AirAsia Group: Highly-levered Malaysian airline sweetheart. Gambling, or justified high-risk bet?

Remember when you bought your first home? I don’t. My generation is destined to rent for life. As long as you have a salary, nobody will bat an eye. When you bought your home, you’d only had to pay like 10% of the price while borrowing the rest of the 90% from the bank. In fact, that is the norm.

Well, today, I’d like to announce that AirAsia Group can now be considered as a home-property investment. AirAsia Group; No, not AirAsia X (who even remembers the little X anyways?). As of August, AirAsia Group consists of a whopping 85.6% of debt to its enterprise value. Almost the highest in the industry, like in the 80^th percentile. Then again, at least they are not the highest. Congratulations to El Al Israel Airlines, the champion of airline debt financing with 96% debt.

There is an unusually high number of companies at the 90^th percentile.

I mean, it’s not the companies’ fault, right? The leverage is, mostly, due to the massive drop in the share prices of airline companies. A drop due to the uncertainty about when air travel will go back to pre-coronavirus levels, that causes airline to have liquidity problems, right? Or is it? AirAsia Group paid out RM3+ billion just last year. Ouch. I guess that’s too late to reverse now.

With talks of the company looking to raise RM1 billion to help with its liquidity needs, I guess it’s worthwhile to value the company. Since I, too, have some “home-property” investment of my own. Disclosure, I own shares in the home-property-investment of AirAsia Group. And I will save my plans for my “home-property” investment for the closing end.

Story to numbers with a traditional DCF valuation

AirAsia Group is a budget airline based in Malaysia. The company has been expanding outwards to other regions, started with neighboring ASEAN countries, and now to the rest of Asia. It even launched a new company for flights beyond Asia, but that is a “completely different” company, with its own stock ticker.

 

I think the company will experience a significant drop in top-line revenue, just like the rest of the industry in 2020. But quickly bounces back next year but only reaching back to pre-coronaconomy levels in 2022. After that, I think the company will experience fairly decent growth, 7% mid-term growth, benefiting from the emerging economy, but not as high as 2015-2017 levels. Because I believe the company will have learned the lesson from the pain of its aggressive expansion coming back to haunt the company. This lower growth will translate to a healthier margin. I think the company will focus on profitability than growth after this, learning the lesson to play it safe than to run hard and fast, and crash and burn. They will see profitability levels return to pre-2017 of 17% than 2018-2019’s 5%. In the long-term, I see them converge with the industry as the company competes heavily on price.

AirAsia Group’s profitability has been hurt by the massive expansion.

In terms of risk, currently, the company touts one of the highest cost of capital in the industry at 13%. Still, in the long-term, I assume they will converge to the Malaysian market, as they become a mature company, with a 6% cost of capital. AirAsia Group has a slightly below-average capital efficiency, with a sales-to-capital ratio of 0.93, meaning for every ringgit of investment, they only generate RM0.93 in sales. The industry average, pre-pandemic, was 1.2. I assume that the company, coming out of the crisis, can reshuffle its investment efficiency better to 2, 75^th percentile of the industry. Still, converging to the industry average in the long-term due to competition.

The moment of truth, the DCF valuation of AirAsia Group, everyone has been dying to know. By the way, I am valuing the company in US dollars so that the currency conversion may be slightly off depending on the exchange rate. The company is worth USD2.2 billion (RM9.3 billion). And that translates to a per-share value of… -USD0.30 (-RM1.26). Wait… what?

Snapshot of the DCF model

Technically, the share price would not go negative, the most it can go is to zero, thanks to limited liability. The negative value is because AirAsia Group has more debt than even its entire company’s value. But, before you call your stockbroker to sell your holdings. I think there is a very good justification for its current market price and why a traditional DCF, in this case, would not work. There is a way to value a distressed company. But I will save that for the next part of my post. So, please follow the blog via email for that.

 

Comment below your guess of that “method” is.

Data: Airline comparables

Model: Valuation model

Disclaimer: I own shares in AirAsia Group. This writing is for informational purposes only, is not intended to serve as a recommendation to buy or sell any security, is not a research report, and is not intended to serve as the basis for any investment decision.