AIRASIA BHD’S share price has fallen by 25% since word emerged of a disparaging report on the low-cost airline by Hong Kong-based GMT Research. Will the stock fall further after the embargo on the report is lifted and it becomes publicly available on June 24?

So far, the report — entitled Sell: New Dog, Old Tricks, published on June 10 — has only been circulated to GMT’s clients.

Industry sources who have seen the report say it makes some serious allegations about the company’s financial health — that AirAsia (fundamental: 0.2; valuation: 1.4) boosted profits by 39% through related-party transactions, a practice that is no longer sustainable and is putting the airline at risk of default.

The allegations and resulting slump in share price led founder and group CEO Tan Sri Tony Fernandes to hold several conference calls with analysts and fund managers to ease fears.

Consequently, local analysts have brushed off GMT’s report, stating that none of the problems highlighted are new.

“It’s not our policy to comment on other people’s report, so I leave you to it. But let’s just say there was nothing new, nor anything groundbreaking that I and the rest of the analyst community haven’t raised already,” writes Mohshin Aziz, a long-time aviation analyst and an associate director at Maybank Kim Eng Securities.

Mohshin maintains his “buy” call on AirAsia with a target price of RM2.45. “We believe this episode will blow over rather quickly. Be brave and accumulate for a profitable trade,” he says.

In contrast, GMT’s report is said to have valued AirAsia at RM1.23, and advised clients to sell the stock or, better yet, short sell the stock.

GMT’s main grouse with AirAsia was the company’s extraction of resources from its associates, which it alleges, are insolvent as well. As a result, GMT claims that AirAsia’s operating cash flow, without the support from its associates, had essentially fallen to zero by last year.

While the report does not really show how GMT arrived at this figure, it highlights that AirAsia’s related-party transactions have ballooned from RM13 million in 2004 to RM1.7 billion in 2014.

Based on that assumption, AirAsia’s heavy net gearing of 263% and high capital intensity, GMT is estimating that the low-cost airline will need some RM7 billion to bring debt down to more sustainable levels, say those who have seen the report.

However, as Mohshin points out, these concerns have been raised before.

“We have always highlighted our concerns regarding the RM2,862 million owed by related parties — some of which are overdue. These are mostly aircraft lease payments owed to the parent, in addition to working capital. In this report, we outline a worst-case scenario, [namely] to write off the loans to related parties, to establish a floor valuation,” he writes.

“There are questions with the books, I agree, but there is definitely no questioning the cash profits that this juggernaut is going to churn,” he argues, pointing out that at RM1.53, the lowest closing last Thursday, AirAsia is valued at 5.6 times FY2015 earnings.

It is noteworthy that Mohshin doesn’t stand alone. TA Securities, for example, has also issued a report on AirAsia, with a “buy” call and a target price of RM2.42.

So why did GMT’s report have such a strong impact on AirAsia’s share price?

Analysts point out that GMT has had a track record of doing this successfully, referencing the example of Noble Group.

“The modus operandi of these institutions is to spark fear and let the momentum sway things down. First short sell, when it breaks technical support, the technical traders will push it down, and the final leg is for fatigued long-term shareholders to give up. I call this the three pillars of death strategy,” explains one analyst.

Short selling is heavily regulated on Bursa Malaysia, but that has not stopped investors. Following GMT’s report, short selling in Air­Asia’s stocks went from non-existent to almost 6.8 million shares by June 18 — it was the most highly shorted stock on Bursa that day (see chart).

In comparison to the total trading volume, however, the amount is small. On June 17 and 18, at the peak of the selling pressure, 170 million and 96.7 million AirAsia shares changed hands respectively.

It doesn’t help that foreign funds have been trimming their positions in Malaysia, including in AirAsia, which happens to have high levels of foreign holdings — more than 50%. In fact, Bloomberg data shows a sharp selldown by foreign funds over the past few months.

AirAsia’s largest foreign holders are American-based funds, holding a cumulative 39% of the low-cost airline’s shares at its peak in early February. As at last Thursday, American funds have trimmed their positions to 29.5%, based on Bloomberg data.

It is worth noting that foreign funds had been trimming their positions in AirAsia long before the report came out, to reduce their exposure to the weakening ringgit, among other reasons. The ringgit has already fallen 7% against the US dollar since the start of the year to 3.743.

The culmination of these factors have helped drive AirAsia’s share price down to a near five-year low, but the question now is whether it will drop further.

With foreign funds still exiting Malaysian equities, downward selling pressure is expected to continue, but the panic selling of the past two weeks is not expected to go on.

As for GMT’s report, come June 24, investors will get a chance to read it first-hand. But the selling and short selling of AirAsia’s shares may be well past their peaks by then, since GMT’s clients would have had two weeks to act on the advice.

The report, at 40 pages long, is said to be strongly worded and puts Air­Asia in a bad light. It comes with a substantial number of references to past cases to support GMT’s arguments.

It might be a well-researched thesis of AirAsia’s problems, but it does not come close to presenting an open-and-shut case for the airline’s demise. If anything, the recent selldown could be a good buying opportunity for investors, if the 19 “buy” calls on AirAsia as compiled by Bloomberg are to be believed.

Note: The Edge Research’s fundamental score reflects a company’s profitability and balance sheet strength, calculated based on historical numbers. The valuation score determines if a stock is attractively valued or not, also based on historical numbers. A score of 3 suggests strong fundamentals and attractive valuations. Visit www.theedgemarkets.com for more details on a company’s financial dashboard.

This article first appeared in The Edge Malaysia Weekly, on June 22 - 28, 2015.

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