We initiate with an Outperform rating. Re-rating catalysts are aggressive expansion of its profitable KUL hub and the opening of new hubs in Bali and Bangkok. Our SOP-based target price is based on 11x CY14 P/E for the KUL hub and a separate 8x CY14 P/E for the Bali hub. AAX has superior unit costs that helps it build new demand with cheap fares and eat into FSCs. market share, leveraging AirAsia Group.s short-haul networks. 

Based in KUL, AAX operates longhaul (LH) low-cost flights, defined as flights that are longer than four hours. It has a powerful alliance with AirAsia that gives it an unparalleled depth of regional connectivity, with 40-45% of AAX passengers ultimately taking a short-haul flight. The airline has had a turbulent ride and has only just emerged from five years of losses. It posted a profit in 1Q13 after cutting its loss-making flights to Europe, New Zealand and India in 2012. AAX has learnt the hard way what works in the LH LCC business, and is now finally confident of its business model. 

AAX's fleet delivery pipeline will see its capacity triple over the next three years and allow it to add more capacity ex-KUL to North Asia and Australia, where it has found the sweet spot of profitability. As AAX.s operating history in its destination countries mature, yields are likely to rise and investment costs should fall. The new Bali and Bangkok hubs promise even more long-term growth. 

As the LH LCC model yields lower profit margins than short-haul LCCs, AAX.s earnings are very sensitive to changes in yields, fuel prices and exchange rates. Future earnings can come under pressure if the jet fuel prices continue to rise and the US$ continues to appreciate. The gestation period of 12-24 months for new long-haul routes is longer than the 6-12 months for new short-haul routes. While there are no direct competitors in KUL, AAX competes with Jetstar and Scoot/Tiger groups in Singapore. AAX may have to bear start-up losses at its new Bangkok and Bali hubs.

Source: CIMB Daybreak - 02 August 2013, Full PDF Report