Garuda Indonesia (GIAA IJ) New captain on board. 1Q17 review: Time to buckle up, again. Garuda s financials are below break-even

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1 4/16 5/16 6/16 7/16 8/16 9/16 10/16 11/16 12/16 1/17 2/17 3/17 (GIAA IJ) New captain on board Infrastructure Company Report May 2, 2017 (Upgrade) Buy Target Price (12M, IDR) 444 Share Price (4/28/17, IDR) 368 Expected Return 20.7% Consensus OP (17F, IDRtr) 1.4 EPS Growth (17F, %) P/E (17F, x) 25.6 Industry P/E (17F, x) 14.2 Benchmark P/E (17F, x) 16.2 Market Cap (IDRbn) 9,526.3 Shares Outstanding (mn) 25,886.6 Free Float (mn) 3,862.1 Institutional Ownership (%) 85.9 Beta (Adjusted, 24M) Week Low (IDR) Week High (IDR) 520 (%) 1M 6M 12M Absolute Relative (D-1yr=100) PT. Mirae Asset Sekuritas Indonesia Transportation JCI Taye Shim miraeasset.com Mangesti Diah Sulistiani (ext. 127) miraeasset.co.id GIAA 1Q17 review: Time to buckle up, again In 1Q17, (GIAA) reported a net loss of USD99.1mn. Revenue growth was soft (+6.2% YoY to USD909.5mn) owing to weak seasonal demand and heightened competition, and thus could not cover the sharp growth in expenses during the quarter (total expenses jumped 21.3% YoY to USD1.0bn). With regard to GIAA s operations, we highlight the following points: Passenger growth picked up across Garuda s full-service carrier (+8.4% YoY, domestic and international combined) and low-cost carrier Citilink (+8.2% YoY). However, passenger yield compressions were seen in both domestic (USc7.7; -7.4% YoY) and international (USc5.9; -9.7% YoY) flights. We suspect Garuda is maintaining its strategy of sacrificing margins (P) for volume (Q). Encouragingly, RPK picked up faster than ASK at both the full-service carrier (FSC; ASK +11.8% vs. RPK +16.6% YoY) and low-cost carrier (LCC; ASK +6.6% vs. RPK +9.3% YoY). Given improvement in seat load factor (+2.9%p to 72.1% at the FSC and +1.8%p to 74.6% at the LCC), we think the pickup in RPK resulted from management s route optimization combined with lower ticket prices. Cargo revenue continued its strong performance, with the FSC servicing 90,500 tonnes (+21.6% YoY) and the LCC 17,900 tonnes (+13.5% YoY). Amid tight competition to fill seats in the passenger segment, Garuda appears to be continuing its strategic focus on cargo segment penetration. Higher fuel prices and increased ASK (greater fuel burn) put increased pressure on CASK. The FSC s CASK inched up 4.3% YoY to USc6.1, while the LCC s CASK increased 14.2% YoY to USc4.9. However, considering that the average Singapore jet fuel swap price in 1Q17 jumped 48.1% YoY to USD64.5/bbl, we think fuel prices were well managed (e.g., hedging strategy). Going forward, the extension of OPEC/non-OPEC crude oil supply cuts should be the near-term price driver. Garuda s financials are below break-even GIAA has yet to reach the break-even point, based on our analysis. From a contribution margin angle, we find that GIAA is generating insufficient revenue to cover its fixed costs. See our analysis on the next page of this report. Positive on new CEO; Upgrade to Buy Mr. Pahala Nugraha Mansury was recently appointed as the new CEO of Garuda Indonesia. Given his longstanding experience as CFO with Bank Mandiri (BMRI/Hold/TP: IDR11,380), we expect Mr. Mansury to prudently assess the financials of GIAA and add stability. As earnings volatility is one of the airline s key discount factors, we believe greater earnings stability/clarity should lift the valuation discount currently imposed on GIAA. We upgrade our investment call on GIAA to Buy. FY (Dec.) 12/13 12/14 12/15 12/16 12/17F 12/18F Total OP (USDmn) 3, , , , , ,267.9 Operating profit (USDmn) OP Margin (%) Net Profit (USDmn) EPS (IDR) BPS (IDR) P/E (x) 99.7 N/A P/B (x) ROE (%) ROA (%) Note: Net profit refers to net profit attributable to controlling interests PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES & DISCLAIMERS IN APPENDIX 1 AT THE END OF REPORT.

2 Break-even analysis: Garuda needs to sell more tickets Below, we examine the cost structure of in greater detail. Briefly, we believe GIAA has yet to reach the break-even point. From a contribution margin angle, we find that GIAA is not generating sufficient revenue to cover its fixed expenses. Our analysis follows. Given limited information available, we use our own assumptions in deriving s contribution margin (revenue variable expenses). To break down operating expenses, we assume fuel (flight operations), commissions and reservations (ticketing, sales and promotion), maintenance and overhaul, spare parts and fuel (maintenance and overhaul), passenger service (passenger service), aircraft and flight services and ground handling (user charges and station) to be variable expenses. We assume the rest of the expenses to be fixed expenses. The analysis below (see Table 3) is conducted to illustrate the importance of revenue generation and cost management. Variable costs vary in total directly and proportionately with changes in the airline s activity. For Garuda to generate a higher contribution margin, it would need to generate higher revenue. However, the key challenge is heightened competition. As the airline industry is getting overheated (as evidenced by Garuda s falling passenger yield), we think management needs to implement a prudent strategy to enhance revenue. In our view, the airline should revisit its strategy of sacrificing P (margins/asp) for Q (passenger volume/market share), given that passenger volume (average household demand) is unlikely to pick up significantly in the near term. Table 1. Break-even point analysis (USD thousand) Revenue 3,933,530 3,814,990 3,863,922 Variable expenses 2,540,530 1,931,660 1,867,439 Contribution margin 1,393,000 1,883,329 1,996,483 Fixed expenses 1,827,365 1,868,710 2,016,768 Break-even point Below Above Below The other alternative to improving bottom line is to take a microscopic view of fixed costs. Fixed costs are costs that remain the same in total regardless of changes in activity level. Hence, cost management (i.e., improved efficiency) should be actively implemented on the fixed-cost side of the equation. We note that aircraft and charter (flight operations) is the largest single expense item, accounting for 50.2% of total fixed expenses (as of 2016). Hence, we strongly believe should prioritize aircraft and charter efficiency over other fixed expenses. Related to this, we are encouraged by the fact that management is looking to add only three new aircraft this year, which should ease investor concerns over inflated aircraft and charter expenses going forward. Table 2. Aircraft and charter expense is the largest single fixed expense (USD thousand) Fixed expenses 1,827, ,868, ,016,767.5 Flight operations 1,001, ,140, ,262,664.4 Aircraft and charter 765, , ,011,777.2 Aircraft and charter expense to total fixed expenses 41.9% 48.4% 50.2% In 2016, the airline would have incurred a sizeable pickup in fixed expenses if not for employee benefit adjustments, pulling bottom-line earnings into the red. We expect to see (and advise management to pursue) pockets of improvements in fixed expenses in the areas of i) flight operations (+10.7% YoY), ii) passenger services (+16.8% YoY), iii) user charges and station (+21.4% YoY), and iv) finance expenses (+28.7% YoY). 2

3 Table 3. Garuda s contribution margin is lower than its fixed expenses (USDthousand) Revenue 3,933,530 3,814,990 3,863,922 Variable expenses 2,540,530 1,931,660 1,867,439 Flight operations 1,560,266 1,049, ,652 Fuel 1,560,266 1,049, ,652 Ticketing, sales and promotion 240, , ,983 Commissions 127, , ,535 Reservations 112,835 96, ,447 Maintenance and overhaul 253, , ,519 Maintenance and overhaul 179, , ,062 Spare part 73,396 77, ,073 Fuel 1,156 1,187 1,383 Passenger services 187, , ,305 Passenger services 187, , ,305 User charges and station 298, , ,980 Aircraft and flight services 196, , ,526 Ground handling 102,414 82,611 85,454 Contribution margin 1,393,000 1,883,329 1,996,483 Fixed expenses 1,827,365 1,868,710 2,016,768 Flight operations 1,001,983 1,140,787 1,262,664 Aircraft and charter 765, ,775 1,011,777 Salaries and allowances 151, , ,475 Depreciation expenses 59,803 67,656 61,580 Insurance 17,863 16,368 13,367 Employee benefits 4,871 5,448-12,532 Others 1,704 3,070 1,997 Ticketing, sales and promotion 109,481 79,845 64,299 Salaries and allowances 50,455 42,304 49,476 Promotions 46,180 27,107 18,263 Rental 10,944 8,616 2,311 Professional services and training 1, Employee benefit expenses 5 1,190-5,751 Others 5,170 5,188 4,906 Maintenance and overhaul 166, , ,790 Depreciation expenses 92,181 84,931 81,189 Salaries and allowances 54,729 61,677 78,052 Rental 8,891 5,747 13,920 Employee benefits 8,076 6,062-18,599 Insurance 633 1,123 1,421 Others 2,382 1,836 1,806 Passenger services 115,457 95, ,985 Salaries and allowances 107,433 87, ,039 General inventories consumption 2,942 2,582 1,797 Employee benefit expenses -61 2,367-7,219 Professional services and training 2, Others 2,915 2,254 3,103 User charges and station 40,372 35,468 43,067 Salaries and allowances 19,623 17,045 22,733 Rental 13,554 12,536 18,417 Depreciation expenses 3,649 2,010 2,125 Employee benefits 1, ,736 Others 1,910 3,571 3,529 General and administrative 246, , ,798 Hotel operation 34,078 29,699 28,180 Transportation operations 17,799 17,529 17,849 Network operation 16,763 10,304 11,952 Finance expenses 73,321 68,585 88,279 3

4 Introducing the new chief of On April 12 th, 2017, Mr. Pahala Nugraha Mansury was appointed as the new President Director and CEO of. Prior to joining the largest airline of Indonesia, he served as the CFO of Bank Mandiri (BMRI/Hold/TP: IDR11,380). After joining the bank in 2003, Mr. Mansury assumed various strategic positions, such as leading the banking group s corporate development, change management, and economic research offices. In 2006, Mr. Mansury served as the bank s EVP coordinator of finance & strategy and as CFO. And from 2010 until moving to his current position, he served as the bank s managing director of finance & strategy. In short, Mr. Mansury has extensive experience within the financial industry, particularly as the CFO of the banking group. Mr. Mansury is a Chartered Financial Analyst (CFA) and currently serves as the vice president of CFA Indonesia. Mr. Mansury made significant contributions during his tenure at Bank Mandiri. In 2013, he won the Best CFO in Indonesia award in Southeast Asia, as surveyed by the Institutional Investor Corporate Awards. Bank Mandiri also won several awards at the same event thanks in large part to Mr. Mansury s contributions. In 1Q13, he helped Bank Mandiri achieve loan disbursement of IDR391.6tr, a 19.7% YoY improvement from the same period of 2012 (IDR327.2tr). Mr. Mansury graduated from the University of Indonesia with a BSc in Accounting and later received his MBA in Finance from Stern School of Business, New York University. He started his career as a change management consultant with Andersen Consulting, based in Jakarta. Later, he joined Booz Allen & Hamilton as a senior consultant for a year and soon moved to Boston Consulting Group. He was promoted as a Project Leader in several banking projects until According to the statement from Mr. Gatot Trihargo (Deputy Assistant in Ministry of SoE), one of the key reasons for the appointment of Mr. Mansury as the new President Director of is Garuda s need for a figure who can handle the airline s financial and operational affairs. We firmly believe Mr. Mansury has the qualifications, experience, and insights to take the airline to greater heights. Figure 1. Mr. Pahala Nugraha Mansury Source: Internet, Earnings stability ahead; We upgrade investment call to Buy Given Mr. Mansury s proven track record as a financial specialist, we expect to see more earnings clarity ahead. We revised down our 2017F (from USD57.9mn to USD27.0mn) and 2018F (from USD70.2mn to USD57.7mn) earnings forecasts to reflect soft 1Q17 results. However, we think earnings projections are likely to be more reliable (and sustainable) going forward. Of note, we have yet to factor in the tax amnesty related expenses (USD137mn) which is expected to have been booked into the P&L during April (2Q17). We will factor in the extraordinary expenses to our forecast once we gain clarity on the issue. We assign a higher target P/B of 0.84x (from 0.75x previously), as we lower the risk-free rate (falling market yield) and risk premium imposed on the company. Our revised TP of IDR444 implies 20.6% upside from the current price. 4

5 Figure 2. 12M Forward P/B trend (Current share price represents 36.2% discount to 5yr average) (x) Avg 12MF P/B: 1.01x 0.64x /12 7/12 1/13 7/13 1/14 7/14 1/15 7/15 1/16 7/16 1/17 Source: Figure 3. Passengers carried (1,000 pax) 10,000 Citilink 9,000 Garuda international 8,000 Garuda domestic 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 Figure 4. Passenger growth by segment (YoY, %) 140 Garuda domestic 120 Garuda international Citilink 100 Total Q10 4Q11 4Q12 4Q13 4Q14 4Q15 4Q16 Table 4. March operating performance of Garuda Group 3/16 1/17 2/17 3/17 MoM YoY Passengers carried (pax) 2,636,021 2,951,014 2,489,734 2,946, % 11.8% ASK ( 000) 4,771,803 5,534,726 4,868,919 5,403, % 13.2% RPK ( 000) 3,375,236 4,011,076 3,434,946 4,013, % 18.9% SFL (%) % 5.1% Aircraft utilization 8:33 9:22 9:19 N/A NM NM Frequency 22,141 23,698 20,862 23, % 5.3% OTP N/A % % Fuel burn (L) 165,172, ,112, ,606, ,443, % 13.5% Block hours (hours) 45,422 51,090 45,213 49, % 10.0% Cargo carried 30,970,314 36,261 32,887 39, % -99.9% CLF (%) N/A NM NM Yield (US cent) % -7.4% CASK (US cent) % 5.4% CASK ex-fuel (US cent) % -4.7% Average fuel price USD/L % 28.2% 5

6 Figure 5. ASK vs. RPK Figure 6. Passenger yield trend (bn km) ASK RPK (USc) Garuda domestic Garuda international Citilink Garuda group Q10 4Q11 4Q12 4Q13 4Q14 4Q15 4Q16 4 4Q10 4Q11 4Q12 4Q13 4Q14 4Q15 4Q16 Figure 7. CASK vs. CASK ex-fuel Figure 8. Fleet structure (USc) CASK CASK-ex fuel (fleets) Citilink Wide body (YoY, %) 250 Narrow body Growth (R) Q10 4Q11 4Q12 4Q13 4Q14 4Q15 4Q F 0 6

7 (GIAA IJ/Buy/TP: IDR444) Income Statement (Summarized) Balance Sheet(Summarized) (USDmn) 12/15 12/16 12/17F 12/18F (USDmn) 12/15 12/16 12/17F 12/18F Revenue 3, , , ,267.9 Cash and equivalents Scheduled airline services 3, , , ,544.3 Total current assets 1, , , ,464.1 Non-scheduled airline services Fixed assets , ,132.0 Others Total assets 3, , , ,019.7 Cost of revenue 3, , , ,499.2 Short-term bank loan 1, , , ,683.3 Gross profit Long-term bank loan (current) 1, , , ,271.9 Operating expenses Lease liabilities (current) 2, , , ,955.2 Operating profit Long-term bank loan 1, , , ,309.4 EBITDA Bonds payable Total non-operating items Lease liabilities Interest expenses Total liabilities Losses on foreign exchange Paid-in capital Net non-operating gains Capital surplus , ,067.8 Pretax profit Other comprehensive income Corporate tax Stock option Minority interest Retained earnings Attributable net profit Shareholders' equity , , ,105.0 Growth indicators Key indicators (%) 12/15 12/16 12/17F 12/18F 12/15 12/16 12/17F 12/18F Revenue ROE (%) Scheduled airline services ROA (%) Non-scheduled airline services EPS (IDR) Others BPS (IDR) Cost of revenue P/E (x) Gross profit P/B (x) Operating expenses Gross margin (%) Operating profit NM OP margin (%) EBITDA NM Net profit margin (%) Total non-operating items NM EBITDA margin (%) Interest expenses Interest coverage ratio (x) Losses on foreign exchange NM Debt to equity ratio (x) Net non-operating gains Total passenger (pax) Pretax profit NM Seat load factor (%) Corporate tax NM Passenger yield (USc) Minority interest ASK (mn) 51,868 58,591 62,001 67,482 Attributable net profit NM RPK (mn) 40,049 43,245 47,440 52,373 7

8 APPENDIX 1 Important Disclosures & Disclaimers Disclosures As of the publication date, PT. Mirae Asset Sekuritas Indonesia, and/or its affiliates do not have any special interest with the subject company and do not own 1% or more of the subject company's shares outstanding. Stock Ratings Industry Ratings Buy Relative performance of 20% or greater Overweight Fundamentals are favorable or improving Trading Buy Relative performance of 10% or greater, but with volatility Neutral Fundamentals are steady without any material changes Hold Relative performance of -10% and 10% Underweight Fundamentals are unfavorable or worsening Sell Relative performance of -10% * Our investment rating is a guide to the relative return of the stock versus the market over the next 12 months. * Although it is not part of the official ratings at Mirae Asset Sekuritas Indonesia, we may call a trading opportunity in case there is a technical or short-term material development. * The target price was determined by the research analyst through valuation methods discussed in this report, in part based on the analyst s estimate of future earnings. The achievement of the target price may be impeded by risks related to the subject securities and companies, as well as general market and economic conditions. Analyst Certification Opinions expressed in this publication about the subject securities and companies accurately reflect the personal views of the Analysts primarily responsible for this report. PT. Mirae Asset Seukritas Indonesia ( Mirae Asset Daewoo ) policy prohibits its Analysts and members of their households from owning securities of any company in the Analyst s area of coverage, and the Analysts do not serve as an officer, director or advisory board member of the subject companies. Except as otherwise specified herein, the Analysts have not received any compensation or any other benefits from the subject companies in the past 12 months and have not been promised the same in connection with this report. 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