Expect a good year from Air Arabia, say analysts

Sunday, Dec 09, 2012

Air Arabia continues to fly high. On the back of solid earnings in the second and third quarters, investors expect a strong 2012 for the Sharjah-based budget carrier. This is likely to mean a good dividend for the year and further capital appreciation - gains made from a higher share price.

“I would say it is one of the few stocks in the UAE which offers a combination of growth and dividend,” said Nishit Lakhotia, senior research analyst, Securities and Investment Company (SICO), Bahrain. “The company is in a high growth phase in terms of its earnings. And, assuming the same total dividend distribution as last year, [that would mean] a payout of about 60 per cent based on my 2012e earnings estimate.”

In 2012, the stock has gained 27.6 per cent and its one-year return has been 31.5 per cent. Analysts are upbeat about the share because of the operational performance of the company and strong estimates for future earnings. “We believe that Air Arabia is an income-generating stock that still has room for growth. It has successfully managed to raise its load factor and capacity, pushing analysts to revise their estimates upwards, especially after they added more destinations and increased frequencies,” said Talal Touqan, head of research at Al Ramz Securities.

Financials

The third quarter was the strongest ever for the carrier, with a net profit of Dh226 million led by higher revenues, operational margins and gains (Dh50.2 million) from hedging the oil price. Over the previous quarter, earnings in the third quarter surged 247 per cent, higher than most of analysts’ estimates. The 21 per cent jump in revenue was aided by a higher load factor (more passengers were carried), improved yield and more aircraft being deployed from its base in Sharjah.

Mohammed Kamal, director, equity research at Dubai-based investment bank Arqaam Capital, expects the same operating environment to hold in the fourth quarter. SICO and Egyptian investment bank, EFG Hermes forecasts operational improvements to continue in the next quarter. EFG-Hermes has upgraded Air Arabia’s net income for the financial year 2012 by 24 per cent.

“While we reduce our cost-of-sales estimates to reflect lower operating costs incurred in the third quarter, we increase estimates for (non-operating) other income. This leads us to a 24 per cent increase in our net profit forecasts for FY2012 to AED409 million,” wrote Abid Riaz, director, equity research at EFG-Hermes, after the third quarter results were released.

“The source of growth in 2013 will be addition of new routes and commissioning of new aircraft,” said Kamal. “The performance of secondary hubs whether in Egypt or Morocco or eventually Jordan, will be a secondary consideration. What Air Arabia is doing is building a network that will stretch from Europe to Asia. I think monetizing that network will happen in the longer term, not in 2013 or the next few quarters.”

Ratios

Air Arabia has a forward ROE (return on equity) of eight per cent in 2012, compared to a global average of zero-to-negative, said Touqan. The average three year ROE of Air Arabia is 6.3 per cent. This is higher than the three year average of its peers such as Jazeera Airways and SpiceJet [of India, which has started operating from UAE], according to Anil Kumar. head of wealth management at the listed Omani investment bank Fincorp. He added: “The company carries cash of Dh 1.2 billion that is higher than its total outstanding debt as on September 30, 2012. Being a cyclical stock, however, it is expected to be volatile.”

Its gross margin remains at around 19 per cent. As of Q3 2012, the current ratio of the company stood around 1.5 times, in line with the sector benchmark. The company’s long-term debt to equity ratio increased to 23.5 per cent, compared to 17 per cent at the end of 2011. Touqan says this “was mainly due to higher financial lease liabilities stemming from previous arrangements to finance the purchase of aircraft.”

Lakhotia is not too concerned about the debt to equity ratio. “It is still very low in terms of industry norms,” he said. “Debt, in the end, is low cost funding and they are making the best use of it by purchasing aircraft.”

“The trailing price-earnings ratio of Air Arabia has dropped from 11x to around 8x over the last couple of years,” according to Touqan.

Dividend

Air Arabia has consistently paid out from 80 to over 100 per cent of its earnings as a cash dividend, which is possible because the company has a strong cash [reserves] on its balance sheet. However, analysts believe the dividend payout is likely to be lower than last year. “If the company decides to maintain the same payout ratio, it may be able to distribute 6 to 8 fils next year,” said Touqan.

Despite the upgraded net profit expectations, Riaz of EFG believes Air Arabia will reduce its dividend this year because of the delivery of aircraft it had purchased. However, he still forecasts a yield of 7.5 per cent for 2012.

According to Lakhotia, “Based on the full year 2012 earnings forecast, and if they maintain last year’s dividend distribution, their payout ratio will only be 60 per cent. Despite the conservative dividend assumption, the stock offers more than 8 per cent yield for FY12 (estimated).”

Risk versus Reward

According to Touqan, “The volatility of the stock, measured by annualized standard deviation, is estimated around 19.9 per cent compared to 17.4 per cent for DFM’s General Index. Nonetheless, when expected return is divided over these numbers, Air Arabia would most probably have a relatively lower risk-to-return ratio.”

Final Call

EFG-Hermes has a Buy rating on Air Arabia. The calculate its fair value to be Dh0.92, based on the November 18 price of Dh0.71. The stock is already up 4.22% from that date. However, EFG-Hermes’s Riaz, warned that concerns about long-term cash flow and future competition, were a risk to its recommendation.

Securities and Investment Company (SICO), Bahrain has an Add recommendation on the stock. “We have a revised target price of AED 0.81 per share (earlier AED 0.72), offering a 12.5 per cent upside from current levels,” said Lakhotia in a December 2 note. “We also maintain our Positive short-term rating on the stock as we expect the airline’s strong operational performance to continue in the near term.”

Fincorp has a Buy rating on the stock. According to Kumar, “Our target for this stock is AED 0.845 which is 10x our 2012 EPS forecast. Dividend yield is very attractive at around eight per cent.”

By Gaurav Ghose Financial Features Editor

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