Strong earnings from AirAsia Malaysia, Thailand and Digitalization to offset losses from carriers in other regions

AirAsia (AAGB:MK) Fair Value: M$4.70
AirAsia (AAGB:MK) Rating: Outperform

24 May 2018, Malaysia – AirAsia Group’s recurring profit nearly tripled y/y in 1Q18 notwithstanding the higher oil prices and its limited fuel hedging. During the results briefing, management shared AirAsia Group’s Digitalization initiatives to be launched this year which will boost revenue. Overall, we expect strong earnings contribution from AirAsia’s Malaysia and Thailand operations given the benign industry demand and supply while losses could persist for its Philippines (which could potentially delay its IPO plans beyond 2H2019), Indonesia, India and Japan-based carriers.  

RECURRING PROFITS NEARLY TRIPLED Y/Y IN 1Q18, BEATING EXPECTATIONS

AirAsia Group (AAGB:MK) delivered strong financial results for 1Q18, beating ours and market expectations. Excluding one-off items, AirAsia Group’s recurring profit grew 176% y/y to M$601 million during 1Q18, mainly driven by stronger profits from its Malaysia and Thailand operations as well as lower unit cost ex-fuel. Operating and recurring profit margins improved significantly to 29% and 24% respectively. However, due to its large capex, AirAsia Group generated negative free cash flows of M$133m during the quarter. An interim single-tier dividend of M$0.12 per share was declared. We expect a larger special dividend distribution when the sales proceeds of AAC are in.

SURPRISE 4% REDUCTION IN NON-FUEL UNIT COST – AIRASIA GROUP’S BIGGEST COMPETITIVE ADVANTAGE VERSUS SECTOR PEERS

The key highlight of the 1Q18 results was the 4% y/y reduction in unit cost ex-fuel. This helped to offset the negative impact of the higher oil prices, resulting in steady unit cost y/y. AirAsia Group is scheduled to start taking delivery of the new Airbus A321neo aircraft from 2Q19 onwards which will further reduce its unit cost ex-fuel and raise its competitive cost advantage versus sector peers.

FURTHER INCREASE IN OIL PRICES STILL A RISK

Fuel is AirAsia Group’s largest cost component, accounting for 47% of its operating costs and 33% of total revenue in 1Q18. AirAsia Group has hedged only 10% of its 2018 fuel consumption so far (as at March 2018) and will therefore be more significantly impacted by the higher fuel prices this year compared to last year.

AirAsia Group: Planned aircraft fleet growth (2018)

AirAsia Group: Planned aircraft fleet growth (2018)

 

AIRASIA MALAYSIA TO GAIN MARKET SHARE WITHOUT COMPROMISING ON YIELDS AS COMPETITORS SCALE BACK

AirAsia Group plans to grow its aircraft fleet by 15% y/y this year to 225 aircraft. The benign combination of robust travel demand and limited supply growth in the Malaysian market will enable AirAsia Malaysia to pass on part of the fuel price increase to its customers more effectively. AirAsia Malaysia’s key competitors Malaysia Airlines and Malindo have been scaling back so the overall Malaysian aviation sector capacity growth will be limited, increasing by only around 4%-5% this year based on our estimates; we expect AirAsia Malaysia to gain market share on domestic and international routes this year without compromising too much on yields.

AIRASIA THAILAND’S PROFIT REBOUND TO CONTINUE GIVEN BENIGN INDUSTRY DEMAND AND SUPPLY

AirAsia Thailand (AAV:TB)’s net profit increased 77% y/y during 1Q18 and we expect the carrier to be a key contributor to AirAsia Group’s profits in 2018 as the Thai aviation industry’s demand-supply balance  is expected to be benign.

WE EXPECT AIRASIA PHILIPPINES TO FACE STIFF COMPETITION ON DOMESTIC ROUTES WHICH COULD DELAY ITS IPO PLANS; AIRASIA INDONESIA TO REMAIN LOSS-MAKING AND RAISE MORE CAPITAL

AirAsia Philippines has surprisingly not been hurt by the closure of Boracay as it managed to redeploy its excess capacity to Cebu without suffering much negative impact. However, we still expect 2018 to be a challenging year for AirAsia Philippines as competition is particularly stiff on domestic routes with risk of overcapacity, which is a negative read-through for Cebu Air (CEB:PM) as well. This could potentially delay its IPO plans further, beyond 2H2019. We expect Indonesia AirAsia (CMPP:IJ) to remain loss-making for the rest of this year given the industry overcapacity and will need further capital injection. Meanwhile, AirAsia Japan plans to launch its first international flight to Taipei.

AIRASIA INDIA AND VISTARA’S AGGRESSIVE FLEET EXPANSION WILL HURT INDIGO AIRLINES AND JET AIRWAYS

AirAsia India targets to grow its fleet from 16 to 21 aircraft by the end of this year, enabling it to launch flights to international destinations. Its aggressive capacity expansion has resulted in a marked 6ppts y/y decline in passenger load factor and its losses doubled. We expect AirAsia India to incur further losses as it accelerates its expansion phase. With Vistara (owned by Singapore Airlines SIA:SP and Tata Group) doing the same, we expect the heightened competition to put pressure on yields, hurting the incumbent carriers Jet Airways (JETIN:IN) and Indigo Airlines (INDIGO:IN) which are already reeling from the impact of higher oil prices.

DIGITALIZATION INITIATIVES TO BOOST REVENUE

During the 1Q18 results briefing, management shared AirAsia Group’s ambitious vision to transform from an airline into a global tech company. Some of its Digitalization initiatives to be launched in 2Q and 3Q this year include:

1) Better targeting & pricing which is expected to boost incremental bookings by 5% to 7%,

2) Automated alert on flight booking performance which is expected to raise incremental revenue by US$1.6 million,

3) Real-time customer profile which could lift incremental revenue by US$2.7 million per month,

4) Advance analytics through Machine Learning & Artificial Intelligence,

5) Air ticket booking predictive scores which could add incremental revenue of US$5.4 million per month.

The number of unique users on AirAsia Group’s mobile app and website has risen 106% y/y and 13% y/y to 51.5m and 97.9m respectively in 1Q18.

Management is also bullish on the potential earnings upside of BigPay and will launch its new e-commerce market place website OurShop on 4th July 2018. Its Navitaire system is expected to boost ancillary revenue by US$60 million per year, starting from 4Q18.

SUCCESSFUL PASSENGER DATA MONETIZATION CAN POTENTIALLY LIFT AIRASIA’S NET PROFIT BY M$574 MILLION PER YEAR AND RAISE ITS FAIR VALUE TO M$13 PER SHARE

AirAsia Group can potentially raise its revenue by M$1.6B per yearboosting its net profit by M$574m million per year (versus its net profit of M$1.64B in 2017), if it can successfully collect and monetize its Big Data based on our estimates. This will enable AirAsia Group to achieve M$2.2B net profit a year which would be a significant positive share price driver for AirAsia.

Investors will begin to value AirAsia Group like a growth stock given its improved long-term revenue and earnings growth prospects. Valuing AirAsia Group at 20x P/E would imply a fair value of M$13 per share. This is four times AirAsia Group’s current share price of M$3.23! 

 

Note: Stocks with upside of more than 10% based on our fair value are assigned an Outperform rating. Stocks with downside of more than 10% based on our fair value are assigned an Underperform rating. Stocks with upside or downside of less than 10% based on our fair value are assigned an In-line rating. These are Crucial Perspective’s proprietary rating classifications and by no means serve as investment recommendations.

 

Independent Research Declaration: Crucial Perspective does not own any position in the equities featured in this report nor have we received any compensation for writing this report. 

 

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