Operating Profitability Weakens

Air arabia Operating Profitability Weakens May 16, 2011 Key data Fair Value per share (AED) 0.75 Closing Price (AED) * 0.73 52-week High / Low (AED) 0.90/0.72 YTD / 12-month return -11%/-19% P/E (TTM) 11.4 Shares Outstanding (Millions) 4,667 Market Cap (AED Millions) 3,407 Free Float 55.0% Reuters / Bloomberg Code AIRA.DU/AIRARABI UH *Price as of close on May 15, 2011 Sources: Bloomberg and NBK Capital Key METRICS 2010A 2011F 2012F 2013F EPS 0.066 0.031 0.039 0.041 EPS Growth -32.4% -51.9% 24.1% 6.0% P/E 11.1 23.2 18.7 17.6 Dividend Yield 11.0% 3.5% 3.2% 3.4% EV/EBITDA 7.2 8.4 4.7 3.5 Revenue (Millions) 2,080 2,291 2,535 2,755 Revenue Growth 5.5% 10.1% 10.7% 8.7% EBITDAR (Millions) 480 374 484 543 EBITDAR Growth -6.1% -22.1% 29.3% 12.2% EBITDAR Margin 23.3% 16.3% 19.1% 19.7% Sources: Company financials and NBK Capital Quarterly FORECASTS AED M illions 2Q2010A 1Q2011A 2Q2011F 3Q2011F Revenue 485 513 576 611 EBITDAR 88 58 54 135 a = actual, f = forecast. Sources: Company financials and NBK Capital Rebased Performance 0.95 0.90 0.85 0.80 0.75 0.70 0.65 0.60 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Air Arabia Sources: MSCI, Bloomberg, and NBK Capital MSCI UAE Highlights 12-Month Fair Value: AED 0.75 Recommendation: Hold-Risk Level: 4** Reason for Report: 1Q2011 Update Despite having achieved some strong operating statistics, Air Arabia posted a disappointing financial performance in 1Q2011. Air Arabia registered an 11% increase in traffic in 1Q2011 to 1.2 million passengers and a high load factor of 86% (compared to 80% in 1Q2010). However, growth in revenue was lower than that achieved for the number of passengers, which highlights the continued pressure on yields. Air Arabia s revenue increased by 6% to AED 513 million, 8.7% lower than our forecast. On the other hand, yield (revenue per passenger) fell by 5% to AED 446, a surprising outcome given the cost pressure the company is facing from rising fuel costs. Air Arabia s yield stood at AED 469 in 4Q2010, and given that jet fuel prices have been on the rise since 4Q2010, we were anticipating yields to expand to compensate for the increase in this cost item. In our forecast, we assumed a 5% improvement in yields. The combination of rising fuel costs and the drop in revenue per passenger proved to be lethal. Air Arabia s operating profit came in at a meager AED 1 million, while EBITDAR saw a 33% decline to AED 58.2 million (36% lower than our forecast). This differential is largely due to a weakerthan-expected top-line performance, as the fuel expense was in line with our forecast. We believe that such a weak operating profit will roll over to 2Q2011, as we expect the fuel expense to increase by about 30%. We foresee that 2Q2011 will be one of the most challenging quarters in Air Arabia s history, but we anticipate an improvement in the company s fortunes in 3Q2011. We lowered our 12-month fair value target for Air Arabia s stock price by 6%, from AED 0.80 per share to AED 0.75 per share. This drop is driven by a lower forecast for operating profit in 2011 and a lower assumption for yield expansion over the short-term. We feel that Air Arabia s stock price has some downward protection as cash and available-for-sale investments (after accounting for the dividend payment) account for AED 0.47 per share (65% of the current price). Based on yesterday s closing price, our recommendation for Air Arabia is Hold. Analyst Samir Murad, CFA T. +965 2259 5145 E. samir.murad@nbkcapital.com **Please refer to page 6 for recommendations and risk ratings. nbkcapital. com

Revenue misses our forecast due to a decline in yields Air Arabia registered an 11% increase in traffic in 1Q2011 to 1.2 million passengers and a high load factor of 86% (compared to 80% in 1Q2010). However, this improvement in passenger traffic numbers was offset by a 5% decline in yield (revenue per passenger), from AED 468 in 1Q2010 to AED 446 in 1Q2011. Accordingly, growth in revenue was lower than that for the number of passengers, with revenue increasing by just 6% to AED 513 million 8.7% lower than our forecast. The 5% drop in Air Arabia s yield in 1Q2011 came as a surprise, given that the airline s fuel expense was 28% higher in 1Q2011 than in 1Q2010. We were anticipating an improvement in the yield in 1Q2011 to offset some of the increase in fuel costs. According to management, the airline started to introduce fuel surcharges in late February, the impact of which started to be felt in March. We view this as an indication of better yields in 2Q2011 than in 1Q2011, as the average ticket price should increase due to the inclusion of fuel surcharges. Accordingly, we anticipate yields will improve by 10% in 2Q2011 and by an additional 10% in 3Q2011. Overall, our revenue forecast for 2011 shows a 9% increase over 2010 but represents a 7% reduction from our previous estimate. Figure 1 Revenue per Passenger 500 495 490 480 470 468 469 460 Revenue per passenger was surprisingly weak in 1Q2011 AED 450 446 440 435 430 420 410 400 1Q2010 2Q2010 3Q2010 4Q2010 1Q2011 Revenue per Passenger Sources: Air Arabia and NBK Capital As expected, fuel costs rise sharply, and we anticipate an additional increase in 2Q2011 Jet fuel prices have soared in 2011, with the current price already 56% higher than the average in FY2010. Air Arabia, which has hedged for only 15% of the airline s fuel requirement for 2011, remains severely exposed to this cost item. Fuel costs accounted for 34% of Air Arabia s FY2010 revenue and 43.5% of 1Q2011 revenue. The company s defense against the increase in this cost rests on Air Arabia s ability to pass some of the cost increase to its customers, a strategy that did not bear fruit during 1Q2011. nbkcapital. com 2

Figure 2 Jet Fuel Prices (Kerosene Type) 3.5 3.3 3.1 2.9 Fuel prices have been soaring Dollar per Gallon 2.7 2.5 2.3 2.1 1.9 1.7 1.5 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Source: US Energy Information Administration Air Arabia barely breaks even at the operating level in 1Q2011, and profitability for the rest of 2011 depends significantly on the airline s ability to increase yields Air Arabia saw a 33% decline in EBITDAR to AED 58.2 million, 36% lower than our forecast. This differential is largely due to a weaker-than-expected top-line performance, as the fuel expense was in line with our forecast. The airline barely broke even at the operating profit level, as the operating profit stood at a meager AED 1 million (a 94% decline from the level in 1Q2010). We expect that such a weak operating profit will roll over to 2Q2011, as we forecast that the fuel expense will increase by about 30%. We foresee 2Q2011 being one of the most challenging quarters in Air Arabia s history, but we anticipate an improvement in the company s fortunes in 3Q2011. Figure 3 Income Statement Summary Income Statement (AED Thousands) First-Quarter Results Common Size 2010 2011 Change 1Q2010 1Q2011 Air Arabia barely broke even at the operating profit level Total Revenue 482,054 513,218 6% 100.0% 100.0% Cost of Revenue 432,178 478,026 11% 89.7% 93.1% Gross Profit 49,876 35,192-29% 10.3% 6.9% Selling and Marketing 10,135 7,774-23% 2.1% 1.5% General and Administrative 23,506 26,457 13% 4.9% 5.2% Operating Income 16,235 961-94% 3.4% 0.2% Interest Income(Exp), Net Non-Operating 32,999 19,167-42% 6.8% 3.7% Other, Net 373 22,576 0.1% 4.4% Net Income 49,607 42,704-14% 10.3% 8.3% EBITDA 28,583 22,475-21% 5.9% 4.4% Depreciation/Amortization 12,348 21,514 74% 2.6% 4.2% EBITDAR 86,446 58,175-33% 17.9% 11.3% Lease Rentals 57,863 35,700-38% 12.0% 7.0% Sources: Company financial statements and NBK Capital nbkcapital. com 3

We cut our fair value target by 6% to AED 0.75 per share to reflect a more challenging environment in the short-term than we had previously anticipated We revised our 2011 forecasts for Air Arabia to reflect a lower-than-previously-anticipated expansion in yields. In addition, we tweaked our fuel assumptions based on current market conditions. Overall, the changes we made resulted in a 14% decline in our EBITDAR forecast for 2011, from AED 435 million to AED 374 million. Due to Air Arabia s weaker-than-expected performance in 1Q2011, continued pressure on yields, and escalating jet fuel prices, we cut our fair value target for Air Arabia by 6% to AED 0.75 per share. Given that our new fair value is just 1% higher than Air Arabia s latest close, our recommendation for the stock is Hold. nbkcapital. com 4

Financial Statements Balance Sheet (A ED Tho usands ) Fiscal Year Ends December 2009 2010 2011 2012 2013 2014 2015 ASSETS Cash 1,996,251 1,844,563 1,000,312 783,533 800,806 109,517 79,280 Total Receivables, Net 292,211 575,065 312,700 346,167 373,684 393,219 412,659 Total Inventory 5,051 6,437 7,403 8,513 9,364 10,301 11,331 Total Current Assets 2,293,513 2,426,065 1,320,415 1,138,213 1,183,855 513,036 503,270 Property/Plant/Equipment, Total - Net 1,135,691 1,788,712 2,830,313 3,551,479 4,471,121 5,583,932 6,169,031 Goodwill and Intangibles 1,281,821 1,281,821 1,281,821 1,281,821 1,281,821 1,281,821 1,281,821 Long Term Investments 1,284,229 805,747 787,679 771,025 764,902 766,959 796,594 Other Long-Term Assets, Total 76,243 67,653 85,007 100,376 116,598 131,404 148,047 TOTAL ASSETS 6,071,497 6,369,998 6,305,234 6,842,913 7,818,296 8,277,152 8,898,762 LIABILITIES & EQUITY Historical Forecast Accounts Payable 427,601 541,396 514,287 531,093 553,863 567,197 562,698 Other Current Liabilities, Total 129,352 177,993 149,333 165,438 180,114 194,369 207,807 Total Current Liabilities 556,953 719,389 663,620 696,532 733,977 761,566 770,505 Long-Term Debt - 214,303 428,606 857,212 1,714,424 2,000,000 2,404,300 Other Liabilities, Total 46,235 59,377 62,346 65,463 68,736 72,173 75,782 Minority Interest 6,220 6,344 6,471 6,601 6,733 6,867 Total Liabilities 603,188 999,289 1,160,916 1,625,678 2,523,738 2,840,472 3,257,454 Total Equity 5,468,309 5,370,709 5,144,318 5,217,235 5,294,557 5,436,680 5,641,308 TOTAL LIABILITIES AND EQUITY 6,071,497 6,369,998 6,305,234 6,842,913 7,818,296 8,277,152 8,898,762 Income Statement (A ED Tho usands ) Historical Forecast Fiscal Year Ends December 2009 2010 2011 2012 2013 2014 2015 Total Revenue 1,971,965 2,080,313 2,290,550 2,534,777 2,755,095 2,970,136 3,171,193 Operating Expenses (1,642,609) (1,825,183) (2,071,896) (2,144,391) (2,233,383) (2,282,166) (2,246,687) Depreciation/Amortization (50,214) (55,448) (137,731) (204,102) (277,719) (375,496) (497,425) Operating Income 279,141 199,682 80,923 186,285 243,993 312,474 427,081 Interest Income (Expense), Net 156,266 115,569 82,888 11,450 (45,789) (78,902) (116,931) Other, Net 16,823 (5,692) (13,021) (11,520) (897) 7,380 35,058 Minority Interest - (3,770) (3,845) (3,922) (4,001) (4,081) (4,162) Net Income 452,231 305,789 146,945 182,292 193,307 236,872 341,046 Cash Flow Statement (A ED Tho usands ) Historical Forecast Fiscal Year Ends December 2009 2010 2011 2012 2013 2014 2015 Cash from Operating Activities 410,667 446,851 440,369 388,720 530,790 695,088 912,974 Cash from Investing Activities 233,919 (135,347) (1,092,923) (886,646) (1,165,152) (1,473,256) (1,089,165) Cash from Financing Activities (415,460) (463,192) (191,697) 281,147 651,635 86,879 145,954 Net Change in Cash 229,126 (151,688) (844,251) (216,779) 17,273 (691,289) (30,237) Sources: Air Arabia and NBK Capital nbkcapital. com 5

RISK AND RECOMMENDATION GUIDE RECOMMENDATION UPSIDE (DOWNSIDE) POTENTIAL BUY MORE THAN 20% ACCUMULATE BETWEEN 5% AND 20% HOLD BETWEEN -10% AND 5% REDUCE BETWEEN -25% AND -10% SELL LESS THAN -25% RISK LEVEL LOW RISK HIGH RISK 1 2 3 4 5 Disclaimer The information, opinions, tools, and materials contained in this report (the Content ) are not addressed to, or intended for publication, distribution to, or use by, any individual or legal entity who is a citizen or resident of or domiciled in any jurisdiction where such distribution, publication, availability, or use would constitute a breach of the laws or regulations of such jurisdiction or that would require Watani Investment Company KSCC ( NBK Capital ) or its subsidiaries or its affiliates to obtain licenses, approvals, or permissions from the regulatory bodies or authorities of such jurisdiction. The Content, unless expressly mentioned otherwise, is under copyright to NBK Capital. Neither the Content nor any copy of it may be in any way reproduced, amended, transmitted to, copied, or distributed to any other party without the prior express written consent of NBK Capital. All trademarks, service marks, and logos used in this report are trademarks or service marks or registered trademarks or registered service marks of NBK Capital. The Content is provided to you for information purposes only and is not to be used, construed, or considered as an offer or the solicitation of an offer to sell or to buy or to subscribe for any investment (including but not limited to securities or other financial instruments). No representation or warranty, express or implied, is given by NBK Capital or any of its respective directors, partners, officers, affiliates, employees, advisors, or representatives that the investment referred to in this report is suitable for you or for any particular investor. Receiving this report shall not mean or be interpreted that NBK Capital will treat you as its customer. If you are in doubt about such investment, we recommend that you consult an independent investment advisor since the investment contained or referred to in this report may not be suitable for you and NBK Capital makes no representation or warranty in this respect. The Content shall not be considered investment, legal, accounting, or tax advice or a representation that any investment or strategy is suitable or appropriate for your individual circumstances or otherwise constitutes a personal recommendation to you. NBK Capital does not offer advice on the tax consequences of investments, and you are advised to contact an independent tax adviser. The information and opinions contained in this report have been obtained or derived from sources that NBK Capital believes are reliable without being independently verified as to their accuracy or completeness. NBK Capital believes the information and opinions expressed in this report are accurate and complete; however, NBK Capital gives no representations or warranty, express or implied, as to the accuracy or completeness of the Content. Additional information may be available upon request. NBK Capital accepts no liability for any direct, indirect, or consequential loss arising from the use of the Content. This report is not to be relied upon as a substitution for the exercise of independent judgment. In addition, NBK Capital may have issued, and may in the future issue, other reports that are inconsistent with and reach different conclusions from the information presented in this report. Those reports reflect the different assumptions, views, and analytical methods of the analysts who prepared the reports, and NBK Capital is under no obligation to ensure that such other reports are brought to your attention. NBK Capital may be involved in many businesses that relate to companies mentioned in this report and may engage with them. Past performance should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance. Information, opinions, and estimates contained in this report reflect a judgment at the report s original date of publication by NBK Capital and are subject to change without notice. The value of any investment or income may fall as well as rise, and you may not get back the full amount invested. Where an investment is denominated in a currency other than the local currency of the recipient of the research report, changes in the exchange rates may have an adverse effect on the value, price, or income of that investment. In the case of investments for which there is no recognized market, it may be difficult for investors to sell their investments or to obtain reliable information about their value or the extent of the risk to which they are exposed. NBK Capital has not reviewed the addresses of, the hyperlinks to, or the websites referred to in the report and takes no responsibility for the content contained therein. Such address or hyperlink (including addresses or hyperlinks to NBK Capital s own website material) is provided solely for your convenience and information, and the content of the linked site does not in any way form part of this document. Accessing such websites or following such links through this report or NBK Capital s website shall be at your own 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. nbkcapital. com 6

NBK CAPITAL Kuwait Head Office 38th Floor, Arraya II Al Shuhada Street, Block 6, Sharq P.O.Box 4950, Safat 13050 Kuwait T. +965 2224 6900 F. +965 2224 6905 MENA Research 35th Floor, Arraya II Al Shuhada Street, Block 6, Sharq P.O.Box 4950, Safat 13050, Kuwait T. +965 2224 6663 F. +965 2224 6905 E. menaresearch@nbkcapital.com.kw Brokerage 37th Floor, Arraya II Al Shuhada Street, Block 6, Sharq P.O.Box 4950, Safat 13050, Kuwait T. +965 2224 6964 F. +965 2224 6978 E. brokerage@nbkcapital.com United Arab Emirates NBK Capital Limited Precinct Building 3, Office 404 Dubai International Financial Center P.O.Box 506506 Dubai, UAE T. +971 4 365 2800 F. +971 4 365 2805 Turkey NBK Capital Arastima ve Musavirlik AS, Sun Plaza, 30th Floor, Dereboyu Sk. No.24 Maslak 34398, Istanbul, Turkey T. +90 212 276 5400 F. +90 212 276 5401 National Bank of Kuwait Kuwait Abdullah Al-Ahmed Street P.O. Box 95, Safat 13001 Kuwait City, Kuwait T. +965 2242 2011 F. +965 2243 1888 Telex: 22043-22451 NATBANK Jordan Head Office Al Hajj Mohd Abdul Rahim Street Hijazi Plaza, Building # 70 P.O.Box 941297, Amman -11194, Jordan T. +962 6 580 0400 F. +962 6 580 0441 United States of America New York Branch 299 Park Avenue, 17th Floor New York, NY 10171, USA T. +1 212 303 9800 F. +1 212 319 8269 Vietnam Vietnam Representative Office Room 2006, Sun Wah Tower 115 Nguyen Hue Blvd, District 1 Ho Chi Minh City, Vietnam T. +84 8 3827 8008 F. +84 8 3827 8009 INTERNATIONAL NETWORK Bahrain Bahrain Branch Seef Tower, Al-Seef District P.O. Box 5290, Manama, Bahrain T. +973 17 583 333 F. +973 17 587 111 Saudi Arabia Jeddah Branch Al-Andalus Street, Red Sea Plaza P.O. Box 15385 Jeddah 21444, Saudi Arabia T. +966 2 653 8600 F. +966 2 653 8653 United Arab Emirates Dubai Branch Sheikh Rashed Road, Port Saeed Area, ACICO Business Park P.O. Box 88867, Dubai United Arab Emirates T. +971 4 2929 222 F. +971 4 2943 337 Lebanon National Bank of Kuwait (Lebanon) SAL Sanayeh Head Office BAC Building, Justinian Street P.O. Box 11-5727, Riyad El Solh 1107 2200 Beirut, Lebanon T. +961 1 759 700 F. +961 1 747 866 Iraq Credit Bank of Iraq Street 9, Building 187 Sadoon Street, District 102 P.O.Box 3420, Baghdad, Iraq T. +964 1 7182198/7191944 +964 1 7188406/7171673 F. +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 T. +202 333 888 16/17 F. +202 333 79302 United Kingdom National Bank of Kuwait (Intl.) Plc Head Office 13 George Street, London W1U 3QJ, UK T. +44 20 7224 2277 F. +44 20 7224 2101 NBK Investment Management Limited 13 George Street London W1U 3QJ, UK T. +44 20 7224 2288 F. +44 20 7224 2102 France National Bank of Kuwait (Intl.) Plc Paris Branch 90 Avenue des Champs-Elysees 75008 Paris, France T. +33 1 5659 8600 F. +33 1 5659 8623 Singapore Singapore Branch 9 Raffles Place #51-01/02 Republic Plaza, Singapore 048619 T. +65 6222 5348 F. +65 6224 5438 China Shanghai Representative Office Suite 1003, 10th Floor, Azia Center, 1233 Lujiazui Ring Rd. Shanghai 200120, China T. +86 21 6888 1092 F. +86 21 5047 1011 ASSOCIATES Qatar International Bank of Qatar (QSC) Suhaim bin Hamad Street P.O.Box 2001 Doha, Qatar T. +974 447 3700 F. +974 447 3710 Turkey Turkish Bank Head Office Valikonagl Avenue No. 1 P.O.Box 34371 Nisantasi, Istanbul, Turkey T. +90 212 373 6373 F. +90 212 225 0353 nbkcapital. com 7

KUWAIT DUBAI ISTANBUL CAIRO