Cheaper fuel prices to benefit LCCs

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Aviation sector
Brent crude prices fell to a four-year low of US$83 (RM272) a barrel on Oct 16 as supply continued to grow amid slower global demand growth. This led DBSV oil and gas analysts to cut crude price assumptions to US$95 for 2015 and US$92 for 2016.

Low-cost carriers (LCCs) stand to benefit more from lower jet fuel prices as fuel costs account for a larger share of their total operating expenditure (opex) (50% vs 40% for full-service carriers or FSCs). Also, the low fuel price environment will further entrench the LCCs’ cost advantage against FSCs, as a greater share of opex will be controllable non-fuel costs.

Our analysis suggests AirAsia’s earnings would change by RM18 million in the financial year 2015 to 2016 forecast (FY15/FY16F) for every US$1 change in assumed jet fuel price. For AirAsia X Bhd (AAX), it is RM13 million/15 million in FY15/FY16F. If our benchmark jet fuel price assumptions are revised to US$95/US$92 for FY15/FY16F, we would raise FY15/FY16F earnings for AirAsia by 15% to 17% and AAX by 77% to 118%. AAX’s earnings are more sensitive to jet fuel prices due to the low base effect.

However, we are retaining our earnings projections for airlines under our Malaysia coverage pending the upcoming earnings season. Also, any earnings revision is not expected to alter our recommendations.

Despite AAX’s higher earnings sensitivity to jet fuel prices, AirAsia remains our top pick for Malaysian airlines. Incorporating the lower jet fuel price assumptions would reduce AAX’s valuation to 20 times/11 times FY15/FY16F price-to-earnings ratio (PER), which is still unattractive.

Meanwhile, AirAsia’s valuation would drop to seven times/five times FY15 to FY16F PER, if this scenario materialises. Existing unchanged forecasts imply AirAsia and AAX FY15/FY16F PER of eight times/six times and 36 times/24 times respectively. — AllianceDBS Research, Oct 28

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This article first appeared in The Edge Financial Daily, on October 29, 2014.