AirAsia In need of more space

January 14, 2009 at 4:09 am Leave a comment

· Acute need for more airport capacity
After a disappointing year for the airline sector due to high fuel costs, AirAsia grabbed the headlines when it confirmed recent news reports that it is part of the plans to build a dedicated low cost carrier terminal (LCCT) in Labu, Negeri Sembilan via a partnership with Sime Darby. This does not come as a surprise to us as AirAsia’s need for a LCCT with higher capacity is imperative for its future growth. The existing LCCT with a capacity of 10m per annum is already operating at full capacity within 2 years after its completion. Upon completion of its on-going expansion in 2009, another 5m capacity will be added. However, within a year, the expanded LCCT is anticipated to be filled to the brim again. More seriously, there will be a massive capacity shortfall of 10m by 2013.
· KLIA East = Regional LCC hub
Therefore, the construction of a purpose-built new LCCT at Labu makes sense. Still at initial planning stage, the proposed new LCCT costing RM1.6bn (excluding land cost) will be privately funded and AirAsia will be the airport operator. Slated for opening in 2011 with an initial capacity of 30m, the new LCCT will have a capacity of 50m p.a. upon full completion. With better infrastructure and access, KLIA East will be on solid footing to be a leading regional LCC hub once the long-haul operations of AirAsia X gains momentum.
· Brighter days ahead despite demand concerns
Jet fuel costs have declined from a high of US$181 per barrel in Jul 2008 to US$63 per barrel currently. However, the concern now is demand amid the global economic slowdown and increasing competition. Nevertheless, given AirAsia’s low cost structure, we believe it will still be able to defend its turf in the event of a price war. On the flip side, AirAsia may be able to benefit from down-trading by air travellers who are expected to become more cost conscious going forward.
· Earnings revision
We revise our estimates downwards for FY08 by 42.5% to take into account fuel hedging loss in 3QFY08 but also revise our estimates for FY09 and FY10 upwards by 195.6% and 117.3% respectively due to lower jet fuel assumptions of US$75 and US$80 per barrel respectively
(previously US$120 and US$115 per barrel).
· Reiterate BUY call.
We reiterate our BUY call and DCF-derived target price of RM1.90.

Acute need for more airport capacity
After a disappointing year for the airline sector due to high fuel cost, AirAsia grabbed the headlines when it confirmed recent news reports that it is part of the plans to build a dedicated low cost carrier terminal (LCCT) in Labu, Negeri Sembilan via a partnership with Sime Darby. This does not come as a surprise to us as AirAsia’s need for a LCCT with higher passenger and aircraft capacity is imperative for its future growth.
The existing LCCT, which is converted from a warehouse, has limited passenger capacity of up to 10m per annum. Just a short 2 years after its completion in 2006, the LCCT is already at full capacity due to AirAsia’s phenomenal passenger growth rate. For 2008, we expect AirAsia’s Malaysian operation to handle 11.7m passengers, the bulk of which is through the LCCT. The overcapacity situation will be more acute if we take into account passengers handled by other LCCs (including AirAsia X) as well.
Although the existing airport operator, Malaysia Airports Holdings Bhd (MAHB), is currently undertaking the expansion of the existing LCCT which will increase its capacity to 15m passengers per annum upon completion in 2009, the expanded LCCT is anticipated to be filled to the brim again by 2010. More seriously, there will be a massive capacity shortfall of 10m by 2013. In the event that the issue of capacity shortfall is not resolved promptly, AirAsia’s future growth plans could be under threat.

The prime solution to the capacity issue is the construction of a new permanent terminal which is purpose-built for the operation of LCCs. Whilst MAHB has proposed to build a permanent LCCT with passenger capacity of 30m per annum and which will be located next to the main terminal of KLIA, the proposal has not been firmed up as yet despite that there is little time left to act before the capacity crunch happens in the near future. Funding may also be an issue although MAHB has indicated that it has the capacity to internally fund the construction upon completion of its financial restructuring plan.

KLIA East = Regional LCC hub
To be known as KLIA East, the proposed LCCT by AirAsia and Sime Darby is still at the initial planning stage. Based on news reports, the privately-funded new LCCT has already obtained government approval. It will be located in Labu, Negeri Sembilan which is about 18km to the east of the existing LCCT. Upon opening of phase 1 in 2011, the new airport will have an annual capacity of 30m which can be further increased to 50m in the future.
Construction of KLIA East, which is estimated to cost RM1.6bn, can be on a fast-track basis as it will be privately funded. The ownership structure of the airport is still fluid at the moment and investors may come in to take a majority stakes in the new LCCT. AirAsia will merely be operating the new LCCT, and not taking an equity stake. This arrangement will ensure AirAsia’s balance sheet is not laden with more debt.

Although detractors of the proposed KLIA East question the issues of duplication of resources and lack of connectivity, we think otherwise. The privately funded LCCT will ease the financial burden of the government to build a new LCCT so that it can channel its resources to tackle the impact of the global economic slowdown on the domestic economy. As for domestic and regional connectivity, AirAsia is operating under a point-to-point model as opposed to a spoke-and-hub model generally adopted by full-service carriers which requires connectivity. As for international connectivity, this is where AirAsia X fits in. Once the long-haul operations of AirAsia X gains momentum with the delivery of its A330-300 aircraft orders, KLIA East will be on solid footing to be a leading regional LCC hub.

Brighter days ahead despite demand concern

While 2008 has been a washout year for global aviation industry due to high jet fuel cost, brighter days lie ahead in 2009 as jet fuel costs have declined from a high of US$181 per barrel in Jul 2008 to US$63 per barrel currently. As the global economy is expected to deteriorate further in the months to come before a likely mild recovery in the 2H09, crude oil and jet fuel prices are expected to remain at moderate levels.
After AirAsia unwound its fuel hedging positions in 2008, one may ask whether it is now a good time to lock-in jet fuel cost at a 4-year low level. The answer is not as yet, as premiums for 1-year swaps are prohibitively high now at over US$20 per barrel above the spot price, probably due to risk aversion among banks. While AirAsia is currently buying all its jet fuel needs at spot prices, we cannot rule out the possibility that management may hedge its fuel cost in the future when the swap premiums drop to more “reasonable” levels.
The main concern now for the aviation industry is demand as the number of air travellers (be it business or leisure) is anticipated to decline as the global economy continues on its downward spiral. Airlines are now entering into a phase of “heightened” competition as everyone tries its level best to increase (or at least to maintain) load factor by lowering fares and/or introducing promotional fares. Already we are seeing pressure on AirAsia’s load factor amid aggressive capacity expansion. However, given AirAsia’s low cost structure, we believe it will still be able to defend its turf in the event of a price war. On the flip side, AirAsia may be able to lessen the impact of lower demand through down-trading by air travellers who are expected to become more cost conscious going forward.

Earnings revision

We revise our estimates for FY08 downwards by 42.5% to take into account fuel hedging losses in 3QFY08. Although 9MFY08 has already registered a core net loss of RM24.6m, we expect 4QFY08 to be much stronger due to (1) seasonally stronger passenger traffic and (2) substantially lower fuel cost as AirAsia capitalises on the lower spot prices after unwinding its fuel hedge in 3QFY08.
On the other hand, we also revise our estimates for FY09 and FY10 upwards by 195.6% and 117.3% respectively due to lower jet fuel price assumptions of US$75 and US$80 per barrel respectively (previously US$120 and US$115 per barrel respectively). The earnings upgrade has also taken into consideration anticipated lower load factor of 73% from 75%.

Buy call reiterated
We reiterate our BUY call and DCF-derived target price of RM1.90.

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14 January 2009 Newz Bits 13 January 2009 Newz Bits

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