AirAsia X is embarking on many initiatives to reduce costs, targeting to cut  unit  costs  (ex-fuel)  by  5-7%  vs  our  4%  forecast.  Premised  on  an unchanged  1.7x  P/BV,  we  upgrade  TP  to  MYR0.57  (from  MY0.52,  16% upside) and call to TRADING BUY. With yields picking up 2.3% in FY15,coupled with the sharply lower unit costs  on  low oil prices, we expect marginal FY15 losses and for it to be in the black by FY16.

Tightening  its  belt.  We  recently  met  up  with  newly-appointed  acting AirAsia X CEO Benyamin Ismail. While there were no new developments since the recent results briefing, we are encouraged  by the fact that  he has  adopted  a hands-on approach in his new role.  We  also  noted that hiring  has  been  frozen  and  the  headcount  reduction  to  an  eight-mancrew/aircraft  (from  nine)  will  see  some  crews  being  deployed  to  other affiliates  within  the  AirAsia  group.  Benyamin  said  AirAsia  X  will  not  be chasing market share at the expense of widening losses but prefers  to focus on  turning around and  improving profitability.  He said its Malaysiabased  fleet,  Malaysia  AirAsia  X,  will  be  reduced  to  21  aircraft in  FY16 (from 22) and that some of AirAsia X’s older aircraft would be retired that year to kick-off its fleet rejuvenation programme. In the mid-term, due to its fragile balance sheet,  Benyamin said  future incoming fleet deliveries will be under an operating lease (via sales and leaseback), thus requiring minimal capex outlay  and, to  further  optimise capacity,  AirAsia  X  could tactically deploy more aircraft for wet lease.

Turning  around.  AirAsia  X is  embarking  on many  initiatives  to  reduce costs, targeting to cut unit costs (ex-fuel) by 5-7% vs our forecast of only 4%. The retirement of its older fleet this year could  also further improve fuel mileage. The termination of severely loss-making and under-utilised routes  like   Kuala  Lumpur-Adelaide  (Nov  2013  launch)  and  Kuala Lumpur-Nagoya  (Mar  2014  launch)  are  also  expected  to  narrow  FY15 bottomline losses.  With yields picking up 2.3% in FY15  and  the sharply lower unit costs thanks to the low oil prices, we expect losses to be very marginal in FY15 and for AirAsia X to be profitable in FY16.

Upgrade to TRADING BUY.  Premised on an unchanged P/BV  multiple of 1.7x, we upgrade TP to MYR0.57  (from MYR0.52)  as we roll over our BV/share  horizon  12  months  forward.  This  implies  FY16F  P/E  and EV/EBITDA multiples of 13x and 5.6x respectively, which we think is fair. We therefore upgrade our call to TRADING BUY (from Neutral). 

The Plans Thus Far
Tightening  its  belt.  We  recently  met  up  with  AirAsia  X’s  newly-appointed  acting CEO.  While  there  have  been  no  new  developments  since  the  company’s  recent results briefing, we are encouraged  by the fact that  Benyamin  has taken a hands-on
approach to his new role. Meanwhile, AirAsia X’s newly-appointed Group CEO, Dato’Kamarudin Meranun  has also been actively involved in the day-to-day operations of the group.

Reducing  staff  count.  We  also  noted  that  hiring  has  been  frozen  while  the headcount  reduction  to  an  eight-man  crew/aircraft  (from  nine)  will  see  some  of  its crews  being  deployed to  other  affiliates  within the  AirAsia group. We  estimate  that this will see  Malaysia AirAsia  X’s  workforce reduced  to  a head count  of 102  (by 4%)and staff productivity  to improve  by 10% YoY (FY14 estimate:  2%). We expect staff costs to reduce 4.3% YoY in FY15.

A  change  in  game  plan  –  no  longer  fighting  market  share.  Under  the  new leadership,  AirAsia  X  will  not  be  chasing market share  at the  expense  of  widening losses. Instead, Benyamin said the company  would prefer to focus on turning around and improving profitability. We believe this is a necessary move for the carrier. From 23  aircraft  as at end FY14,  Malaysia  AirAsia  X’s  fleet will  be  reduced  to  22  in FY15(plus  two  incoming  aircraft  and  deducting  three  retired  aircraft)  and  to  21  in  FY16after retiring one A330.  Come 2016 onwards, AirAsia X  will start retiring some of its older  aircraft  to  kick-off  its  fleet  rejuvenation  programme  and  to  manage  its  future capacity growth moving  forward.  Benyamin  said, in the mid-term,  due  to its  fragile balance sheet, future incoming fleet deliveries will be on operating leases  (through sales  and  leaseback),  thus  requiring  minimal  capex  outlay.  He  said  future  aircraft deliveries into AirAsia  X will be passed  on  to its two associates, Thai AirAsia X  and Indonesia  AirAsia  X. We  noted  that the  company  also intends  to  create  new  hubs elsewhere  –  which we reckon could potentially be India and Japan  –  to follow in the footsteps of sister company AirAsia (AIRA MK, BUY, TP: MYR3.45).

Wet leases give  good margins.  To optimise capacity, AirAsia  X has four  contracts to date (with durations  ranging from 5-10 months).  Two  of these aircraft are already on wet leases  from January to October. Another one is on wet lease from January until May  while  the remaining one  will be  under wet lease in the 2H15.  These wetleases are deemed lucrative, with net margins of 9-10% on USD-based revenue. The downside  to  such  leases  is  that  the  aircraft  will  be  out  of  AirAsia  X’s  control  and supervision,  thus  putting risk  to maintenance  issues  that  could  potentially  crop  up. We believe that the risk of this is manageable and not a great concern.

Jet  fuel.  Jet  fuel  accounted  for  53%  of  Air  Asia  X’s  operating  costs in  FY15.  The company is in no hurry to increase its hedging exposure, as it is still comfortable withits existing hedging position of USD88/barrel (bbl). Jet fuel spot price currently stands at USD70.82/bbl. This is a 46% decline from the USD130.61 jet fuel average price that AirAsia X paid for in 1Q14. To synchronise with our recent reduction in our Brent oil  forecast,  we  have  now  lowered  our  spot  rate  assumption  for  FY15  jet  fuel  to USD86/bbl from USD92/bbl earlier. Our FY16  and FY17  jet fuel price assumptionsare  also reduced to USD96/bbl from  USD105/bbl earlier. A 1USD change in jet fuel price will inversely move AirAsia  X’s bottomline by MYR13.1m/MYR10m/MYR10.2m in FY15/FY16/FY17 respectively. At current jet fuel price assumptions, our earnings forecast  stands  at  a  MYR5.4m  loss  in  FY15  and  a  bottomline  core  net  profit  of MYR157m and MYR252m in FY16 and FY17 respectively.

USD-denominated  borrowings.  Approximately  90%  of  AirAsia  X’s borrowings  are USD-denominated. This  puts the  company  at  a  disadvantage  given  the  weakening MYR against the USD,  which has reached to a high of MYR3.70 since the MYR was de-pegged.  With the MYR weakening by 5.4% YTD, we expect this puts AirAsia X atrisk of  higher interest payments. Our currency research team expects the USD/MYR to  average  at  3.5875  for  the  full  year,  to  end  at  MYR3.50  to  the  USD  by  4Q15. Despite  our  expectations  of  seeing  total  borrowings  reduced  by  MYR400m  to MYR1.16bn  from  the  improved  operational  profits  and  funds  to  be  raised  from  anupcoming  rights issue,  we  only  expect  interest  expenses  to  reduce  by  8%. This  is owing  to  the  weaker  MYR  against  the  USD.  As  of  FY14,  AirAsia  X’s  current  net gearing  stands  at  208.6%  due  to  the  sharp  losses  in  FY14.  With  the  improved operating financials in FY15, we expect AirAsia  X to see its net gearing reduced to 59.4%  by  end  FY15,  on  the  premise  that  its  FY15  core  losses  have  narrowed substantially to MYR5.4m from FY14’s MYR579.3m.

Currency sensitivity.  Most of AirAsia  X’s costs are USD denominated, notably jet fuel price, maintenance  and  financing costs. A 1 sen movement on the MYR to the USD will inversely impact earnings by MYR4.5m-5.5m. Expanding  distribution  base.  AirAsia  X  will  be  expanding  its ticketing  distribution base to other third parties and  the  Global Distribution System  –  a ticketing network. Although this would account roughly for 10% of ticket sales, average air fares sold by travel agents and third parties  are typically higher than direct bookings  made at the AirAsia website, thus giving boost to yields. In its active list of online travel agencies are  BYO  Jet,  Jet  Abroad,  Skiddoo,  STA  and  Helloworld,  and  Webjet  and  Zuji  will soon  be  entering  the  fold.  Both  Webjet  and  Zuji  are  the  deemed  as  Australia’s leading online travel agencies.

Yield  growth.  AirAsia  X’s  underlying  yields  (revenue  from  ticket  sales  plus  fuel surcharge)  for  FY1  dropped  15.6%  YoY  to  8.83  sen  from  10.47  sen.  With  some maturing routes  seeing yield growth from  2015 onwards, we expect underlying yields to inch up 2.3% in FY15. Although AirAsia X guided that average base fare based on forward bookings in 1Q15 saw an increase of 7% thus far, we think the upside will be offset by the abolishment of fuel surcharges, although this will be compensated by higher average fares. 

Yield movement is highly sensitive to earnings, noting that a 1  sen increase in yieldspositively  translates  to  a  MYR21.3m/MYR17m/MYR17.5m  increase  in FY15/FY16/FY17 earnings respectively.

With  more  network  cuts  ahead  by  Malaysian  Airline  System  (MAS)  balancing  the supply and demand dynamics, we expect an industry-wide recovery in yields, which will be positive for AirAsia  X. However, according to the latest updates by Khazanah
Nasional  on its second phase of the MAS turnaround plan, we understand that route cuts will  mostly be on the long haul routes to Europe and the Middle East. Since then, share  prices  of  AirAsia  and  AirAsia  X  have  reacted  negatively  to  this  news,  which
were further compounded by the latest  rise in oil prices. Thus far, there has not been any indication  on  whether  MAS  will look  into  trimming its  capacity  on the  Australia and North Asia routes  – the  two sectors that AirAsia X is mostly exposed on. On the
bright side,  however, our observation on air fares has also pointed out that  MAS  has started  to  rationalise  its  air  fares  for  the  routes  that  it  is  competing  against  the company, thus pointing to strengthening yields ahead for AirAsia X.

New routes. AirAsia X has no intention of introducing new routes in the near term, as it  is  undergoing  a  network  rationalisation  exercise.  This  exercise  saw  the  Kuala Lumpur-Adelaide  and  Kuala Lumpur-Nagoya routes  being slashed. However, based on media coverage,  AirAsia  X could be  looking into Hawaii soon.  This will not likely be a direct flight from Kuala Lumpur but a stopover to Japan. This, in our view, would make more commercial sense as this will allow AirAsia X to pick up Japanese traffic. This route would be categorised as fifth freedom rights, thus mooting the possibility of the company  creating a hub there in the near future.  Other possible routes that are currently  in  the  works  are  Kuala  Lumpur-London  and  Kuala  Lumpur-Paris,  which could come in as early as 2016.

Associates updates. Indonesia AirAsia X has finally been granted the approval to fly to Melbourne from Bali,  clearing  away  our earlier concerns  given the tragic crash  of Flight  QZ8501.  The  Bali-Melbourne  route  is  expected  to  be  launched  by  18  Mar. Currently Indonesia  AirAsia  X  only  serves  one  route,  Bali-Taipei. We  estimate  that this  will  be  a  profitable  route,  just like  AirAsia  X’s  Kuala  Lumpur-Taipei.  Operating with  two  aircraft  currently,  the  airline  will  only  be  adding  one  aircraft  each  year  in FY15 and FY16. Other routes planned by Indonesia AirAsia X are Jeddah and Japan.Thai  AirAsia  X  has  shown  a  strong  prfit  of  THB20m  for  the  month  of  December owing  to  strong  loads  (84.4%)  and  yields,  a  turnaround  that  came  in  earlier  than expected.  The  carrier  aims to add  five  more  aircraft to bring  its total  fleet  count to seven,  with  new  routes  to  second-tier  cities  in  China  and  Sapporo  (Japan)  being planned  for  2015.  The  rest  are  coming  in  from  frequency  increases,  given  the encouraging demand.

On the premise of lower oil prices and  a  stable currency (when compared to other regions against the  USD), we expect  Thai AirAsia X to breakeven by 2H15. Our total associates  and  joint-venture  (JV)  share  of  losses  of  MYR45m  will  be  mostly  fromIndonesia  AirAsia  X,  which  is  currently  suffering  from  low  utili sation  of  its  aircraft given  the  delayed  approval  for  its  Australia  route.  Furthermore,  the  carrier  could potentially see a delay in being granted approval to commence its Bali-Japan flights, given the safety concerns that had tarnished the  AirAsia  brand following the QZ8501 incident. Moving into FY16 and FY17, we expect associates and JVs to turn positive,and report an associate share of core profits of MYR15m and MYR30m respectively. What we like about Indonesia  AirAsia  X and  Thai  AirAsia  X is that  these two hubsserve  ASEAN’s  two  leading  holiday  destinations.  Indonesia  and  Thailand  are important  markets  all  year  round  for  holiday-goers.  These  two  carriers  could  also potentially  steal  market  share  from  the  full  service  carriers.  We  see  the  route  to sustainable profits by these two JVs to be faster than Malaysia AirAsia X. Forecasts.  The key  changes to our key assumptions are lower yield growth and jet fuel price. We lower our yield growth assumption slightly as we have yet to  see  how MAS cuts its Australian capacity to be on the conservative side. To compensate for this,  however,  we  lower  our  jet  fuel  price  assumptions  further.  Furthermore,  as AirAsia  X only taking incoming aircraft as operational leases, we input a normalised tax  rate  for  FY16  onwards,  once  the  company  is profitable.  All in,  we  raise  FY15Fcore  losses  to  MYR5.4m  from  MYR2.9m. For  FY16F  and FY17F  our  earnings  are raised  by  11%  and  62%  respectively.  The  sharp  revision  in  earnings  into  FY17 reflects the significant downward revision in jet fuel prices,  which we expect to be flat YoY vs FY16. Our changes in assumptions and earnings are as below:

A  turnaround  seen.  AirAsia  X  is  embarking  on  many  initiatives  to  reduce  costs, targeting  to  cut  unit  costs  (ex-fuel)  by  5-7%  vs  our  forecasts  of  only  4%.  The retirement  of  its  older  fleet  this  year  could  also  further  improve  fuel  mileage.  The termination of severely loss-making and under-utilised routes such as Adelaide  and Nagoya  –  that  were  launched  in  Nov  2013  and  Mar  2014  respectively  –  are  also expected to narrow bottomline losses in FY15. With yields picking up  2.3% in FY15,coupled with the sharply lower unit costs reduction thanks to the low oil prices, we expect losses to be very marginal in FY15 and for AirAsia X to be profitable in FY16.

Source: RHB