AirAsia Bhd
(Jan 7, RM1.43)
Maintain buy at RM1.42, target price at RM1.67: Jetstar and AirAsia announced on Wednesday they would form a non-equity alliance that would reduce costs, pool expertise and ultimately result in cheaper fares for both carriers.

The alliance brings together Asia-Pacific’s two leading low- cost, low-fare carriers, and would focus on a range of major cost reduction opportunities and potential savings that would benefit customers throughout the region.

The areas which the parties intend to develop cooperation on include: (1) future fleet specification; (2) airport passenger and ramp handling services; (3) shared aircraft parts and “pooling”; (4) joint procurement; and (5) passenger disruption arrangements.

We are positive on this news as the alliance brings together two of the most successful low-cost carriers in Asia-Pacific with the view of harnessing their collective strengths to bring about greater cost of synergies.

While the typical airline alliance among full-service carriers focuses on revenue sharing, this alliance focuses on cost sharing which is in line with a low-cost carrier’s business model. Nevertheless, the alliance does not rule out a code-sharing arrangement going forward.

We believe cost savings can be achieved mainly due to two reasons — overlapping destinations and common aircraft type. AirAsia currently flies to more than 60 destinations while Jetstar flies to more than 50 destinations.

Based on our research, these two carriers currently have 24 overlapping destinations which allow them to collaborate on passenger and ground-handling arrangements.

AirAsia and Jetstar currently have a combined fleet of 112 Airbus A320 aircraft (AirAsia 64, Jetstar 48), putting them as the largest A320 operators in the Asia-Pacific region which currently has 583 such aircraft in operation.

This accords them significantly bargaining power in the procurement of aircraft and spare parts, both in terms of pricing and design specification. Furthermore, collaboration on spare parts inventory management will also result in the lowering of inventory levels.

While media reports have quoted Datuk Seri Tony Fernandes saying that the alliance may generate as much as A$200 million (RM618.32 million) savings a year with AirAsia achieving RM100 million in FY2010 alone, we are not changing our estimates at this juncture as discussions are still at preliminary stages and no binding agreements have yet to be entered into.

We maintain our buy call and discounted cash flow-derived target price of RM1.67 as we believe AirAsia’s low-cost carrier business model accords more room to ride out the current low revenue yield environment while its continued growth is underpinned by cost-conscious air travellers. — ECM Libra Investment Research, Jan 7
This article appeared in The Edge Financial Daily, January 8, 2010.