As we expected, the Indonesian Government announced yesterday that it will take a more accommodative approach to ensure that the affected 13 carriers will be able to improve their equity position, contrary to market expectations of a suspension. Maintain BUY and MYR2.81 TP(12x target FY15 P/E, 115% upside). With this concern erased, we see the stock price reacting positively today.

Accommodative approach. Contrary to initial concerns of a possible suspension on Indonesia AirAsia’s (IAA) license due to its inability to be in positive equity, the Indonesian Government said yesterday it wouldtake a more accommodative approach to ensure the 13 affected carriers would be able to improve their equity positions. They are required to present their business plans to the Government, though. This is what we have been reiterating since the news first broke. With this concern erased, we see the stock price reacting positively today.

If the deadline is not met? However, a failure to be in positive equity by 31 Jul has prompted the Government to review requests for route approvals. We are not too worried about this as IAA is to undergo some capacity and route cuts. Management said four aircraft leased from Malaysia AirAsia would be taken out of its fleet this year, leading to cutsin one domestic and two international routes. Our observation on the former appears to be Medan-Jakarta where competition is crowded. New routes secured so far are Bangkok-Bali and Bangkok-Surabaya – where no other low cost carrier competes in, thus allowing IAA to boost yields.

Yield recovery could be in store. While we are more conservative on our assumptions where we forecast for IAA’s FY15 average yields to be flat, our observations show that there appears to be upside to our estimates, judging by ticket prices on the routes we assessed. But should tickets be priced too high, it could dent demand and load factor. According to Statistics Indonesia (BPS), passenger traffic remains encouraging (+13.3% YTD May), while inbound tourist arrivals haveshown a 5.5% increase. This suggests that travel demand has been very strong in the domestic market.

Maintain BUY call, MYR2.81 TP. This is premised on an unchanged 12x FY15F P/E. At 5.6x FY15F P/E currently, AirAsia is trading at a steep discount vs its 10x 5-year historical 1-year forward P/E averageand peer’s 13.6x FY15F average. Even in a worst case scenario on impairments (MYR2.866bn), we derive an RNAV of MYR1.57 (+20%).