AirAsia: Not appreciated
and undervalued May 2018

AirAsia is not appreciated, as least on the Kuala Lumpur stock exchange where its share value has fallen by a third over the past two months, and that from a level which Tony Fernandes, founder and CEO of Asia’s leading LCC, regarded as substantially undervaluing his airline.

Unaudited accounts for 2017 indicate that the AirAsia Group achieved a net operating margin of 16.3%, in the upper range of LCC expectations, and grew net profits to $394m, up by 38% on 2016. First quarter results for 2018 are guided as being strong. It has gone through some troubled times, notably in 2014 when a combination of adverse events — a “perfect storm” — pushed it into losses, the airline group has grown rapidly, by about 13% pa on average in seat capacity terms since 2010. (All these figures refer to AirAsia Berhad, excluding the long-haul AirAsiaX and its associates.)

AirAsia Berhad’s current stock market value is about MYR10.3bn (US$2.5bn) with a p/e ratio of 4.9. This contrasts with Ryanair’s p/e of 14, even more so with the newer Asian LCCs — Indigo and Spring Airlines, both at 28, and VietJet at 32 — and the traditional Asian flag-carriers — SIA at 15, Thai Airways at 31, China Southern at 17.

By its own calculations, AirAsia’s Enterprise Value (total of equity market value and net debt) as a multiple of EBITDA (operating cash flow) was 7.3 at the end of the first quarter 2018 against a global average of 12.9. It reckons that the group’s true value is over twice that of implied by the stockmarket — around $5.4bn.

The direct cause of AirAsia’s recent share price slump was a political blunder by Tony Fernandes. In the early May elections in Malaysia Fernandes threw his support behind the incumbent prime minister Najib Razak, who had been in power since 2009, appearing in a promotional video and changing the paint scheme on two of his aircraft from red to blue, Najib’s campaign colours. Then, contrary to the polls and to Fernandes’ horror, 92-year-old former leader Mahathir Mohamad was returned to the prime minstership by the electorate.

This is more than just embarrassment for Fernandes. In Malaysia business success depends on political connections and patronage. The Economist’s “crony capitalism” index, which attempts to rank the importance of political influence on business success, specifically on the success of commercial billionaires, places Malaysia second only to Russia (other Asian countries, notably Indonesia, Singapore and India also rank highly). Moreover, Mahathir has a reputation for ruthlessness; Najib temporarily ended up in gaol on improbable morality charges.

Since the election Fernandes has been trying hard to repair the damage, pleading that his support for Najib was only because he was pressurised by Najib who had objected to AirAsia adding frequencies on the election day. He issued a contrite statement on Facebook, which has attracted millions of views in Malaysia and Southeast Asia.

How all this will play out is anyone’s guess, but it difficult to see how Fernandes and AirAsia can benefit. They are on the wrong side of Mahathir who may now throw his support behind the flag-carrier MAS, which is showing signs of a recovery from the worst of its traumas (and on the wrong side of the Malaysian Aviation Commission which is investigating AirAsia’s scheduling during the election). Fernandes can now try to indicate his support for the Mahathir regime, but then he exposes himself to retribution from whoever replaces Mahathir, an event which may not be too far in the future given the prime minister’s advanced years.

For investors, these tortuous politics in Kuala Lumpur are anathema. And the situation is further complicated by the fact that AirAsia’s valuation on the Bursa is supposed to reflect the prospects of not just the core Malaysian operation but that of airlines in five other Asian countries– Thailand, Indonesia, India, the Philippines and Japan — plus that of its leasing associate, Asia Aviation Capital.

AirAsia’s foreign airlines were all established as partnerships with local enterprises, to comply with ownership regulations, with AirAsia typically taking a 40-49% stake. They were officially deemed to be associates, meaning AirAsia “had significant influence over these investees [but] did not have power over them”. Their results were reflected in AirAsia’s consolidated results on an equity basis as an item below the net operating level, with the amounts reflecting the parent company’s ownership proportions. However, little detail was provided on the how these amounts were calculated, and how exactly the various associates were performing, so analysts were frustrated in their efforts to understand the economics of the whole AirAsia Group

Fernandes himself has attributed AirAsia’s poor share price performance to the group’s over-complex structure and lack of transparency. His proposed solution is to evolve the group so that each of the associates will be 100% owned by the parent company and the stockholders of AirAsia Indonesia, AirAsia Philippines, etc will be able to “trade up” — the OneAirAsia strategy. How this can be achieved in practice is unknown, though the idea, mooted last year, of a Hong Kong holding company appears to have been parked.

As regards the 2017 (January to December, unaudited) accounts, AirAsia has made some progress, renegotiating the Brand Licensing Agreements (BLAs) with Indonesia Air Asia and Philippines AirAsia, with the effect that these airlines are now regarded as subsidiaries, “complying at all times with recommendations made by the [parent] company under the BLA”. We do not have space in this article to explain the accountancy changes involved in this consolidation (to be honest, we couldn’t explain them with limitless space) but we have been able to pull together summary financials for AirAsia Berhad, the Malaysian core operation, including results from consolidated associates, and P&Ls for the four main foreign companies (see table). All the accounts have been converted from local currencies to US dollars to allow inter-company comparison. 2016 figures are pro forma, adjusted by AirAsia from previously published group results, which themselves had been restated, to allow like-for-like comparisons.

• The core Malaysian operation, AirAsia Berhad, accounted for just over half the passengers carried but 82% of the net operating profits generated. Its net operating profits of $393m equated to a margin of 16.4%, by far the highest of the AirAsia airlines. It benefitted from the continued retrenchment of MAS on domestic routes and the failure of Malindo, Lionair’s Malaysian joint venture, to further penetrate this market.
• Thai AirAsia, 45% owned by AirAsia Berhad, is the second most important airline. In 2017 it performed well against loss-making local LCCs, Nok Air and Bangkok Airlines, increasing passengers by 15% to 19.8m. But its net operating profit margin slipped back to 7.9% from 9.5% in 2016.
• Indonesia AirAsia, 49%- owned, performed poorly in 2017, officially blamed on the effects of volcanic eruptions in Bali, though Lionair provides fierce domestic competition and flag-carrier Garuda has chosen to expand rather than contract out of its financial crisis. Passengers carried fell by 2% to 4.6m, and the net operating margin was reduced from 5.5% in 2016 to 3.5% in 2017,
• AirAsia Philippines is seen by Fernandes as proving huge upside potential, though Cebu Pacific is a strong LCC competitor. An IPO was originally planned for the 40%-owned airline in the first quarter of 2018 but has been postponed, officially to the end of the year. The airline moved into profit last year following heavy 2016 losses, though the net operating margin was only 2.5%.
• AirAsia India, 49% owned by AirAsia 51% by the Tata Group, expanded rapidly in 2017 but has not yet achieved break-even at the operating level. An investigation by the Indian authorities into AirAsia’s award of an international licence is worrying.
• AirAsia Japan is now 57% owned by AirAsia Bhd, the rest by local private equity and retail companies. The airline restarted flying last October, the previous venture with ANA having been grounded. A loss of $44m for 2017 was reported.
• AirAsia reported that there were no updates on AirAsia China, a joint company with China Everbright Group and the Henan provincial government. Nor is there any further information on AirAsia Vietnam, a joint venture with local aviation interests.

From fixed assets to digital vision

Air Asia’s stated strategy is to become “asset light”. In March this year it announced the long-planned sale of of its aircraft leasing business, 100%-owned subsidiary Asia Aviation Capital Ltd (AACL), to three entities (FLY Leasing , Incline B Aviation Partnership and Herondell) managed by BBAM, one of the global top five lessors.

The transaction involves 84 A320-family units in the AACL portfolio, of which 79 will be leased back for operation by AirAsia. The price quoted was $1.2bn, of which $1.1bn in cash and $100m in shares in the BBAM entities, representing about 10% of their capital. In addition, AirAsia agreed the future sale of 98 deliveries to BBAM.

According to AirAsia only about $200m of the proceeds of $900m has been allocated to pay down debt, the use of the rest of the funds to be determined, though a special dividend is certain.

Tony Fernandes commented: “This is a perfect outcome to a strategy we started in 2004 and I’m thrilled at the execution of our long-term vision. We have now disposed of most of our physical non-core assets and we are thrilled to be embarking on our new digital strategy which will build a very valuable group of assets.”

When asked what AirAsia’s most valuable asset now is, Fernandes inevitably responds “Data”. He has a vision of evolving AirAsia into a digital empire, leveraging the consumer data garnered from operating a cashless airline. As always with digital visions (and such sales account for only about 7% of AirAsia’s revenues at present), it is hard to pin down exactly what is meant. A recent presentation referred, overwhelmingly, to the “implementation of consumer analytics, data collection, cloud warehousing, data visualisation, integration and machine learning… real time insights, deep learning, predictive intelligence, etc, etc”. In practice, there are a large number of ongoing projects, under the RedBeat Ventures label, for example: Travel 360, Vidi, Rokki (travel portals); Online 365, RedTix (reservations and ticketing); Big Loyalty and BigPay (FFP and credit cards); RedBox (fast parcels).

All this must raise questions in investors’ minds. Why does AirAsia think it has an advantage over other airlines, LCC and Legacy, which are all implementing digital strategies? Who does AirAsia think it will be primarily competing against? Other airlines, the plethora of digital start-ups competing in the same fields, or ultimately, Amazon, Google, Baidu?

Ryanair lesson

Despite all the questions and its structure, AirAsia is a very successful airline, carrying as a group a total of around 74m passengers in 2017 at a load factor of 88% and operating over 200 A320 family aircraft. By 2021 the fleet is planned to increase to 300-plus units, transporting over 100m passengers. The basis of its success was adapting the Ryanair model to the Asian market, initially using the expertise of Conor McCarthy, formerly COO at the Irish airline. But AirAsia has deviated from one aspect of the Ryanair model, which is not generally appreciated.

Michael O’Leary has created a wild, sometimes obnoxious, persona for public consumption, but when it comes to Investor Days or analyst briefings, he is razor sharp in explaining Ryanair’s strict adherence to its core strategy, its operations and plans, and, importantly, how precisely these are represented in the airline’s accounts. He and his team have a mastery of detail and the ability to present clear unambiguous numbers, which gives investors confidence. Tony Fernandes, despite his undoubted charisma, does not. Similarly, Ryanair’s published accounts are standard and austere and useful, whereas AirAsia’s annual reports are overloaded with glossy photos and short on relevant detail.