blue-sky thinking

AirAsia Slashes Its Parachute

Selling planes makes the business more precarious.
Photograph: Taylor Weidman/Bloomberg
THAI AIRWAYS INTERNATIONAL
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At Closing, June 18th
15.10 THB

The biggest problem for airlines is generally that their core business is rotten.

Carriers sell a perishable commodity in a fiercely competitive market where many of their rivals are government-backed, and they must invest heavily in costly, fast-depreciating equipment in order to do so. A seat on a Thursday flight from Kuala Lumpur to Bangkok expires today, and is much the same whether you fly AirAsia Bhd., Thai Airways International PCL, Malaysia Airline System Bhd., Bangkok Airways Pcl, or Malindo Airways.

That's why the announcement that AirAsia will sell 84 planes and 14 engines to aviation lessor BBAM Ltd. at an enterprise value of $2.85 billion is somewhat mystifying.

Co-founder Tony Fernandes has been trailing the move for more than a year, and on some measures it makes sense. At a stroke, the sale will wipe out most of the 7.43 billion ringgit ($1.89 billion) in net debt on the balance sheet at the end of December. It will also lift the odor of suspicion that's clung to AirAsia's leasing business since a short-seller in 2015 criticized its accounting.

At the same time, though, Fernandes is losing one of the carrier's best businesses -- one that's often accounted for as much as a fifth of revenue.

As Gadfly has long argued, AirAsia's status as one of Airbus SE's biggest customers has made its leasing unit a source of consistent, handsome profits -- in stark contrast to its core flying business.  One in 13 orders for the new version of the A320 are destined for AirAsia. 

Up, Up and Away

AirAsia's A320 fleet has nearly quadrupled over the past decade -- and it's only just getting started

Source: Company reports, Gadfly calculations

Note: Forecast figures are based on AirAsia's plans to add 30 aircraft a year until 2027. Shows owned and leased fleet.

Ancillary sales such as in-flight food, airport check-in services and baggage fees make up another fifth of revenue -- and they, too, appear to be under scrutiny for a spin-off, judging by AirAsia's rhetoric about "realizing value from non-core operations."

Core Problem

AirAsia's ticket sales aren't enough to cover its operating expenses. Non-core businesses are what makes it profitable

Source: Company reports, Gadfly calculations

Note: Calculated by deducting operating expenses from ticket sale revenue and adding back baggage, ancillary, and operating lease revenue. Operating lease expenses aren't included in the initial calculated but are netted against operating lease income.

What's the point of all this? AirAsia has long traded at a discount to the European budget carriers against which Fernandes benchmarks himself, but that seems as much a function of different markets as anything more profound -- and it's been narrowing in recent months, anyway. Cebu Air Inc., the Philippines' dominant low-cost airline, is valued more cheaply than AirAsia on forward price-earnings metrics, while India's InterGlobe Aviation Ltd., or IndiGo, enjoys a handsome premium to even EasyJet Plc.

Discount Airline

AirAsia's blended forward 12-month price-earnings ratio has been gaining on its European and U.S. peers

Source: Bloomberg

The disposal is particularly fruitless given upcoming changes to the accounting treatment of aircraft operating leases. The new rules, which come into effect next year, will mean that aircraft on longer-term operating leases come back onto the balance sheet -- so we'll hardly have got used to the new capital-lite AirAsia before it bulks up again.

More to the point, lessors like BBAM rarely get the discounts on buying new planes that airlines do, so outsourcing this operation means AirAsia's fleet costs are likely to go up to cover BBAM's higher purchase prices.

Customer Service

Only IndiGo has more aircraft on order from Airbus than AirAsia

Source: Airbus, Gadfly calculations

Note: Based on numbers before AirAsia-BBAM transaction.

Fernandes's journey in taking AirAsia from a one-ringgit purchase in 2001 into a carrier that's threatening venerable businesses like Singapore Airlines Ltd. and Malaysia Airlines make it seem presumptuous to second-guess his plans. But AirAsia's array of non-core operations, in his eyes a weakness, in many ways represents one of the airline's greatest strengths.

In choosing to slash his parachute in this way, Fernandes may be making his airline more nimble -- but should it ever hit an air pocket, he may come to regret the loss of security.

(Adds data on A320 orders in the sixth paragraph.)
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    David Fickling in Sydney at dfickling@bloomberg.net

    To contact the editor responsible for this story:
    Matthew Brooker at mbrooker1@bloomberg.net

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