AirAsia Bhd
(Jan 16, RM2.77)
Upgrade to buy with a higher target price of RM3.30: Jet fuel price plunged significantly to US$60/barrel (bbl) (RM213) (dropped 50% vs US$120/bbl in early 2014), in-line with the slump in WTI crude oil price to US$45/bbl, due to global production oversupply issue.

AirAsia is benefiting from the slump in jet fuel price, given 60% to 63% of its operational cost is attributed to jet fuel. AirAsia has hedged 50% of jet fuel requirement for 2015 at US$88/bbl with the remaining 50% leveraging on current US$60 to RM65/bbl level (average for financial year 2015 [FY15] likely to be below US$80/bbl).

We have assumed average jet fuel cost at US$80/bbl in 2015 and US$85/bbl in 2016.

On the contrary, the US dollar has also appreciated against regional currencies (ringgit, rupiah). Currently, the exchange rate is RM3.58/US dollar (ringgit depreciated 8.5% against RM3.30/US dollar in early 2014).

Major components of AirAsia’s cost structure (that is jet fuel, maintenance, leasing, interest and others) are denominated in US dollar. We have imputed RM3.50/US dollar for 2015 to 2016.

The recent air incidents such as Indonesia AirAsia flight QZ8501 will have negative impact on short-term air travel demand in the region (post Malaysia Airlines flight MH370 and MH17 incidents). However, we are still positive about long-term growth of air travel demand in the region.

We do not expect AirAsia to face severe fines from flight QZ8501, while the insurance is likely to cover the compensations and aircraft recovery expenses.

Nevertheless, we expect short-term yield depression as AirAsia group offers promotional fares to boost air travel confidence and maintain its load factor at 80%. We have conservatively assumed average yields (including surcharge) to drop 7.6% in 2015.

Overall, we expect AirAsia to register stronger earnings in 2015, given the significant benefits from lower jet fuel prices will only be partially offset by the lower yield and US dollar appreciation.

Risks include world crisis (war, terrorism and epidemic outbreak), surge in jet fuel price, US dollar appreciation; weak air travel demand; and the high-speed train infrastructure between Singapore and Penang).

After taking into consideration of lower yield, lower jet fuel cost and higher US dollar, we have increased financial year 2015 (FY15) to FY16 earnings by 23.4% and 10.5% respectively.

Positives include sustaining lowest cost low-cost carrier operator in Asia with largest network and strong brand name, low jet fuel price, increasing ancillary income, and routes rationalisation of major competitor Malaysian Airline System Bhd.

Negatives include higher cost of living faced by consumers (from good and services tax implementation), and regional air demand slowdown and political issues.

Upgrade to buy with higher TP of RM3.30 (from RM2.64) based on unchanged 10% discount to sum-of-parts.— HLIB REsearch, Jan 16

This article first appeared in The Edge Financial Daily, on January 19, 2015.