AirAsia - Look Beyond This Quarter

kiasutrader

Publish date: Fri, 22 Aug 2014, 09:19 AM

Stripping off the sizeable unrealized forex gain, AirAsia would have recorded a MYR51m core net loss (1Q14: MYR46.7m core profit). The culprits were its loss-making associates, lower yields and higher-than-expected jet fuel prices. Yet, we see the worst is over, as the outlook improves come 2H14. Maintain BUY, with our FV reduced to MYR2.73 (from MYR2.78) following the downward revision in earnings.

A loss-making quarter. Stripping off its sizeable unrealized forex gain, AirAsia would have booked a MYR51m core net loss vs 1Q14’s MYR46.7m and 2Q13’s MYR149.1m core profit. This dragged 1H14 to a MYR4.3m core net loss (1H13: MYR296m core profit), which we deem significantly below our/consensus projections. Notable culprits were its: i) loss-making associates (1H14 losses of MYR132.7m), ii) lower underlying passenger yields (-9.3% YTD), and iii) higher-than-expected unit costs (+4.7% YTD) on higher jet fuel prices. This was likely due to its higher hedging position vis-à-vis lower spot prices.

Key briefing highlights. Management guided that ancillary income is expected to pick up in 2H14 following the launch of several new ancillary products soon. It guided that these initiatives are expected to add in another MYR5/passenger to ancillary income. AirAsia has also submitted an application to set up an offshore entity specialising in the sublease of all its aircraft to its affiliates. With this entity, the airline ought to be able to progressively dispose of aircraft operated by its affiliates – associates and joint-ventures (JVs) – some of which are parked in its balance sheet. Management is optimistic on the potential reduction in capacity, which could give significant room for improvements in yields going forward.

Forecasts. We trim our earnings forecasts by 58%/16%/20% for FY14/FY15/FY16 respectively after toning down our yield assumptions. We remain optimistic that yields could see a significant pick-up into 2H and 2015, which would give a lift to earnings, coupled by the narrowing losses of its loss-making associates.

Maintain BUY. We see that the worst is over, as the outlook improves come 2H14. Maintain BUY, with our FV reduced to MYR2.73 (from MYR2.78) following the downward revision in earnings. We have pegged the stock at a higher 14x FY15F P/E (from 12x) to be on par with the average of its Asian peers (see Figure 4).

Key Briefing Highlights

Ancillary initiatives in the pipeline to boost revenue. Management guided that ancillary income is expected to pick up in 2H14 following the launch (and upcoming launches) of several new ancillary services. These include on-board duty free offerings (end August), in-flight Wifi connectivity (to be launched in 3Q14), “premium flex” (launched recently), courier delivery (launched last week) and higher take-up of Fly-Thru services.

We note that management also guided that these initiatives are expected to add another MYR5/passenger to ancillary income. In-flight Wifi is expected to fetch a charge of MYR5-10 for each flight per user.

Take up of Fly- Thr u services improves. The take-up of Fly-Thru services has improved significantly, where the number of passengers serviced has doubled. This has brought a connecting fee of MYR15.8m to AirAsia’s ancillary revenue for its Malaysia-based operations. Much of this effort was due to the widening gap of its layover time window to 90-600mins from 120-360mins, thus enabling more connecting city and flight pairs. There are 739 Fly-Thru routes currently, with 635 out of Kuala Lumpur and 104 out of Bangkok (Don Mueang Airport). Cengkareng Airport in Jakarta, which is expected to see the opening of Terminal 3 next year (this ought to remove the current airport congestion issues), will also start Fly-Thru services. Other airports planned include Kota Kinabalu Airport and Ngurah Rai Airport (Bali). A key factor that has seen Fly-Thru take-ups contributing well is the commencement of AirAsia X’s (AAX MK, SELL, FV: MYR0.68) new hub in Bangkok. The carrier is also awaiting the license to operate another long haul low cost carrier hub in Bali, Indonesia.

Scaling back on aircraft disposal. The earlier targeted disposal of 12 aircraft has been scaled back to only four this year. The initial plan would have seen eight aircraft taken out from its Malaysia-based fleet and four from its Indonesia operations. However, in view of the favourable outlook ahead, management has decided to allocate more aircraft for India now (possibly up to six from just three planned earlier this year). This would provide more economies of scale for its India operations to break even. Load factor there has also been very encouraging, ranging to the high 80% levels. Meanwhile, on the Malaysia side, in view of the upcoming capacity cuts by Malaysian Airline System (MAS) (MAS MK, NEUTRAL, FV: MYR0.27), AirAsia has decided to add in more aircraft allocated at both its Kuala Lumpur and Kota Kinabalu hubs. Its Indonesia operations, which management expects to be profitable in 4Q14 onwards, is also expected to see its fleet numbers maintained vs an initial reduction in size (of
four aircraft).

Of the four aircraft to be disposed of this year, one was recently sold for USD26m. This booked in a cash profit gain for AirAsia amounting to USD8m. The airline already has buyers lined up for the remaining three aircraft slated for disposal.

Fleet addition. All in, the net addition in total aircraft for its Malaysia-based operations is expected to amount to six. Two were added back in 2Q14, with another two aircraft each in 3Q14 and 4Q14. This will roughly average out a net addition of 4.3 aircraft into its Malaysian fleet this year, ie in line with our expectations. For FY15, AirAsia has a tentative fleet roll-out of two aircraft for Malaysia, five for Thailand, another three in India and three in Japan. For its Malaysia-based operations, we expect the average increase in aircraft of 4.8 in FY15.

Spinning off its aircraft into a leasing house. AirAsia has submitted an application in Labuan to set up an offshore entity specialising in the sub-leasing of all its aircraft to its affiliates. The entity is targeted to commence by September. With this entity, AirAsia should be able to progressively dispose of the aircraft operated by its affiliates (associates and JVs), some of which are parked in its balance sheet. Eventually, some of AirAsia’s older aircraft will also be disposed of into this entity. Note that management targets to have 60 aircraft managed by this new entity by the end of next year.

As this leasing entity will need to be backed by sufficient capital to take the aircraft into its books, AirAsia said that there was the possibility of bringing in other leasing investors at the early stage and, eventually, an IPO in the long run. We deem this strategy as feasible, noting that the AirAsia group has sizeable incoming orders over the next decade from Airbus (AIR FP, NR), which could eventually be parked into this leasing entity.

We estimate that, as at FY13, as much as 16 aircraft are parked in AirAsia’s balance sheet. By end-FY14, the number of aircraft leased to affiliates will potentially increase to 24-25, which could put a burden on its balance sheet moving forward. This is given the aggressive fleet expansions of its newly set up associates like AirAsia India and AirAsia Japan. Such a move should remove a sizeable portion of liabilities (reflecting the financial lease), and share of interest costs and depreciation of the leased aircraft operated by its associates. This is positive for AirAsia, as future income statements (except for the associate share of earnings) and balance sheet would truly reflect its Malaysia-based operations, where it is already recording healthy cash flows. We have yet to factor this into our model, pending more clarity and guidance from management.

Associates updates:

Thai AirAsia is expected to see a significantly better performance in the 2H. The recent launch of Thai AirAsia X should also further stimulate demand, driven by rising passenger feeds. The carrier also intends to grow its Chiang Mai hub. Three aircraft are earmarked for addition in 2H14 with another five slated for next year.

Indonesia AirAsia, which has been loss-making over the past few quarters due to intensive competition and the significant depreciation in the IDR vs the USD, is guided to be profitable come next year. As of 1H14, AirAsia’s equity share of losses has amounted to MYR108.5m. We do, however, expect the carrier to see significant improvements in 2H14. While management has guided that the carrier will be profitable next year, we do not see this happening until FY16, as the USD in the medium term is expected to be stronger when compared to its conversion rate between 2011-2013 when it hovered below IDR10,000/USD1. Efforts to improve profitability are, however, in place, as management focuses on optimising its route network by cutting its loss-making ones. There is also more emphasis on focusing on building frequencies on high-demand routes and new ones
as well. The consolidation of smaller competing carriers has lifted hope for yields to be boosted further and we have witnessed a significant 6% y-o-y improvement in average airfares for Indonesia AirAsia in the 2Q14. In its efforts to turn around, the carrier will not be adding any new aircraft to its fleet in the near term.

Management guided that Philippines AirAsia is expected to see a cash operating profit come 4Q14 and a net profit in FY15, thanks to the recent completion of its network realignment earlier this month. Like Malaysia, the landscape there is also suffering from irrational pricing that is expected to normalise soon. Efforts are also in place to promote the Philippines as a
destination for its Shanghai-Manila and Seoul-Manila routes. Management guided that there will not be any aircraft addition next year. Flights from Seoul (South Korea) and Shanghai (China) to Manila are still within the four hours range, thus making flying on a narrow body aircraft possible. We expect the Philippines to be profitable next year.

AirAsia India, which recently commenced operations, currently has one aircraft in operation but is expected to take in as much as 3-5 more in 2H14. Management guided that, with six aircraft, the carrier will be capable of breaking even given the economies of scale that can be achieved. For 1H14, AirAsia’s equity share of losses amounted to MYR12.8m and we expect full-year losses of MYR26m/MYR55m/MYR30m in FY14/FY15/FY16 respectively. Note that the current losses are not reflected in AirAsia’s income statements, as the total accumulated losses exceeded its initial investment of USD2.156m (for its 49% share of USD4.4m in AirAsia India). The airline has, however, indicated that it will provide a second tranche of capital injection of USD5.04m (for its 49% share of the USD10.3m in additional capital).