Tiger Airways Holdings Limited - Vying for a piece of Indonesian gado-gado (CIMB)

UNDERPERFORM Maintained

S$0.87 Target: S$0.54

Mkt.Cap: S$475m/US$366m

Airlines

Subscription for 33% stake in Mandala Airlines

Longer-term positive, but maintain Underperform. As expected, Tiger announced last Friday that it has finalised an agreement to subscribe to 22.6m shares in Mandala Airlines, for a 33% stake. We expect Tiger to park new aircraft delivered in Indonesia, lowering the probability of the deferment of its new fleet. Tiger should also be able expand its route portfolio and improve its fleet efficiency with a new Asian base. However, we maintain our Underperform rating, earnings estimates and target price of S$0.54, still based on 8x CY12 EPS. Share price de-rating could include continuing operating losses in the coming quarters for Australia, potential start-up losses for Mandala, and the dilution impact from its recent rights issue.

The news

New share subscription. Tiger announced last Friday that it had signed a share subscription agreement to take 22.6m shares in Mandala Airlines, representing a 33% stake. The Saratoga Group, an investment holding company with investments in natural resources, energy, infrastructure and consumer goods, will hold a 51% stake with the remaining 16% held by creditors following Mandala’s financial restructuring. This announcement had been more or less expected, since Tiger had signed a term sheet in May for the acquisition. Tiger will “pay” for its investment with in-kind contributions, whereby Tiger provides Mandala with certain services, worth an estimated S$14.6m.

Comments

Lowering probability of new-aircraft deferment. We believe Tiger will park new aircraft delivered in Indonesia, lowering the probability of the deferment of its new fleet. Previously, Tiger had planned to increase its fleet in Singapore from 14 to 20 and maintain its Australian fleet at eight for FY12, on top of two aircraft leased to SEAIR. According to its fleet delivery schedule, it would still be welcoming another five aircraft for its Asian operations. Tiger would have to secure another low cost base to accommodate its five aircraft. Otherwise, it would risk over capacity in Singapore or be forced to defer its fleet delivery. We were previously concerned that Tiger might have to defer its new capacity given that the Thai-Tiger venture is most likely cancelled and its investment in Philippine SEAIR is still facing regulatory roadblocks.

Flying international and domestic routes using up to five A320s initially. The Mandala investment is still subject to regulatory approval, which could take up to 90 days. Tiger plans to commence operations once the investment is completed. Mandala will be adopting Tiger’s low cost carrier model and focus on international and domestic routes, similar to Indonesia AirAsia. Indonesia AirAsia currently operates 20 aircraft vs. Mandala’s potential five.

Stiff competition in Indonesia; losses for next three years? The Indonesian aviation market is booming, but not all players are benefitting equally. The domestic LCCs like Lion Air have a stranglehold on the domestic routes, which Indonesia AirAsia had struggled to break into. As a result, over the past few years, Indonesia AirAsia scaled back on its domestic network to focus on the international routes, particularly from Bali to Perth, and connecting Jakarta to the AirAsia group’s two other hubs i.e. Kuala Lumpur and Bangkok.

We believe that Mandala will follow the same strategy, and focus first on the international routes where the presence of Lion Air and other Indonesian LCCs are thin. As a result, Mandala is expected to give Indonesia AirAsia significant competition on key routes like Bali-Perth where Indonesia AirAsia is reportedly making most of its profits.

Although we expect losses from Mandala in the initial years, Indonesia AirAsia has been recording profits for the past five quarters since 2Q10, suggesting that even with strong domestic competition, it is possible for foreign LCCs to operate profitably, as long as the focus remained with international routes, rather than trying to compete head-to-head with the local LCCs in the domestic sectors. We think Mandala will contribute to Tiger more significantly only three years from now, which is the average breakeven period for start-up airlines, as it may not enjoy economies of scale in the early years, while we expect Indonesia AirAsia and other established players in the market to discount heavily upon Mandala’s entry in order to protect their market shares.

Valuation and recommendation

Maintain Underperform. Tiger’s subscription to a 33% stake in Mandala Airlines lowers the probability of its new-aircraft deferment and should allow Tiger to expand its route portfolio. However, we expect tough operating conditions in Indonesia, while its loss-making Australian operations could continue to put a dampener on its earnings in the coming quarters. We believe Tiger will continue to bleed from its loss-making Australian operations in the coming quarters. While Tiger Australia has increased its daily flights from 16 to 18, we have yet to receive any updates on the potential removal of CASA’s flight restrictions for Tiger, which suggests Tiger might have to endure a longer period of losses. Last, the dilutive impact from its recent rights issue should limit share-price upside in the near term. Maintain Underperform and target price of S$0.54, still based on 8x CY12 EPS, the industry’s historical 4-year forward P/E.