August 19, 2008 Key Data * Price as of close on August 18, 2008. Sources: Reuters, Zawya, and NBK Capital Rebased Performance 2.40 2.20 2.00 1.80 1.60 1.40 1.20 Sources: MSCI, Reuters, and NBK Capital Key Ratios a = actual, f = forecast. Sources: Reuters and NBK Capital Analysts Current Price* AED 1.58 52-Week High AED 2.21 52-Week Low AED 1.16 Reuters AIRA.DU 2Q2008 EBITDAR a AED 98.2 mln 2Q2008 EBITDAR f AED 110.0 mln Samir Murad, CFA Direct: +965-2595145 samir.murad@nbkcapital.com Badder Al Ghanim Direct: +965-2595330 badder.alghanim@nbkcapital.com Avg. Value Traded per Day AED 163.0 mln Market Cap AED 7.4 bln Current Number of Shares 4,666.7 mln Bloomberg AIRARABI UH Ownership Structure Privately Held: 45% Public: 55% 1.00 Aug-07 Oct-07 Dec-07 Feb-08 Apr-08 Jun-08 Aug-08 AIRA.DU MSCI UAE 2008 f 2009 f 2010 f 2011 f 2012 f P/E 14.9 13.7 11.4 10.7 10.1 EPS Growth 34% 9% 20% 6% 6% EV/ EBITDAR 7.9 6.5 5.2 4.7 4.1 EBITDAR Margin 28% 28% 27% 27% 26% EBITDAR Growth 45% 23% 24% 11% 15% Dividend Yield 1.7% 1.8% 2.2% 2.3% 2.5% ROAE 9% 9% 10% 10% 10% 3Q2008 EBITDAR f AED 231.0 mln 4Q2008 EBITDAR f AED 160.5 mln Highlights 12-Month Fair Value: AED 1.84 Recommendation: Accumulate - Risk Level**: 4 Reason for Report: 2Q2008 Update Air Arabia s total revenue reached AED 871 million in 1H2008, which is 70% over the same period last year. This increase in revenue is mostly due to a combination of a 33% increase in passenger numbers in 1H2008 and an 18% increase in yields. As we discussed in our last update, profitability is being hampered by rising fuel prices. Fuel costs as a percentage of revenue increased from 30% in 1H2007 to 43% in 1H2008. Air Arabia s fuel costs per ASK have been increasing at triple the rate of the increase in yields, as fuel costs per ASK increased by 100% compared to a 32% increase in yields over the past six quarters. Air Arabia posted an EBITDAR of AED 186.4 million in 1H2008, 6% lower than our forecast. Net income increased by 39% in 1H2008, but this was buoyed by interest income of AED 79.5 million, without which net income would have declined by 25%. FlyYeti, the low-cost airline that Air Arabia started in Nepal, suspended its operations in 2Q2008. Management cited political instability in Nepal as the main reason for this decision. This does not have a material effect on our forecast as FlyYeti was planned to be a small-scale operation with a maximum of four aircraft with Air Arabia owning 51%. We forecast revenues of AED 650 million for 3Q2008, as we expect to see a 12% increase in yields (quarter-onquarter), a 13% increase in output (quarter-on-quarter), and a load factor of 93%. Based on our expectation of a 5% drop in fuel costs per ASK, we forecast Air Arabia s EBITDAR at AED 231 million in 3Q2008. As for the bottom line, we forecast a net income of AED 206 million in 3Q2008, 25% higher than in 3Q2007. We arrived at a 12-month fair value for Air Arabia of AED 1.84 by using a combination of discounted cash flow (DCF) and peer comparison based on forward price/earnings-to-growth (PEG) multiples. This value is 16% higher than the close on August 18, 2008, hence, our Accumulate recommendation. ** Please refer to the last page for recommendations and risk ratings.
Valuation Air Arabia continued its solid operating performance by increasing traffic figures even as the airline has been increasing fares to offset some of the increase in fuel costs. Rising fuel costs prevented the airline from posting financial performance figures that reflect the success Air Arabia has been achieving at the operating level. However, the recent decline in oil prices may be the window of opportunity that the airline needs to post good numbers in 2008. We remain bullish on our outlook for Air Arabia, and we expect the airline to post a record performance in 3Q2008 (both in terms of financial and operating results) because of a higher yield, a higher load factor and slightly lower fuel prices. Our 12-month fair value estimate for the share price of Air Arabia has declined by 2.9% from our last estimate to reach AED 1.84. This change was driven primarily by an 18% decline in the fair value using the peer comparison method based on forward PEG multiples. However, this decline was offset by a 5% increase in the fair value derived from our discounted cash flow (DCF) model. Since our fair value estimate is 16% higher than Air Arabia s latest share price, our new recommendation for Air Arabia s stock is Accumulate. Figure 1 Fair Value per Share Our new 12-month fair value for Air Arabia is AED 1.84 Valuation Method Old New Weight Value Weight Value Change Discounted cash flow 70% AED 1.77 70% AED 1.86 5.0% Peer comparison 30% AED 2.17 30% AED 1.78-18.0% Weighted average fair value 100% AED 1.89 100% AED 1.84-2.9% Source: NBK Capital Second Quarter 2008 Operational Performance The number of passengers flying with Air Arabia grew by 33% year-on-year to 1.6 million in 1H2008. This was coupled with an increase in the load factor from 82.4% in 1H2007 to 86% in 1Q2008, which reflects the strong demand for the airline s services. Air Arabia increased its output by 33%, from 2.7 billion ASK in 1H2007 to 3.6 billion ASK in 1H2008. The increase in ASK was matched by an almost 40% increase in RPK, which led to the increase in the load factor. FlyYeti, the low-cost airline that Air Arabia started in Nepal, suspended its operations in the second quarter in 2008. Management stated that political uncertainty in Nepal was constraining the airline s ability to renew aircraft leases which had to be reviewed on a monthly basis. Also, the airline was having problems with jet fuel supply, as the sole supplier in Nepal was charging rates much higher than global rates. We were surprised by the suspension of the FlyYeti operation, as it was posting some promising numbers for a startup. According to management, FlyYeti was achieving an 80% load factor, on the back of strong yields, before the airline suspended operations. NBK Capital Page 2 of 8
Figure 2 Operating Statistics 2006 2007 1H2007 1H2008 Load factor rises to 86% Passengers (Millions) 1.7 2.7 1.2 1.6 RPK (Billions) 3.7 5.0 2.2 3.2 ASK (Billions) 4.7 5.8 2.7 3.6 Load factor 80% 86% 83% 86% Source: Air Arabia Second Quarter 2008 Financial Performance Air Arabia s total revenues reached AED 871 million in 1H2008, which represents an increase of 70% over the same period last year. This increase in revenue is mostly due to a combination of a 33% increase in passenger numbers in the first half of 2008 and an 18% increase in yields, as Air Arabia has been adding surcharges to offset some of the increase in fuel costs. Once again, as we discussed in our last update on Air Arabia entitled Fuel Hurts Margins, Air Arabia s growth is being hampered by rising fuel prices. Fuel costs as a percentage of revenue increased from 30% in 1H2007 to 43% in 1H2008. Air Arabia posted an EBITDAR of AED 186.4 million in 1H2008, 6% lower than our forecast of AED 198.2 million. Buoyed by interest income of AED 80 million (compared with AED 8 million in 1H2007), Air Arabia reported a net profit of AED 159.8 million in 1H2008, an increase of 39% compared with 1H2007. Excluding the effect of interest income from both quarters, Air Arabia s net income would have declined by 25% year-on-year. Figure 3 1Q2008 Income Statement Income Statement (AED Millions) Second-Quarter Results Common Size 2007* 2008 Change 1H2007 2Q2008 Rising fuels costs were the main reason behind the decline in operating margins Total Revenue 513 871 70% 100.0% 100.0% Fuel Costs 153 373 143% 29.9% 42.9% Other Cost of Revenue 240 372 55% 46.7% 42.8% Gross Profit 120 125 4% 23.4% 14.3% Selling and Marketing 21 17-15% 4.0% 2.0% General and Administrative 11 29 159% 2.2% 3.4% Operating Income 88 78-11% 17.2% 9.0% Interest Income(Exp), Net Non-Operating 8 80 894% 1.6% 9.1% Other, Net 19 2-89% 3.7% 0.2% Net Income 115 160 39% 22.4% 18.4% *Based on estimates from Investor Presentation. Sources: Air Arabia and NBK Capital NBK Capital Page 3 of 8
A Look at Fuel Costs In Figure 4, we have plotted the average price per barrel for WTI light crude oil and Air Arabia s fuel cost per ASK over the past six quarters. Fuel costs for Air Arabia are directly correlated to market prices for oil since the airline does not receive fuel subsidies and has not been hedging its fuel requirements. Figure 4 Fuel Cost per ASK vs. Oil Price 130 0.13 120 0.12 110 0.11 100 0.10 Air Arabia s fuel cost per ASK exhibits high correlation with the price of oil USD 90 80 70 0.09 0.08 0.07 AED 60 0.06 50 0.05 40 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 0.04 Average Oil Price $/barrel Fuel Cost per ASK Source: NBK Capital In Figure 5, we show the effect of rising oil prices on Air Arabia s income statement. Again, we plot Air Arabia s fuel costs per ASK for the last six quarters but this time against the yield that the airline generates. Over the past six quarters, Air Arabia s yield has increased by 32%, while fuel costs per ASK have increased by 100%. This shows that Air Arabia s fuel costs per unit of output have been increasing at triple the rate of the increase in fares. NBK Capital Page 4 of 8
Figure 5 Fuel Cost per ASK vs. Oil Price 0.35 0.16 0.30 0.29 0.14 0.25 0.22 0.12 0.12 Fuel costs per unit of output have been increasing at triple the rate of the increase in fares Yield (AED) 0.20 0.15 0.10 0.06 0.10 0.08 0.06 0.04 Fuel Cost per ASK (AED) 0.05 0.02 0.00 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 0.00 Yiled Fuel Cost per ASK Source: NBK Capital Outlook Air Arabia proved that there is a strong demand for its service in 1H2008, as the airline was able to increase output by 33%, compared with 1H2007, even as it increased prices by 32% (mainly to offset some of the increase in fuel costs), and achieved an increase of 3.6 percentage points in load factor. Accordingly, the only obstacle for Air Arabia has been the soaring energy prices; however, the recent correction seen in the oil market may be the break that will allow the airline to achieve a financial result in 2008 that is as impressive as Air Arabia s operational performance. In our opinion, the timing of the recent correction in oil prices could not have been better. The third quarter is the quarter with the highest yield and the highest load factor of the year, and with softer oil prices, margins are poised to improve. We are forecasting revenues of AED 650 million for 3Q2008, as we expect to see a 12% increase in yields (quarter-onquarter), a 13% increase in output (quarter-on-quarter) and a load factor of 93%. Based on our expectation of a 5% drop in fuel costs per ASK, we forecast Air Arabia s EBITDAR at AED 231 million in 3Q2008. As for the bottom line, we forecast a net income of AED 206 million in 3Q2008, 25% higher than 3Q2007. We made some minor adjustments to our full-year figures, as the performance in the first half of the year was below our expectations (1H2008 EBITDAR was 6% below our forecast). Our new forecasts show that we are expecting Air Arabia to achieve an operating income of AED 355 million and a net income of AED 496 million in 2008. These forecasts are based on the assumption that oil prices will soften further in the fourth quarter and average around USD 105 per barrel. NBK Capital Page 5 of 8
Nepal Hub We were surprised by the suspension of operations of FlyYeti, but we do not expect this to have a material impact on Air Arabia s value. Even though FlyYeti was posting some promising numbers, it was always part of the original plan for FlyYeti to remain a smallscale operation with a maximum of four aircraft and Air Arabia owning 51%. In the shortterm, we expect the suspension of FlyYeti s operation to have a positive impact on the performance in the second half of 2008, as FlyYeti had not yet broken even, and according to management, all expenses relating to it were booked in 1H2008. Our forecasts no longer include any figures relating to the operation in Nepal, and we do not expect operations to resume even though management has not made a final decision on the matter. Morocco Hub Air Arabia is expected to make an official announcement regarding the hub in Morocco toward the end of the third quarter. Also, there is a chance that the hub might start operations before the end of the year. As mentioned in our previous reports, the operation out of the Rabat hub is expected to be large, and it might be very close in size to the operation in Sharjah. We did not incorporate the Rabat hub into our forecasts mainly because we still do not know what relationship the hub will have with Air Arabia (as it is not clear whether Air Arabia has a controlling stake or minority share with a management contract). Also, management has yet to disclose any information regarding the initial plan for the hub. We will account for the Rabat hub as soon as such information becomes available to us. The Airport Hotel Air Arabia has recently announced that it has started construction of a 300-room hotel at Sharjah Airport on a plot of land that the airline already owns. Construction is expected to be complete by early 2010, and the cost will total around AED 200 million. Air Arabia has signed a management contract with Rotana Hotels to manage the property under their Centro brand. The Centro brand by Rotana Hotels is designed to offer quality service at affordable rates, which targets both business and individual travelers seeking budget accommodation. We have included the operation of the hotel in our forecasts for Air Arabia. We assume that the hotel will start operations by mid-2010. NBK Capital Page 6 of 8
FINANCIAL STATEMENTS Balance Sheet (AED Thousands) Forecast Fiscal Year Ends December 2007 2008 2009 2010 2011 2012 ASSETS Cash and Short-Term Investments 2,969,906 2,056,240 2,276,806 2,631,427 2,515,318 1,861,954 Total Receivables, Net 135,720 221,507 274,733 345,485 395,155 464,247 Total Inventory 748 822 905 995 1,095 1,204 Total Current Assets 3,106,374 2,278,569 2,552,444 2,977,907 2,911,567 2,327,405 Property/Plant/Equipment, Total - Net 112,240 1,010,567 1,139,370 1,221,517 1,779,402 2,915,817 Goodwill, Net 1,320,860 1,320,860 1,320,860 1,320,860 1,320,860 1,320,860 Long Term Investments 593,778 1,406,729 1,475,725 1,548,208 1,624,353 1,704,342 Other Long-Term Assets, Total 204,308 77,794 127,443 193,003 259,261 337,197 TOTAL ASSETS 5,337,559 6,094,519 6,615,843 7,261,495 7,895,444 8,605,622 LIABILITIES & EQUITY Accounts Payable 193,790 317,459 390,225 492,549 569,679 675,263 Other Current Liabilities, Total 104,303 179,693 223,089 280,807 321,260 377,585 Total Current Liabilities 298,094 497,153 613,314 773,356 890,938 1,052,848 Long-Term Debt - - - - - - Other Liabilities, Total 9,988 10,488 11,012 11,563 12,141 12,748 Total Liabilities 308,082 507,640 624,326 784,919 903,079 1,065,595 Total Equity 5,029,477 5,586,879 5,991,518 6,476,576 6,992,365 7,540,026 TOTAL LIABILITIES AND EQUITY 5,337,559 6,094,519 6,615,843 7,261,495 7,895,444 8,605,622 Income Statement (AED Thousands) Forecast Fiscal Year Ends December 2007* 2008 2009 2010 2011 2012 Total Revenue 803,669 2,078,589 2,571,585 3,233,231 3,701,033 4,339,588 Operating expenses 626,001 1,685,894 2,080,096 2,636,412 3,055,859 3,621,638 Depreciation/Amortization 23,552 37,224 56,427 65,809 75,334 80,160 Operating Income 154,117 355,471 435,063 531,011 569,840 637,791 Interest Income (Exp), Net Non-Operating 100,683 135,918 99,977 111,032 112,932 87,207 Other, Net 27,172 4,277 4,479 4,702 4,947 5,217 Net Income 281,972 495,666 539,518 646,744 687,719 730,215 Cash Flow (AED Thousands) Forecast Fiscal Year Ends December 2007* 2008 2009 2010 2011 2012 Cash from Operating Activities 97,965 505,893 554,341 686,020 712,987 810,658 Cash from Investing Activities 594,837 (1,481,295) (198,895) (169,714) (657,166) (1,281,468) Cash from Financing Activities 3,266,700 (62,181) (134,880) (161,686) (171,930) (182,554) Net Change in Cash 3,959,501 (1,037,582) 220,567 354,620 (116,109) (653,364) * From June 19, 2007 to December 31, 2007. Sources: Annual Report and NBK Capital NBK Capital Page 7 of 8
NBK Capital Kuwait Head Office 17th Floor, Dar Al-Awadi Building Ahmed Al-Jaber Street, Sharq P.O. Box 4950, Safat 13050 Kuwait Tel: +965 224 6900 Fax: +965 224 6904 International Network United Arab Emirates NBK Capital Limited Precinct Building 3, Office 404 Dubai International Financial Center P.O. Box 506506, Dubai United Arab Emirates Tel: +971 4 365 2800 Fax: +971 4 365 2805 Turkey NBK Capital Arastima ve Musavirlik AS SUN Plaza, 30th Floor Dereboyu Sk. No.24 Maslak 34398, Istanbul, Turkey Tel: +90 212 276 5400 Fax: +90 212 276 5401 NBK Capital MENA Research Tel: + 965 224 6663 Fax: + 965 224 6984 E-mail: menaresearch@nbkcapital.com Disclaimer This document and its contents are prepared for your personal information purposes only and do not constitute an offer, or the solicitation of an offer, to buy or sell a security or enter into any other agreement. Projections of potential risk or return are illustrative, and should not be taken as limitations of the maximum possible loss or gain. The information and any views expressed are given as of the date of writing and subject to change. While the information has been obtained from sources believed to be reliable, we do not represent that it is accurate or complete and it should not be relied on as such. Watani Investment Company (NBK Capital), its affiliates and subsidiaries accept no liability for any direct, indirect or consequential loss arising from use of this document or its contents. At any time, the employees of NBK Capital and its affiliates and subsidiaries may at their discretion hold a position, subject to change, in any securities or instruments referred to, or provide services to the issuer of those securities or instruments. www.nbkcapital.com NBK Kuwait Abdullah Al-Ahmed Street P.O. Box 95, Safat 13001 Kuwait City, Kuwait Tel: +965 242 2011 Fax: +965 243 1888 Telex: 22043-22451 NATBANK International Network Bahrain Bahrain Branch Seef Tower, Al-Seef District 428 P.O. Box 5290, Manama Bahrain Tel: +973 17 583 333 Fax: +973 17 587 111 Jordan Amman Branch Shareef Abdul Hamid Sharaf St P.O. Box 941297 Shmeisani, Amman 11194 Jordan Tel: +962 6 560 8800 Fax: +962 6 560 8811 Saudi Arabia Jeddah Branch Al-Andalus Street, Red Sea Plaza P.O. Box 15385 Jeddah 21444, Saudi Arabia Tel: +966 2 653 8600 Fax: +966 2 653 8653 Lebanon National Bank of Kuwait (Lebanon) SAL BAC Building Justinian Street, Sanayeh P.O. Box 11-5727, Riyad El Solh Beirut 1107 2200, Lebanon Tel: +961 1 741111/742222 Fax: +961 1 747846/747866 Risk and Recommendation Guide Low Risk Iraq Credit Bank of Iraq Street 9, Building 178 Sadoon Street, District 102 P.O. Box 3420 Baghdad, Iraq Tel: +964 1 7182198/7191944 +964 1 7188406/7171673 Fax: +964 1 7170156 Egypt Al Watany Bank of Egypt 13 Al Themar Street Gameat Al Dowal AlArabia Fouad Mohie El Din Square Mohandessin, Giza, Egypt Tel: +20 2 33388816/33388817 Fax: +20 2 33379302 United States of America New York Branch 299 Park Avenue New York, NY 10171 USA Tel: +1 212 303 9800 Fax: +1 212 319 8269 United Kingdom National Bank of Kuwait (International) Plc Head Office 13 George Street London W1U 3QJ, UK Tel: +44 20 7224 2277 Fax: +44 20 7224 2101 NBK Investment Management Limited 13 George Street London W1U 3QJ, UK Tel: +44 20 7224 2288 Fax: +44 20 7224 2102 France National Bank of Kuwait (International) Plc Paris Branch 90 Avenue des Champs-Elysees 75008 Paris, France Tel: +33 1 5659 8600 Fax: +33 1 5659 8623 Singapore Singapore Branch 9 Raffles Place #51-01/02 Republic Plaza Singapore 048619 Tel: +65 6222 5348 Fax: +65 6224 5438 Vietnam Vietnam Representative Office Room 2006, Sun Wah Tower 115 Nguyen Hue Blvd, District 1 Ho Chi Minh City Vietnam Tel: +84 8 827 8008 Fax: +84 8 827 8009 China Shanghai Representative Office Suite 1003, 10th Floor, Azia Center 1233 Lujiazui Ring Road Shanghai 200120 China Tel: +86 21 6888 1092 Fax: +86 21 5047 1011 Associates Qatar International Bank of Qatar (QSC) Suhaim bin Hamad Street P.O. Box 2001 Doha, Qatar Tel: +974 447 3700 Fax: +974 447 3710 Turkey Turkish Bank Valikonagl CAD. 7 Nisantasi 34371, Istanbul, Turkey Tel: +90 212 225 0330 Fax: +90 212 296 0336 Recommendation Upside (Downside) Potential Buy more than 20% Accumulate between 10% and 20% Hold between -5% and 10% Reduce between -10% and -5% Sell less than -10% Risk Level 1 2 3 4 5 High Risk Copyright Notice: This is a publication of NBK Capital. No part of this publication may be reproduced or duplicated without the prior consent of NBK Capital.