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
Mai Nehad
� +202 3332 8626
* 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
-
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
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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
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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
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