NEUTRAL on the sector, following our downgrade from OVERWEIGHT during the recent reporting season’s review. This was due to the operating challenges in the sector with AIRASIA facing more yield compression while AIRPORT is busy beefing up its operating team in order to meet the Quality of Service requirement set by MAVCOM. However, considering the recent share price weakness for AIRPORT (-7.7% YTD), we believe investors can take this opportunity to accumulate on weakness, premised on the prospects of the extension of its operating agreement. Hence, we are upgrading AIRPORT from MARKET PERFORM to OUTPERFORM with an unchanged Target Price of RM8.55 based on 1.72x PBV to FY19E BVPS. As for AIRASIA, we reiterate our UNDERPERFORM call on the stock based on an unchanged Target Price of RM1.95 pegged to FY19E PER of 9.0x after our recent downgrade during its 4Q18 results review.

1QCY19 share price performance. Over 4QCY18, share price for AIRASIA registered positive return of 2% while AIRPORT registered negative return of 2%. Still, we are of the view that the share price performance in the quarter was relatively stable in the face of uncertainties in the sector which is highly dependent on the government’s decision and mandate, i.e. development of new airports, implementation of departure levy and others.

Disappointing quarter, for the 4QCY18 reporting season as two stocks under our aviation sector coverage namely, AIRASIA and AIRPORT missed earnings expectations, which both were worst off compared to the last quarter 3QCY18 when results were broadly in-line to above expectations. The disappointment in earnings was mainly driven by higher-than-expected maintenance cost for both companies.

AIRPORT’s traffic, a good start. AIRPORT’s 2M19 passengers (including ISG) registered growth of 4.1% YoY-Ytd (+4.3% for Malaysian operation and +3.5% for Turkey operation YoY-Ytd), on track to meet our target of 4.3%. The steady growth for its Malaysian operations was mainly backed by domestic traffic, which registered growth of 8.1%, YoY-Ytd.

Industry updates. AIRPORT’s management released its FY19 headline KPIs targeting an EBITDA of RM2,163.3m (inclusive of its airport in Turkey) with Malaysia’s EBITDA flattish at RM1,210.1m compared to FY18, despite targeting passenger growth of 4.9% in Malaysia. This is due to management’s intention to incur more operational capex for the maintenance for KLIA and KLIA2 in order to meet the QoS set by MAVCOM. That aside, management also indicated that Penang Airport is currently operating 20% above its original capacity and a capacity upgrade/expansion is imminent soon followed by KLIA.

As for the extension of their operating agreement from 2034 to 2069, AIRPORT will be tabulating their proposed Regulated Asset Base (RAB) framework to the government and MAVCOM by 3QCY19 for validation as the first cycle of RAB is scheduled to be enforced by next year 1st January 2020. We believe that it would be a re-rating catalyst for AIRPORT if they are able to secure the extension of their operating agreement through the implementation of RAB, as it would allow them to raise Passenger Service Charges for the funding to develop or expand its airports coupled with longer depreciation and amortisation period that would further reduce their depreciation and amortisation costs. We opine that a gradual increase in PSC charges would not deter travellers from flying especially when Malaysia is one of the very few countries with low PSC charges.

As highlighted in our previous report, the proposal of an airport REIT and departure levy is creating uncertainties and confusion amongst investors, particularly as details on the proposed structure is lacking with minimal updates. While we are not against the proposal of the departure levy, we maintain our view that the proposed rate of RM40 and RM20 for international and ASEAN passengers, respectively, should go through a study by the regulator MAVCOM, which was created to promote a level playing field for all stakeholders.

Maintain NEUTRAL. To recap, we downgraded the sector from OVERWEIGHT to NEUTRAL post the Feb 2019 reporting season due to the heightened operating challenges in the sector with AIRASIA facing more yield compression while AIRPORT is busy beefing up its operating team in order to meet the Quality of Service requirement set by MAVCOM. However, considering the recent share price weakness for AIRPORT, which came down by 7.7%, YTD, we believe that investors can take this opportunity to accumulate on weakness, premised on the prospects of the extension of its operating agreement. Hence, we are upgrading AIRPORT from MARKET PERFORM to OUTPERFORM with an unchanged Target Price of RM8.55 based on 1.72x PBV to its FY19E BVPS (+0.5SD to its 2-year average). As for AIRASIA, we reiterate our UNDERPERFORM call on the stock based on an unchanged Target Price of RM1.95 pegged to FY19E PER of 9.0x (4-year average) after our recent downgrade during its 4Q18 results review.

Source: Kenanga Research - 4 Apr 2019