We  maintain  our  OVERWEIGHT  call  on  the  sector  with  MAHB  (FV: MYR7.53)  as our top pick. While Malindo’s entry pose  a  threat  to  both AIRA  (BUY;  FV:  MYR3.94)  and  MAS  (TRADING  BUY,  FV:  MYR0.43),  we gather that traffic numbers from both remain encouraging though yield compression  is  highly  likely.  2Q  is  a  critical  quarter  for  airlines  due  to the intensifying competition, warranting our top pick on MAHB as a key beneficiary.

- Favourable traffic numbers. Malaysia Airports (MAHB) reported higher passenger traffic and aircraft movement of 11.9% and 9.6% respectively in  5M13,  indicating  that  it  is  on  track  to  hit  our  full  year  forecast  for passengers  (+11%)  and  aircraft  (+5%).  Similarly,  Malaysian  Airlines (MAS)  reported  a  strong  YTD  revenue  passenger  kilometer  (RPK) growth  of  21.3%,  mainly  attributable  to:  i)  membership  in  the  oneworld alliance  boosting  international  loads  by  22.1%;  and  ii)  domestic operations  growing  by  14%.  While  AirAsia  (AIRA)  has  yet  to  report  its passenger traffic numbers we would expect traffic to continue to grow as it  had  taken  in  two  additional  aircraft  in  2QFY13.  Moving  forward,  with carriers undergoing aggressive capacity expansions, traffic numbers will continue  to  remain  favorable.  For  instance,  since  Malindo  commenced operations in late March, domestic passenger numbers out of airports in Kuala  Lumpur  (KLIA,  LCCT  and  Subang)  have  spiked  by  17%  y-o-y  in April and 26%  y-o-y in May.

- The  Malindo  effect.  While  competition  from  Malindo  clearly  spells trouble  for  AIRA  and  MAS,  we  gather  that  load  factor  for  both  carriers have not been too heavily impacted. Although AirAsia and MAS are likely to  see  yield  compression  on  the  domestic  side  due  to  Malindo,  we  see Malindo’s low airfare offering as unsustainable in the long run due to the high unit cost base attributed to its complimentary inflight entertainment, luggage and meals as well as the higher airport tax paid.

- 2QFY13  critical  for  competition  assessment.  The  upcoming  2QFY13 earnings  results,  to  be  announced in  August,  will  be key  in  determining the impact of Malindo’s entry into the domestic market. While there is a risk of  yield  compression  for both  MAS  and  AirAsia,  we  note  that 2Q  is also  the  weakest  quarter  of  the  year  for  carriers.  However,  more positively is the weakening jet fuel price in 2QFY13 – down 5% y-o-y and 10% q-o-q – which may give carriers the needed earnings boost.

- OVERWEIGHT.  We  maintain  our  OVERWEIGHT  call  on  the  aviation sector.  We  have  switched  our  top  pick  to  MAHB  from  AIRA  given  the former’s potential upside in passenger growth  while the latter is likely to be susceptible to yield compression. Nevertheless, we still like AIRA for its  strong  fundamentals  and  the  fact  that  investors  have  yet  to  price  in the valuations of its listed holdings.

Source: RHB