This article first appeared in The Edge Financial Daily, on October 5, 2015.

AirAsia Bhd
(Oct 2, RM1.26)
Maintain buy with an unchanged target price (TP) of RM1.82: AirAsia Bhd announced last Thursday that its board of directors had approved the subscription of a 49% portion of 4.2 trillion rupiah (RM1.27 billion), translating into two trillion rupiah of perpetual bonds by converting its receivables owed from PT Indonesia AirAsia (IAA).

The remaining portion of 51% will be taken up by Indonesian shareholders.

Although we are not surprised as we highlighted that IAA shareholders had approved the fundraising exercise in our previous report, we are positive on the development as it would bring IAA out of the negative equity position and lift some of the overhang of concerns about AirAsia’s subsidiaries.

While AirAsia’s 49% portion will be through the conversion of debt, the remaining 51% subscription will see IAA getting a cash injection of two trillion rupiah, which could be used for working capital or to pay off some of IAA’s outstanding creditors, chief among them is AirAsia.

The perpetual bonds carry a 12% per annum deferrable interest payment and are redeemable after seven years, failing which the interest will be raised to 17% per annum.

We opine that the interest rate is slightly high, but fair given that perpetual bonds are treated as equities.

Recall earlier that AirAsia’s management had put in place capital-raising plans: 1) Convert payables owed to AirAsia into equities, 2) Inject a capital of US$40 million (RM176.4 million) by local investors and matched by AirAsia to comply with regulatory requirements on equity position and 3) Issue a convertible bond of US$150 million to ease IAA’s cash flow position.

The only drawback following the conversion of IAA’s receivables into equities is that we expect AirAsia could take a non-recurring RM620 million hit to its bottom line.

This is due to the write-off of these receivables, which we expect will take place by the first half of financial year ending Dec 31, 2016 (1HFY16).

However, the transaction is non-cash in nature and AirAsia will be compensated by semi-annual interest payments.

We maintain our “buy” call on AirAsia with an unchanged TP of RM1.82 based on price-earnings ratio (PER) of 8.5 times for FY16 earnings per share (EPS).

Our 8.5 times PER is pegged at a 34% discount to the Asian low-cost carrier (LCC) valuation of 12.9 times.

Our “buy” call is premised on: 1) Benefiting from lower jet fuel prices with exposure to spot market at 49% in fourth quarter of FY15 (51% hedged) and 100% in FY16 (fully unhedged), 2) Capacity and fare rationalisation by Malaysia Airlines Bhd and 3) Revamping of IAA and AirAsia Inc (Philippines) capital structure into stronger entities.

In addition, we view the undertaking by shareholders to inject money into IAA as a vote of confidence in the viability of the subsidiary. — MIDF Research, Oct 2