A bit of luck is what you really need right now

Dino D'Amore
By Dino D'Amore June 29, 2015 14:15

A bit of luck is what you really need right now

Passenger traffic to North African destinations was starting to pick-up again following the failed Arab Spring, but it is likely, following the terror attacks of Friday, that many airlines will see a rapid and dramatic fall-away in demand from tourist and business transits, we wait to see the full effect.

I am sure that most reading this news will know of the GMT Research report of 10th June on AirAsia, which depressed shares of the airline by over a quarter after it published “Old Dogs- New Tricks” questioning accounting practices at the airline.

GMT concluded in its report that AirAsia has inflated group profits by recording earnings from aircraft leased into its minority-owned associate airlines in Indonesia and the Philippines and looking beyond the accounting practices at the airline one notes that receivables owed to AirAsia by its associates, joint ventures and related parties rose to 2.5 billion Malaysian ringgit ($665m) in 2014, from 1.3 billion ringgit in 2013, this according to the GMT report leaves the AirAsia group with a net debt-to-equity ratio of 263%.

The GMT report states “Real profits have collapsed and AirAsia now needs a recapitalisation that will dilute existing shareholders by more than 100%.”

Tony Fernandez stated to the media that AirAsia has dismissed GMT’s allegations, insisting that the airline has a “good business outlook”, is “rich in assets” and has a “strong balance sheet”. Substance is added by AirAsia when they confirm that the airline plans to address concerns about its associate airlines by injecting a total of US$72.9m of new share capital into the Indonesian and Philippine units, alongside its local partners. AirAsia also plans to raise at least another US$100m for each associate by issuing convertible bonds to new investors.

Fernandes insists that AirAsia is not at risk of default and has no need for a rights issue at the group level.

Now we here at Airline Economics have sat on this report for a number of weeks waiting to see what analysts and Tony Fernandez at AirAsia had to say about the same. Now that the latter has broken silence it seems prudent to make comment:

There is no doubt that the equity markets seem to disagree with Tony Fernandez, to a point at the very least, AirAsia has had a punishing time of late and the market understands the simple and blunt fact that if it were not for oil prices halving then parts of the AirAsia Group would be in a pretty bad state right now, they understand that the AirAsia Group model requires adjustment. They understand that the current make-up of the AirAsia Group was never intentional but was indeed a requirement to get around local rules that prohibit foreigners from owning majority shareholdings in airlines, thus it is far from ideal but in reality there was no better option available.

It could be argued that the AirAsia Group was all too quick to move for minority stakes in AirAsia-branded businesses in Japan, Indonesia, the Philippines and India. India went very badly in its first year and with the addition of new routes it may yet turn around, but it has not yet to our knowledge, the Japanese venture (mark I) was a doomed project from the start because of a lack of understanding about how the Japanese book their flights, that really was a very poor move. The Indonesian and Philippine ventures on the other hand have both underestimated local airline strength but moreover and most importantly these ventures suffered greatly because AirAsia X was not able to connect them because it was not correctly set-up in the first place to feed the minority owned airlines in the group – AirAsia looked global when it should have been connecting the branded dots around Southeast Asia. We have reported in detail on each of these matters but one cannot escape the fact that AirAsia Group does require a shift of focus to concentrate on high yielding routes alone to get back on track and reduce risk – In short the airlines in the group need to scale-back fleet and expansion plans (if that scenario came to pass then there would be a glut of A320s on the market that might well depress prices). This would also serve to reduce the risk to the airline group of any recessionary fears/economic shocks in the near term.

The AirAsia investors we have spoken to could not give two hoots about the GMT report – They, and they believe their peers, are well aware of how the airline operates. They are far more worried about what is going on in Thailand and its effect on Thai AirAsia which was the other profitable part of the group after the Malaysian airline – If the Thai business falters due to regulatory factors or due to another low cost moving into the market such as Lion Air or the like then the Malaysia operation is suddenly carrying the rest of the group on its own, that would not be possible as things stand, investors see this area as the big concern.

Tony Fernandez states to the media that you can trust AirAsia and that things are looking good for the future. Indeed recent adjustments to AirAsia X, AirAsia Japan (Mark II) and AirAsia India should indeed bring huge improvements in margin for the group during 2015, on top of that the relaxation of a ban on Philippine airlines in the US and now the EU should also assist with traffic, so I would argue that right now you can indeed trust Tony. In any event AirAsia does have a great deal of room for maneuver to adjust financially to circumstances as and when required, but of course that was the crux of the GMT report – Some of that maneuvering might in the process burn shareholders – Discount all of those options and protect shareholders and all of a sudden AirAsia does not have a great deal of room to maneuver financially at all. Also one might argue that it took the AirAsia Group far too long to pull out of loss making routes and launch new routes in India and across the AirAsia X network, the speed of change was very far removed from the likes of Spirit Airlines in the US where there is no such thing as a second chance or waiting period for a route to gain traction. The bottom line remains the same today as it was last year when we wrote on the same subject – If AirAsia X can effectively feed the various airlines of the AirAsia Group then the whole group will start to look a great deal more like JetStar – The model it should have used from the word go. AirAsia management have made the changes required to put this into place and as such AirAsia load factors and yield in 2015 will confirm if AirAsia is too much of a risk or if it does indeed remain an exciting airline group to invest in –high risk in a tough market, yes – but an exciting prospect nonetheless.

Investors also worry that AirAsia has bases of operation within countries that will not weather any financial storms well (India, Philippines, Malaysia, Thailand). AirAsia being a low cost airline should actually see demand fall away at a far slower rate than other airlines in the event of a financial storm and indeed in the aftermath it should see an uptick first because it is the lowest cost option. But investors we have spoken to see the global economy reaching the beginning of the end of this current post financial crisis limbo.

Indeed if we have another 2007/08 style crash then the world will be unable to fight the same as central banks have used up their ammunition trying to tackle the last crises, the Bank of International Settlements (BIS) has warned. In its annual report the BIS claimed that central banks have backed themselves into a corner after repeatedly cutting interest rates to shore up their economies. These low interest rates have fueled short term economic booms, some of which have turned to bust and been answered with even lower rates. The BIS stated that central banks were “fumbling in the dark in search of new certainties.”

Now as stocks are plunging across the globe as Greece looks set to default on tomorrow’s debt repayment a divergence in the direction of eurozone bond yields is at play in the markets today, with money flowing into Germany’s fixed-income market, and out of Spain, Italy, Portugal and Greece. The Swiss National Bank intervened again in foreign exchange markets over the weekend in an effort to hold down the franc’s massive rise. At the same time Puerto Rico’s debt crisis has topped 70% of GDP at US$72bn and the government there is getting ready to give investors a haircut. Puerto Rico’s electricity provider, which has borrowed US$9bn, is also expected to miss a payment to creditors this week – That would be one of the largest municipal defaults ever if it happened. All this coming in the same week will mean that markets on the run up to 4th July will be volatile to say the least. All the while the Chinese stock market slow motion crash continues, closing today down another 3.3% at 5,180.51 (bear market territory) and is over 20% down on the month – This has forced Chinese regulators to now consider suspending all IPOs to stabilize equity markets. On top of all this the US Federal Reserve is now making noises that interest rates will now not start to move up until November 2015.

We have all known that the economic can could not be kicked down the road forever and it could be argued that the up side of all this could be a further fall in oil prices during the coming weeks – Even so airlines should have ensured that they are buffered against the economic adjustments to come, investors worry that AirAsia Group along with a myriad of other airlines across the globe, is not as insulated as it could have been.

Dino D'Amore
By Dino D'Amore June 29, 2015 14:15