AirAsia - Reaching an inflexion point, 3 Nov 2014

AirAsia

We raise Airasia to BUY from HOLD and raise our fair value to RM3.10/share from RM2.10/share, pegging Airasia at 12x FY15F EPS. Several factors have prompted this tactical upgrade:- (1) earnings have reached an inflexion point with lower fuel price and bottoming yields; (2) a stronger balance sheet post perpetual Sukuk issuance; and (3) attractive valuations after a 30% correction since its previous high in 2011-2012.

Our FY14F-16F earnings are raised by 6%-47% to factor in:- (1) lower spot crude oil price assumption of USD105/barrel; (2) conservative yield growth of 1%-2% over the next 3 years from flat previously; and (3) factors in incremental equity and cash from the Sukuk proceeds. We now expect FY15F/16F EPS growth of 35%/16% from 3%/7% previously. The massive increase in our forecast is due to a depressed earnings base previously, which translates into much higher sensitivity to changes in key variables.

Fuel, which forms a significant chunk of cost (54% of cost), has fallen significantly by 7% over the past one month and by 25% from the recent high of USD115/barrel in June 2014 to USD86/barrel. We expect little existing hedges for FY15F since Airasia was tight on cash in FY14 with little room to hedge further out.

Although there is uncertainty in the mid-term outlook depending on how MAS restructures its short-haul business model, yield trends have bottomed (See Exhibit 7 & 8), while MAS has already started cutting domestic capacity since Jul 2014 (See Exhibit 5). As Airasia has a fairly heavy reliance on domestic traffic, it should benefit from this development.

Airasia raised RM1bil via a callable, perpetual Sukuk program. The Sukuk will be treated as equity (but no dilution in EPS), which works to lower Airasia’s net gearing to 130% (FY15F) from 170% previously. The stronger balance sheet provides better room for Airasia to lock in the weak crude oil price levels. However it may increase cost of financing as coupon rates will likely balloon post every call milestone.

Airasia’s share price has fallen 18% since our downgrade at RM3.02/share. While this was accompanied by a negative turn in earnings revision cycle, we are starting to see value emerging in the stock.

Valuations are now attractive at 9.7x FY15F EPS, having fallen from up to 12x in FY12. At >30% discount to regional peers and 12% discount to historical average PE of 11x, we see little downside risk from here on. Earnings is reaching an inflexion point and we think Airasia is now set for a strong re-rating, further underpinned by the outflow of funds from MAS soon

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