Yesterday, Macquarie Equities Research (MQ Research) released a report on the potential privatisation of AirAsia X (AAX) to further streamline the long-haul low cost carrier (LCC)’s business in the future. In the report, MQ Research shares their views on the motivation behind the business consolidation and explains why AirAsia is their top pick in Asian airlines. Read on to find out more…
MQ Research: AirAsia and AirAsia X
MQ Research thinks there are increasingly blurry lines between the operating business models of narrow-body-and-below-4-hours AirAsia with wide-body-and-above-4-hours AirAsia X, and thus a privatisation of AAX makes business sense. This paradigm shift comes post the rollout of enhanced-technology extended-range aircraft in the past year, along with airport expansion not keeping up with demand at major airports. MQ Research sees an AAX, wholly-owned by AirAsia, bringing revenue enhancement, better land grab and cost synergy to the group; i.e. a bigger and strong AirAsia group will be better for long-term profitability in MQ Research’s view.
MQ Research takes an example of the positive progress seen from the merger of long-haul Scoot and then short-haul Tigerair in better managing its network. MQ Research stresses that this is purely their hypothetical view. There has been news of a merger but it has been denied by management. AirAsia is their top pick in Asian airlines, with a target price of RM6.30 (+48% total shareholder return (TSR)). MQ Research rates AAX with Neutral and target price of RM0.38 (-3% TSR).
Then: early stages of unproven long-haul LCC model
AAX was set up as a separate entity in 2007 due to differing capital needs and risks. Separation of risks and returns was needed as long-haul airline markets have traditionally been a low-margin business, with far more demand and supply volatility than short-haul markets. The long-haul LCC model was unproven with its litany of unsuccessful ventures then.
Now: circumstances changed, creating a grey area
More mature industry. A decade has passed since then and MQ Research thinks that long-haul LCCs have found their footing.AAX’s turnaround—from losses in FY11-FY15 to what MQ Research sees as sustainable profitability in the medium term—is testament to the success of measures put into place by the new management and a more mature market. Also, peer Scoot, launched in 2012, turned profitable in 2016.
Enhanced technology aircraft. MQ Research sees an accelerating trend of greater overlap between narrow-body and wide-body aircraft operations, thus creating a grey area for business models of AirAsia and AAX, who have been promoters of clear separation of products and services, and operating radius. AirAsia’s current workhorse, the A320ceo, has a sweet spot in the 2-3-hour range, but new generation aircraft, e.g. A320neo, received by AirAsia in 2017, and upcoming A321neo, expected by AirAsia in 2019, can perform well at even a 4-hour flight range. This pushes the boundaries for AirAsia to deploy narrow-body aircraft on secondary routes in the 4-5 hour radius, which is breaking into AAX’s “territory”.
Constrained airports with limited slots in the 4-hour radius, such as KL-Hong Kong, KL-Guangzhou, KL-Bali among others, present opportunities for AAX’s wide-body aircraft, rising capacity from 180 to 377 seats per one-way flight slot.
A privatisation eliminates conflict of interests when network planning decisions are made, in MQ Research’s view. MQ Research thinks a merger is too preliminary to be discussed at this stage. As both entities are trading at fairly similar valuations, MQ Research puts aside valuation as a reason for privatisation. AirAsia can fund the privatisation using its own cash though MQ Research believes a share swap would be better. AirAsia’s cash pile exceeds AAX’s market cap.
Downside: AAX privatisation exposes AirAsia to a riskier business model, and compresses AirAsia’s Profit after Tax margins by 4.4-4.7bps, with all other factors held constant.
Source: Macquarie Research - 20 Feb 2018