Monday 12 March 2012

TRANSPORT (OVERWEIGHT) Sector News Flash: Qantas Deal Fails to Take Off

THE BUZZ
Qantas announced to the Australian Exchange last week that it  was terminating its possible partnership with MAS to setup a premium airline as  the two were not able to reach mutually agreeable commercial terms. Qantas' CEO, Alan Joyce, said Asia remained a priority for the Qantas Group and it will continue to explore opportunities in the region, including joint ventures and alliances. Separately, the union workforce of MAS has bypassed  management to meet the Prime Minister a couple of weeks ago, urging him to  review the share swap deal between the main shareholders of MAS and AirAsia. It is understood that the Prime Minister is seriously looking into the matter. A key official in AirAsia says that it is prepared to part ways should it become a problem for the Prime Minister, although its CEO, Tan Sri Tony Fernandes, has denied any plans to scrap the collaboration. Officials at Khazanah and the Prime Minister’s Department aredetermined to ensure that the collaboration remains on course. 

OUR TAKE
Another blow for MAS. Sponsorship at risk? The announcement came as a surprise to us as we had assumed that negotiations on  setting  up a regional premium carrier between MAS and Qantas would eventually be concluded despite the delays in finalizing the partnership. With Qantas ending talks for a potential collaboration, a key concern is whether Qantas could pull out of its sponsorship of MAS in joining the oneworld alliance as this would be deemed a competitive threat since Qantas no longer sees Malaysia as a potential hub for its Asian premium airline. But with Qantas reaching a dead end for now (as it has ran out of options on partnerships), we reckon Qantas will continue to be the sponsor  of MAS as  the former will still ultimately benefit from the traffic feed generated. With no partnerships at hand, MAS faces tough headwinds in its expansion plan to setup a short-haul regional premium carrier as this would mean  that  it would have to rely on its own balance sheet to for fleet acquisition.

Why the deal didn't go through. Although the reason of the termination was never disclosed, we reckon  it could be largely due to the  amount of assets  that MAS is required to inject into the partnership. Qantas has indicated that it would want to spend as little as possible on new jets, which probably put off MAS  which  has its own set of problems in acquiring new aircrafts too.

Qantas faces dead end. With Singapore Airlines already  having an established partnership with Virgin, it remains to be seen which airline can be Qantas’ new partner for its Asian premium carrier. A possible partner could be Thai Airways, which is now concentrating on strengthening its presence in Asia, and given that it also has plans to establish a regional carrier of its own called Thai Smile. However, we think the chances for this to happen are still slim, noting that there is a difference in the target market as Thai Smile Air intends to serve the market gap that exists between the low cost carrier and the full service segments. We also don't think Indonesia's national flagship carrier, Garuda Indonesia could be a potential partner of Qantas as geographically serving the lucrative Chinese market would still not be feasible for flights exceeding 6 hours on the former's upcoming delivery of A320s. Furthermore, Garuda is still the dominating carrier in terms of international destinations (other than ASEAN per se), and what the Indonesian carrier needs is  wider  access to Europe and North America  after being slapped with numerous  bans back in 2007–2009.  With no  viable  options at hand for Qantas to revive its International Business, it appears to be at a dead end for now.

Share swap to be reversed? While the cries of the union workforce of MAS over the need to protect jobs are felt by the Prime Minister, we have reiterated that the key low hanging fruit for MAS to pick lies in trimming its excessive workforce (MAS has some 20,000 employees vs AirAsia's 9,000 and SIA's 21,000). Furthermore, with routes between AirAsia and MAS already rationalized as well as key employees from AirAsia  being deployed to MAS, we think the unraveling of the share swap deal inked last year would not bode well for the Malaysian corporate scene. Aside from scrapping the share swap deal, rumours are abound that the union is requesting MAS (in  an  attempt to protect jobs) to abort  its  plans to start a new premium  short-haul carrier (and instead focus on Firefly) as well as abort  its panned entry into the oneworld alliance. We think any reversal of the share swap is highly unlikely but we do not discount this possibility entirely.

Malaysia Airports' potential volume feeder fizzles out. With MAS and Qantas  both  ending  partnership talks, Malaysia Airports  will lose the opportunity  to tap into  higher feeder  traffic  arising from being  a key operating hub for Qantas' Asia-based premium carrier. Nonetheless, this will have no impact to our BUY call on the company as we are fairly optimistic on  the airport operator’s ability to  expand its retail revenue significantly once the KLIA2 is fully operational over the medium to long term. In addition, the completion of the recent private placement exercise  that raised some RM616mm  which was  taken up by both local and foreign investors could instill confidence  in the longer-term prospects of KLIA2. Previously,  there were concerns from some quarters over the possibility of a lukewarm response to the private placement since the higher capex allocation for KLIA2 was announced.

SIA potentially sustaining its premium market share. With Qantas reaching a dead end in establishing anAsia-based regional premium carrier, this would bode well for SIA in retaining its market share in the premium segment which has been declining over the recent years due to the intensifying competition from other regional full service carriers.

Maintain OVERWEIGHT. With SIA (FV: SGD12.47), AirAsia (FV: RM4.57), Malaysia Airports (FV: RM7.53) and Tiger (FV: SGD0.87) in our list of BUYs, we maintain our OVERWEIGHT recommendation on the aviation sector. Given concerns  over their weakening balance sheets amid intensifying competition, we maintain our sell calls for MAS (FV: RM0.90) and THAI (FV: THB21.13).  Our OVERWEIGHT call is largely centred on the activities of passengers downtrading to low cost carriers, hence benefiting the likes of AirAsia and Tiger as well as Malaysia Airports as it stands to take advantage of the potential higher revenue arising from  travellers spending more money in  airports. While  SIA will continue to face headwinds from the intensifying competition, we think that its valuation is appealing as we continue to believe its share price has bottomed  out  and  considering the fact that its balance sheet remains solid  with a high net cash level to weather any downturn. With our overall sector call driven by the low cost segment, we continue to have AirAsia as our TOP BUY in the aviation sector.

Source: OSK188

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