We maintain our OVERWEIGHT rating on the aviation sector premised on: (i) AIRASIA’s high yields and passenger load factors driven by stronger travel demand coupled with the sale of their leasing arm Asia Aviation Capital, and (ii) an improved earnings outlook for AIRPORT buttressed by the newly suggested PSC structure that will equalize PSC charges at all airports in Malaysia by FY18. Since our last report cut-off date, AIRASIA’s share price has weakened 18%, likely due to the rising fuel price coupled with the weakening MYR against the greenback. AIRPORT was also down 7%, likely due to the poor passenger traffic in Turkey. As of 11M16, AIRPORT’s passenger traffic for Malaysian and Turkey operations were up 5.8% and 5.3%, respectively – in line with our estimates. For FY17, we maintain growth estimates of 6.0% and 7.0% for Malaysia and Turkey, respectively. Meanwhile, we maintain our OUTPERFORM rating for both AIRPORT and AIRASIA based on unchanged TP of RM7.31 and RM3.82, respectively

Marginally improved set of results. In 3QCY16, stocks under our coverage (AIRASIA, AIRPORT) registered relatively better results with AIRASIA coming in at 77% of estimates – which we deem above expectations due to their higher-than-expected load factors as well as a seasonally stronger 4Q. Despite registering a CNL of RM7.0m over 9M16, we deem AIRPORT as broadly in line as we expected a seasonally stronger 4Q to bring them back into the black; to be in line with our CNP estimate of RM4.0m.

But poor share price performance. QoQ, AIRASIA’s share price weakened to RM2.35 level (report cut-off date: 22/12/2016). We believe the 18% drop in share price is likely due to the rising fuel cost coupled with the weakening Ringgit against USD (from 4.10 to 4.45 over 4QCY16). However, we feel that the selling might be overdone considering that: (i) c.80% of its budgeted fuel in FY17 is hedged at USD59/barrel (refer below for more), and (ii) FX risks which mostly arise from the purchase of fuel in USD is relatively negligible - our back of the envelope calculations indicate that every 10 sen depreciation of MYR against the USD would cause a c.2.5% decrease in AIRASIA’s CNP. Meanwhile, AIRPORT’s share price was down 7% from our previous report cut-off date, likely due to the poor passenger growth in Turkey (+5.3% vis-à-vis double digit growth in previous year) from the travel threats - bogging down share price performance.

FY17 passenger growth estimates. As of 11M16, AIRPORT’s total passenger movement for Malaysian and Turkey operations registered growth of 5.8% and 5.3% YoY-YTD; in line with our estimates of 6.0% and 7.0%, respectively. Malaysian operations passenger growth remains robust supported by improved load factors from strong travel demand and new foreign airlines and MAB operating at increased frequencies. Meanwhile, Turkey’s travel statistics remain subdued from recent bombing incidents and travel threats, which have severely affected their international passenger growth, registering monthly negative growth since June 2016. We note that since the bombing at Ataturk Airport in June 2016, we have revised our Turkey passenger estimates downward twice to 7% (previously from 20% to 10%, then 10% to 7%). Moving into FY17, we keep our 6.0% and 7.0% estimates unchanged for Malaysian and Turkey, respectively, as we expect Malaysian passenger growth to remain strong from strong travel demand coupled with increased capacities from airlines, i.e. AIRASIA, Malindo while Turkey’s international passenger traffic is seen remaining subdued.

New PSC structure to be implemented in FY17. Beginning 1 Jan 2017, the new PSC charges will be implemented in all airports operating in Malaysia (refer to Sector report dated 1/11/16 for detailed info). The new PSC rates are expected to boost AIRPORT’s revenue by c.10% and provide improved earnings visibility for their Malaysian operations which we have accounted for in our estimates. We look forward to the next hike in PSC in FY18 whereby KLIA Main and KLIA2 will have the same PSC rates. For FY17, the only difference in PSC rates for KLIA Main and KLIA2 is their International PSCs whereby KLIA1 is at RM73 while KLIA2 is at RM50.

Positive on AIRASIA. For FY17, we remain positive for AIRASIA premised on: (i) high yields on higher ancillary income – targeting RM60/pax in the long-term, and (ii) healthy load factor (c.85%) from strong travel demand coupled with fleet expansion. Despite the rising fuel costs, we believe AIRASIA’s fuel risks are greatly minimized as c.80% of its FY17 fuel is hedged at USD59/barrel. In comparison, we note that 9M16 fuel already averaged at USD59/barrel. New PSC rates will have minimal impact for AIRASIA as most of AIRASIA’s international flights are flown towards the ASEAN region which will fall under the new RM35 ASEAN segment (PSC effectively only up by RM3) – allowing AIRASIA to keep their competitive pricing. Furthermore, we are also excited on its leasing arm divestment plan i.e. AAC in 1H17 and investors are expecting a round of special dividend pay-out. Assuming the entire stake of AAC is valued at USD1.0b, an 80% stake sale of AAC coupled with a 100% dividend pay-out would translate to RM1.04 of dividend/share. However, we have yet to factor this in into our estimates as the final amount and portion of the stake sale remains uncertain.

Maintain OVERWEIGHT for Aviation sector. For AIRPORT, we maintain our positive stance, as we believe the newly improved PSC structure will see the equalization of charges in KLIA Main, and KLIA2 by FY18 providing better earnings visibility for the group. Despite the current poor international traffic at Turkey, we believe travel sentiment would gradually improve, citing the recovery of Malaysian domestic air travel and the return of China travellers post the triple air tragedy in 2014. Hence, we believe our current valuations of 1.58x FY17E PBV based on +0.5SD 5 year historical is fair given the better earnings outlook ahead from new PSC structure. Maintain OP call with an unchanged TP of RM7.31 for AIRPORT. Meanwhile, we expect AIRASIA to continue registering high load factor and yields, post fleet expansion on the back of strong travel demand coupled with their dynamic pricing of tickets. We make no changes to AIRASIA’s OP call with an unchanged TP of RM3.82 based on 9.0x FY17E PER as we believe that it will be a good time for investors to accumulate on weakness underpinned by the prospect of special dividends. Maintain OVERWEIGHT recommendation on the sector.

Source: Kenanga Research - 5 Jan 2017