Aviation sector
Upgrade to “overweight” from “neutral”: The slump in oil prices will benefit the aviation sector. While we do not see demand growing strongly, sector earnings will be underpinned by yield recovery, with an additional positive impact from lower jet fuel prices.

The soon-to-be privatised Malaysia Airline System Bhd (MAS) is in the midst of a restructuring that will likely involve capacity cuts on loss-making routes and frequency reductions. More importantly, this ought to put to an end its irrational pricing strategy, the chief cause behind the sector’s depressed yields. MAS has yet to announce the size of its capacity cuts, but we estimate that this could be about 10% to 15% of its available seat per km at best, as its core focus ought to be on cutting its workforce (by 30%) and raising ticket prices.

We expect 2015 passenger growth to inch up 6% year-on-year (y-o-y) after recovering from the tragic flight MH370 and MH17 incidents in 2014. This year, we forecast a passenger growth of 4.4% y-o-y, less than the 18.4% growth recorded in 2013. The recovery in the 2015 passenger growth may not reach double-digit levels, though, given the uncertain consumer sentiment. For 2016, we expect a passenger growth of 5%. The weaker ringgit could also have positive implications on inbound foreign tourist arrivals that would benefit airlines and airport operators.

While we collectively see an overall improvement in earnings across the carriers we cover, we prefer to stick to those that have scaled in their operations with proven cost efficiency structures. As such, we see AirAsia Bhd as a sound pick. Within our Malaysian aviation coverage, AirAsia X’s bottom line would be the most sensitive to jet fuel price fluctuations. We note that the carrier is unprofitable currently and we estimate that a US$1 (RM3.48) per barrel change in oil price would have an inverse impact on its bottom line by RM12.4 million and RM13.5 million in financial year 2015 (FY15) and FY16 respectively. Meanwhile, AirAsia’s sensitivity to a US$1 per barrel change would inversely impact earnings by 2.3% in both FY15 and FY16.

The slump in oil prices would benefit the aviation sector. While we do not see demand growing strongly, sector earnings would be underpinned by the yield recovery, with an additional positive impact from lower jet fuel price. As such, we upgrade the sector to “overweight” from “neutral”. We prefer AirAsia for its compelling valuations and thrifty operating structure and the stock remains our sector top pick (or approximately RM18.4 million to RM19.2 million). Carriers with strong balance sheets and cash piles like AirAsia could possibly take the opportunity to take a larger hedging position of its needed fuel intake into 2016. — RHB Research, Dec 16

This article first appeared in The Edge Financial Daily, on December 17, 2014.