ISG Airport will increase its annual passenger capacity to 41m in two years’ time at a cost of EUR20m. The announced capacity expansion is higher than our estimate, while the planned capex is a tad lower. Aided by higher Turkish passenger traffic growth, we lift our DCF-based TP to MYR6.85 (from MYR6.80, 4% upside), and remain NEUTRAL amidst a lack of near-term re-rating catalysts. Earnings contributions from Turkey remain exposed to the MYR/EUR rate, which has already appreciated by 6% YTD.

Confident of strong growth at Turkey unit. Compared to Istanbul Sabiha Gokcen (ISG) Airport’s announced plan to increase passenger handling capacity to 41m by end-2018, we had earlier estimated a gradual expansion in capacity of the existing terminal to 38m by 2018. A greater -than-estimated capacity expansion suggests Malaysia Airports (MAHB) has confidence in continuing strong growth at its Turkish operations. We raise our passenger traffic growth assumption at ISG by 1.0-1.5 ppts for 2018-2020.

Turkey should continue to register strong growth. The top two airlines in Turkey continue to register strong traffic growth despite the recent security threats that have troubled the country. Pegasus Airlines, which uses ISG airport as a hub and has the largest market share of seat capacity at the airport, saw a third straight quarter of more than 15% YoY growth in passenger traffic in 1Q16. Turkish Airlines reported a fourth successive quarter of more than 10% YoY growth in passenger traffic for the same period. An under-penetrated domestic aviation market, location advantage over the Middle East as a transit hub and a large aircraft delivery pipeline for Pegasus Airlines and Turkish Airlines should continue to support double-digit passenger traffic growth at ISG over the next few years.

Appreciating MYR vs EUR remains a downside risk. We expect ISG airport, with one passenger terminal and a single runway, to account for c.47% of MAHB’s EBITDA this year. Based on our expectation of strong passenger traffic growth in Turkey, ISG’s EBITDA contribution may rise to c.53% in four years. Earnings from Turkey are denominated in EUR and the appreciation of the MYR/EUR rate may weigh on the expected strong earnings contribution from ISG. We estimate that a 10% appreciation in the MYR vs EUR would lower our consolidated EBITDA for this year and valuation by 5% and 3% respectively.

Maintain NEUTRAL, with a higher TP. Aided by higher passenger traffic growth at ISG airport during 2018-2020, we increase our DCF-based TP to MYR6.85. We also assessed the fair value of MAHB using a target EV/EBITDA multiple and arrived at a value of MYR6.93 per share. Given the sluggish earnings growth and margin at its Malaysian operations, and downside risks to earnings contributions from its Turkish operation from the appreciating MYR vs EUR, we keep our NEUTRAL rating on the stock.

Valuation and target price We value MAHB’s equity shares using a DCF approach, and our valuation estimate of MYR6.85 per share suggests that the shares are priced to perfection. We value its Malaysia airport operations at MYR7,688m (MYR4.64 per share) and its Turkey operations at MYR3,673m or MYR2.21 per share (EUR796m converted to MYR using MYR/EUR exchange rate of 4.61). We employed a WACC of 8%, which is based on a stock beta of 1, a risk-free rate of 3.75%, a market risk premium of 6% and a target gearing of 40%.