Airlines need to brace for possibility of higher fuel prices (The Star)

Author: Valuegrowth1nvesting   |   Publish date: Sat, 28 May 2016, 01:02 PM 

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Airlines need to brace for possibility of higher fuel prices

THE fortunes of AirAsia Bhd seems to be ever changing.

Nearly a year go things were different after a report raised a few questions about the airline’s viability and that in turn had contributed to AirAsia’s share price plummeting. But now, after announcing a six fold rise in profits, it appears that its fortunes have reversed.

AirAsia share price rose 12% or 28 sen yesterday to close at RM2.40 a piece.

It was as low as 78 sen on Aug 26 last year.

 

According to current Bloomberg data, out of the 25 analysts tracking the stock, 17 have a “buy” call, five a “hold”, while there aren’t any “sell” call. 

Bloomberg’s consensus 12 month target price for AirAsia is RM2.65 a share.

This is a marked difference from before, when the research company GMT Research wrote that AirAsia had needed RM1.6bil in re-capitalisation.

To some experts though, the report was a wake-up call for the major owners of AirAsia and that incident had brought them back to getting more involved in the running of the airline.

AirAsia group turned in RM876mil in net profit for its first quarter ended March 31, from RM149mil previously.

This was driven by higher passenger loads, a 2% drop in unit cost, better yields, favourable currency movements and an extremely low fuel environment.

“We continue to be positive about AirAsia group’s improving fundamentals in 2016, especially at its previously loss-making associate airline as cheaper fuel supported their turnaround efforts,” says AffinDBS Research.

Even AirAsia X, a sister company that had been bleeding for the longest time, turned the corner but analysts are still cautious, as they want to wait and see a while longer.

Several analysts describe AirAsia’s group results as “stunning and above expectation.”

Malaysia Airlines Bhd (MAS) also this week announced that its cost is down by 32.9% year-on-year. 

That is a huge difference from previously but a lot also had to do with the 6,000 job cuts, low-cost fuel environment, and other improvements that are aimed at setting the airline on a path to sustainable profits. 

The airline did not announce how much money it made, but Christoph Mueller, its group CEO did say earlier to employees that they made RM16mil for the first quarter of 2016.

In MAS’ quarterly report, it said that the headcount reduction and improved work efficiency had also resulted in payroll savings (before exceptional items) of 40.5% year-on-year. At the same time, Mueller warned of a tough second quarter.

But observers say more needs to be done. “It needs to bring its cost down more as the future industry outlook will not be as rosy as the recent past,” says an analyst.

Solid profits

At the moment, the aviation industry is enjoying a stellar time, with demand outstripping supply in most markets and carriers recording solid profits due to lower jet fuel prices.

But higher fuel prices could be in the offing.

This week Brent crude oil prices touched the US$50 a barrel mark and jet fuel prices were also higher at US$56 a barrel from US$55 a barrel on May 13.

“Demand is still holding up well in this region, but we have to be realistic. The year 2015 was great for the industry, so will 2016 be. But expect some tapering in 2017-2018 as the global economic outlook is not so good. The party also cannot last forever, but many airlines have learnt lessons in the past to be better prepared for the future,” Maybank Investment Bank Bhd senior analyst Mohshin Aziz says.

The Interactional Air Transport Association also warned that “we are perhaps coming towards the end of the biggest stimulus to traffic from lower oil prices, and the bigger picture is that the wider economic backdrop remains subdued.”

Andrew Herdman, director-general of the Association of Asia Pacific Airlines added that while Asian carriers are encouraged by the sustained growth in passenger demand, they continue to face a challenging operating environment characterised by intense competition, cost pressures and volatile currency markets.

This is further emphasised by Schroder Investment Management (Singapore) Ltd chief economist and strategist Keith Wade who says that while the global economic outlook is brighter than it was earlier in the year, in the longer-term it is likely to remain tough.

The question is will airlines begin raising fares if oil prices rise again?

“When jet fuel prices reach the US$70 to US$80 a barrel level, the industry will start re-balancing itself. The airlines will adjust fares and capacity. They will do counter balancing before deployment of new capacity,” Mohshin adds.

But for now Mohshin says “at US$50 a barrel, airlines should not complain, it is still at its lowest since 2004 and it is strong days.”

According to AirAsia’s group CEO Tan Sri Tony Fernandes the rise of Brent to US$50 a barrel had “no major impact. (It is) still much lower than what it used to be. We are hedged.”

Airlines globally have hedged about 40% of their fuel requirements at about US$55 to US$56 a barrel.

As for AirAsia, CIMB Research says the group is 75% hedged for the remaining quarters of FY16 at an average jet fuel strike price of US$54/bbl.

“AirAsia will not be taking further hedges for this year but has opted to extend its hedges into next year, currently at 30% of 1Q17’s and 20% of 2Q17’s requirements with an average strike of US$57-58/bbl. This position will be built up further and will give AirAsia excellent cost protection at record low oil prices,” the house says.

Even at US$56 a barrel, jet fuel prices are still at a level that is considered lower on a historic basis, adds Maybank’s Mohshin.

When all is said and done, the airlines will have to brace for tougher times ahead if fuel cost goes up as they will have to be selective about adding more capacity and whether the roaring earnings will be sustainable.