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Tuesday, September 27, 2016

Brokers Report: Aviation sector - New PSC Rates

Maintain overweight on aviation sector

Aviation industry
Last week, it was reported that the Transport Minister has confirmed the upward revision for PSCs, which will be implemented for all airports in Malaysia starting 1st January 2017. 

While rates are not firmed up yet, tentative new rates suggest all airports will have the same structure with International and Domestic PSCs at RM73 and RM11 in addition to a new segment known as ASEAN routes at RM35. We are positive on the tentative rates, as they indicate 10% higher PSC revenue for AIRPORT translating to a potential 25% upgrade to our FY17E earnings. While the magnitude of hike might appear huge for AIRASIA operating in KLIA2, we note that the effective impact would be minimal as most of AIRASIA’s international flights are flown towards ASEAN countries, which will fall under the new RM35 ASEAN segment – allowing them to keep their competitive pricings. We upgrade AIRPORT’s FY17E earnings by 25% on the back of a 10% increase in Malaysia PSC revenue post adjustment to new rates while keeping AIRASIA’s earnings unchanged. 

Post adjustment for AIRPORT, we upgrade its call to OUTPERFORM (from MP) with higher TP to RM7.33 (from RM6.43) based on higher FY17 PBV of 1.58x (+0.5SD 5 year historical) from 1.39x (-0.5SD). Meanwhile maintain OP call and TP of RM3.82 for AIRASIA. Hence, maintain OVERWEIGHT on the sector.

New PSC rates. 

Last week, it was reported that new rates for PSC will be implemented at all airports in Malaysia in a move to level the playing field starting 1st January 2017. While rates are not firmed up yet, tentative new rates reported by ‘The Sun’ suggested that the new PSC charges will be RM11 for domestic flights, up from RM9 for KLIA Main and RM6 for KLIA2; RM73 for international flights, up from RM65 out from KLIA Main and RM32 from KLIA2 and an addition of a new segment – inter-ASEAN flights which will be priced at RM35. (refer back for Table)

Positive on the suggested new rates. 

Currently, besides PSC revenue generated from departing passengers, AIRPORT enjoys additional revenue on top of existing PSC only if the current PSC is lower than the benchmark rates stipulated in the Operating Agreement 2009 (currently 2nd tariff cycle). This additional revenue - more commonly known as MARCS PSC is a subsidy by the government and the amount subsidized is the difference between the benchmark rates and PSC. We are positively surprised by the suggested new PSC rates as this would indicate c.10% higher PSC revenue for AIRPORT’s Malaysian operations on the followings: (i) most of the new rates are higher than existing benchmark rates, and (ii) despite new ASEAN routes indicating lower PSC of RM35 instead of previous RM65 in KLIA Main along with the other four international airports, AIRPORT will be subsidized by MARCS PSC for the difference in current benchmark rate of RM71.

Impact towards AIRASIA in KLIA2. 

While the magnitude of hike (international: +128%; domestic: +12%) for airlines operating in KLIA2 namely AIRASIA seems huge, we note that the impact will be minimal as (i) most of AIRASIA’s international flights are flown towards the ASEAN region which will fall under the new RM35 ASEAN segment – allowing AIRASIA to keep their competitive pricings. While it is possible that there could be a shift in passengers away from AIRASIA towards other airlines due to the more ‘level playing field’, we opine that AIRASIA has high chances of holding up their passenger numbers citing Malindo Airlines and Tiger Airways’ shift in operations from KLIA2 towards KLIA Main in 15th March 2016. Despite these two operating in the higher PSC KLIA Main, their shifts in operations are evident through improving KLIA Main traffic numbers from April to August showing increasing monthly YoY improvements (+2% to +26%) against negative YoY performance in January-March (- 9% to -13%).

Earnings upgrade for AIRPORT. 

We upgrade AIRPORT’s FY17 earnings estimates by 25% to RM111.3m on the back of a 10% increase in Malaysia’s PSC revenue based on the new PSC rates suggested. That said, we assumed an unchanged passenger growth assumption of 3% (Malaysian operations) for FY17 as we believe the rate hikes will not deter travellers from travelling as the impact towards air ticket prices are minimal. Meanwhile, we keep AIRASIA’s earnings estimates, call and TP (OP; TP: RM3.82) unchanged as well.

Maintain OVERWEIGHT on Aviation Sector. 

Post upgrade in AIRPORT earnings, we revise our valuations upwards for AIRPORT from FY17 PBV of 1.39x (-0.5SD) to +0.5SD 5-year historical Fwd. PBV of 1.58x. We believe AIRPORT warrants the upgrade premised on the much-improved PSC structure providing better earnings outlook post equalisation of PSC charges for KLIA Main and KLIA 2. Hence, we upgrade AIRPORT to OUTPERFORM (from MP) with higher TP of RM7.33 (from RM6.43) post adjustment. We believe further upside on AIRPORT lies with a faster-than-expected recovery for their ISG operations as the negative news fade away. Meanwhile, we reiterate AIRASIA’s OUTPERFORM call with an unchanged TP of RM3.82. Hence, we maintain OVERWEIGHT on the Aviation Sector.

Source: Kenanga Research - 26 September 2016

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