Low-Oil, Low-Profit

Change in target price Narongpand Low-oil, low-profit Lisahapanya SELL: Oil price collapse unlikely to bring profit bounce [email protected] We expect THAI’s jet fuel cost to drop 34% in 2016. This cost saving, +66 2 257 4636 however, should be muted. With an increasing number of its regional peers having done away with fuel surcharge, THAI is likely to be forced to drastically cut the surcharge currently being added to air tickets. Our 2016 profit estimate assumes 80% of surcharge to be eliminated and if all surcharges were removed, its 2016 profit could

swing to a loss. With continued challenges ahead, we cut price target to Bt7.9 from Bt9.0. Retain SELL.

25 January 2016 Expectations worsening We have been rating THAI as SELL on an expectation that despite Thailand management change, turning the airline around would take longer than Transport market anticipated. This played out well with 9M15 results showing operational improvements to have come entirely from lower fuel expenses. Reuters THAI.BK With share price dropping, a credit rating agency recently downgrading THAI’s Bloomberg THAI TB credit rating in January 2016 and THAI announcing its asset sales, Priced on 21 January 2016 expectations are worsening. Thai SET @ 1,245.6 Recent oil prices collapse may not help 12M hi/lo Bt15.70/7.50 We forecast jet fuel price averaging US$52/bbl in 2016 and estimate THAI’s

12M price target Bt7.90 jet fuel cost to drop by 34% in 2016. This cost saving, however, should to be ±% potential -9% muted by the likely removal of fuel surcharge currently added to air tickets. We estimate about a fifth of THAI’s passenger yield is fuel surcharge. Given Shares in issue 2,182.8m Free float (est.) 33.6% the fact that an increasing number of its regional peers have done away with the surcharge, competition is likely to force THAI to cut or remove its Market cap US$525m surcharge. This would, in turn, work to offset the benefit from low-oil.

3M average daily volume Risk is skewed to the downside Bt28.4m (US$0.8m) We trim 2016CL profit 4%. Our estimate assumes THAI to remove c.80% of Foreign s'holding 31.5% its fuel surcharge. A reduction in surcharge lowers passenger yield from

Major shareholders Bt2.55/RPK in 2015CL to Bt2.14/RPK in 2016CL, offsetting the drop in fuel Ministry of finance 51.0% cost. While our estimate indicates THAI will make Bt5.6bn profit in 2016 vs. Vayupak Fund 15.4% loss in 2015, risk is skewed to the downside. Sensitivity shows 2016CL profit would swing to loss if, like competitors, THAI eliminated all oil surcharge and

still see yield excluding surcharge drop 5% from 2015 level on weak demand.

Maintain SELL With share price reaching our previous price target, we cut the price target Stock performance (%) for THAI to Bt7.9 from Bt9, implying 11% price downside. With continued 1M 3M 12M challenges ahead and a weak balance sheet, we reiterate our SELL call. Absolute 4.8 (17.1) (44.9)

Relative 6.4 (5.8) (32.0) Financials

Abs (US$) 4.6 (18.4) (50.5) Year to 31 December 13A 14A 15CL 16CL 17CL

17.6 (Bt) (%) 150 Revenue (Btm) 206,336 188,368 181,953 150,427 153,183 Rev forecast change (%) - - (4.5) (18.2) (18.2) 14.9 100 Net profit (Btm) (12,047) (15,612) (21,615) 5,589 5,757 12.2 NP forecast change (%) - - nm (4.4) 18.5 50 EPS (Bt) (5.5) (7.2) (9.9) 2.6 2.6 9.5 CL/consensus (10) (EPS%) - - 966 235 157 6.8 0 EPS growth (% YoY) (293.4) nm nm nm 3.0 Jan-14 Jul-14 Jan-15 Jul-15 Thai Airways (LHS) PE (x) nm nm nm 3.4 3.3 Rel to SET (RHS) Dividend yield (%) 0.0 0.0 0.0 7.4 7.6 ROE (%) (19.2) (31.8) (74.7) 26.7 21.0 Source: Bloomberg Net debt/equity (%) 289.0 408.1 1,140.8 689.3 536.3 www.clsa.com Source: CLSA

Find CLSA research on Bloomberg, Thomson Reuters, Factset and CapitalIQ - and profit from our evalu@tor proprietary database at clsa.com For important disclosures please refer to page 9. Low-oil, low-profit Thai Airways - SELL

Expectations worsening We have been rating THAI as SELL on an expectation that despite management change, turning the airline around would take longer than market anticipated. This played out well with 9M15 results showing operational improvements to have come entirely from lower fuel expenses. With share price dropping, a credit rating agency recently downgrading THAI’s credit rating in January 2016 and THAI announcing its asset sales, expectations are worsening.

Figure 1 Figure 2 THAI’s 9M15 operating loss reduction.. ..came from the drop in fuel expenses

(Btm) Operating profit Non-fuel Fuel and oil 160 152 0 (Btm) 138 (2,000) 140 (4,000) (4,536) 120 59.0 -Bt13.2bn (6,000) 45.8 (8,000) 100 (10,000) (12,000) 80 -Bt11.7bn (14,000) 92.6 92.3 60 (16,000) (18,000) (16,224) 40 9M14 9M15 9M14 9M15 Source: THAI

Figure 3 TRIS Rating downgrades the company rating of Thai Airways International PLC Date Rating Outlook 11-Sep 03 AA- - 12-Jul 04 AA- Stable 25-Jul-08 A+ Stable 23-Jan 09 A Stable 17-Dec 10 A+ Stable 27-Dec-13 A+ Negative 12-Jan-16 A Stable Source: TRIS rating

Figure 4 Share price movement from 1 Jan 2015 to now vs. SET

120 Rebase = 100 THAI's share price SET index 110

100

Jul 15 Jul

Jan 15 Jan 16 Jan

Oct 15 Oct

Jun 15 Jun

Apr 15 Apr

Feb 15 Feb

Mar 15Mar

Dec 15 Dec

Sep 15 Sep

Aug 15 Aug Nov 15 Nov May 15May Source: Bloomberg

25 January 2016 [email protected] 2 Low-oil, low-profit Thai Airways - SELL

Recent oil prices collapse may not help We forecast jet fuel price averaging US$52/bbl in 2016 and estimate THAI’s jet fuel cost to drop by 34% in 2016. This cost saving, however, should to be muted by the likely removal of fuel surcharge currently added to air tickets. We estimate about a fifth of THAI’s passenger yield is fuel surcharge. Given the fact that an increasing number of its regional peers have done away with the surcharge, competition is likely to force THAI to cut or remove its surcharge. This would, in turn, work to offset the benefit from low-oil.

Figure 5 CLSA jet fuel price forecasts (US$/bbl) 2012A 2013A 2014A 2015CL 2016CL 2017CL 2018CL New 127 123 113 66 52 62 70 Old 127 123 113 73 79 87 (10) (35) (29) Source: CLSA

Figure 6 We expect jet fuel price to average US$52/bbl vs US$66/bbl in 2015

140 (US$/bbl) Jet fuel price 2016CL 2017CL 120 2018CL

100

80 US$70/bbl US$62/bbl 60 US$52/bbl Current Jet fuel price = US$39.5/bbl 40

Jul 14 Jul 15 Jul 16 Jul

Jan 14 Jan 15 Jan 16 Jan

Mar 14 Mar 15 Mar 16 Mar

Sep 14 Sep 15 Sep

Nov 14 Nov 15 Nov

May 15 May 16 May May 14 May Source: CLSA

Figure 7 Jet fuel cost calculation (US$/bbl) 2014A 2015CL 2016CL 2017CL 2018CL Spot price 113 66 52 62 70 Hedged price 95 70 na na Average THAI's Jet fuel price 120 89 59 62 70 Source: CLSA, THAI

25 January 2016 [email protected] 3 Low-oil, low-profit Thai Airways - SELL

Figure 8 We estimate surcharge to account for c. 20% of THAI’s pax yield in 2015

3.0 (Bt/RPK) 2.55 2.5 Surcharge = 20% 2.0

1.5

1.0

0.5

0.0 2015CL Source: CLSA

Risk is skewed to the downside We trim 2016CL profit 4%. Our estimate assumes THAI to remove c.80% of its fuel surcharge. A reduction in surcharge lowers passenger yield from Bt2.55/RPK in 2015CL to Bt2.14/RPK in 2016CL, offsetting the drop in fuel cost. While our estimate indicates THAI will make Bt5.6bn profit in 2016 vs. loss in 2015, risk is skewed to the downside. Sensitivity shows 2016CL profit would swing to loss if, like competitors, THAI eliminated all oil surcharge and still see yield excluding surcharge drop 5% from 2015 level on weak demand.

Figure 9 THAI’s earnings revisions (Btm) 9M15A 2015CL 2016CL 2017CL New (18,119) (21,615) 5,589 5,757 Old (18,119) (9,942) 5,845 4,859 %chg (117) (4) 18 Consensus estimate (Btm) (2,504) 2,405 4,317 Source: CLSA

Figure 10 Our profit estimate for 2016 assumes THAI to remove 80% of its fuel surcharge

(Bt/RPK) 3.0 2.55 2.5 2.14

2.0

1.5

1.0

0.5

0.0 2015CL 2016CL Source: CLSA

25 January 2016 [email protected] 4 Low-oil, low-profit Thai Airways - SELL

Figure 11 An increasing number of Asian airlines have done away with the surcharge List of airlines that have already remove fuel surcharge Japan Airline ANA AirAsia Bhd Thai AirAsia Korean Air Source: CLSA

Figure 12 If we assumed 100% of fuel surcharge is removed and passenger yield excluding surcharge continued to drop by 5% from 2015CL level, THAI would go from making profit to making a loss in 2016CL (%) 2015CL 2016CL remove 80% 2016CL remove 100% 2016CL remove 100% of of fuel surcharge of fuel surcharge fuel surcharge and pax yield fall by 5% Pax yield ex fuel surcharge 2.04 2.04 2.04 1.94 Surcharge 0.51 0.10 - - Pax yield 2.55 2.14 2.04 1.94 THAI's net profit (Btm) (21,615) 5,589 2,212 (1,288) Source: CLSA, THAI

Figure 13 Key operating assumptions Actual NEW Old 9M15A 2015CL 2016CL 2017CL 2015CL 2016CL 2017CL Cabin Factor (%) 73.1 73.3 73.0 73.0 73.0 73.0 73.5 Passenger Yield (Inc surchange) (Bt/km) 2.46 2.55 2.14 2.21 2.56 2.58 2.58 Freight Load Factor (%) 59.2 60 60 60 60 60 60 Freight Yield (Bt/km) 8.3 8.76 8.76 8.76 7.84 7.84 7.84 ASK (Btm) 61,820 79,798 74,811 73,980 81,773 77,035 77,478 RASK (Bt/seat/km) 2.2 2.3 2.1 2.1 2.4 2.4 2.5 CASK (Bt/seat/km) 2.3 2.4 1.9 2.0 2.3 2.3 2.3 Source: CLSA, THAI

Maintain SELL With share price reaching our previous price target, we cut the price target for THAI to Bt7.9 from Bt9, implying 11% price downside. With continued challenges ahead and a weak balance sheet, we reiterate our SELL call.

Figure 14 Price target downgrade to Bt7.9 from Bt9 Thai Airway's price target New Old Target Target price Target Target price multiple (x) (Bt) multiple (x) (Bt) EV/EBITDAR 6.5 (2.0) 6.5 0.6 PE 7.0 17.9 11.0 29.5 PB 1.7 7.8 (0.2) (3.1) Blended price target 7.9 9.0 Source: CLSA, THAI

25 January 2016 [email protected] 5 Low-oil, low-profit Thai Airways - SELL

Figure 15 Net gearing is high; declining net D/E is partly due to asset revaluation in late ’15

14 (x) THAI's net D/E

12 11.5 10

8 7.0 6 5.4 4 4.1 2.9 2

0 2013A 2014A 2015CL 2016CL 2017CL Source: CLSA, THAI

Figure 16 Low PBV relative to history is justified by challenges THAI faces

3.5 (X)

3.0

2.5

2.0

1.5 +1sd1.53x

1.0 avg1.1x -1sd0.68x

0.5

Jul 14 Jul Jul 11 Jul 12 Jul 13 Jul 15 Jul

Jan 11 Jan 12 Jan 13 Jan 14 Jan 15 Jan

Source: CLSA

Figure 17 Full service airlines regional peer Price Mkt cap PE (x) Div Yld PBV (x) ROE (%) EV/Ebitda (%) (x) (Lcc.) (US$m) 16CL 17CL 16CL 17CL 16CL 17CL 16CL 17CL 16CL 17CL Full service airline 753 HK Air China 5.0 12,477 6.1 5.8 2.7 2.7 0.9 0.8 14.3 13.4 5.3 5.1 9202 JP ANA Holding 319 9,601 18.4 16.8 1.6 1.6 1.5 1.4 8.4 8.7 6.1 5.3 293 HK Cathay Pacific 12.5 6,068 8.6 8.0 4.7 5.0 0.9 0.8 10.5 10.5 4.8 4.7 2610 TT China Airlines 11.2 1,827 7.5 8.0 1.2 0.9 1.1 1.0 14.9 12.1 5.9 6.0 600115 CH China East Airline 7.1 11,352 12.3 11.5 0.9 0.8 2.4 2.0 20.4 17.4 5.7 5.4 1055 HK China Southern Airline 4.5 9,498 6.1 5.3 2.7 2.6 0.9 0.8 16.6 15.9 4.6 4.4 2618 TT EVA Airways 17.7 2,039 8.2 8.3 0.2 0.2 1.3 1.1 19.4 14.3 4.6 4.6 9201 JP Japan Airlines 4,203 13,039 8.5 8.3 2.4 2.4 1.7 1.4 21.2 18.4 4.9 4.3 QAN AU Qantas Airways 3.9 5,679 12.2 6.9 - 2.1 2.5 2.1 23.3 32.0 4.7 3.5 THAI TB Thai Airways 8.7 525 3.4 3.3 7.4 7.6 0.8 0.6 26.7 21.0 16.5 6.2 Average Average 8.6 7.8 1.8 2.0 1.3 1.1 14.5 13.8 4.6 4.2 Source: CLSA, Bloomberg

25 January 2016 [email protected] 6 Low-oil, low-profit Thai Airways - SELL

Valuation details We value THAI using blended valuation approach incorporating target multiples of 6.5x EV/Ebitdar, 7.0x PE and 1.7x PB, using THAI's 2016CL financials. EV/Ebitdar is a good way to look at airlines, since other earnings metrics are often distorted by operating versus financial-lease mix, making comparisons tricky. We take a blended approach to overcome such shortcomings.

Investment risks Political unrest is a key risk to Thailand's tourism industry that has historically caused demand to drop. Thai Airways has high exposure to global economy relative to domestic peers given that the airlines have many international routes. Fluctuation in jet fuel price can significantly affect overall profit margin fuel accounted for about 33% of total expenses in 2014. Lastly, violence on the ground in Thailand could cause air travel demand to drop.

25 January 2016 [email protected] 7 Low-oil, low-profit Thai Airways - SELL

Summary financials Year to 31 December 2013A 2014A 2015CL 2016CL 2017CL Summary P&L forecast (Btm) Revenue 206,336 188,368 181,953 150,427 153,183 Op Ebitda 21,123 3,233 12,445 30,341 30,162 Op Ebit 1,097 (17,302) (6,075) 11,561 11,035 Interest income 516 280 439 356 306 Interest expense (6,057) (6,073) (5,815) (5,782) (5,203) Other items (8,485) 6,358 (11,187) 108 277 Profit before tax (12,929) (16,737) (22,638) 6,242 6,416 Taxation 929 1,165 1,045 (481) (481) Minorities/Pref divs (47) (39) (22) (173) (178) Net profit (12,047) (15,612) (21,615) 5,589 5,757

Summary cashflow forecast (Btm) Operating profit 1,097 (17,302) (6,075) 11,561 11,035 Operating adjustments - - - - - Depreciation/amortisation 20,026 20,535 18,520 18,780 19,126 Working capital changes 936 (2,221) (3,719) (10,155) 40 Net interest/taxes/other 3,675 5,007 (16,505) (4,466) (5,181) Net operating cashflow 25,734 6,019 (7,779) 15,721 25,020 Capital expenditure (27,381) (6,721) (4,000) (8,000) (8,000) Free cashflow (1,647) (702) (11,779) 7,721 17,020 Acq/inv/disposals (696) 48 - - - Int, invt & associate div 856 551 (10,531) 7,916 (775) Net investing cashflow (27,220) (6,122) (14,531) (84) (8,775) Increase in loans (956) (5,482) 19,318 (20,951) (14,573) Dividends (1,223) (48) 0 0 (1,397) Net equity raised/other (4,626) 17,728 3 0 - Net financing cashflow (6,805) 12,199 19,321 (20,951) (15,970) Incr/(decr) in net cash (8,291) 12,096 (2,990) (5,314) 276 Exch rate movements 6,845 (10,365) 0 0 0 Opening cash 13,304 21,736 23,467 20,477 15,163 Closing cash 11,857 23,467 20,477 15,163 15,438

Summary balance sheet forecast (Btm) Cash & equivalents 11,857 23,467 20,477 15,163 15,438 Debtors 13,640 12,693 11,979 10,864 11,063 Inventories 7,521 6,394 5,802 4,380 4,489 Other current assets 25,466 21,731 30,932 25,573 26,041 Fixed assets 231,449 224,021 209,501 198,721 187,595 Intangible assets 861 1,263 1,288 1,314 1,340 Other term assets 16,290 17,698 28,283 20,602 21,784 Total assets 307,085 307,267 308,262 276,616 267,751 Short-term debt 24,800 45,113 46,115 47,570 60,674 Creditors 6,186 4,875 5,312 4,010 4,110 Other current liabs 51,382 52,122 55,859 39,111 39,828 Long-term debt/CBs 151,550 146,875 165,191 142,827 115,195 Provisions/other LT liabs 16,248 16,987 19,058 17,674 18,027 Minorities/other equity 89 81 102 232 366 Shareholder funds 56,830 41,215 16,625 25,192 29,552 Total liabs & equity 307,085 307,267 308,262 276,616 267,751

Ratio analysis Revenue growth (% YoY) (1.3) (8.7) (3.4) (17.3) 1.8 Ebitda growth (% YoY) (30.0) (84.7) 285.0 143.8 (0.6) Ebitda margin (%) 10.2 1.7 6.8 20.2 19.7 Net profit margin (%) (5.8) (8.3) (11.9) 3.7 3.8 Dividend payout (%) - - - 25.0 25.0 Effective tax rate (%) 7.2 7.0 4.6 7.7 7.5 Ebitda/net int exp (x) 3.8 0.6 2.3 5.6 6.2 Net debt/equity (%) 289.0 408.1 1,140.8 689.3 536.3 ROE (%) (19.2) (31.8) (74.7) 26.7 21.0 ROIC (%) 0.4 (7.1) (2.6) 4.9 4.9 EVA®/IC (%) (7.1) (14.6) (10.2) (2.6) (2.6) Source: CLSA

25 January 2016 [email protected] 8 Important disclosures Thai Airways - SELL

Companies mentioned Thai Airways (THAI TB - BT8.70 - SELL) Air China (753 HK - HK$4.97 - SELL) AirAsia (AIRA MK - RM1.32 - BUY) ANA (9202 JP - ¥319 - SELL) Cathay Pacific (293 HK - HK$12.50 - UNDERPERFORM) China Airlines (N-R) China East Airline (N-R) China Southern (1055 HK - HK$4.50 - SELL) EVA Airways (N-R) JAL (9201 JP - ¥4,203 - OUTPERFORM) Korean Air (N-R) Qantas (QAN AU - A$3.93 - UNDERPERFORM)

Analyst certification The analyst(s) of this report hereby certify that the views expressed in this research report accurately reflect my/our own personal views about the securities and/or the issuers and that no part of my/our compensation was, is, or will be directly or indirectly related to the specific recommendation or views contained in this research report.

Important disclosures Recommendation history of Thai Airways International PCL THAI TB

Narongpand Lisahapanya BUY O-PF )

t Other analysts U-PF SELL B

( 35 No coverage N-R

r p

o t S 25

May 13 Sep 13 Jan 14 May 14 Sep 14 Jan 15 May 15 Sep 15 Jan 16

Date Rec Target Date Rec Target 18 Aug 2015 SELL 9.00 11 Jun 2014 SELL 13.50 23 Jun 2015 U-PF 13.20 21 May 2014 SELL 10.00 30 Mar 2015 U-PF 12.30 18 Feb 2014 SELL 11.00 15 Dec 2014 U-PF 17.50 07 Jan 2014 SELL 12.00 26 Nov 2014 SELL 13.60 22 Nov 2013 SELL 14.00 26 Aug 2014 SELL 10.50 15 Aug 2013 BUY 26.00 20 Jul 2014 SELL 11.00 Source: CLSA

The policy of CLSA (which for the purpose of this clear, fair, and not misleading. Analysts may not receive disclosure includes subsidiaries of CLSA B.V. and CLSA compensation from the companies they cover. Americas, LLC ("CLSA Americas")), and Credit Agricole Regulations or market practice of some Securities (Taiwan) Company Limited (“CA Taiwan”) is to jurisdictions/markets prescribe certain disclosures to be only publish research that is impartial, independent, made for certain actual, potential or perceived conflicts of

25 January 2016 [email protected] 9 Important disclosures Thai Airways - SELL

interests relating to a research report as below. This the listed company within the coming three months. research disclosure should be read in conjunction with Unless mentioned otherwise, CLSA/CLSA Americas/CA the research disclaimer as set out at Taiwan does not own a material discloseable position, www.clsa.com/disclaimer.html and the applicable and does not make a market, in the securities. regulation of the concerned market where the analyst is As analyst(s) of this report, I/we hereby certify that stationed and hence subject to. This research disclosure the views expressed in this research report accurately is for your information only and does not constitute any reflect my/our own personal views about the securities recommendation, representation or warranty. 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CLSA has put in place a number of internal controls Key to CLSA/CLSA Americas/CA Taiwan investment designed to manage conflicts of interest that may arise as rankings: BUY: Total stock return (including dividends) a result of CLSA engaging in Corporate Finance, Sales expected to exceed 20%; O-PF: Total expected return and Trading and Research activities. Some examples of below 20% but exceeding market return; U-PF: Total these controls include: the use of information barriers expected return positive but below market return; SELL: and other information controls designed to ensure that Total return expected to be negative. 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25 January 2016 [email protected] 10 Important disclosures Thai Airways - SELL

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25 January 2016 [email protected] 11 Important disclosures Thai Airways - SELL

investors should be aware that CLSA, CLSA Americas, CA CLSA India please contact [email protected]. Taiwan and/or their respective affiliates or companies or such individuals may have one or more conflicts of United States of America: Where any section of the interest. Regulations or market practice of some research is compiled by US analyst(s), it is distributed by jurisdictions/markets prescribe certain disclosures to be CLSA Americas. Where any section is compiled by non- made for certain actual, potential or perceived conflicts of US analyst(s), it is distributed into the United States by interests relating to research reports. Details of the CLSA solely to persons who qualify as "Major US disclosable interest can be found in certain reports as Institutional Investors" as defined in Rule 15a-6 under required by the relevant rules and regulation and the full the Securities and Exchange Act of 1934 and who deal details are available at with CLSA Americas. 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25 January 2016 [email protected] 12 Important disclosures Thai Airways - SELL

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