- Concerns about a deadly new strain of bird flu (H7N9) intensified last Friday as the disease claimed the sixth victim in Eastern China. Agricultural authorities in Shanghai ordered a wide-scale slaughter of poultry in an effort to stem its spread.

- China has now confirmed 16 cases of H7N9 with patients ranging from age 4 to 87, who became ill between 19 Feb and 31 March. The number of cases, while small, is considered large for the early stages of an outbreak. Flu experts say that the fact that it is spread over a relatively wide geographic area is a reason for concern. Positively, so far, there are no signs of human-to-human infections.

- Two key disease outbreaks in the past were the SARS outbreak in 2003 and the swine flu outbreak in 2009. The swine flu outbreak was first detected in Mexico, initially causing 103 facilities in Mexico and infected 47 people in the United States, 6 in Canada, 2 in Scotland and 1 in Spain. This occurred during the financial crisis when global air traffic was already experiencing a slowdown anyway.

- Another outbreak was the bird flu (SARS) in 2003, which, similar to H7N9, originated from the Asian region. Based on past trends, the impact on the aviation industry (once it reaches pandemic stage) is negative and immediate.

- SARS outbreak was formally announced in late February 2003 and took four months to contain before World Health Organisation (WHO) formally announced SARS epidemic as ended in late June 2003. As a result of SARS, MAS registered 4 consecutive months of massive passenger traffic decline.

- Sharpest dip was seen in May 2003 (effectively 3rd month after SARS was officially announced) when MAS registered a 39% YoY drop in pax traffic and 23% drop in RPK (See Chart 2 and 3). MAS’ valuation de-rated by almost 45% YoY to as low as 1.4x PBV during the period. AA was not operating any Chinese routes in 2003, while the 2009 swine flu impacted mainly transpacific flights, which AA does not operate.

- Since then, AA has expanded services to China, which now accounts for c. 5% of AA’s total capacity. Meanwhile, our latest check with management suggests that MAS has 10% capacity exposure to destinations in China, Taiwan and Hong Kong. However, given that the outbreak is still small relative to past outbreaks, and no travel restrictions have been advised, we leave our numbers unchanged for the time being.

- Nonetheless, we note that although the H7N9 is still at an early stage, concerns on this have sent Chinese airlines’ shares falling last Friday. Air China fell 10% while China Eastern Airlines fell 8%, their biggest single-day declines since Apr 2009 and Oct 2011 respectively.

- For the meantime, we maintain our HOLD calls on MAS and AA at RM0.75/share and RM2.80/share respectively, as well as our NEUTRAL call on the aviation sector. A massive influx of capacity leading to yield constraint is a key earnings risk this year, while any impact from the spread of H7N9 could be a further downside catalyst.

Source: AmeSecurities