This article first appeared in The Edge Malaysia Weekly on October 9, 2023 - October 15, 2023

THE deadline for Capital A Bhd to announce details of the long-awaited proposed disposal of its aviation assets to medium-haul affiliate AirAsia X Bhd (AAX), as part of a plan to resolve the low-cost carrier’s financially distressed status, has come and gone. Capital A had until last Saturday (Oct 7) to file its regularisation plan.

But last Thursday, the group asked for a further three-month extension until Dec 31 to submit its regularisation plan to the regulatory authorities — its fourth extension request since it triggered the Practice Note 17 (PN17) criteria in July 2020.

According to analysts, Capital A is holding off announcing its proposed regularisation plan as it awaits Bursa Securities’ go-ahead for AAX to be uplifted from its PN17 status, even though the two are not inter-conditional upon each other.

Maybank Investment Bank Research (Maybank IB Research) aviation analyst Samuel Yin Shao Yang says Capital A likely needs AAX to shed its status as a financially distressed firm first so that it can get the latter to buy up Capital A’s short-haul airlines, as part of the group’s own regularisation strategy to uplift itself from PN17 status.

“This would enable Capital A to book a profit big enough to get itself out of PN17 category,” he tells The Edge.

On the other hand, the removal of AAX from the financially distressed category would put the medium-haul airline in a much stronger negotiating position as the valuation for Capital A’s aviation business was one of the major sticking points keeping the two companies and their advisers from striking a deal, analysts say. It has been pointed out that a reason for the delay in finalising the proposed regularisation plan was the difficulty in estimating the value of continuing the goodwill of Capital A’s aviation business.

How much is Capital A’s aviation business worth? In an Aug 30 report, Kenanga Research values Capital A’s airline assets at RM2.5 billion based on 10 times the group’s forward price-earnings ratio (PER) for the financial year ending Dec 31, 2024 (FY2024).

Maybank IB Research’s Yin ascribed a much higher valuation of RM5.47 billion, or 91 sen per share based on a forward PER (FY2024) of eight times.

Other analysts say a valuation that falls between RM2.5 billion and RM5 billion is a more appropriate figure. Given AAX’s recent share price spike, they also believe the proposed deal is likely to be sweetened with free warrants to convince AAX’s shareholders to accept Capital A’s offer for its aviation assets. The new warrants would help reduce the dilution of existing AAX shareholders’ shares.

Also interesting to keep an eye on is the valuation to be attached to Capital A’s digital assets given the dearth of comparable industry benchmarks, which will inevitably underpin the market value of Capital A shares post the disposal of its aviation business.

Kenanga Research values the digital assets at RM996.8 million, which is a 30% discount to Axiata Group Bhd’s Boost US$320 million valuation in 2020, while Yin has a far higher valuation of RM5.66 billion or 94 sen per share.

Shares of AAX have gained a significant 435% since the announcement of the proposed acquisition of Capital A’s aviation business on Nov 29 last year. Its share price touched an all-time high of RM2.57 on Sept 13 and at the close of trading last Thursday, the stock was valued at RM1.06 billion compared with Capital A’s RM4.07 billion.

Even so, Bloomberg data shows AAX’s PER is 0.95 times on a trailing 12-month basis. This valuation (notwithstanding that it has been skewed by an inflated earnings lifted by lumpy extraordinary gains of RM33 billion in FY2022) puts the airline below Capital A at 10.37 times PER, Singapore Airlines Ltd (14.75 times), Cathay Pacific Airways (24.6 times) and Japan Airlines Co Ltd (16.1 times).

In November last year, as a precursor to its regularisation strategy, AAX revealed that it will buy up Capital A’s aviation arm held through AirAsia Bhd (AAB) and AirAsia Aviation Group Ltd (AAAGL) in a share swap deal. Following the acquisition, AAB, AAAGL and AAX will form a consolidated group, which will be named AirAsia Aviation Group. The consolidated group will comprise six airlines — four short-haul and two medium-haul airlines: Malaysia AirAsia, AirAsia Thailand, AirAsia Indonesia, AirAsia Philippines, Malaysia AAX (MAAX) and Thai AirAsia X (TAAX). AAX was then looking to complete the implementation of the regularisation plan by July this year.

The strategic consolidation also aims to streamline and simplify Capital A’s structure by separating its business into three main portfolios — aviation services (such as engineering and in-flight catering), digital and logistics.

AAX was classified as a PN17-listed issuer in October 2021 when its external auditor Ernst & Young (EY) expressed a disclaimer of opinion on its audited financial statements for the 18-month financial period ended June 30, 2021, after the airline was hit hard by the Covid-19 pandemic.

AAX’s debt restructuring in March 2022 was a coup for the medium-haul airline as it managed to reverse RM33 billion of liabilities and provisions for liabilities that had been waived under the scheme and its creditors had agreed to take a 99.5% haircut. The reversal immediately led to the airline reporting a net profit of RM33.62 billion for the quarter ended March 31, 2022, from a net loss of RM11.94 million in the preceding quarter.

Fast forward to its most recent quarter ended June 30, 2023 (2QFY2023), AAX has generated four consecutive quarters of profits. The airline posted a net profit of RM5.54 million in 2QFY2023, RM328 million in 1QFY2023, RM153.48 million in 4Q2022 and RM25.09 million in 3Q2022. AAX changed its financial year end from June 30 to Dec 31 in August last year.

At end-June 2023, AAX had recorded a positive shareholders’ equity of RM96.13 million, which exceeded its share capital of RM51.03 million and a cash balance of RM268.96 million. However, the latest balance sheet data shows that AAX’s net current liabilities for 2Q2023 amounted to RM65.2 million. It is worth noting that its independent auditor had highlighted the airline’s net current liabilities position as at end-June 2021 in the basis for disclaimer of opinion report.

The airline applied for a waiver from having to submit and implement a regularisation plan, and for uplifting from its PN17 status on July 20 this year.

The outlook remains bright for the aviation sector. Analysts expect airlines’ earnings momentum to escalate in 2H2023 as air travel continues to normalise.

“Post-Covid-19, fares are a lot higher and aircraft lease rates are sharply lower relative to pre-Covid-19. Moreover, AAX is now effectively debt-free,” says Yin in a July 26 report.

He is expecting AAX’s 49%-owned TAAX to contribute sizeable earnings going forward, thanks to its recently concluded debt rehabilitation, which saw its creditors taking a haircut on the amount owed to them by TAAX. And unlike MAAX, TAAX will not have to share profits with creditors going forward.

“This is significant because TAAX has never contributed profits to AAX since commencing operations in 2013,” Yin says, adding that AAX is expected to record a one-off share of profits from TAAX of more than RM300 million in 4Q2023. “The fare environment in Thailand is also more favourable than in Malaysia and we expect it to remain as such in the near term.”

Yin has a “buy” call on AAX, with a target price of RM3.56 per share, implying an upside potential of about 50% from the stock’s closing price of RM2.38 last Thursday. The upliftment from its PN17 classification is the next upside catalyst for AAX, he adds.

Both Capital A and AAX share common shareholders — Capital A co-founders Tan Sri Tony Fernandes and Datuk Kamarudin Meranun.

The top shareholders of AAX are Kamarudin and Fernandes, who hold 8.94% and 2.69% direct stakes respectively, as well as an indirect stake of 31.59% through Tune Group Sdn Bhd (17.83%) and AAB (13.76%).

Both Kamarudin and Fernandes also hold an indirect stake of 24.61% in Capital A through Tune Live Sdn Bhd (12.23%) and Tune Air Sdn Bhd (12.4%).

Capital A was one of the airlines worst affected by the pandemic. PN17 criteria was triggered in July 2020 after its external auditors EY issued an unqualified audit opinion with material uncertainty relating to going concern in respect of its audited financial statements for FY2019, plus its shareholders’ equity on a consolidated basis was 50% or less of its share capital.

But the group has bounced back post-pandemic to register its third straight quarter of profit in the quarter ended June 30, 2023 (2QFY2023), driven by high ticket prices arising from strong demand for air services coupled with the delay in rebuilding capacity to pre-pandemic levels. It posted a net profit of RM1.12 billion in 2QFY2023, RM57.1 million in 1QFY2023 and RM256.2 million in 4QFY2022, compared to a net loss of RM901.31 million in 3QFY2022.

Still, its current liabilities exceeded current assets by RM11.94 billion as at end-June 2023. In addition, the group reported a shareholders’ equity deficit of RM10.2 billion.

Capital A has taken steps to boost its financial situation. Last week, it secured a credit facility of up to US$150 million (RM707 million) with a financial institution, which will help boost its current assets.

Of the 11 analysts covering Capital A, five have a “hold” rating, four a “sell” and two a “buy”, with an average price target of RM1.02, which indicates a potential upside of about 6% from last Thursday’s closing price of 96.5 sen.

In an Oct 5 report, Kenanga Research analyst Raymond Choo Ping Khoon expects the demand for business and leisure air travel to continue to recover throughout 2023, which is consistent with Tourism Malaysia’s projection of 16.1 million tourist arrivals in Malaysia this year, up 60% from 10.1 million last year.

“We expect air travel to return to pre-pandemic levels in 2024,” he says, projecting tourist arrivals to climb further by 24% to 20 million, compared with the pre-pandemic level of 26 million.

Choo says Capital A’s system-wide revenue passenger kilometres (RPK) is on track to meet his forecast of a 79% growth to 43 billion in FY2023, after recovering by 20 billion to 24 billion in FY2022.

“Capital A expects its passenger demand to continue to rise over the immediate term, judging from the encouraging load factors recorded at 159 international routes. The group reiterated that the passenger throughput recovery is gaining traction. By end-2023, the group will have had all its 200 aircraft deployed to cope with the rising demand.

“In addition to fleet reactivation, it expects further upside from the current high yield environment. Specifically, the group anticipates fares to peak in 4Q2023,” he says, noting that in 2Q2023, fares were already 15% higher than pre-Covid-19 levels in 2Q2019.

Association of Asia Pacific Airlines director-general Subhas Menon says forward booking trends indicate resilient travel demand in the coming months. “While this augurs well for the passenger business segment, airlines are facing higher costs, driven by inflation and the recent rise in jet fuel prices, which threaten to squeeze margins. Delays in aircraft deliveries and parts shortages may affect airline fleet deployment plans.

“Competition is also intensifying, in tandem with the increase in capacity globally. Asian airlines remain focused on efforts to increase productivity, as the industry strives to return to profitability following three consecutive years of heavy losses,” he says in a statement released last Thursday.

Asia Pacific airlines carried 25.7 million international passengers in August, a 129.7% year-on-year growth, bringing demand to an average 76.5% of pre-pandemic levels. In RPK, demand rose by 102% y-o-y, while available seat capacity expanded by 88.7% y-o-y, leading to a 5.4 percentage point increase in the average international passenger load factor to 82.8%.

On the back of continuing increased travel demand, all eyes are on Capital A’s planned divestment of its aviation assets to AAX. It remains to be seen whether the proposed disposal will enable the group to realise the value of its investment at a fair valuation and whether it would get acceptance from AAX’s minority shareholders. Until then, we can only wait. 

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