This article first appeared in The Edge Financial Daily, on April 19, 2016.

AirAsia Bhd
(April 18, RM2.05)
Maintain market perform with a higher target price (TP) of RM2.19: In the past few weeks, AirAsia Bhd has hogged the limelight again for several reasons: Placement exercise by the founders that will raise its effective stake to 32.4% from its existing 18.9%, a 10 times hike in charges proposed by the Department of Civil Aviation (DCA), and the suspension of Rayani Air.

We believe these events would have raised much interest as well as confusion among investors, especially the founders’ move in raising their stakes at this point of time and not at an earlier time.

Is the placement necessary? According to AirAsia, the rationale for the placement exercise is to pare off debt, capital expenditure and its headquarters in klia2, amounting to RM1 billion.

However, we already expected its net gearing to reduce from 2.3 times to two times in the financial year 2016 (FY16) prior to the placement exercise, while its interest coverage ratio of 2.5 times is considered comfortable for the highly-geared airline industry.

To recap, AirAsia’s debt interest coverage ratio dipped to a low of 1.5 times back in the second quarter of 2014, and yet was still traded at a price-earnings ratio (PER) of 18.9 times and price-to-book value (PBV) of 1.9 times.

On such a balance sheet, AirAsia will still be able to continue with its expansion plans. Historically in FY08 with high net-gearing as high as 4.1 times and negative interest coverage ratio, it still managed to trade at 0.9 times PBV back then.

Why are Fernandes and Kamarudin agreeing to pump in RM1 billion now and pay RM1.84 a share when during the height of the crisis, the shares had fallen to 78 sen? “Of course, we had thought about it then ... but there was so much volatility at that point, Tan Sri Tony Fernandes explained” in a recent interview in The Star (9/4/16).

Clearly, the privatisation idea had been mulled over by both of them. We believe that while they had the intention to increase their stake back then, we reckon that it did not happen probably due to the timing in securing financing as the selldown of AirAsia’s shares happened too abruptly.

Why the new placement of 20%? Nine months after the selldown, we believe the founders are well-prepared to take up a new placement of 20% in AirAsia injecting about RM1 billion into the company.

We questioned why 20% and not 10%, 12% or 15%? Post placement, the founders would effectively own 32.4% of AirAsia, or just slightly below the mandatory general offer (MGO) threshold of 33%.

Raising their combined stake to 32.4% as a preventive measure against further selldowns is a smart move by both Fernandes and Kamarudin, as they could always increase their stake easily to trigger a MGO should there be any sharp selldown in AirAsia’s shares in the future.

Now that shareholder confidence is renewed, DCA fees hike to be staggered over time and Rayani Air being suspended, AirAsia’s outlook looks promising, driven by low jet fuel prices and the improvements in its associates.

While we are upgrading our TP to RM2.19 based on nine times FY16 forward PER (three-year Fwd -0.5 Standard Deviation) from RM1.86 (one times FY16 PBV), we are maintaining our “market perform” call on AirAsia as we believe that the market has priced in the positive factors. —Kenanga Research, April 18