Skies clearing up as China opens borders

KUCHING: Things are looking up for the aviation industry as China reopens its borders after having shut itself off from the world for nearly three years.

Earlier this week, China lifted quarantine requirements for inbound travellers, ending almost three years of self-imposed isolation even as the country battles a surge in Covid cases.

According to AFP, Beijing last month began a dramatic dismantling of a hardline zero-Covid strategy that had enforced mandatory quarantines and punishing lockdowns.

It said the policy had a huge impact on the world’s second-biggest economy and generated resentment throughout society that led to nationwide protests just before it was eased.

“Chinese people rushed to plan trips abroad after officials last month announced that quarantine would be dropped, sending inquiries on popular travel websites soaring,” the report said.

“But the expected surge in visitors has led more than a dozen countries to impose mandatory Covid tests on travellers from the world’s most populous nation as it battles its worst-ever outbreak.

“China’s Covid outbreak is forecast to worsen as it enters the Lunar New Year holiday this month, during which millions are expected to travel from hard-hit megacities to the countryside to visit vulnerable older relatives.

“And Beijing has moved to curb criticism of its chaotic path out of zero-Covid, with its Twitter-like Weibo service saying it had recently banned 1,120 accounts for “offences against experts and scholars”.”

With it comes the expectation that prized Chinese visitors will return to Malaysia.

Maybank Investment Bank Bhd (Maybank IB Research) expect passenger traffic to continue recovering, jet fuel prices to ease and airfares to remain high.

“To be sure, we do not expect many to return this year due to: China battling its Omicron wave; the requirement for negative PCR tests before returning to China; and not all aircraft being returned to service yet.

“That said, we expect more to return in 2024 albeit at two thirds ef 2019 levels. There could be upside to this figure if Malaysian airlines rebuild their fleets.”

 

2022: Post-Covid recovery took flight

This time last year, Malaysia was only emerging from the Delta wave that claimed many lives. For Malaysia Airport Holdings Bhd (MAHB), the research firm recalled that anuary 2022 passenger (pax) traffic only hit 33 per cent of pre-Covid levels (domestic at 63 per cent, international at six per cent).

“With the arrival of the Omicron variant into Malaysia that month, one would be forgiven for being downcast on the Malaysian aviation sector’s prospects.

“But as the Omicron variant was discovered to be less lethal than the Delta variant, many Asean countries — including Malaysia — chose to reopen their international borders in April 2022,” Maybank IB Research said.

“Fast forward to Nov 2022, the situation could not have been more different relative to a year ago. MAHB Malaysian pax traffic hit 60 per cent of pre-Covid levels (domestic at 69 per cent, international at 51 per cent).

“To be sure, MAHB Turkish pax traffic fared better by hitting a peak of 96 per cent of pre-Covid levels in May 2022 (domestic at 79 per cent, international per cent 124 per cent) before settling at 85 to 95 per cent of pre-Covid levels thereafter.”

Regulatory wise, Malaysian Aviation Commission (Mavcom) released its first consultation paper that will guide how MAHB’s new Operating Agreement (OA) with the government of Malaysia will be drafted.

For Capital A Bhd (Capital A), 2022 started off rough with it being designated as a PN17 listed issuer in January 2022 which sent its share price tumbling.

Not long after that, the ringgit began depreciating against the US dollar as the United States Federal Reserve Board began hiking the Federal Funds Rate and jet fuel prices skyrocketed as the Russian-Ukrainian war erupted.

“They were especially concerning as US dollar-denominated expenses typically accounts for 60 to 70 per cent of airlines’ operating expenses and jet fuel typically accounts for 30 to 50 per cent of airlines’ operating expenses,” Maybank IB Research added.

To compensate, airlines including Capital A’s four airlines began hiking airfares from March 2022 onwards. Despite higher airfares, the number of passengers carried by Capital A’s four airlines continued to improve. In 3Q22, it hit 54 per cent of 3Q19 levels.

“The reason why Capital A could hike airfares without compromising on the number of passengers carried was because its competitors, namely Batik Air Malaysia and Malaysia Airlines cut their fleet size during the Covid-19 pandemic,” it continued.

“Capital A was comfortable enough with its financial position to announce a 51 per cent joint venture to set up a low cost carrier in Cambodia in December 2022.”

In other news, AirAsia X completed its debt restructuring on March 16, 2022 which resulted in a write back of provisions and forgiveness of liabilities amounting to RM33.6 billion in 1Q22.

Meanwhile, the US Federal Aviation Authority returned Malaysia’s safety assessment rating to Category 1 in October 2022. MYAirline, another low cost carrier commenced operations in December 2022.

MAHB announced that it received a discount on the utilisation fees that it was supposed to pay the Turkish government for FY21 and FY22 amounting to 114.8 million euros per annum, but did not disclose the discount itself.

 

2023: Recovery to consolidate

For MAHB, Maybank IB Research expect its Malaysian pax traffic to have inched to circa 70 per cent of pre-Covid levels (domestic: circa 80 per cent, international: about 60 per cent) towards end-2022.

Domestic pax traffic was driven by the return to service of Malaysia AirAsia’s aircraft (end-2022 target: 60, end-3Q22: 47) and the commencement of service by MYAirline with its initial fleet of three aircraft.

International pax traffic was driven by the return of foreign airlines to Malaysia (end-2022 target: 56 to 60, end-3Q22: 50).

“We expect MAHB to, at least, breakeven earnings wise in 4Q22,” it opined.

“Into 1Q23, Mavcom ought to have released its second consultation paper that will guide MAHB’s new OA with the GOM. Hopefully, this will result in a new OA for MAHB after much delay.

“Previously, we expected MAHB’s Malaysian pax traffic to average 90 per cent of pre-Covid levels (domestic: 100 per cent, international: 80 per cent) in 2023.

“Currently, we expect MAHB’s Malaysian pax traffic to average 78 per cent of pre-Covid levels (domestic: 85 per cent, international: 70 per cent) in 2023. The revision is due to the slower-than-expected return to service of Malaysia AirAsia’s aircraft (end-2022 target: 60, end-2023 target: 105).”

In the long term, we expect domestic pax traffic to continue to be driven not just by the return to service of Malaysia AirAsia’s aircraft but also by the expansion of service by MYAirline. MYAirline aims to expand its fleet size to 50 in five years.

Similarly, International pax traffic will continue to be driven not just by the return to service of Malaysia AirAsia’s aircraft but also by the return of foreign airlines to Malaysia.

For Capital A, Maybank IB Research expect the number of passengers carried to have continued recovering towards end-2022 driven by the return to service of 140 aircraft (end-3Q22: 103).

“In our estimation, Capital A ’s 4Q22 core net loss will come in a lot narrower y-o-y and q-o-q to circa RM500 million as airfares remain high due to year end holidays; while the ringgit has recovered against the US dollar at RM4.40 per US dollar and jet fuel prices have eased to circa US$110 per barrel.

“In 2023, we continue to expect Capital A ’s number of passengers carried to recover to 78 per cent of 2019 levels. This will be driven by the return to service of its entire fleet of circa 200 aircraft by end-2023.

“We expect airfares to ease a tad as Capital A and its competitors reinstate capacity but with our expectation that the ringgit will trade at an average of RM4.50 per US dollar and jet fuel price will average at US$110 per barrel, we expect Capital A to breakeven by 3Q23.”

Maybank IB Research’s jet fuel price assumption is premised on brent crude oil price of US$95 to US$100 per barrel and jet fuel – brent crude oil crack spread of US$10 to US$15 per barrel.

“Our jet fuel – brent crude oil crack spread assumption may seem aggressive given the current crack spread of USD30/bbl. That said we believe that it will normalise to the historical average of of US$10 to US$15 per barrel.

“Crude oil refining capacity moved away from producing jet fuel during the Covid-19 pandemic due to lower demand. As refining capacity and demand recovers post-Covid, we expect the jet fuel – brent crude oil crack spread to moderate.”

Assisting Capital A is also lower aircraft lease rates. Aircraft lease rates, especially for non-brand new A320s which Capital A utilises most of, was down circa 25 per cent from pre-Covid levels due to lower demand relative to new ones.

On its PN17 designation, recall that Capital A is proposing to sell its 4 airlines – Malaysia AirAsia (MAA), Indonesia AirAsia (IAA), Philippines AirAsia (PAA) and Thai AirAsia (TAA) – to AAX in exchange for AAX shares.

It is hoped that the sale will result in a gain on disposal that will be more than enough to offset its negative shareholders’ equity position of RM7.07 billion as at end-3Q22.

Capital A will be left with Asia Digital Engineering, airasia SuperApp, teleport, BigPay and exposure to MAA, IAA, PAA and TAA via AAX shares. Capital A hopes to complete this disposal and lift its PN17 designation by mid-2023.

“The above notwithstanding, the Malaysian aviation sector is not without challenges. The main challenge is returning aircraft to service after being idled during the Covid-19 pandemic.

“There are currently backlogs at maintenance, repair and operations centres around the world due to a surge in demand for aircraft to be returned to service coupled with lack of labour and parts.

As alluded to above, only circa 60 per cent of Malaysia AirAsia’s fleet has been returned to service. If the remaining circa 40 per cent is slow to be returned to service, this poses downside risk to not just our estimates for Capital A but MAHB as well.”

 

China to add fuel to the recovery fire

A major catalyst for the Malaysian aviation sector in 2023 is the reopening of China’s borders as from January 8 2023, China will no longer require any quarantine for international arrivals whether Chinese or foreigner.

Passengers must provide negative PCR test results from within 48 hours of departure, and complete a China Customs health self-declaration online, via website, WeChat mini-program, or app.

Inbound travellers to China will no longer need to apply for a green health code from the Chinese embassy in the country of departure.

This is significant as it was the requirement to quarantine upon return that discouraged the very few Chinese who were eligible to travel out of China under its ‘five one’ policy (i.e. one flight from one country per week) before 8 Jan 2023 from even departing China in the first place.

To facilitate outbound travel, China National Immigration Administration will resume normal passport and exit permit application processing from 8 Jan 2023. While China has not lifted its ban on the sale of outbound tour packages, we believe that it is imminent.

“Thus, we expect Chinese visitors to gradually return to Malaysia,” Maybank IB Research opined. “Of the 3.1 million Chinese that visited Malaysia in 2019, two million of them flew into Malaysia.

“Under a ‘blue sky’ scenario where the two million Chinese visitors that flew to Malaysia in 2019 return in 2024, our 2024 earnings estimates for MAHB and Capital A could be lifted by RM100 million each.

“Our existing earnings estimates assume 1.3 million Chinese visitors flying into Malaysia in 2024.”

To be sure, Maybank IB Research does not expect many Chinese visitors to return to Malaysia in 2023 due to: China battling its Omicron wave; the requirement for negative PCR tests before returning to China; and Malaysia AirAsia not having returned all its aircraft to service yet.

“Going forward, we assume that Capital A’s Malaysia AirAsia and Philippines AirAsia will restores all their flights to China by 2024 but assume that MAHB’s Malaysian operations will welcome only 1.3 million Chinese visitors or two thirds of pre-Covid levels in 2024.

“The latter is because Malaysia Airlines, Batik Air Malaysia and AirAsia X all cut their fleet size during the Covid-19 pandemic. Thus, it will not be easy to fly the previous two million Chinese visitors from 2019 to Malaysia so soon.”

 

MAHB still good for a return flight

Maybank IB Research was negative on MAHB still having to pay Istanbul Sabiha Gokcen’s (ISG) utilisation fees from the Covid years and slower-than-expected return to service of its partner airlines’ aircraft.

“Yet, we are positive on China reopening its borders. Net impact is to cut our FY23 core net profit by 36 per cent, raise our FY24 core net profit by 10 per cent and trim our target price by one per cent to RM7.31.

“We also flag that MAHB will likely resume paying dividends this year as it returns to profitability.”

On December 28, 2022, MAHB received a discount on the utilisation fees that it was supposed to pay the Turkish government for FY21 and FY22 amounting to 114.8 million euros per annum due to the Covid-19 pandemic then. The balance is payable by end-FY25 subject to 6. per cent interest per annum.

“We had expected the utilisation fees to be waived. MAHB did not state the discount but we estimate it to have been 45 per cent based on the PSCs that ISG received in FY21 and FY22 relative to FY19.

“Previously, we expected MAHB’s Malaysian pax traffic to average 90 per cent of pre-Covid level in FY23.

“Currently, we expect MAHB’s Malaysian pax traffic to average a lower 78 per cent of pre-Covid levels in FY23 due to slower-than-expected return to service of Malaysia AirAsia’s aircraft.

“Thus, we cut our FY23 core net profit by 36 per cent. Yet, we still expect MAHB to return to profitability in FY23.”

Maybank IB Research still expect MAHB’s Malaysian domestic pax traffic to average at 100 per cent of pre-Covid levels in FY24 as Malaysia AirAsia returns its entire fleet to service by then and MYAirline expands its service.

“Moreover, we now expect MAHB’s Malaysian international pax traffic to average at 85 per cent of pre-Covid levels in FY24. This is premised on 1.3 million Chinese visitors returning then. Net impact of the above is to raise our FY24 core net profit by 10 per cent.”

 

Capital A to regain altitude in 2023

Following a volatile FY22 due to the Russian-Ukrainian war, Maybank IB Research expect jet fuel prices to ease from an average of US$125 per barrel in FY22 to US$110 per barrel in FY23 due to two factors.

“Firstly, brent crude oil prices have eased to less than US$100 per barrel — to US$80 currently — as the hitherto high prices led to demand destruction.

“Secondly, jet fuel–Brent crude oil crack spreads (US$30 per barrel currently) are easing as refining capacity recovers.

“We assume average jet fuel price of US$110 per barrel going forward.”

While the high jet fuel prices from 1Q22 may have driven Capital A to raise fares, Maybank IB Research understood that fares remained high as competitors cut capacity.

For example, in Malaysia, where Capital A traditionally derives most of its profits, there are now eight per cent fewer planes relative to pre-Covid levels.

“Coupled with Capital A returning to service its entire fleet of circa 200 aircraft by end-2023 (end-3Q22: 103, end-4Q22 target: 140), we expect the low cost airline to breakeven some time in 3Q23.

“We tweak our FY22/FY23 core net loss estimates wider by a tad MYR30m-MYR33m on minor housekeeping. That said, we lift our FY24E core net profit by MYR84m to account for the resumption of Malaysia AirAsia and Philippines AirAsia’s service to and from China at pre-Covi levels.

“Note that we did not account for the resumption of Thai AirAsia’s service to and from China at pre-Covid levels as it cut its fleet size from 63 as at end-2019 to 53 currently.”

In other corporate updates, AirAsia Aviation Group was recently named one of the top 20 safest low cost airlines in the world for 2023.

AirAsia Malaysia, AirAsia Thailand and AirAsia Philippines as well as medium haul affiliate airlines – AirAsia X Malaysia and Thai AirAsia X received this significant recognition for their robust overall safety procedures and comprehensive Covid 19 mitigation plans through a recent announcement by the safety aviation experts at airlineratings.com – achieving the top 7/7 stars for both areas.

Bo Lingam, group chief executive officer of Airasia Aviation Group Ltd said: “Safety is a key deciding factor for travellers and is also a key factor affecting any airline’s reputation. This is now more important than ever post pandemic.

“We maintain a strict focus on upholding the highest standards of safety at all times and wish to thank the aviation experts at Airlineratings.com for their recognition of this.

“During the downtime in flying over the past two years, we also introduced numerous innovations and contactless procedures to make flying more seamless and hygienic.

“Travel is now bouncing back and all these measures help restore confidence in air travel and stimulate consumers to get back on board in the skies with us.”