Malaysian Airline System – 2QFY09 : Poor Operating Results

August 7, 2009 at 2:28 am Leave a comment

· Operational results missed expectation by a mile
While MAS posted a net profit of RM875.5m in 2Q09, results were distorted by net derivative gains of RM1.34bn, mainly arising from higher q-o-q mark-to-market oil price. Despite recognising fuel cost for accounting purposes at spot rate, operating loss of RM420.8m was reported. Such poor operating results were magnified further if we look at the proforma income statement prepared on non-FRS 139 basis which showed net losses of RM804.5m and RM1,598.1m for 2Q09 and 1H09 respectively. This effectively means 1H09 results missed our full year non-FRS139 estimates of RM740.5 by a mile.

· Poor yielding operational performance
MAS registered weak operational statistics across the board. Though load factor improved to 65.8% in 2Q09, yield dropped 20% q-o-q due to intense fare cutting in the industry. The 65.8% load factor was simply not enough to sustain revenue due to a drop in yield. This has led to a 7.6% q-o-q drop in revenue. Furthermore, MAS has not made much headway in cutting non-fuel costs.

· Cash pile being depleted by derivative losses
MAS’ cash pile (including negotiable instruments of deposits) has been depleted by 36.4% to RM2.9bn since 31 Dec 2008 mainly due to outlay for settlement of expired derivatives as well as premium for the restructuring of derivatives. Assuming oil prices stay at current level, we expect additional RM1.6bn cash outflows for settlement of outstanding derivatives. Of this amount, RM833.0m will be due within the next 12 months. By the time all of its derivatives expire in 2011, MAS cash pile may be depleted to RM1.3bn.

· Reiterate SELL call, earnings estimates cut
We have revised our costs FY09 upwards by RM700m due to the fact that MAS has not managed to cut costs as budgeted earlier in the year. We have also revised our yield estimates lower to 27 sen/RPK. Consequently, we cut our earnings estimate for FY09. We reiterate our sell call on concerns of a sustained weak operational and financial performance in the months ahead, with an unchanged target price of RM2.00.

Operational results missed expectation by a mile
While MAS posted a net profit of RM875.5m in 2Q09, results were distorted by net derivative gains of RM1.34bn, mainly arising from higher q-o-q mark-to-market oil price. Despite recognising fuel cost for accounting purposes at spot rate, operating loss of RM420.8m was reported. Such poor operating results were magnified further if we look at the proforma income statement prepared on non-FRS 139 basis which showed net losses of RM804.5m and RM1,598.1m for 2Q09 and 1H09 respectively. This effectively means 1H09 results missed our full year non-FRS139 estimate of RM740.5 by a mile.

One-off gain shadowing losses of RM420m
MAS adopted the FRS 139 accounting standard in 1Q09 and booked RM3.9bn mark-to-market (MTM) unrealised losses mainly on fuel derivatives that were incurred due to the differences between the prices of the structured derivatives at approximately US$100/barrel and prevailing oil prices then of around US$49.6 at the end of 1Q09.
Now that oil prices have recovered to above US$70 as at 30 June, MAS proceeded to book a one-off derivative gain of RM1.34bn to reverse part of 1Q09’s unrealised losses from derivatives. This gain is purely an accounting transaction and has distorted MAS 2Q09 earnings numbers. Effectively, without the one-off gain, MAS would have recorded core EBIT losses of RM420.8m.

Poor yielding operational performance
Hurt by an RM137.9m operating loss and a weak load factor of 56.1% in 1Q09, MAS adopted a “yield passive, load active” strategy in 2Q09 amid intense fare cutting in the industry. Though load factor improved 9.7 points q-o-q to 65.8%, yield plunged 20% q-o-q and 16.9% y-o-y to 30 sen/RPK. A 65.8% load factor amidst 20% lower yield is simply not enough to generate sufficient revenue to breed profits.
The consequence of the 20% fall in yield was a q-o-q 7.6% and y-o-y 31% drop in revenue to RM2.49bn in 2Q09. Weak global as well as regional demand for air travel also compounded the steep drop in revenue. The International Air Travel Association recently released data that underlined the continued deterioration of the aviation industry with a 7.2% drop in global demand and a 14.5% drop in Asia Pacific demand.

Derivative losses to hit cash and balance sheet
1H09’s cash flow statement showed some worrying cash outflow items such as the net settlement losses derivatives of RM798m and premium of RM564m to restructure existing derivatives. Though the RM546m premium might be a one-off item, the RM798m settlement on derivative losses might be repeated in the next two years if oil prices stay below US$100/barrel.
If oil price stays at current level of US$71 per barrel, we expect MAS having to settle financial derivative liabilities amounting to RM1.6bn as at 30 June 2009. Of this amount, RM833.0m will be due within the next 12 months. By the time all of its derivatives expire in 2011, MAS cash pile may be depleted to RM1.3bn.

Earnings revision
Apart from falling yield and revenue, MAS’ operational losses can also be attributed to its inability to cut non-fuel costs as envisaged under its business turnaround plan. Earlier this year, management budgeted cost cuts of 7% across the board which will yield savings of around RM700m to RM1bn. So far, MAS has not managed to achieve the desired effect. In fact, non-fuel costs actually increased 12% q-o-q to RM2.2 bn.
As such, we have removed the budgeted cost savings of RM700m from our non-fuel costs calculations and have downgraded FY09 earnings. We are also expecting yield to drop further and have revised our yield estimates downwards by 7% in FY09 to 27sen/RPK.

Maintain SELL
We maintain our sell call on concerns of a sustained period of weak operational as well as financial performance for MAS in the months ahead. Our target price is unchanged at RM2.00. While it does translate to a slightly higher 1.4x FY10 book value (we had previously ascribed 1x to derive our earlier target prices), PE valuations are relatively inexpensive for FY10 and FY11 at 13x and 6x respectively.

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