We  believe  the  best  case  for  MAS  is  to  maintain  its  listed  status  and undergo  a  restructuring  exercise  to  boost  yields  and  improve productivity,  while  trimming its sizeable workforce.  With  news  reports hinting  of  an imminent restructuring and  an emphasis  on productivity, this bodes well for the airline in the long term. We upgrade the stock  to NEUTRAL, with an unchanged FV of MYR0.19.

• Share  price  hit  by  negative  news.  Negative  news  flow  on  Malaysia Airlines (MAS) has intensified of late, sparked by comments in the media by  Government  officials  that  it  may  be  “too  late  to  save”  the  national carrier,  although  this  was  subsequently  denied.  This  follows  the  huge MYR1.2bn  loss  reported  in  FY13  and,  more  recently,  another  sizeable loss of  MYR448m in 1QFY14. Compounding  its  financial problem  is  the tragic disappearance of  Flight MH370 on 8 March  this year, which has significantly tarnished the carrier’s reputation.
• Picking  the  low-hanging  fruit.  We  relooked  the  carrier’s  business model to understand its main problem and came up with three scenarios:i)  restructuring  under  current  conditions,  which  includes  spinning  off profitable  divisions  to  rise  cash,  downsizing  its  workforce  and  cutting capacity,  ii)  privatisation  and  iii)  declaring  bankruptcy.  Our  ideal assessment  is  a  combination  of  downsizing  of  MAS’  workforce  and cutting  capacity. We estimate that  by  downsizing  its  workforce by 19%and reducing capacity by  10%
• Upgrade to NEUTRAL. As its major shareholder  Khazanah has given a clearer indication that it will take a  relook at the carrier’s business model and come up with a restructuring plan within six to 12 months,  we think that  a  privatisation  or  bankruptcy  is unlikely  at  this  juncture.  Moreover, the carrier’s  shares are  currently trading  within the neutral region of ourMYR0.19  FV, which is pegged to  a 1.0x FY14F P/BV (unchanged). As such,  we  are  upgrading  the  stock  to  NEUTRAL  from  Sell.  We  believe MAS could  potentially  trade as high as  a  1.2x FY14 P/BV, which is the median P/BV of all airlines listed globally. This could also possibly see its share price inch higher by 14% to MYR0.23 in the near term.

Key Highlights

Negative  news  flow  dampens  outlook.  Negative  media  news  flow  on  MAS  has intensified of late, sparked by comments made by Government officials that it may be too  late  to  save  the  national  carrier,  although  this  was  subsequently  denied.  This follows huge losses of MYR1.2bn made in FY13, and more recently another sizeable loss  of  MYR448m  in  1QFY14.  Compounding  the  financial  problem  is  the  tragic disappearance  of  MAS’  Flight  MH370  on  8 March  2014,  which  has  significantly tarnished the carrier’s reputation.

What  went  wrong?  MAS underwent a route rationalisation exercise  back in 2012, cutting  capacity  by  as  much  as  8.3%  y-o-y,  as  measured  by  available  service kilometer (ASK). The move  helped the airline  reduce its losses to MYR433m  in 2012 from  MYR2.5bn  in  the  previous  year.  MAS’  route  rationalisation  has  allowed  it  to optimise  its  fleet  and  boost  its  underlying  yield  up  by  4.5%  y-o-y.  While  overall revenue  inched  down  2.7%  y-o-y  due  to  reduced  capacity,  this  was  offset  by  cost reductions  stemming  from  the  route  cuts,  which  to  some  degree,  also  cut  fuel, leasing, maintenance  and handling  costs.  During the same year,  MAS saw its cash burn from operating cash flow reduced to MYR305m from MYR597m.  But what did MAS do differently in 2013?

In 2013, MAS adopted a more aggressive approach by expanding its capacity 17% yo-y to 59.9m ASK. It had committed to a number of aircraft deliveries and at the same time entered into the  oneworld  alliance. This gave  the carrier  some optimism  that it was  timely  to  increase  its  capacity.  Besides  MAS,  its  competitors  were  also expanding,  such  as  AirAsia  X  (AAX  MK,  NEUTRAL,  FV:  MYR0.70),  AirAsia  (AIRA MK,  BUY,  FV:  MYR2.78)  and  the  newcomer  Malindo  Air,  which  commenced operations  in  late  March  2013.  Despite  the  capacity  increase,  MAS  succeeded  in optimising  its  route  network  and  reducing  airport  turnaround  time,  thanks  to  the feeder traffic from its oneworld alliance. This pushed the  utilisation rates  of  its widebody aircraft to 14 hours (from 13 hours) and narrow-body aircraft to 11 hours (from 9 hours).

However,  the  carrier’s  aggressive  capacity  expansion  forced  it  to  cut  its  airfares aggressively in  an attempt to boost loads to achieve  the desired  economies of scale.Although  overall  unit  costs  (based  on  available  tonnes  capacity  measurement,  or ATK)  improved  by  1.4% y-o-y  on  a larger capacity base,  this  was outweighed by  adrop in overall yields of 1.8% y-o-y , thus ballooning the losses to MYR1.2bn in FY13 from MYR433m in the previous year.

Had MAS maintained its fleet size with  unchanged  yields, would it have suffered a worse  fate?  What  went  wrong?  We  work  out  the  numbers  below  on  how  it  would have been for MAS had it maintained its  yields, at the expense of a much lower load factor given higher airfares.

Our analysis above suggests that the decline  in yields  was one of the culprits  behindthe company’s losses in FY13,  other than its bloated cost structure. Had  the  yields been  maintained, the downside to earnings  would have been  lesser.  In this scenario, we  estimate  that  losses  would  have  been  lower  at  MYR1.1bn,  compared  with  the reported net loss of MYR1.2bn  the carrier  incurred  last year.  Furthermore, had there been more efforts in cutting costs, MAS’ bottomline would not have been as bad.

Challenging  times.  Further  compounding  its  already  dire  situation  was  the  recenttragedy  of missing Flight  MH370.  Management acknowledged that it will be an uphill battle for MAS to turn  a profit  after the  incident, especially  during  the weaker travel period in 2Q and 3Q.

Since the incident,  the number of  passengers from China has  dropped significantly partly due to a boycott,  which forced  MAS to cancel some of its flights  and deploy its aircraft  elsewhere. While  we  see  this  as  a  temporary  setback,  with  the  profit  drag reducing  cash  for  its  working  capital,  the  incident  has  further  raised  investors’concerns. Investors  had earlier been banking on a recovery in FY14.  In addition, the market  conditions  remain  challenging,  given  the  aggressive  expansion  by  its competitors. 

After  skipping  its  regular  promotional  offerings  as  well  as  the  annual  Malaysian Association  of Tour & Travel Agents (MATTA) Fair following the flight tragedy, MAS recently rolled out its Malaysia Airlines Travel Fair (MATF), offering passengers up to 50% discounts  on its airfares, in  an  attempt to recoup lost revenue  and replenish its depleted forward bookings.

Source: RHB