This article first appeared in The Edge Financial Daily on February 20, 2018

KUALA LUMPUR: Malaysia Airports Holdings Bhd (MAHB) is probably the most expensive big-cap stock listed on Bursa Malaysia, in terms of historical price-earnings (P/E) valuation. The airport operator is trading at 89.4 times but some analysts see further upside on the counter.

Its optimism hinges on the continued passenger volume growth in local airports. However, the new Quality of Service (QoS) frameworks, and aeronautical charges by the Malaysian Aviation Commission (Mavcom) could become a wild card in the picture.

QoS is to be implemented in July, and the aeronautical charges in 2020.

Analysts’ target prices (TP) for MAHB range from RM7.30 to RM12.40. The stock closed unchanged at RM8.65 yesterday, for a market capitalisation of RM14.37 billion.

MIDF Research analyst Danial Razak, who has a “buy” call on MAHB with a TP of RM9.98, told The Edge Financial Daily that the recent dip in share price after the release of its January passenger traffic data is a buying opportunity.

“We think it is a good time for investors to accumulate, because we are quite optimistic on MAHB earnings in the short to medium term. We expect that passenger volume will continue to grow until the Visit Malaysia Year 2020, but when the new regulations are implemented, we might revise our forecast,” he said in a phone interview.

MAHB has a historical price-earnings ratio (PER) of 89.64 times, as compared to neighbouring Airports of Thailand PcL’s 45.39 times.

Other regional aviation-related counters are generally lower than the MAHB valuation as well. Singapore Airlines Ltd’s PER was at 22.95 times, while AirAsia Bhd has a PER of 7.99 times. However, the airlines are subject to the fluctuation of fuel cost, which has been creeping up in recent months.

MAHB is JP Morgan Research analyst Mak Hoy Kit’s top pick in Malaysia, the reason being the company’s exposure to rising tourism and low-cost travel demand.

Mak, who has a TP of RM12.40, said upcoming catalysts for the group includes positive earnings momentum, international passenger service charge (PSC) standardisation at the Kuala Lumpur International Airport (KLIA), a potential stake sale at Istanbul Sabiha Gokcen International Airport, higher dividends, and positive development at Aeropolis.

Nonetheless, Mak acknowledged that there are risks to MAHB’s earnings, and returns on invested capital risk, once Mavcom implements the QoS and new aeronautical charges frameworks.

These frameworks have triggered some concerns among the investing fraternity concerning MAHB.

Mak did a sensitivity analysis that showed with every 1% penalty on MAHB’s aeronautical revenue under QoS, there will be a negative impact of up to 3.6% on the group’s net profit for the financial year ending Dec 31, 2018 (FY18), and 2.7% in FY19.

According to CIMB Research analyst Raymond Yap, the fundamental philosophy behind these two new frameworks is to ensure MAHB, as a natural monopoly, does not take advantage of its superior competitive position vis-à-vis airport users, to either offer substandard service or charge exorbitant tariffs.

“MAHB risks paying penalties of up to 5.03% of aero revenues at KLIA and Kuala Lumpur International Airport 2 (klia2) in the event that these two airports fail to meet minimum thresholds of service quality [under the QoS],” he wrote in his report to investors last week.

Yap highlighted that the new aeronautical charges are the key reason he cut MAHB’s TP to RM7.30 — the lowest among Bloomberg’s consensus — and downgraded the counter to “reduce”.

“We believe MAHB will do its utmost to avoid penalties. Hence, we have not factored in any penalties in our forecasts.

“However, we estimate that MAHB may have to incur capex (capital expentiture) of RM900 million or more over the next four years to replace its aerotrain and baggage-handling systems at KLIA, as these are the two sensitive points for service quality,” Yap said.

The aeronautical charges framework, dubbed the Regulated Asset Base (RAB) framework, computes the amount of revenue that is allowed for airport operators to earn during a regulatory period based on an expected cost of capital to be incurred, depreciations and operating costs.

“Our previous valuation was based on the existing Operating Agreement (OA) signed between MAHB and the government. However, implementation of the RAB framework, whose key criteria is to ensure that return on invested capital (ROIC) does not exceed the weighted average cost of capital (WACC), will supersede the OA on tariff matters,” Yap said.

“The OA permits increases in aero tariffs based on a preset time frame, or based on predetermined conditions that are not linked to financial metrics. Tariffs never decrease, they only increase inexorably upwards, and tariffs move along their own independent trajectory. [But] under the RAB framework, an increase in aero tariffs would only be allowed if the ROIC is below the WACC,” he said.

In contrast, Mak views that the concerns have been overplayed. In fact, he issued two research notes on the subject matter this month.

“We believe the selldown is on the back of fears that returns will be capped, thereby eroding discounted cash flow valuations over the long term. We believe it is a good time to accumulate on weakness,” he said, adding that MAHB’s ROIC is not likely to deviate significantly from the existing OA after implementing the RAB framework.

Given that the OA is a binding agreement between the government and MAHB, Mak believes that whatever form the regulated returns structure will take, it is not likely to result in MAHB’s returns or cash flow to be in a worse-off position.

“One of the most pertinent terms of the OA is the consumer price index plus an increase on PSC, which we believe is likely to be the ‘floor’,” he said.

Danial, on the other hand, said his current valuation does not take into account the new frameworks.

“At this juncture, we have not imputed the impact of the new rules. It would be too early for us to gauge the impact. The PSC has already been regulated, and the new rules are meant to globalise the standard. Having said that, our projection is still relatively conservative, [and] our TP is not the highest,” he added.