Research Department UAE - Transportation

Air Arabia Update Note 28 March 2010

Air Arabia 1

A Challenging Year Ahead Hold

� Downgrading stock to Hold and cut TP by 12% to AED1.11/share

� Yields remain a concern as excess capacity and competition are

issue at a time when fuel costs are rising; Air Arabia’s early summer fares are at a discount to competition’s cheap offerings

� Downplaying impact of Morocco and Egypt hubs (12% of value)

as we don’t expect them to contribute positively to numbers before 2012f

We downgrade Air Arabia to Hold from Buy and cut our TP by 12% to

AED1.11 share (6% upside). Our change in view reflects sustained yield pressures, rising fuel costs, and the expected deployment of the majority of

fleet additions at the Moroccan (29%-owned) and Egyptian (40%-owned) hubs. Air Arabia is trading at a 2010e P/E of 12.68x (a small 5% discount to peers)

and an EV/EBITDA of 7.75x (a 13% premium to peers).

Yield pressures remain an issue as Middle East airlines are still plagued with excess capacity and competitive pressures. Air Arabia’s

early summer fares to India (roughly a third of its traffic) are at heavy discounts of over 40% to Emirates and 27% to Indian carriers, which highlights Air

Arabia’s cutthroat competition and shows that it is pricing relative to Indian carriers (further supported by a 7% discount to fares offered by Indian LCC Air

India Express). This implies a strong likelihood of yield pressures extending to the peak summer season where airlines typically make most of their profit. We

thus believe that any upside surprise in Air Arabia’s 2010e numbers will come

from passenger traffic (we expect 13% traffic growth in 2010e). We forecast 2010e net income to drop 15% on yield pressures and higher fuel costs.

We downplay the impact of Moroccan and Egyptian hubs as we expect

both to be profitable by 2012f. Despite very limited guidance from management, we assigned separate values to both hubs (AED0.13/share or

12% of our valuation). We assume all aircrafts will be financed by the Sharjah hub and leased out to the others. Previously, we had assumed that all of Air

Arabia’s 44 aircrafts order book would be deployed at Sharjah, which inflated revenue and net income estimates. The new hubs will contribute associate

income, lease income, and management fees (c.1% of revenue) to Sharjah.

End of lock-up period on founders’ shares (c.50%) could place some pressure on share price and strong dividends won’t sustain in coming

years. Air Arabia surprised the market with a strong dividend (AED0.1/share and 104% DPO) for a second consecutive year, but we believe this will not

sustain (we assume a DPO of 25% going forward) as AED3 billion aircraft deliveries begin in 4Q10e. The dividend is holding up the share price at the

moment and we see limited catalysts after the stock goes ex-dividend on 1 April. The key catalyst remains any sign of improving yields. Other catalysts

include higher-than-expected traffic numbers and more guidance on new hubs.

*EV Includes 75% of AFS Investments a= actual; e/f = HC’s estimates/forecasts; c = consensus estimates

KPIs New Old Consensus

2009e 2010f 2009e 2010f 2009c 2010c

Revenues (AEDm) 2,124 2,309 2,205 2,642 2,408 2,890

EBITDA (AEDm) 338 410 390 558 334 415

EBITDA Margin 15.9% 17.8% 17.7% 21.1% 13.9% 14.3%

Net Income (AEDm) 386 402 475 585 402 433

EPS (AED) 0.08 0.09 0.10 0.13 0.09 0.09

EPS Growth -15% 4% 11.4% 23.2% -11% 8%

DPS 0.02 0.02 0.03 0.03 0.04 0.03

P/E 12.68x 12.20x 10.32x 8.38x 12.20x 11.32x

EV/EBITDA* 7.75x 8.39x 7.61x 5.69x 9.73x 9.64x

Dividend Yield 2.0% 2.0% 2.4% 3.0% 3.7% 3.3%

Target Price (AED) 1.11

Market Price (AED)* 1.05

Upside 5.7%

Listed on

DFM

Bloomberg Code AIRARABI UH

RIC AIRA.DU

Enterprise Value (AEDm)

2,620

Net Debt (AEDm) (1,376)

Market Cap. (AEDm) 4,900

Market Cap. (USDm) 1,335

Number of Shares (m) 4,666.7

Foreign Ownership Limit 49.0%

Foreign Ownership Level 25.4%

Daily Turnover (AEDm) 23.3

Daily Turnover (USDm) 6.4 *Price as at 25 March 2010

Shareholders Structure

Free Float 55.0%

Sharjah Civil Aviation Authority 17.4%

Al Maha Holding 8.7%

Abraaj Capital Funds 6.3%

UAE Finance Ministry 2.8%

Others 9.9%

Price Performance Chart

Hatem Alaa

� +202 3332 8614

� halaa@hc-si.com

Mai Nehad

� +202 3332 8626

� mnehad@hc-si.com

* Disclaimer: See page 13

0.5

0.7

0.9

1.1

1.3

1.5

1.7

1.9

M A M J J A S O N D J F

AIRA DFM

UAE - Transportation

Air Arabia 2

Uncertain Outlook, Downgrading to Hold � Downgrade to Hold from Buy and cut TP 12% to reflect continued yield pressures, rising fuel costs, and the likely

impact of the two new hubs—previously we had assumed all aircraft deliveries would go to the Sharjah base

� 2010e is shaping up to be a difficult year; we expect a 15% drop in bottom line as yields remain pressured, fuel costs rise, and associates contribute losses

� End of lock up period on founding shareholders shares could place some pressure on share price in near-term;

dividends surprise for second consecutive year will not recur as aircraft deliveries near

We cut our TP by 12% and downgrade Air Arabia to Hold

We downgrade Air Arabia to Hold from Buy as we believe the airline is challenged in the near-term with continued yield pressures and rising fuel costs. We also incorporate the potential value of the two new hubs—Morocco (29%-owned and launched in May

2009) and Egypt (40%-owned to be launched in April 2010). Previously, we had assumed that all new aircraft deliveries would be utilized by the holding company, which inflated our income statement forecasts as it does not reflect future reality given the

carrier’s multiple hub model.

We cut our TP by 12% to reflect the abovementioned changes. Our new sum-of-the-parts (SOTP) TP of AED1.11/share implies an upside of 6% to the current market price (see table 2 below for valuation details). The majority of our valuation comes from the

existing Sharjah operation and the carrier’s net cash balance plus investments with each contributing 44% to our valuation. After holding up relatively well over the course of 2009, we include 75% of Air Arabia’s investment portfolio in our valuation (from 50%

previously). The Egyptian and Moroccan hubs contribute a total of only 12% to our valuation at this stage given minority ownership by Air Arabia and their limited contribution to overall operations in the medium term.

Valuation appears rich on multiples with Air Arabia trading at a 2010e P/E of 12.68x, which is at a slight 5% discount to peers. It is

trading at a 2010e EV/EBITDA of 7.75x, which is at a 13% premium to peers.

Table 1: Air Arabia on Multiples Compared to other LCC Peers

Airline Country Mkt. Cap.

(USDm)

EV/EBITDA (x) EBITDA CAGR

P/E (x) Net Income CAGR

P/B (x)

2009a 2010e 2011f 2009a 2010e 2011f 2009a 2010e

Air Asia Malaysia 1,138 8.27x 8.11x 7.42x 16% 5.98x 6.82x 6.12x 5% 1.42x 1.17x

easyJet UK 2,878 17.84x 8.08x 6.00x 82% 26.67x 14.96x 10.45x 62% 1.46x 1.35x

GOL Brazil 1,621 13.19x 7.66x 5.98x 60% 5.97x 11.16x 9.87x -22% 2.07x 2.20x

Jet Blue USA 1,595 7.32x 5.96x 5.20x 17% 26.05x 13.99x 10.24x 66% 1.04x 0.83x

Norwegian AS Norway 814 3.50x 6.90x 6.60x 36% 10.51x 10.65x 7.95x 18% 3.09x 2.58x

Ryanair Ireland 6,837 8.11x 9.14x 8.16x 43% 23.61x 17.69x 15.01x - 1.83x 1.87x

Southwest USA 9,641 10.72x 6.94x 5.28x 41% 72.22x 22.81x 18.28x 126% 1.77x 1.76x

Virgin Blue Australia 1,356 10.94x 6.56x 5.07x 89% - 16.34x 9.31x - 1.61x 1.62x

Vueling Spain 484 16.08x 2.29x 2.53x - 8.51x 5.80x 5.74x 53% 4.71x 1.86x

Average 10.66x 6.85x 5.80x 22.44x 13.36x 10.33x 2.11x 1.70x

Air Arabia* UAE 1,335 6.25x 7.75x 8.39x 13% 10.84x 12.68x 12.20x -2% 0.98x 0.93x

Premium/Disc. -41% 13% 45% -52% -5% 18% -54% -45%

*EV includes 75% of investments Source: Bloomberg, HC Research

UAE - Transportation

Air Arabia 3

Table 2: Air Arabia’s SOTP Valuation Summary

AED million 2010e 2011f 2012f 2013f 2014f 2015f 2016f 2017f 2018f SHARJAH

Passengers (000s) 4,607 4,908 5,109 5,306 5,498 5,670 5,704 5,744 5,790 Revenue 2,124 2,309 2,451 2,597 2,745 2,887 2,962 3,042 3,128

EBITDAR 521 565 603 664 719 766 794 821 848

EBITDAR Margin 24.5% 24.5% 24.6% 25.6% 26.2% 26.5% 26.8% 27.0% 27.1%

Lease Rentals (183) (155) (107) 17 176 346 478 514 516

EBITDA 338 410 496 681 896 1,112 1,272 1,335 1,364

Working Capital Inv. (5) (5) (6) (6) (6) (7) (7) (7) (7)

CAPEX (579) (1,215) (1,546) (2,967) (2,965) (2,643) (992) (144) (153)

Free Cash Flow (246) (811) (1,056) (2,293) (2,076) (1,538) 274 1,184 1,203

WACC* 11.6% 11.2% 10.9% 10.2% 9.7% 9.3% 9.3% 9.4% 9.5%

Perpetual Growth Rate 2.5%

PV of Free Cash Flow (226) (673) (795) (1,591) (1,339) (920) 150 590 542

Terminal Value 6,563 17,532

Valuation 4,581

Stake 100% Value/AA Share (AED) 0.49

Contribution to Value 44%

EGYPT

Passengers (000s) 470 778 1,620 2,754 4,374 5,994 7,128 7,452 7,452 Revenue 190 274 622 1,078 1,747 2,441 2,961 3,158 3,221

EBITDAR (13) 44 118 237 437 610 740 789 805

EBITDAR Margin N/A 16.0% 19.0% 22.0% 25.0% 25.0% 25.0% 25.0% 25.0%

Lease Rentals (25) (40) (76) (146) (238) (336) (406) (432) (436)

Management Fees (2) (3) (6) (11) (17) (24) (30) (32) (32)

EBITDA (40) 1 36 81 181 250 305 326 337

Taxes 8 - (5) (12) (29) (40) (49) (53) (54)

Net Income (32) - 19 47 117 161 196 210 218

Working Capital Inv. (1) (1) (3) (5) (9) (12) (15) (16) (16)

CAPEX (4) (5) (12) (22) (35) (49) (59) (63) (64)

Free Cash Flow (36) (6) 16 42 108 149 182 194 202

WACC 14.4%

Perpetual Growth Rate 2.5%

PV of Free Cash Flow (33) (4) 11 25 57 69 73 68 62 Terminal Value 534 1,735

Valuation 861

Stake 40% Value/AA Share (AED) 0.07

Contribution to Value 7%

MOROCCO

Passengers (000s) 630 887 1,205 1,955 2,835 3,799 4,612 4,763 4,763

Revenue 300 417 578 957 1,415 1,934 2,395 2,523 2,573

EBITDAR 41 83 133 239 354 484 599 631 643

EBITDAR Margin 13.6% 20.0% 23.0% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0%

Lease Rentals (54) (71) (89) (149) (221) (299) (366) (382) (386)

Management Fees (3) (4) (6) (10) (14) (19) (24) (25) (26)

EBITDA (16) 8 38 81 119 165 208 223 232

Taxes 5 0 (8) (19) (27) (38) (48) (52) (54)

Net Income (11) (0) 18 43 63 89 112 121 126

Working Capital Inv. (1) (2) (3) (5) (7) (10) (12) (13) (13)

CAPEX (6) (8) (12) (19) (28) (39) (48) (50) (51)

Free Cash Flow (19) (2) 15 39 56 79 100 108 113

WACC 9.9%

Perpetual Growth Rate 2.5%

PV of Free Cash Flow (17) (2) 12 27 36 46 53 52 50

Terminal Value 686 1,568

Valuation 943

Stake 29%

Value/AA Share (AED) 0.06

Contribution to Value 5%

2010e Cash 1,671

75% of Investments 904

2010e Debt (295)

Net Cash + Investments 2,280

Value/AA Share (AED) 0.49

Cont. to Value 44%

Total Equity Value 5,199

Value/AA Share (AED) 1.11

*We apply a multiple WACC for the Sharjah base as capital structure changes over time to finance aircraft deliveries

Source: HC Research

UAE - Transportation

Air Arabia 4

Sustained yield pressures and rising fuel costs dim 2010e outlook

We believe that 2010e is shaping up to be an even tougher year than 2009 for Air Arabia with yield pressures sustaining and a less favorable cost environment. Air Arabia benefited from a drop in fuel costs in 2009e driven by lower oil prices and lucrative hedging

contracts that covered over half of the carrier’s fuel needs for the year.

Despite sustained yield pressures (with an expected drop of 5% YoY tamer than the 16% drop witnessed in 2009), we expect Air Arabia to achieve single-digit revenue growth (c.8%) in 2010e as passenger growth (an estimated 13% growth at Sharjah, in line

with management guidance) outpaces yield compression. We discuss the yield compression issue in detail in the subsequent

section. We, however, expect net income to drop 15% YoY for the year driven by several factors: (i) a forecasted 19% YoY increase in fuel costs (versus a 30% drop in 2009) as oil prices are currently hovering at USD75–USD80/bbl versus an average of

USD62/bbl in 2009. The carrier hedged c.35% of its fuel needs in 2010e in the mid-sixties. We now assume a sustainable oil price of USD80/bbl (from USD70/bbl previously); (ii) a forecasted loss in associates of AED43 million as the Egyptian operation incurs

losses in its first year of operations while losses at Morocco narrow. Air Arabia’s hotel at Sharjah, which is not reflected in our numbers, is expected to begin operations in August 2010 and could incur losses; and (iii) a forecasted increase in cash non-fuel

costs (excluding finance costs) of 6% YoY, which is tamer than the 19% growth in 2009.

Chart 1: 2010e is shaping up to be a tough year for Air Arabia…

…with falling yields… ….and rising fuel costs

Source: Air Arabia, HC Research

End of lock-up on founders’ shares could place some near-term pressure on share price

The lock-up period for Air Arabia's founding shareholders (c.50% of share capital according to management) ended on 23 March

2010. We believe that this could place some pressure on the share price if some of the founders decide to exit through on-market

sales. However, we see this as a bit unlikely since founders subscribed at AED1/share, which is close to the current share price, and thus an on-market sale would imply a total return of 15% as founders’ sole other cash return was last year’s DPS of AED0.10.

This excludes to-be-distributed dividends based on 2009 results (AED0.10/share as well) as they are embedded in the current share price. Still, a distressed seller scenario should not be ruled out. Alternatively, some founders could conduct a bulk sale to a

new strategic shareholder possibly at a premium to the current market price but that would be difficult given the challenges facing the industry.

Another dividend surprise but unlikely to recur in the medium-term

Air Arabia surprised the market for the second year in a row with a proposed strong dividend of AED0.10/share, implying a dividend payout of 104%. The dividend served as a needed catalyst for the stock (rising 12% since the announcement). However,

we believe that this will be the last year for some time that Air Arabia pays such strong dividend as aircraft deliveries for its AED13 billion order book begin in 4Q10e. We have assumed a dividend payout of 25% over our forecast horizon. We believe that once the

stock goes ex-dividend (on April 1), there will be no major catalyst for the share price until we see a sustainable improvement in yields and more light is shed on its Moroccan and the to-be-launched Egyptian hubs.

-50

50

150

250

350

450

550

650

1Q08 2Q08 3Q08 4Q08 2008

Av.

1Q09 2Q09 3Q09 4Q09 2009

Av.

2010

Av.

Revenue/PAX (AED)

0

50

100

150

200

250

300

1Q08 2Q08 3Q08 4Q08 2008

Av.

1Q09 2Q09 3Q09 4Q09 2009

Av.

2010

Av.

Fuel Cost/PAX (AED)

Expecting yields to drop 5% in 2010e

Coupled with a 5% increase in fuel costs/PAX

UAE - Transportation

Air Arabia 5

Yields Likely to Remain Depressed � Despite sustained outperformance of global traffic trends, Middle East airlines remain plagued with yield

pressures due to large capacities and increased competition

� Competition will be the main driver of yield compression in 2010e; main competition is from Indian carriers and Emirates. flydubai is an infant but growing threat.

� Early booking prices for the peak summer season indicate potentially severe yield compression; Air Arabia’s

fares to Indian routes are at 36%–47% discounts to Emirates and 27% on average to Indian carriers

Middle East passenger traffic continues to buck the global trend with robust growth…

The global airline industry experienced a tough year in 2009 as passenger traffic (measured in RPKs) dropped 4% YoY. The Middle

East, on the other hand, witnessed solid passenger traffic growth of 11%. The region is expected to continue bucking the global

trend in 2010e with the International Air Transport Association (IATA) expecting Middle East passenger demand to grow 15%, outpacing an expected global recovery of 6%. Continued outperformance was evident in January 2010 with Middle Eastern traffic

growing 24% versus global traffic growth of 6%.

Chart 2: Middle East traffic continues to outperform global traffic

Source: International Air Transport Association (IATA), HC Research

…but yields remain depressed

Despite the robust traffic growth, yields were pressured as Middle Eastern carriers struggled to keep their seats filled—a trend that

is expected to continue in 2010e. The IATA recently raised its estimate for 2010e losses by Middle Eastern carriers by 25% to USD400 million on sustained yield pressures. The IATA, however, slashed its estimate of global airline losses by 50% to USD2.8

billion due to a recovery in load factors and yields that was evident in 4Q09. Comparing yield compression at Air Arabia with a

select group of global LCCs, we find that yield compression has started to ease (and in some instances yields actually started to improve) at some US and European LCCs (see table 3 below).

Table 3: Change (YoY) in Yields (Average Revenue/Passenger) at Air Arabia vs. Other LCCs

Airline Country 1Q09 2Q09 3Q09 4Q09

Air Arabia UAE -3.8% -18.8% -8.7% -23.5%

Allegiant Air USA -4.8% -12.0% -17.2% -8.4%

AirTran USA -2.8% -8.4% -10.2% -1.2%

easyJet UK 7.3% 8.7% 5.3% 1.5%

GOL Brazil -1.6% 4.7% -31.8% -25.0%

JetBlue USA 1.4% -6.9% -10.9% -4.0%

Norwegian AS Norway -1.3% -17.2% -21.9% -26.5%

Ryanair Ireland -17.7% -9.9% -19.6% -11.3%

Southwest Airlines USA -0.1% -1.0% -10.3% 5.0%

Source: Airline Disclosures, HC Research

3.1%

0.4%

4.7%

11.2%9.5%

12.9% 13.2%

10.8%

18.2%

14.3%16.5%

19.1%

23.6%

-5.6%

-10.1% -11.1%

-3.1%

-9.3%-7.2%

-2.9%-1.1%

0.3% 0.5%2.1%

4.5%6.4%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10

Middle East RPK Global RPK

UAE - Transportation

Air Arabia 6

Why yields are likely to remain an issue for Air Arabia (and other Middle East airlines) in 2010e

Capacity growth outpacing demand

At a time when airlines worldwide have been cutting capacities (as measured by ASKs) as demand weakened, Middle East airlines’ capacities have been growing significantly through new aircraft deliveries and increased frequencies on some routes. Middle East

ASKs have increased by an average of 14% in 2009 versus a drop of 3% for the global industry. With capacity increases outpacing demand, Middle Eastern carriers were forced to keep their fares down to achieve decent seat factors. Air Arabia was no exception

as its Sharjah capacity grew 27% in 2009, but it managed to achieve a solid load factor of c.80% for the year through keeping

fares down (19% lower YoY).

Chart 3: Middle East airline capacity has been growing substantially at a tough time

Source: IATA, HC Research

Competitive Threats

Indian Carriers Air Arabia continues to face increased competition on the UAE-India routes, which represents around a third of its Sharjah traffic

and 13 of its 46 destinations. Four Indian carriers fly between different Indian cities and Abu Dhabi/Dubai: national flag carrier Air India, its LCC arm Air India Express, Jet Airways, and Kingfisher Airlines. Only Air India Express and Jet Airways fly out of Sharjah.

Indian airlines have been increasingly raising their frequencies over the past year to capitalize on the UAE’s robust passenger traffic growth. Air India Express succeeded in gaining a foothold in the UAE (capturing 2%–3% of seat capacity at UAE airports)

especially after Air India redirected some of its international traffic to its LCC arm given negligible premium class business. More Indian LCCs such as SpiceJet and IndiGo, which currently only fly domestically, have plans to start international operations in 2010

and 2011 with the UAE likely to be among the first international destinations they introduce.

Chart 4: Air India Express is capturing 2%–3% of seat capacity at UAE airports

Abu Dhabi Airport Capacity Share by Carrier* Dubai Airport Capacity Share by Carrier*

*As of 24 June 2009 Source: Center for Asia Pacific Aviation (CAPA), HC Research

10.8%

7.3%

13.1%12.3%

14.5%15.2% 15.3%

13.8%15.2% 15.3% 15.4%

14.1%

17.2%

-2.0%

-5.9%

-4.4%-2.5%

-5.0%-4.3%

-2.8% -2.5% -2.4% -3.3%-1.4%

-0.7%1.2%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10

Middle East ASK Global ASK

Singapore

Airlines 3%Air India

Express 3%British

Airways 3%

Qatar

Airways, 5%

Other 24%

Etihad 62%

Pakistan

Int'l Airlines 2%

Qatar

Aiways 2%

Singapore

Airlines 2%Air India

Express 2%

Other 34%

Emirates

58%

UAE - Transportation

Air Arabia 7

The increased competition on the UAE-India routes has induced Air Arabia to strive to keep its fares at a heavy discount to

maintain a competitive position—a trend that seems to continue. For instance, Air Arabia’s offered fare for the UAE-Mumbai route, which overlaps with all other Indian airlines, is at a discount of 1%–19% to Indian competition for the week commencing 1 April

2010. Moving further towards the summer season, Air Arabia’s fares are still at a discount of 7% on average to LCC Air India Express and 27% to all Indian carriers. We believe the heavy early booking discounts at Air Arabia compared to Indian carriers

indicate Air Arabia’s cutthroat competition and the likelihood of continued yield pressures heading into the summer season, which is when airlines typically make most of their profits (Air Arabia generated 44% of its recurring 2009 net income in the third

quarter). Worth noting, many flyers make their booking close to their departure date at a time when fares typically increase.

Chart 5: Air Arabia’s offered fare on the UAE-Mumbai Route is at an average discount of 12% to Indian carriers*

*Round trip for the week commencing 1 April 2010 Source: Airline Websites, HC Research

Chart 6: Air Arabia’s offered fares for the UAE-India route are at an average discount of 27% to Indian carriers*

*Round trip for the week commencing 1 July 2010 Source: Airline Websites, HC Research

Emirates

Air Arabia customarily prices its fares at a discount of 20%–25% to conventional carriers but the discount varies depending on seat availability on certain routes at certain times of the year. With Emirates—Dubai’s flag carrier and Air Arabia’s number one

conventional airline competition—continuing to offer low prices, Air Arabia is under pressure to maintain a decent discount. Taking Indian routes again for illustrative purposes (only for their significant contribution to Air Arabia’s traffic), Air Arabia’s fares are at a

11%–29% discount to Emirates for flights commencing the first week of April. Interestingly enough, making the same comparison for the peak summer season we find Air Arabia’s pricing at a deeper discount of 36%–47% to Emirates. We believe the deep

discounts for the summer season compared to Emirates’ fares are due to Air Arabia seemingly pricing its fares at a discount to Indian carriers, as indicated by the above analysis. We thus believe that any upside surprise in Air Arabia’s 2010e numbers will be

in passenger traffic.

1,101 1,110

1,285 1,3021,365

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200

400

600

800

1,000

1,200

1,400

1,600

Air Arabia Kingfisher Airways Air India Air India Express Jet Airways

AED

1,000

1,200

1,400

1,600

1,800

2,000

2,200

2,400

2,600

Ahmedabad Bangalore Calicut Chennai Delhi Hyderabad Kochi Mumbai Thiruvan. Jaipur Nagpur Goa

AED

Air Arabia Air India Express Jet Airways Air India

UAE - Transportation

Air Arabia 8

Chart 7: Air Arabia offers more than a 40% discount compared to Emirates on Indian Routes in the summer season

Week Starting 1 April 2010 Week Starting 1 July 2010

Source: Air Arabia, Emirates, HC Research

Chart 8: Air Arabia’s Flight Frequencies to Indian Destinations vs. Other Carriers*

*Frequencies from Abu Dhabi, Dubai and Sharjah Source: Airline Websites, Bloomberg, HC Research

flydubai

flydubai, Dubai’s own LCC, started operations in June 2009. It currently has a seven-fleet aircraft and flies to 13 destinations. The carrier is in heavy expansion mode with 44 aircrafts on order including seven to be delivered this year and plans to add more

destinations, including India, Pakistan, Saudi Arabia, and Iran. We maintain the view that flydubai is not yet a major competitive threat for Air Arabia given its still much smaller size and destination outreach, but it is destined to become a competitive threat

especially as it expands its reach to the Indian subcontinent.

-11%

-17%

-32%

-14%

-23%

-27%

-20%

-23%

-29%

-35%

-30%

-25%

-20%

-15%

-10%

-5%

0%

-

500

1,000

1,500

2,000

2,500 Emirates Air Arabia Discount

-36%

-39%

-47%

-37%

-39%

-43% -43%

-46%

-43%

-48%

-46%

-44%

-42%

-40%

-38%

-36%

-34%

-32%

-30%

-

500

1,000

1,500

2,000

2,500

3,000 Emirates Air Arabia Discount

7 7 7 7 7 3 7 7 14

4 14

3 14

9

28

- 3

21

5

10

-

-

10

-

10

-

1 5

17 12

10

- 3

21

7

7

11

14

14

15

14

7

7

7

4 7

7

7

7

14

21

21

28

5

14

21

28

14

2

7

14

7

7

7

14

7

7

7

-

20

40

60

80

100

120

Ahmedabad Bangalore Calicut Chennai Delhi Goa Hyderabad Islamabad Jaipur Kochi Karachi Mumbai Nagpur Thiruvan.

Number of Flights per Week

Air Arabia Air India Air India Express Jet Airways Indian Airlines Emirates Etihad Kingfisher

UAE - Transportation

Air Arabia 9

The Multiple Hub Model: How Will It Turn Out? � No significant positive impact from Egyptian and Moroccan hubs before 2012f when both operations are

expected to become profitable; hubs will contribute lease income and management fees to holding company (Sharjah).

� Morocco (5% of valuation) had a good start in 2009 but relatively strong competition is a threat; Egyptian

operation (7% of valuation) is expected to launch in April 2010 and is anticipated to prove quite successful given country’s supportive demographics and a first-mover advantage.

� Hubs are essential for deployment of Air Arabia’s 44-aircraft order book; we assume aircrafts will be financed at

the holding company level and leased out to other hubs with Air Arabia taking its first debt in 4Q10e and turning

into a net debt position by 2012f.

New hubs will only begin to contribute positively to numbers by 2012f

Management remains cautious in providing guidance regarding Air Arabia’s two hubs at Egypt and Morocco given their start-up

nature. We believe the two new operations will not have a significant impact on numbers in the near-term but will be crucial drivers for Air Arabia’s future development as they gradually build up their fleets and destination offerings. We place little emphasis

on the two hubs at this stage as we believe they will only begin to contribute positively to consolidated numbers by 2012f. By then we expect both operations to be profit-making.

The new hubs will allow for better deployment of future additions to the fleet. We had been assuming that all future fleet additions

will be utilized at Sharjah, which is highly unlikely and would only inflate the presentation of future revenue and EBITDA since Air Arabia will account for its two new operations using the equity method. In addition to associate income, Air Arabia will benefit from

its two other hubs through lease income and management fees that we estimate at c.1% of revenue.

Morocco—Off to a good start but strong competition abounds

Air Arabia Maroc, 29%-owned by Air Arabia, started operations in May 2009 from Casablanca. The airline has three aircrafts

currently and flies to 12 destinations in Europe. Initial numbers from Morocco are promising with the airline carrying around 270,000 passengers (c.4% of traffic at its hub—Mohamed V Airport) with a seat factor of 71%, which is even better than first-year

numbers from the Sharjah base when Air Arabia saw a seat factor of 68%.

Competition at Morocco is more severe than at Air Arabia’s home base with a number of other LCCs already in the market. There

are two local LCCs: Atlas Blue (the LCC arm of Royal Air Maroc with Marrakech as its hub) and Jet4U (sharing the same hub as Air Arabia Maroc). Additionally, European LCCs such as Ryanair and easyJet have frequent flights to Morocco, capturing roughly 2%–

3% each of Morocco’s available seat capacity. To reflect Morocco’s tough competitive environment, we have assumed a sustainable seat factor of 70% at Air Arabia Maroc (versus 80% for the Sharjah and Egypt bases).

Chart 9: Air Arabia Maroc’s Flight Frequencies to Some European Destinations vs. Other LCCs*

*Frequencies from Casablanca and Marrakech Source: Airline Websites, Bloomberg, HC Research

3 3

7 63 4 3 3

4

21

7

3

56

7

3

0

5

10

15

20

25

30

Brussels Lyon Paris Milan Venice Amsterdam Barcelona Istanbul

Air Arabia Maroc easyJet RyanAir Atlas Blue Vueling

UAE - Transportation

Air Arabia 10

We also assumed (i) similar average fares to Sharjah (although we believe that average fares will be higher than Sharjah given the

European exposure), (ii) a sustainable EBITDAR margin of 25%, (iii) maintenance CAPEX at 2% of sales, and (iv) working capital investments at 0.5% of sales. The airline will be subject to an effective tax rate of 30%. Our valuation for the Moroccan operation

yielded AED273 million for Air Arabia’s stake, or AED0.06/share. (see Table 2 above).

Egypt–Possesses immense potential

The 40%-owned Egyptian hub is expected to begin operations in April 2010 initially out of the Borg El Arab airport near Alexandria.

Air Arabia is aiming to fly out of as many as five airports in Egypt eyeing Cairo, Luxor, Hurghada, and Sharm El Sheikh. We

maintain the view that the Egyptian venture will eventually be a big success given the country’s favorable demographics and the absence of other LCCs.

Alexandria’s ageing Al Nozha Airport will completely shut down commercial aviation operations over the course of 2010 with all

traffic to be transferred to the modern Borg Al Arab International Airport, located 40 kilometers southwest of Alexandria. The new airport will handle up to 4.5 million passengers, from 1.2 million passengers currently, and is expected to host 32 regional and

international airlines. We think that Air Arabia will succeed with its model at Alexandria especially given that most of its residents commute to Cairo to fly internationally with limited international flying options out of Alexandria. To fully realize its potential in the

country, Air Arabia ought to have Cairo also as a hub.

We assume a sustainable seat factor of 80% for Air Arabia Egypt, but we believe the operation has the potential to exceed this. For simplicity, we applied the same assumptions for fares, margins, CAPEX, and working capital investments for Egypt as for the

Moroccan hub. The airline will be subject to an effective tax rate of 20%. Our conservative valuation for the Egyptian operation yielded AED345 million for Air Arabia’s stake, or AED0.07/share (see Table 2 above).

Expecting fleet across three hubs to reach 67 by 2016f from current 21 aircrafts

We assume that Air Arabia will add 46 aircrafts until 2016f to its current fleet of 21 (18 at Sharjah and 3 at Morocco) given that: (i)

Air Arabia has on order 44 A320 aircrafts to be received until 2016f with first delivery expected in 4Q10e, and (ii) currently signed lease agreements for the future delivery of two aircrafts. Worth noting is that it is highly likely that fleet deliveries will differ from

the assumptions below as Air Arabia: (i) has the flexibility to alter the fleet delivery schedule for the 44 A320s within possible bounds to suit its needs, (ii) can lease and/or purchase (it has the option to buy five more planes under the current agreement

with Airbus) more aircrafts if demand is strong and to cover possible shortfalls in meeting demand that is partly linked to Airbus’s delivery capabilities.

Chart 10: Fleet Deployment Assumptions Across Air Arabia’s Three Hubs

Source: Air Arabia, HC Research

18 19 2021 22 23 23 23

34

56

1014

19 21

24

6

11

16

2123

0

10

20

30

40

50

60

70

80

2009a 2010e 2011f 2012f 2013f 2014f 2015f 2016f

Number of Aircrafts

Egypt Morocco Sharjah

UAE - Transportation

Air Arabia 11

Expecting first debt in 2010e and turning to a net debt position by 2012f

We assume Air Arabia will finance c.60% of its AED13 billion order book through debt with first debt to appear on the carrier’s balance sheet by the end of 2010e. The remaining balance will be financed through current cash plus investments (AED3.2 billion

in December 2009) and operating cash flows. Our numbers now assume that the company will turn into a net debt position by 2012f. Aircrafts are likely to be fully financed (through either purchase or lease) by the holding company (Sharjah) and then leased

to other hubs, which is similar to the model currently being implemented at Morocco.

The carrier has other options, however, that could be implemented in parallel with or replace the aforementioned financing model.

A likely scenario is engaging in sale-and-leaseback for some of the aircrafts, which would reduce on-balance sheet debt. Another option would be self-funding by the Moroccan and Egyptian hubs, but we think that such a scenario is quite unlikely at this stage.

Chart 11: Air Arabia’s Forecasted CAPEX Bill and Net Cash/Debt Position

Large CAPEX bill to meet aircraft deliveries… …turning AA to a net debt position by 2013f

Source: HC Research

0%

20%

40%

60%

80%

100%

120%

0

500

1,000

1,500

2,000

2,500

3,000

3,500

2010e 2011f 2012f 2013f 2014f 2015f 2016f 2017f 2018f

CAPEX (AEDm) CAPEX/Sales

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

-2,000

-1,000

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

2010e 2011f 2012f 2013f 2014f 2015f 2016f 2017f 2018f

Net Debt (AEDm) Net Debt/Equity

UAE - Transportation

Air Arabia 12

Financial Statements AEDmn 2009a 2010e 2011f 2012f 2013f 2014f

Income Statement

Number of Passengers (000) 4,066 4,607 4,908 5,109 5,306 5,498 Total Revenue 1,972 2,124 2,309 2,451 2,597 2,745

Revenue Growth -5% 8% 9% 6% 6% 6%

Staff Costs (361) (386) (419) (449) (480) (511)

Fuel Costs (570) (679) (755) (805) (836) (878)

Maintenance (185) (200) (212) (222) (232) (242)

Ground and Technical Handling Charges (112) (118) (126) (131) (137) (142)

Landing and Overflying Charges (106) (112) (121) (127) (133) (140)

Selling and Marketing Costs (25) (26) (28) (31) (33) (35)

Other Operating Costs (85) (87) (89) (96) (102) (109)

Management Fees from Other Hubs 2 5 7 12 20 32

EBITDAR 521 522 607 777 910 1,132

EBITDAR Growth 2% -2% 9% 7% 10% 8%

EBITDAR Margin 27.0% 24.5% 24.5% 24.6% 25.6% 26.2% Lease Rental Expense (239) (261) (267) (272) (277) (283)

Lease Rental Income 28 79 111 165 295 459

EBITDA 320 338 410 496 681 896

Depreciation and Amortization (41) (51) (96) (133) (204) (276)

EBIT 279 287 314 363 476 620

Interest Income 156 129 115 106 85 43

Interest Expense - (3) (44) (89) (164) (290)

Income from Associates (32) (43) (0) 37 90 180

Other Income (Expense) 48 16 17 18 19 20

Net Income 452 386 402 435 506 572

Net Income Growth -0.4% -14.6% 4.0% 8.3% 16.4% 13.0%

Net Margin 22.9% 18.2% 17.4% 17.8% 19.5% 20.8%

Balance Sheet

Cash and Equivalents 1,996 1,671 1,442 1,312 669 586

Receivables 270 315 364 417 472 531

Other Current Assets 28 23 19 14 9 3

Total Current Assets 2,294 2,010 1,825 1,743 1,150 1,121

Property and Equipment 1,136 1,674 2,803 4,226 7,000 9,700

Investments 1,205 1,205 1,205 804 402 -

Investments in Associates 29 30 30 67 157 337

Goodwill and Other Intangibles 1,282 1,282 1,282 1,282 1,282 1,282

Other Non-Current Assets 126 131 133 136 140 147

Total Non-Current Assets 3,778 4,322 5,453 6,515 8,981 11,466

Total Assets 6,071 6,331 7,278 8,258 10,131 12,587

Total Debt - 295 886 1,477 2,896 4,846

Total Current Liabilities 1,026 700 784 876 1,040 1,264

Total Non-Current Liabilities 46 342 903 1,465 2,794 4,597

Total Shareholder Equity 5,000 5,289 5,591 5,917 6,297 6,726

Cash Flow Statement

Net Income 491 386 402 435 506 572

Depreciation and Amortization 50 51 96 133 204 276

Other Non-Cash Items 29 44 44 51 73 108

Net Change in Working Capital 46 (5) (5) (6) (6) (6)

Operating Cash Flow 617 476 536 613 778 949

Net CAPEX (254) (579) (1,215) (1,546) (2,967) (2,965)

Other Investments 343 (45) (1) 401 401 400

Investing Cash Flow 90 (624) (1,216) (1,145) (2,566) (2,566)

Financing Cash Flow (478) (176) 450 402 1,145 1,533

Change in Cash 229 (325) (229) (130) (643) (83)

UAE - Transportation

Air Arabia 13

Rating Scale

Recommendation Upside

Buy Greater than 20%

Hold -5% to 20%

Sell Less than -5%

Disclaimer This memorandum is based on information available to the public. This memorandum is not an offer to buy or sell, or a solicitation of an offer to buy or sell the

securities mentioned. The information and opinions in this memorandum were prepared by HC Brokerage from sources it believes to be reliable and from information available to the public. HC Brokerage makes no guarantee or warranty to the accuracy and thoroughness of the information mentioned in this memorandum, and accepts no responsibility or liability for losses or damages incurred as a result of opinions formed and decisions made based on information

presented in this memorandum. HC Brokerage does not undertake to advise you of changes in its opinion or information. HC Brokerage and its affiliates and/or its directors and employees may own or have positions in, and effect transactions of companies mentioned in this memorandum. HC Brokerage and its affiliates may

also seek to perform or have performed investment-banking services for companies mentioned in this memorandum.

UAE - Transportation

Air Arabia 14

HC Research research@hc-si.com

Karim Khadr Regional Head of Research karim.khadr@af-hc.com +971 4 2935381

Tudor Allin-Khan, CFA Amr Abdel Khalek

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