Sunday, August 30, 2009

Cutting prices and making money

22 August 2009

IT has never been tougher being in the aviation industry. Key issues of gyrating fuel costs, lower traffic volumes and pressure on yields have seen legacy airlines globally buckling while low-cost carriers flourish.

Over in Malaysia, the trend couldn’t have been clearer with the recent earnings announcements by national carrier Malaysia Airlines (MAS) and budget player AirAsia Bhd.

Recently, the industry was greeted with bad news when MAS announced disappointing results.

It posted a net profit of RM875.5mil for the second quarter to June 30, but sustained an operating loss of RM420mil after taking out a gain of RM1.34bil from a partial reversal of provisions of nearly RM4bil for derivative losses.

Looking at the proforma income statement prepared on non-FRS 139 basis, it actually showed net losses of RM804.5mil and RM1.6bil for the second quarter and the first half respectively.

(The airline has opted to be an early adopter of FRS 139, the financial reporting standard that covers the recognition and measurement of financial instruments, beginning from financial year 2009.)

Its dwindling cash position is another key concern. The first half’s cash flow statement shows some worrying cash outflow items such as the net settlement derivative losses of RM1.3bil. These consist of RM798mil for the settlement of expired derivatives and RM546mil for the premium of the restructuring of the derivatives.

“Though the RM546mil premium might be a one-off item, the RM798mil settlement on derivative losses might be repeated in the next two years if oil prices stay below US$100 per barrel,” says an analyst from ECM Libra. He says the main concern is when the fuel hedges expire, as the contracts have to be settled in cash.

At present, MAS has hedged 47% of its fuel requirement at around US$100 per barrel for the rest of 2009 and about 63% at US$90 to US$100 per barrel for 2010 and 2011.

“If the oil prices stay at current level of US$71 per barrel, MAS will have to settle financial derivative liabilities amounting to RM1.6bil as at June 30, 2009. Of this amount, RM833mil 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 RM1.3bil,” he says.

Furthermore, there are issues concerning its cost-cutting measures. Under its business turnaround plan, MAS had earlier mentioned it will embark on such measures that will yield savings of RM700mil to RM1bil. So far, MAS has not achieved this.

“In fact, non-fuel costs actually increased 12% on a quarterly basis to RM2.2bil,” says the ECM analyst.

On a more positive note, OSK Investment Research analyst Ng Sem Guan feels that MAS’ earnings have probably bottomed in the second quarter.

Based on reported passenger numbers, especially on the growth in the domestic market, he feels MAS’ losses will gradually reduce in the third and fourth quarter.

Its various promotions have helped to boost system-wide load factors to 66% in the second quarter, and the aggressive capacity reduction has also pushed the international load factor to 65%.

“MAS has managed to attract some customers back from the low-cost carriers. That’s a good sign. It’s step one,” says Ng.

Furthermore, with the restructuring of MAS’ hedging positions, Ng opines this will provide a certain degree of protection with respect to its unrealised MTM (mark-to-market) exposure in the event fuel price falls again.

MAS has spent RM564mil restructuring its hedge positions, to lengthen the maturity of part of its positions as the board is of the view that crude oil will eventually go up in the longer run. It has also selectively bought put options, which will reduce the downside exposure of its existing fuel hedges.

AirAsia flying high

Across the budget aisle, we see a classic case of a low-cost carrier faring well during a downturn. AirAsia posted a sterling first-half net profit of RM294.2mil in what is normally a seasonally weaker first half of the year. These results beat street estimates by a resounding 73%.

Its second-quarter core net profit (taking out the exceptional items) of RM128mil is a 4.41 times increase from the period a year ago, and is impressive, considering it was achieved by cutting ticket prices by 19% to RM160 per passenger and with no fuel hedging gains to buffer its performance.

According to data provided by the International Air Travel Association (IATA), global passenger demand declined 7.2% in June. However, AirAsia’s passenger traffic increased 11.8% quarter-on-quarter (qoq) to 3.5 million passengers, while RPK (revenue passenger km) increased 16.3% qoq to 4 million km.

In addition, AirAsia managed to keep its seat load factor steady at 74.8% despite a 6% qoq increase in ASK (available seat-km), a yardstick for capacity.

Interestingly, AirAsia’s second quarter revenue/RPK dropped 21% on a quarterly basis to 16.2 sen, which is rather similar to the 20% revenue yield decline experienced by MAS in the same period.

“While MAS’ fare cutting resulted in operational losses, AirAsia posted operating profit of RM271.3mil,” says the ECM analyst.

“We continue to like AirAsia for its resilience amidst the challenging operating environment,” says KAF Research analyst Vince Ng in his report. He is reiterating a target price of RM2 for the stock.

While earnings may be running ahead, and traffic in the second half is seasonally stronger, Ng is still maintaining his core net profit forecast of RM332mil for AirAsia as yield pressures and rising crude oil prices can be a concern in the coming quarters.

The analyst from ECM has a target of RM1.90 based on a discounted cashflow valuation.

Meanwhile, how do airport operators fare during present trying times?

Maybank Investment Bank analyst Khair Mirza says Malaysia Airports Holdings Bhd’s (MAHB) second-quarter passenger data, and MAS’ second-quarter results confirm his view of AirAsia getting bigger market share.

Data from both carriers and the airport operator confirm that AirAsia has widened the gap with MAS in terms of passengers carried in the Malaysian air travel market in the first half of the year.

Overall passenger movements at KL International Airport increased 4.1% to 7.13 million, while movements in other Malaysian airports increased 7.8% to 5.31 million.

“MAS’ first half market share of the air travel market fell by 5.3 points on a yearly comparison to 22%, while AirAsia gained 6 points to 37%. The two carriers’ combined share remained at 58%-59%. It has been stagnant at this level since 2005,” he says.

On this note, Khair is bullish on MAHB as it merely collects “toll.” He expects publicity-shy MAHB to report higher airport non-aeronautical revenues in its second quarter results this month.

MAHB has been investing in its airport non-aeronautical segment. These include more effective selling of advertising space at KLIA’s main and the low cost carrier terminals. MAHB has also increased retail space at all international terminals. This will help compensate for the lower charges MAHB collects from these passengers.

Khair is also confident that MAHB will deliver the new LCCT in the second half of 2011.

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