MFRS 16 will be a headwind in the next coming years as the majority of AAGB’s fleet are leased. Nonetheless, AAGB is expected to gain from lower amount of interest beyond the fifth year of the lease term. 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 AAGB, the percentage of departure levy from the total ticket price is still immaterial at around 1.6% on average for normal fares. A further rerating catalyst for AAGB would be a favourable review in the passenger service charges by the Government. All in, we maintain our BUY call with an adjusted target price of RM2.08 per share (from RM2.39 per share).

Source: MIDF Research - 29 Aug 2019