Can X mark the spot again?

Time to take another look at AirAsia X

SO is it time to look at AirAsia X (AAX) again?

We know that the airline business is tough. Perhaps flying long haul for a low cost carrier has never really been viable in the first place.

Last week, Air Berlin, which is Germany’s second-biggest airline, was forced to file for insolvency after its largest shareholder Etihad, the UAE-based carrier, halted financial support. The airline has accumulated losses of about US$2bil over the past six years as it faced heavy competition from low-cost rivals such as Ryanair and easyJet.

Now, the German government has stepped in with a US$150mil loan to keep Air Berlin flying through the busy summer months while it negotiated the sale of parts of the business to Lufthansa and one other airline.

But could it be timely to relook at AAX stock when its valuations are at single digit levels, and earnings are coming from a low base?

Yes its recent second quarter results were below market expectations, demand for its China routes were poorer and the Australian market became more competitive.

Nonetheless, AAX typically posts better results in the second half of the year, as that is the seasonally stronger period.

Also, if you think the ringgit and oil prices are at the low end, perhaps this could be another play for the stock, as AAX is a beneficiary of the strengthening local currency.

In 2016, both AirAsia and AirAsia X were one the best performers for Bursa Malaysia.

Fuelled mainly by a turnaround in its financials, AAX was on the uptrend last year.

While AirAsia was already profitable, it was a comeback for AirAsia X, which posted a net profit of RM201.58mil in the fourth quarter ended Dec 31, 2015. This was its first profit in 8 quarters of losses.

Since then, the company has been making profits, although its share price has been in the doldrums over the past few months as it expanded into the China market and sacrificed yields. The AAX strategy is to price at whatever level it takes to keep load factors elevated, so of course there were sacrifices.

On Thursday, AAX announced rather poor results although this was already largely expected by the investing fraternity.

There are now five “neutral” calls on the stock, two “buys” and two “sells.”

When you look at the calls by the analyst, they are indeed far and wide.

While analyst Ahmad Magfur Usman of Nomura Research has a buy call for the stock with a target price of 54 sen, Raymond Yap of CIMB Investment Research is maintaining his reduce call on the stock with an unchanged target price of 25 sen.

Ahmad says the AAX is trading at 8 times his FY18 earnings estimate of RM169mil while Yap’s call is based on the stock trading at 1 time its 2017 price to book value.

For this year, the stock is only up 11.1% at its price of 39.5 sen.

AAX recorded a jump in net profit to RM47.44mil in the second quarter ended June 30 from RM1.02mil a year earlier, contributed by foreign exchange (forex) gains and deferred tax.

The airline’s bottom line was propped up partly by a foreign exchange (forex) gain on borrowings of RM31.90mil, a contrast from a forex loss of RM31.26mil previously. It also benefited from higher deferred taxation during the quarter.

Revenue rose 17% y-o-y to hit RM1.036bil in the second quarter. The higher revenue was due to a 34% rise in passengers carried driven on the back of 26% increase in seat capacity. Load factor is five percentage points higher at 80%. Average base fare was slashed by 14% y-o-y from RM526 to RM455 as a strategy to stimulate demand.

Revenue per available seat kilometre (RASK) was down 7% y-o-y to 12.28 sen in the second quarter.

The drop in RASK was due to increased capacity on existing routes resulting in lower yields, it said. On the other hand, cost of available seat kilometre (CASK) improved 7% y-o-y to 12.32 sen while CASK ex-fuel improved 16% y-o-y to 8.13 sen. This was on the back of better cost efficiencies and higher aircraft utilisation.

Ahmad says that the underlying yields dropped 9% year on year in the first of 2017 as AAX pushed on a load active strategy. During the period, its capacity increased by 27%, while passengers carried increased by 34%. Its aircraft utilisation hours also improved to 16.4 hours daily from 14 hours last year. Non-fuel unit costs was further brought down 11% for the quarter, and 16% for the first half period.

“We see this as a solid foundation for AAX to sustain its low cost model,” says Ahmad.

Freight and cargo revenue, meanwhile, rose by 27% to RM39.2mil in the quarter under review due to higher tonnage transported . Meanwhile its borrowings reduced 13% or RM149mil to RM1.01bil, hence net gearing stood at 61% from 73.6%. Salient points

Public Investment research analyst Nur Farah Syifaa’ Mohamad Fu’ad said that excluding its forex gain and tax incentives, the second quarter core net profit is RM2.2mil, bringing its first half core net profit to RM51.5mil, which was below consensus estimates by 26.9%.

In her report, she is maintaining her earnings forecast for now, which is a net profit of RM191.5mil and RM214.5mil for FY17 and FY18 respectively.

“We maintain our earnings forecast for now, as we expect stronger travel demand in the second half of the year would lead to higher profit. Our neutral call is retained with target price of 41 sen based on 8x FY18,” she says.

Not differing very far is MIDF Investment analyst Tan Yow Ken, also neutral, with a target price of 43 sen.

He said that for the second quarter, Chinese routes were uncharacteristically soft. Demand for Chinese routes was soft in the second quarter as Chinese carriers expanded aggressively to Europe and North America. However, AAX believes that it is too early to sound the alarm bell, as Chinese tourists are expected return once the novelty of European and North American routes wear off. Nonetheless, Tan is starting to see results from AAX embarking on a load active, yield passive strategy to squeeze out its competitors and gain market share.

“The effects are starting to bear fruit, as seen on its KL-Perth and KL-Taipei routes where AAX has maintained its capacity whereas competitors have started reducing theirs,” he said.

His FY17 and FY18 net profit forecast is RM176.2mil and RM212.3mil respectively.

Tan is reducing his FY17 and FY18 earnings forecast by 23.5% and 12.3% respectively as he reduces his average fare and increase his operating expense assumptions.

“Our target price is pegged to a forward FY18 price-to-earnings ratio of 8.5x. Our neutral stance is predicated on AAX’s aggressive capacity expansion through higher utilisation of aircraft through increasing frequencies and route network, which on the flipside, comes at the expense of yields,” said Tan.

Yap of CIMB expect AAX’s third quarter to be impacted by possible start-up losses on the new 4x weekly Osaka-Honolulu route which commenced on June 28.

“Competition with MAS and Malindo may heighten from the fourth quarter onwards as both airlines are planning to take more A330 deliveries and compete with AAX on medium-haul routes to North Asia.

The key upside risks would be possible ringgit appreciation and fall in oil prices,” he said.

Ahmad Maghfur who has a buy call on the stock, has lowered his target price to 54 sen from 65 sen previously.

This is derived from a PE of 11 times FY18 earnings, slightly below its peers’ average of 11.9 times. He says the stock is attractive at 1x book value and 8 times its 2018 earnings.

AirAsia X remains one of the cheapest low cost carriers across various price multiple comparisons. While its long haul low cost model casts some doubts among investors, AirAsia has proven that cost efficiencies can be further improved on route optimisation, something that most carriers (even some long haul low cost ones) are still struggling to achieve.

Ahmad says that the catalysts for AAX would be a strong turnaround at its associate levels and new route launches.