There were three news articles yesterday that are critical to our local aviation coverage and, while the wider air fare pricing band for Indonesian LCCs and AirAsia-Malaysia Airports issues being ironed out are positives, IAAX’s potential suspension risk is not – although thiscan be managed. Maintain OVERWEIGHT. We believe the current share prices of our BUY stocks have priced in the worst case scenarios.

Indonesia relaxes domestic air fare price structure for low-cost carriers (LCCs). Under Indonesia’s air fare regulations, LCCs are forbidden to price tickets lower than 40% of a respective domestic route’s ceiling price. This level is to drop to 30% from 26 Sep onwards. Note that this was the original floor threshold before the QZ8501 crash. Accordingly, a pricing cap is also in place, forbidding LCCs to charge more than 85% of these routes’ respective ceiling prices. It is understood that this ceiling has been lifted too, although there was no mention on the quantum of the pricing cap. This wider pricing band for LCCs allowsfor more competitive pricing, which could boost loads – especially against full-service carriers. This is positive for Indonesia AirAsia’s (IAA)domestic yields and further solidifies our view that a turnaround is possible. As highlighted before, we maintain our BUY call on AirAsia(AIRA MK) with an unchanged MYR2.68 TP, based on 10x forward P/E.

Facing suspension risk. AirAsia X’s (AXX MK) 49%-owned Indonesia AirAsia X (IAAX) is facing the risk of being suspended by the Transport Ministry if it fails to meet aircraft ownership requirements by endSeptember. Carriers have 12 months upon the issuance of aircraft operating certificates to meet the minimum aircraft ownershiprequirement, ie five on the balance sheet and five on leases. Failure to do so can result in a suspension or a fine, or both. IAAX only has two aircraft now. Wile we are aware of this requirement, we had earlier anticipated that authorities would be more flexible on newly-established carriers. As of now, flight bookings on IAAX are still open into 2016. To honour existing advanced bookings by customers, as a temporarymeasure, we believe that this deadline could be extended. This was the case with the earlier deadline of end-July for the positive equity ruling for IAA being extended to end-September. One way to counter this issue would be to transfer IAAX’s long-haul operations and flying rights to IAA until it has enough aircraft to operate independently. This would also be possible if IAA enters into an exclusive wet lease (lease of aircraft and its crew) arrangement with IAAX. AirAsia X’s share of losses from IAAX in1H15 was MYR31.6m, and management is targeting IAAX to break even by FY16 as aircraft utilisation improves with new route launches (Jeddah, Brisbane, Auckland, Tokyo and China). Should IAAX face the risk of closure, losses to AirAsia X would be limited to its USD14.7m investment and impairing receivables due of MYR43.1m (as at 1H15). IAAX’s aircraft could then be wet-leased to third parties (generating a 10% net margin). The impact on the loss in feeder traffi c to other AirAsia entities would be minimal, as IAAX only operates two aircraft. These issues, nonetheless, present the risk of wider losses ahead for AirAsia X, for which we have a SELL and MYR0.15 TP (0.8x forward P/BV).

Ironing out issues. On the Malaysian front, the media reported that the boards of both AirAsia and Malaysia Airports (MAHB MK, BUY, TP: MYR7.75) are to meet with the management of both companies this month to iron out issues between the twoparties. To some degree, this was also mooted by Malaysian Transport Minister Dato’ Sri Liow Tiong Lai. We hope the issues between the two can be resolved soon. AirAsia recently served a letter of demand amounting to MYR409m to Malaysia Airports involving compensation for losses and damages caused by the delay in completion of KLIA2 and its operational issues caused by the soft soil at its parking bay.

Maintain OVERWEIGHT. With the aviation stocks under our coverage taking a beating, valuations for AirAsia and Malaysia Airports are looking compellingly attractive at their current levels and seem to have priced in the worst case scenario. As such, while we continue to maintain our OVERWEIGHT recommendation on the sector, both AirAsia and Malaysia Airports are BUYs. AirAsia X, unfortunately,remains a SELL. This is because signs of a turnaround are not materialising fast enough and the situation has been further compounded by the new potentialsuspension issue in Indonesia.