Global Investment House – Kuwait- Air Arabia Aviation – Initial Update- March 2008- Air Arabia was established in February 2003 by the government of Sharjah as the region's first low-cost carrier. The company commenced operations on Oct. 28, 2003 with a paid-up capital of AED10mn. It underwent an AED2.57bn IPO in Mar. 2007. On Jun. 19, 2007, Air Arabia was transformed from a Limited Liability Company (LLC) to a Public Joint Stock Company (PJSC). After incorporation, the total capital of the company is AED4.67bn. The company listed its shares on Dubai Financial Market (DFM) in July, 2007.
Air Arabia started operations in Oct. 2003 out of its main hub, Sharjah International Airport, with two leased Airbus A320 aircraft flying to five destinations (Beirut, Bahrain, Damascus, Kuwait and Muscat). By May 2006, it increased its fleet size to 9 leased aircraft. Air Arabia had 11 leased aircraft (A320) at the end of 2007. It signed a contract in November 2007 to purchase 34 aircraft (A320) with an option for additional 15 aircraft to be delivered by 2013. Air Arabia currently operates routes between Sharjah and 39 destinations in 21 countries throughout the Middle East, North Africa, Indian subcontinent, and Central Asia. The Indian subcontinent accounts for nearly 37% of total destinations.
Air Arabia added a second hub in Nepal to serve markets across South and Central Asia, the Far East, Middle East and Indian subcontinent. The company established a joint venture with Yeti Airlines, the market leader in domestic air travel in Nepal. The new joint venture, FlyYeti.com, was launched on Jan. 20, 2008 in Nepal's capital, Kathmandu as Nepal's first LCC.
Performance Analysis
Passengers grew by a CAGR of 70% over the four year period from 2004 to 2007. Passenger traffic during 2007 reached 2.7mn, growing by 53% over 2006, and formed 70% of the total passenger traffic at Sharjah International Airport. Air Arabia expects passengers to reach 4.5mn passengers by 2010, a possible target considering the carrier's planned route and fleet expansions.
Air Arabia's load factors as measured by Revenue Passenger Kilometer (RPK) divided by Available Seat Kilometer (ASK) witnessed significant improvement from 66.7% in 2004 to 86.2% in 2007. Although the carrier's fleet increased from 3 A320s to 11 A320s, each having 162 seats, the growth in passengers outweighed the growth in capacity resulting in improved load factors.
Revenues grew at a CAGR of 92% during the four year period from 2004 to 2007. Revenues grew by 71% during 2007 to reach AED1.28bn. Passenger revenues form more than 90% of Air Arabia's revenues. Ancillary revenues which mainly consists of baggage and cargo revenues forms around 3% of revenues. Passenger revenues are expected to continue the increasing trend going forward given the carrier's planned fleet and route expansions. We expect total revenues to grow at a CAGR of 16.3% during the period from 2008 to 2011.
Air Arabia registered a net profit of AED376mn in 2007, growing by a remarkable 272% compared to 2006 net profit of AED101mn. This significant increase in net profit is partly attributed to a massive rise in income on bank deposits, which came on the back of the increase in Air Arabia's bank deposits balance following the company's IPO. Excluding profit from bank deposits, the growth in net profit in 2007 would stand at 186%. Net profit margin improved from 13.5% in 2006 to 29.3% in 2007. We expect net profit to grow at a CAGR of 16.2% during the period from 2008 to 2011.
Following the IPO, Air Arabia's balance sheet grew significantly from AED367.5mn in 2006 to AED5.5bn in 2007. The company's paid-up capital stood at AED4.67bn in 2007 as opposed to AED50mn in 2006. Air Arabia is currently a zero debt company. The company will use the IPO proceeds mainly for the purchase of new aircrafts and for strategic acquisition opportunities.
Valuation & Outlook
We believe that Air Arabia is set to grow further as a Low Cost Carrier in the Middle East region. The industry has a high growth potential as it is still in a nascent stage with a market penetration rate around 1% in the Middle East compared to a market penetration of around 30% in domestic US market, and intra-EU routes, and 6% in Asia. Also, the overall aviation sector in the region is witnessing unprecedented levels of growth on the back of strong regional economies, booming tourism, airport expansions, new capacities, and new routes. Boeing and Airbus expect the Middle East aviation market to expand by 5.5% and 6.2% per year on average till 2025. IATA expects the Middle East region to show the highest AAGR (Average Annual Growth Rate) from 2007 to 2011 in terms of passenger traffic, growing by 6.8% compared to an expected 5.1% AAGR for global traffic.
The UAE aviation market in particular has a high potential, evidenced by the latest move from Dubai's Ruler and Prime Minister of the United Arab Emirates, Sheikh Mohammed bin Rashid Al Maktoum, who instructed the authorities to set up a low cost airline in Dubai to complement the international air services already provided by Emirates airlines. The country has registered the highest growth rates in terms of tourist arrivals in the Middle East region. In addition, the favorable demographic profile in UAE should also bolster the aviation sector considering that around 78% of the UAE's population are expatriates.
We believe that Air Arabia has well positioned itself to leverage on the booming aviation market in the region. The company has added a second hub in Nepal to expand its services to other high growth potential markets such as the Indian subcontinent. Airbus expects Middle East to India traffic to increase by 6.3% annually on average over the ten year period from 2005-2015. Also, Air Arabia was considering a third hub in Morocco to expand its geographical reach to other regions such as Europe. The company's strong balance sheet will also help Air Arabia achieve its strategic targets. The company had already signed an order to purchase up to 49 Airbus, which will expand the frequencies of its current routes as well as help in adding new destinations. Also, Air Arabia is seeking strategic acquisition opportunities that will strengthen its position in the market.
We initiate our coverage of Air Arabia with a ‘Buy’ recommendation. Based on the combination of Discounted Cash Flow Method and EV/EBITDAR multiple, we have valued the company’s shares at an intrinsic value of AED2.21 per share, with a 15.4% premium over the current market price of AED1.92 per share.
