By Khairul Khalid
Shares of AirAsia plunge almost 20% and sheds around RM1.2 billion in market capitalisation, after a research report alleges the company of dubious accounting practices. Is a crisis really brewing in Asia’s leading low-cost airline?
Business model: AirAsia Bhd was established in 2001 by co-founders Tony Fernandes and Kamarudin Meranun. They bought AirAsia from DRB-Hicom for a token RM1 and assumed the company’s RM40 million debt that was repaid in less than two years.
The company started business with two planes (Boeing 737-300s), one destination (Langkawi), and staff of 250. Today, along with its affiliates (Thai AirAsia, Indonesia AirAsia or IAA, AirAsia Philippines or AAP, and AirAsia India), the airline is Asia’s largest low-cost carrier in terms of fleet size number of passengers carried. The airline serves around 121 destinations from 16 hubs in Malaysia, Thailand, Indonesia, the Philippines, and India.
It currently operates a fleet of 81 Airbus A320s and has won the accolade of world’s best low-cost carrier airline in the World Airline Survey by Skytrax for the past seven years in a row.
AirAsia posted pre-tax profit of RM193 million for the first quarter ended March 31, 2015 (1Q15), up 44% year-on-year.
AirAsia is also planning to raise about US$300 million (RM1.13 billion) of fresh funds to pare down the borrowings of its troubled overseas operations – IAA and AAP. As of March 2015, the amount due from the associates is about RM2.76 billion.
The RM2.76 billion due include loan advancement, finance expenses, brand licensing fees, as well as aircraft leasing. The total due has almost doubled from RM1.3 billion in financial year 2013 (FY13). A big reason for this is the fact that both IAA and AAP have struggled to perform in their respective markets, partly due to cut-throat pricing and high operational costs.
On June 10 2015, Hong-Kong based company GMT Research issued a report accusing AirAsia of questionable accounting practices and using transactions with its associate companies – IAA and AAP – to boost the budget airline’s profit. The report spooked the market as AirAsia’s share price subsequently fell to five-year lows and by almost 20%.
In response to the GMT report, AirAsia explained that its board, audit committee, and management have wanted to consolidate its associates for some time, but were prevented from doing so due to the differing airline regulations of different countries.
Shareholders and management: According to a Kenanga report dated June 19, 2015, Tune Air Sdn Bhd – the private investment vehicle of co-founders Fernandes and Kamarudin – is currently the largest shareholder of AirAsia with a 19.1% stake.
The other two major shareholders are US-based Wellington Management Fund with 13.4% and the Employees Provident Fund with 8.1%. Around 59% of AirAsia’s stocks are free-floating shares.
Aireen Omar is the chief executive officer (CEO) of AirAsia’s Malaysian operations, reporting directly to group CEO Fernandes who has held the top post since the company’s inception in 2001. Kamarudin, who co-founded the company with Fernandes has been executive chairman of AirAsia since 2013.
Share performance:
What analysts think: Worries about AirAsia’s financials in GMT Research’s report, especially with regards money owed by AirAsia’s associates to their parent company, are also shared by local analysts, such as UOB Kay Hian (UOBKH) in a report dated June 18, 2015.
“We had long highlighted that AirAsia Bhd’s substantial receivables were ‘problematic’ and in some ways the recent selldown can be attributed to just that. Still, we believe the selldown is a tad overdone,” said UOBKH which maintained its “hold” recommendation on AirAsia.
Similarly, AllianceDBS analysts said that AirAsia’s interest income is not sustainable.
“Recognition of interest income on amounts due from associates and joint ventures, which made up 22% of core net profit in 1Q15, has helped AirAsia to prop up bottomline,” said AllianceDBS in a report dated June 16, 2015.
The report further stated that this does not reflect economic reality and distorts earnings quality, given it could be challenging for AirAsia to collect the dues from its associates – IAA and AAP.
“This income stream is not sustainable going forward when the underlying dues are reduced via partial payout and a debt-equity swap.
“After adjusting for the above distortions, our calculations suggest net profit would be 30% to 35% lower than our current core net profit forecasts for FY15 to FY17 (which is premised on AirAsia’s current accounting policies),” said AllianceDBS.
AllianceDBS is also concerned about AirAsia’s aggressive depreciation policy as another factor that distorts its earnings quality and could lead to future losses when the aircraft are eventually disposed of.
There are, however, analysts who are confident about AirAsia’s future. For example, Maybank analyst Mohshin Aziz said that AirAsia’s fundamentals are still sound.
“Only the share price is behaving as if there is a crisis. We believe things will settle soon and the company fundamentals will be relooked. People are in a state of panic and nobody is looking at fundamentals,” said Mohshin on June 18, 2015 after AirAsia hosted a conference call for analysts.
Public Bank is also optimistic that AirAsia will bounce back.
“We remain optimistic on AirAsia due to lower fuel prices, higher ancillary income, and better environment with more rational market in Malaysia,” said Public Bank in a report dated June 18, 2015.
UOBKH, in its report dated June 18, 2015, pointed out at AirAsia’s rapid growth over the years as a positive.
“Since its listing, AirAsia has achieved an impressive feat of aggressive growth over the years to what it is today with only one placement to date. Not many airlines can boast such internal funding capabilities for a highly capital expenditure intensive industry.
Earnings forecast:
StockStalk: Potential investors in AirAsia would already have been wary of the troubles in the travel industry, with the triple tragedies of Malaysia Airlines’ MH370 and MH17, and IAA’s QZ8501 last year still fresh in people’s minds.
The aftermath of the GMT Report, alleging financial shenanigans and misleading accounting in AirAsia, and causing its share price to slide and lose almost RM1.2 billion in little more than two weeks, will cause further anxiety. Year-to-date, AirAsia’s share price has fallen by more than 30%.
Although AirAsia has defended its non-consolidation of foreign associates as a matter of legal restrictions beyond its control, doubts still persist especially over its struggling associates IAA and AAP.
On the upside, the AirAsia brand is still strong, not just in Malaysia but across the region. AirAsia management expects both IAA and AAP to break even by end of the year. It has also been reported that group CEO Fernandes plans to be more hands on in AirAsia’s operations to turnaround AirAsia’s fortunes.
“There are questions about the books I agree, but there is definitely no questioning on the cash profits that this juggernaut is going to churn,” said Maybank analyst Mohshin Aziz on June 18, 2015.
However, other external factors could also come into play.
AirAsia’s cost advantages gained could be offset by the current weakening in ringgit and stronger US dollar. 57% of AirAsia’s cost base and 79% of its borrowings are in US dollar. AirAsia’s 54% foreign shareholding is also a concern. Current uncertainties in the Malaysian economy could result in a massive selldown.
For the laymen, it is hard to tell whether predictions of a crisis brewing in AirAsia are real or exaggerated. Still, potential investors need to take all of these factors into account. Hopefully, AirAsia will addresses its financial transparency issues immediately and focus on making its turnaround plans for IAA and AAP come to fruition very soon.
For the divided, one milestone to watch out for is this: AirAsia has indicated that it expects IAA and AAP to break even by year-end. Whether they do or not by that time is a factor to consider seriously.
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Important Note and Disclaimer: This article should not be taken as a cue to either buy or sell the stock. The intention is to highlight the key factors you might want to think about before plunging in or scrambling out. While KINIBIZ makes every endeavour to ensure facts are right and opinion is fair, no liability can be assumed for anyone relying on this information. In other words let the buyer (or seller) beware — a reflection of Bursa Malaysia, we say.
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