Airarabia. Air Arabia: Gaining Altitude. Initiating Coverage. Key information. Company Snapshot. June Please read Disclaimer on the back

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1 Air Arabia: Gaining Altitude Airarabia the first low cost carrier: Airarabia has the distinction of being the first low cost carrier of the MENA region. The company currently caters to 85 destination across MENA, Indian subcontinent, Central Asia and Europe, with its fleet of 32 owned and leased Airbus A320s. Arabia has followed the basic model of low frills, point to point services of an LCC (Low Cost Carrier) closely, adjusting it according to the needs and demands of the market. Improving IATA outlook on Middle East: IATA has upgraded it forecast for revenues on the back of higher air travel volumes and improved growth in air freight. According to IATA expecting that airlines from the Middle East are expected to produce the highest margins and absolute profits. According to the data issued by IATA for April-2013, Middle East once again showed the highest growth as RPK (revenue passenger kilometer) showed a growth of 1 Y/Y, where as PLF (passenger load factor ) at 76.9% was below industry average, which we believe will improve on the back of the higher penetration expectation. Fleet size to grow to more than 50 planes: Airarabia is targeting to achieve a fleet size of 50 aircrafts by the end of 2016, setting it up to cater approximately 8.4mn passengers by the end of With higher passenger inflow Airarabia has also shown an improvement in its RPK (revenue passenger kilometer), from SAR 1.2bn to SAR 10.8bn, we further expect the RPK to improve to SAR 17.1bn by the end of Margin Stability through fuel hedging and diluting revenue: The company is looking to stabilise and improve its profitability by diversifying its revenue streams. In 2012, other services like baggage handling, Cargo, Catering, flight handling etc contributed around 1 to the total revenues, whereas margins from other service stood at 33% as comapred to 12% from airlines business. The company is further looking to improve the share of other revenue to the top line in order to improve profitability. The company is further adding control on the cost side by hedging fuel price to keep its margins stable. Valuation: Airabaia with a fleet size of 32planes, which is expected to grow to 50 by the 2016, along with an ever increasing number of destinations, is strategically placed to cater the growing MENA market. The stock is currently trading at PE and PB of 11.9x and 0.99x respecively. We initiate our coverage on Airarabia with an Overweight stance, on our 12-months price target of AED 1.81/share Recommendation Overweight 12-month price target; AED 1.81 Current Price: AED 1.13 Upside / (downside): 61% Price Chart July September November January March May July August October December February April Key information Reuters code: AIRA-DU Bloomberg code: AIRARABI:UH Country: UAE Sector: Airline Primary Listing: DFM M-Cap: AED 5,086mn 52 Weeks H/L (AED): 1.16/0.6 Senior Analyst Talha Nazar DFM Airarabia Analyst Jassim Al-Jubran Company Snapshot Company Snapshot Revenue 2,435 2,942 3,165 3,519 4,232 5,045 % Growth 16% 21% 8% 11% 2 19% Profit for the year ,085 % Growth -12% 55% 7% 1 34% 62% Owners of the Company ,070 % Growth -12% 56% 7% 1 34% 62% EPS ROE 5% 8% 8% 8% 11% 15% ROA 4% 5% 4% 4% 5% 8% PE (x) PB (x) EV/EBITDA (x)

2 Valuation DCF We have used the Discounted Cash Flow valuation to attain the company s 12 month price target. Following are the Key basic steps & assumptions we have assumed to value Air Arabia. 4-year forecasted cash flow Terminal value calculation based on Gordon Growth model Expected Terminal growth of 2% Using Capital Asset Pricing Model to calculate cost of equity. The calculation is based on the following variables Risk free rate of 2.5% based on 10 years US bond Yeild of 2. + country risk premium of UAE of 0.5% Equity Risk Premium of 13.59% Beta of We are using weighted Average Cost of Capital (WACC) for discounting the future FCF of the company, where the calculation of WACC is based on the following variables Cost of equity based on CAPM Cost of Debt at 3.25% Contribution from equity and debt in Air Arabia s Capital structure is taken at 61% & 39%, respectively Using the above assumption, we arrived at DCF based value of AED 2.34/share for the company Growth WACC 6% 7% 8% 9% % % Residual Income For residual income approach we used the following assumption Cost of Equity of 14.1% based on assumption for the DCF model. A growth rate of 4%, based on Payout of 64% Average expected ROE of 12% Justified PB of 1.23x Based on the above assumption, our price target the company is AED Valuation Mix We assigned 5 weigh to each of our valuation methodology. Our 12month price target for Airarabia is AED based on the current market price we initiate our coverage on Air Arabia with an OVERWEIGHT stance. Methodology Value Weights Weighted Value DCF Resudual Income months price target

3 Air Arabia Airarabia is the first low-cost carrier (LCC) operating out of the MENA region. The company commenced its operations in late 2003, with a network reaching 5 destination. The company currently caters to 85 destination across MENA, Indian subcontinent, Central Asia and Europe, with its fleet of 32 owned and leased Airbus A320s. The LCC operates from three main hubs UAE, Morocco and Egypt Air Arabia Network Moscow Kazan london Amesterdam Ufa Yekaterinburg Brussels Cologne Kiev Kharkov Astana Basel Lyan Venice Torino Toulouse Milan - Bergamo Odessa Donestk Almaty Montpeller Bologna Barcelona Madrid Istanbul Casablanca Tangler Nador Fez Marrakech Alexandria Aleppo Erbil Latakya Damascus Beirut Amman Basra Kuwait Dammam Assiut Sohaj Yanbu Medina Gassim Riyadh Luxor Jeddah Khartoum Sharjah Tehran Shiraz Salalah Muscat Kabul Pershawar Salakot Delhi Jalpur Karachi Ahmedabad Nagpur Mumbal Goa Hyderabad Chennal Bangalore Calicut Coimbatore Kachi Trivandrum Kathmandu Dhaka Chittagong Nairobi Hub Destination Source: Airarabia Following the basic business Model of LCC s, with a little difference As discussed in our special report on LCC sector Flying Low - The evolution of low cost carrier in Middle East, business model of LCC s relies basically on low-frills, point-to point, low over head services. Air Arabia has followed the basic model of an LCC carrier however adjusting it according to the needs and demands of the market. Business Model Breakup The company has a multi hub business model which gives it access to key emerging markets and an opportunity to penetrate new region The company operates from Sharjah Airport, in contrast to its direct competitor fly dubai which operates out of Dubai airport. This has resulted in lower overheads for the company, along with heavy investment by Air Arabia in Sharjah airport gives it negotiation leverage. In order to control its cost the company hedges part of its fuel. In 2012 it hedged 25% of it total fuel requirement, which is expected to reach 52% in 2013, and 48% in The company uses a standardized fleet of Airbus A320 s The company s aircrafts are used on average 15 hours/day. As can be seen above in the network map, the company provides point to point services to it clients. In order to achieve longer distance the company has a multiple hub business model. Due to its station at the Sharjah airport, the company has minimal turnaround time as compared to Dubai airport. 3

4 IATA upgrades forecast for air travel-middle East on the forefront IATA has upgraded it forecast for revenues on the back of higher air travel volumes and improved growth in air freight. It is expecting that airlines from the Middle East are expected to produce the highest margins and absolute profits. According to IATA Upgrades to global air travel (RPKs) growth in 2013 from 4.5% to 5.4% and air freight (FTKs) from 1.4% to 2.7% have been made because we believe the low point in the global industrial production cycle has been passed in the third quarter of last year. There have now been six months of improving output and business confidence. Highlighting the significance of the region IATA in its March 2013 financial forecast stated that The fastest growing region will once again be the Middle East where expansion has recently accelerated back to double figures, benefiting from continuing gains on long-haul markets. IATA Figuers System-wide global commercial airlines Traffic (RTK), % change over year Capacity (ATK), % change over year E 2013F E 2013F Global (4.3) (3.5) Regions North America (6.3) (5.6) (0.3) 1.1 Europe (7.7) (5.4) Asia-Pacific (2.2) (4.8) Middle East Latin America Africa (5.4) 15.0 (0.5) (1.5) Source: IATA March 2013 Financial Forecast According to the data issued by IATA for April-2013, Middle East once again showed the highest growth as RPK (revenue passenger kilometer) showed a growth of 1 Y/Y, where as PLF (passenger load factor ) at 76.9% was below industry average, which we believe will improve on the back of the higher penetration expectation. Regional Growth Y/Y Comaprison Apr 2013 RPK ASK PLF FTK AFTK FLF Africa 4.6% % 1.4% 6.4% 22.4% Asia/Pacific 4.7% 6.1% 76.5% -0.4% -0.7% 55.3% Europe 2.2% 2.9% 78.7% 0.9% 1.5% 46.9% Latin America 2.8% % 12.2% 1.4% 39.9% Middle East % 76.9% 8.6% 8.2% 44.8% North America 0.6% % -0.1% 0.4% 34.7% Total Market 3.2% 4.4% 78.1% 1.4% 1.3% 44.7% RPK: Revenue-Passenger-Kilometers; ASK: Available-Seat-Kilometers; PLF: Passenger-Load-Factor FTK: Freight-Tonne-Kilometers; AFTK:Available Freight Tonne Kilometers; FLF: Freight Load Factor All Figures are expressed in % change Y/Y except PLF and FLF which are the load factors for the specific month. Source : IATA Economics, 4

5 Increasing Passenger volume on the back of higher fleet size Airarabia in 2004 had a fleet of three planes( A-320s), which by the end of 2012 stood at 32 planes. On the back of the increase in the fleet size the company has been able to achieve strong growth in number of passengers from 0.5mn to 5.3mn over the same time period. Airarabia is targeting to achieve a fleet size of 50 aircrafts by the end of 2016, setting it up to cater approximately 8.4mn passengers by the end of With higher passenger inflow Airarabia has also shown an improvement in its RPK (revenue passenger kilometer), from 1.2bn km to 10.8bn km, we further expect the RPK to improve to 17.1bn by the end of With improving fleet size the airlines ASK (available seat kilometers) is also expected to see an improvement from 13.0bn km in 2012 to 20.7bn km in Air Arabia Passengers Millions F 2014F 2015F 2016F 0.0 Number of Aircrafts-RHS Passengers (mn)-lhs Source: Airarabia, Aljazira Research AirArabia Load Factor % 15 Billions F 2014F 2015F 2016F 8 75% 7 65% 6 RPK (bn)-lhs ASK (bn)-lhs Average Load Factor-RHS Source: Airarabia, Aljazira Research 5

6 UAE growing population-safe Haven Status helping UAE has been able to benefit from the onslaught of the Arab spring, as wealthy individuals from the effected countries has parked their investments in Dubai, which has been the major attraction for investors. Sharjah is just 20Km away from Dubai, due to which a lot of passengers traveling in and out of Dubai also use Sharjah airport for travel. Along with that a healthy number of budget tourists from the Asian region are attracted towards Airarbia for their travelling needs. Along with that, a huge number of budget conscious labor population in Dubai and Shrajah usually opt for the cheaper flights of Airarabia. Asteco Dubai Real Estate Monitor 3 2 The line graph below demonstrates the average percentage sales and rental trend on a quarterly basis. Dec 2012 Mar % 12% 1 8% 6% 4% 2% -2% -4% Millions Q-o-Q Percentage Change UAE Population Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Apartment Sales Villa Sales Office Sales Apartment Rentals Villa Rentals Office Rentals Source: Asteco Source: World Bank 6

7 Diluting Profit pool- improving margins Air Arabia provides a multiple of services like Airline, baggage handling, cargo and others. However, airlines contribution in the revenue pool is the highest as it stood at 87% in It should be noted that operating margins from Airlines services in 2012 stood at 12% as compared to 33% from other services, with increasing contribution of other service in the top line we believe the company is expected to show an improvement in its profitability margins. Air Arabia Profit Pool % 92 % 91 % 90 % 87 % % 8% 9% 10 % 13 % Passenger Revenue Other Revenue Source: Company Reports Contribution in Operating Profit Operating Margins % 91.5 % 35% 3 28% 33% 7 25% % 12% % 8.5% 1 5% 6% Airline Other 2011 Airline Other 2012 Source: Company Reports Source: Company Reports Based on the above analysis, we believe the increasing share of other revenue source can result in increasing profitability margins along with an improved base margins which will result in less margin fluctuation due to the oil prices. However, it should be noted that the other revenue sources are ancillary service to the main airline business, a weakness in the airline business is bound to have a negative impact on other revenues. 7

8 Fuel Hedging-Providing Margin Stability Fuel price constitutes more than 5 of the total operating cost of the company. Any movement in the fuel prices can negatively impact the company margins. Air Arabia initially was hurt by the fluctuation in the fuel prices, however in order to counter the instability in margins, the company adopted to hedge its fuel prices in order to maintain healthy margins. The company in 2012 hedged 25% of its fuel cost. For 2013, the company expects to hedge 52% of its fuel cost. The company s hedging decision will be based on the fuel prices and the outlook that the management has on the fuel price movement. Jet Fuel Price $/bbl Jan-08 1-Mar-08 1-May-08 1-Jul-08 1-Sep-08 1-Nov-08 1-Jan-09 1-Mar-09 1-May-09 1-Jul-09 1-Sep-09 1-Nov-09 1-Jan-10 1-Mar-10 1-May-10 1-Jul-10 1-Sep-10 1-Nov-10 1-Jan-11 1-Mar-11 1-May-11 1-Jul-11 1-Sep-11 1-Nov-11 1-Jan-12 1-Mar-12 1-May-12 1-Jul-12 1-Sep-12 1-Nov-12 1-Jan-13 1-Mar-13 1-May-13 Jet Fuel Price Avg Yearly Price Source: eia,us Energy information administration Fuel Hedging % 52 % 6 75 % 69 % 60 $/bbl % 52 % 48 % 31 % E 2014E 2015E Hedge Fuel Non-Hedged Fuel Average Hedge Price-RHS Source: Airarabia 8

9 Key financial data Amount in SARmn, unless otherwise specified e 2014 e 2015 e 2016 e Income Statement Revenue 2,435 2,942 3,165 3,519 4,232 5,045 % Growth 16% 21% 8% 11% 2 19% Direct costs (2,112) (2,418) (2,561) (2,802) (3,345) (3,774) Gross profit ,271 Selling and marketing expenses (33) (45) (47) (49) (53) (54) General & Admin. Expenses (106) (125) (132) (133) (143) (148) Profit on deposits Finance costs (21) (35) (85) (121) (112) (104) Other income Net Profit ,085 % Growth -12% 55% 7% 1 34% 62% Attributable to: Owners of the Company ,070 % Growth -12% 56% 7% 1 34% 62% Non-controlling interests Net Profit After Minority Interest ,085 EPS Balance Sheet ASSETS Non-current assets Property and equipment 2,423 3,302 4,307 5,890 7,392 7,776 Advance for new aircraft Intangible assets 1,092 1,092 1,092 1,092 1,092 1,092 Goodwill Available-for-sale investments Trade and other receivables Total non-current assets 5,242 6,173 7,293 8,920 10,491 10,925 Current assets Trade and other receivables Bank balances and cash 1,345 1,330 2,426 2, ,016 Total current assets 1,873 1,872 2,980 3,091 1,722 1,946 Total assets 7,114 8,045 10,273 12,011 12,213 12,871 EQUITY AND LIABILITIES Capital and reserves Share capital 4,667 4,667 4,667 4,667 4,667 4,667 Retained earnings ,383 Equity attributable to owners of the Company 5,241 5,429 5,603 5,822 6,212 7,017 Non-controlling interests Total equity 5,249 5,441 5,615 5,834 6,224 7,029 Non-current liabilities Finance lease liabilities 865 1,259 3,108 4,433 4,078 3,752 Total non-current liabilities 977 1,353 3,196 4,521 4,166 3,840 Current liabilities Trade and other payables ,036 1,191 1,344 Finance lease liabilities Total current liabilities 888 1,252 1,462 1,656 1,823 2,002 Total liabilities 1,865 2,604 4,658 6,177 5,989 5,841 Total equity and liabilities 7,114 8,045 10,273 12,011 12,213 12,871 Cash Flow From Operating Activities 771 1,299 1,310 1,363 1,727 2,181 From Investing Activities (394) (513) (1,647) (2,231) (2,306) (1,186) From Financing Activities (475) (426) 1, (934) (928) Changes in Cash (98) 361 1, (1,513) 67 Opening Balance 1,845 1,349 1,330 2,426 2, Ending Balance 1,349 1,330 2,426 2, ,016 9 Source: Company reports

10 Key Ratios e 2014 e 2015 e 2016 e Financial Ratios Liquidity Current Ratio Quick ratio Margins Gross Margins 13% 18% 19% 2 21% 25% ETIBDA Margins 15% 19% 19% 18% 23% 28% EBIT 1 13% 12% 11% 13% 19% Net Margins 11% 14% 14% 14% 16% 22% Profitability ROE 5% 8% 8% 8% 11% 15% ROA 4% 5% 4% 4% 5% 8% ROIC 4% 6% 5% 5% 6% 1 RPK (Revenue Passenger Kilometer) (AED bn) ASK(Avaliable Seat Kilometer) (Km bn) Load Factor 82% 82% 83% 83% 83% 83% Efficency Receivables Turnover Payables Turnover Asset Turnover (x) Valuations Dividend Yeild 14% 7% 6% 6% 6% 6% Book Value per share Market Capitalization (AED mn) 2,753 3,920 5,087 5,087 5,087 5,087 Enterprise Value (AED mn) 1,139 3,509 5,127 6,039 7,442 8,570 PE (x) PB (x) EV/EBITDA (x) Source: AlJazira Capital Research 10

11 RESEARCH DIVISION AGM - Head of Research Abdullah Alawi a.alawi@aljaziracapital.com.sa Senior Analyst Talha Nazar t.nazar@aljaziracapital.com.sa Senior Analyst Syed Taimure Akhtar s.akhtar@aljaziracapital.com.sa Analyst Saleh Al-Quati s.alquati@aljaziracapital.com.sa Analyst Jassim Al-Jubran j.aljabran@aljaziracapital.com.sa BROKERAGE AND INVESTMENT CENTERS DIVISION General Manager - Brokerage Division Ala a Al-Yousef a.yousef@aljaziracapital.com.sa Sales And Investment Centers Central Region Manger Sultan Ibrahim AL-Mutawa s.almutawa@aljaziracapital.com.sa AGM-Head of international and institutional brokerage Luay Jawad Al-Motawa lalmutawa@aljaziracapital.com.sa Area Manager - Qassim & Eastern Province Abdullah Al-Rahit aalrahit@aljaziracapital.com.sa Regional Manager - West and South Regions Abdullah Al-Misbahi a.almisbahi@aljaziracapital.com.sa RESEARCH DIVISION AlJazira Capital, the investment arm of Bank AlJazira, is a Shariaa Compliant Saudi Closed Joint Stock company and operating under the regulatory supervision of the Capital Market Authority. AlJazira Capital is licensed to conduct securities business in all securities business as authorized by CMA, including dealing, managing, arranging, advisory, and custody. AlJazira Capital is the continuation of a long success story in the Saudi Tadawul market, having occupied the market leadership position for several years. With an objective to maintain its market leadership position, AlJazira Capital is expanding its brokerage capabilities to offer further value-added services, brokerage across MENA and International markets, as well as offering a full suite of securities business. RATING TERMINOLOGY 1. Overweight: This rating implies that the stock is currently trading at a discount to its 12 months price target. Stocks rated Overweight will typically provide an upside potential of over 1 from the current price levels over next twelve months. 2. Underweight: This rating implies that the stock is currently trading at a premium to its 12 months price target. 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