AirAsia - Delaying aircraft reduces gearing to just 1.9x

AirAsia has provided the perfect catalyst for an upgrade. With the delay in delivery and additional RM500m in proceeds from a share placement, AirAsia will be able to position itself to grow without risking deterioration in its balance sheet. Given the lowered balance sheet risk and enhanced profitability from lowered interest expenses, we upgrade the stock to a BUY with a target price of RM1.84.

Delay of eight aircraft in 2010 will reduce capex by RM1.1b and debt by RM0.88b. AirAsia surprised the market by announcing plans to delay the delivery of eight aircraft in 2010 from 24 to 16 and the possibility of delaying another eight aircraft due for delivery in 2011-14. Previously, the company had maintained that it had no plans to delay delivery. We assume that part of the delivery slated for 2010 will be pushed to 2011 and 2012, by which time the balance sheet would have strengthened adequately. AirAsia also has plans to raise RM500m via a private placement. The net result is a 10% reduction in 2010’s interest expenses, an improvement in interest cover to 2.5x from 1.7x and reduction in gearing from 3.5x to 1.9x.

Load factors will improve. AirAsia’s load factor improved from 69.5% in 1Q09 to 74.8% in 2Q09. We believe AirAsia will be able to achieve higher loads and still achieve about 14% growth in passenger traffic for 2010 with this delay in delivery. By end-09, Air Asia will have 58 aircraft and the progressive delivery of 14 new aircraft will allow for a more gradual buildup in capacity. We have lowered our capacity growth assumption from 14% to 12% for 2010 but maintained passenger traffic growth assumption at 14%.

We estimate AirAsia will issue 400m new shares at RM1.25 each. We also upgrade 2009 net profit estimate by 4.2% to RM638m and 2010 net profit estimate by 13%. 2010 book value, net of dilution, is estimated at RM1.19. The potential impairment in receivables from its Thai associate and Indonesian joint venture still remains a risk.

Our previous target price of RM0.99 was based on peer group EV/EBITDA multiple of 6.9x. Applying the same valuation method, we now derive a target price of RM1.84. This represents a 55% premium to 2010’s book value and just 10.5x average two-year forward PE (excluding deferred tax write-backs). Upgrade to BUY.