Malaysia  Airlines  (MAS)  posted  a  core  net  loss  of  MYR277.5m  in 3QFY13, when we had expected a better quarter. Its load active strategy contributed  to  better  load  factor  but  this  was at  the  expense  of  yield. The  revenue  growth  was  not  strong  enough  to  offset  its  escalating costs.  We  cut  our  earnings  forecasts  and  downgrade  MAS  to  SELL (from Neutral), with a lower MYR0.30 FV (from MYR0.34).

• Below  expectations.  MAS  reported  a  net  loss  of  MYR375.5m  in 3QFY13.  The airline’s core loss stood at MYR277.5m,  after stripping out MYR86.1m  in  unrealised foreign exchange  loss,  a  MYR4.7m gain in fair value  change  of  derivatives  and  other  exceptional  items.  As  we  had expected  further improvement in 3Q, MAS’ 3Q13  results  were below our expectations.
• Revenue growth not enough. According to MAS, the airline recorded a historically  high  load  factor  of  85.8%  (+11.7ppts  y-o-y)  in  9MFY13. However,  the strong growth in passenger  numbers did  not translate into profitability  as  MAS  continued  to  face  high  costs  and  yield  pressure, which are prevalent in the airline industry.
• Outlook  remains  challenging.  MAS’  management  guided  that  the outlook  for  next  year  remains  challenging  as  it  believes  yields  could continue  to  come  under pressure.  The  airline  will  continue  to  focus  on cost-restructuring  to  keep  costs  under  control  as  well  as  rationalize  its routes by focusing on profitable ones.
• Earnings  revision.  Following  the  disappointing  results  and  negative market  sentiment  on  air  fares  moving  forward,  we  are  lowering  our earnings  forecasts  for  MAS  to  -MYR740m/-MYR0.1m  from  – MYR367m/MYR120m for FY13F and FY14F respectively.
• Downgrade  to  SELL.  While  we  believe  MAS’  load  active  strategy, aggressive  promotions  and  oneworld  collaboration  would  help  it  turn around,  depressed airfares  owing to  intense competition  and  MAS’ high cost  structure  may  offset  all  the  above  factors.  Hence,  we  downgrade MAS to SELL (from Neutral) and lower our FV to (from MYR0.34), based on 7.6x adjusted FY14F EV/EBITDAR (from 9x).

Key Highlights

Revenue growth in line with ASK expansion. 3QFY13 revenue growth of 11% y-oy  was  in  tandem  with  a  20%  y-o-y  increase  in  available  seat  k ilometres  (ASK). Nonetheless,  the  strong  growth  in  passenger  numbers  was  largely  offset  by depressed yield of 21.9 sen  (-16% y-o-y) due to intense competition among airlines around the world. 
Cost  escalation  outpaces  revenue  growth.  The  16.6%  y-o-y  surge  in  total operating expenditure outpaced the revenue growth of 11% y-o-y, eroding EBITDA in 3QFY13. The main costs items that had risen in 3QFY13 were: a)  Fuel costs: +11.1%  y-o-y  due to  an  increase in fuel volume by 17%  y-o-y. The  weakening of MYR against USD offset the decrease in jet fuel prices during the period. b)  Aircraft-related expenses:  up  by  MYR90m y-o-y,  which was  in line with the increase in capacity and additional cost incurred  in relation to the new fleet. c)  Selling & marketing expenses:  up by MYR174m y-o-y,  which management claimed  was  due  to  more  aggressive  marketing  and  promotion  activities coupled with higher selling costs. d)  Non-aircraft related  costs: up by MYR46m y-o-y mainly from equipment  hire and other engineering expenses.

Staff cost  increment was  minimal in  3QFY13 and  fell  by  MYR26m y-o-y in 9MFY13 due to the reduction in contract workers including licensed aircraft engineers (LAE).Cash  position  remains  healthy  so  far.  MAS  reported  a  MYR72m  reduction  in operating cash in 3QFY13. To date, the airline has generated positive operating cash of MYR555m, as opposed to cash burn of MYR303m in 9MFY12. Focus  and  strategies  moving  forward.  Moving  forward,  MAS  guided  that  it  will continue to  focus  on strengthening  its  network,  improving  its  subsidiary  &  ancillary business  income,  boosting  productivity  and  the  most  importantly,  reducing  its  high cost structure.  Management will look into key cost items particularly fuel expenses, such as  reducing consumption  (or improving  efficiency),  engaging in  more effective hedging strategy and reducing wastage.

The price of load active strategy.  As we had  highlighted earlier,  MAS is operating within a very competitive industry and its load active, yield passive strategy  will boost load  at  the expense of yield.  MAS is incurring  losses  as  operating costs  are growing 
faster than revenue.

Revising earnings forecasts. As we had earlier anticipated that depressed airfares, especially for full-service carriers (FSCs), would limit MAS’ revenue growth, we make no changes to  our  FY13  yield assumptions.  However, given  the airline’s  high jet fuel costs,  ‘sticky’  cost  structure  (for  which  its  restructuring  efforts  have  yet  to  yield positive  results),  coupled  with  its  need  to  continue  investing  in  marketing  and promotion  activities,  we  are  raising  our  costs  assumptions  and  reducing  our FY13F/14F  earnings forecasts  to  -MYR740m/-MYR0.1m from -MYR367m/MYR120m respectively.

Downgrade to SELL.  Following the earnings revision, we revise  our FV for MAS to MYR0.30 (from MYR0.34), pegged to 7.6x adjusted FY14F EV/EBITDAR (from 9.0x). Downgrade to SELL from Neutral.

Financial Exhibits

SWOT Analysis

Company Profile
MAS is Malaysia's flagship carrier with a focus on South-East Asia and Asia Pacific markets.

Recommendation Chart

Source: RHB