01 October 2012 Asia Pacific/Indonesia Equity Research Airlines (Air Transportation) / UNDERWEIGHT PT Garuda Indonesia Tbk (GIAA.JK / GIAA IJ) Rating OUTPERFORM* Price (27 Sep 12, Rp) 620.00 INITIATION Target price (IDR) 900.00¹ Upside/downside (%) 1,389,093.5 Mkt cap (Rp mn) 14,037,418 Capital drag priced in; this bird should fly (US$ 1,467) Enterprise value (US$ mn) 1,514 ■ Discounted valuation the key attraction. We initiate coverage of Garuda Number of shares (mn) 22,641.00 Free float (%) 28.0 Indonesia (GA) with an OUTPERFORM rating, believing that its discounted 52-week price range 770.0 - 395.0 stock price and organic top-line growth combined with management and ADTO - 6M (US$ mn) 1.6 equipment-led cost cuts provide adequate appeal and compensate for *Stock ratings are relative to the relevant country benchmark. ¹Target price is for 12 months. increasing competition and rising balance sheet leverage. Research Analysts ■ Operational goals well within reach despite competitive environment. Timothy Ross Robust market growth and a segmented product should allow GA to expand 65 6212 3337 its yield while holding loads steady, allowing earnings to rise ahead of [email protected] consensus for the next two years. We do anticipate a decline in FY14E Leonard Huo, CFA NPAT, however, as rising ownership costs more than offset improvement in 65 6212 3062 [email protected] underlying earnings. ■ Reclaiming lost ground. Re-fleeting will permit focus on the neglected domestic LCC business, the reclamation of GA’s natural long-haul revenue stream and the creation of a short-haul premium market. These are structural changes in its business and we believe address many of the rising specific competitive challenges that it faces as well as those inherent to the airline industry (including risks such as fuel, labour, demand growth). ■ Balance sheet stress a known quantity. We have subjected our target price to immense stress—effectively factoring in 2014’s expected capital structure today, but find it difficult to engineer a price target much below the IDR900/share that we believe GA should trade at. This is based on a target EV/CFMV of 200%, which we consider appropriate when comparing its long run average ROIC of 16% with its WACC of 8% and a target EV/EBITDAR of 7.5x—equivalent to the APAC regional average. Share price performance Financial and valuation metrics Year 12/11A 12/12E 12/13E 12/14E Price (LHS) Rebased Rel (RHS) Revenue (US$ mn) 3,096.6 3,555.7 4,135.6 4,776.6 800 120 EBITDA (US$ mn) 239.2 289.0 437.6 439.0 600 100 EBIT (US$ mn) 115.3 161.6 271.9 194.6 80 400 Net profit (US$ mn) 87.8 112.9 190.7 95.6 60 EPS (CS adj.) (US$) 0.00 0.01 0.01 0.00 200 40 Feb-11 Jun-11 Oct-11 Feb-12 Jun-12 Change from previous EPS (%) n.a. Consensus EPS (US$) n.a. 0.005 0.007 0.009 The price relative chart measures performance against the JSX EPS growth (%) n.m. 27.1 67.0 -49.9 COMPOSITE INDEX which closed at 4225.02 on 27/09/12 P/E (x) 16.3 12.8 7.7 15.3 On 27/09/12 the spot exchange rate was Rp9570./US$1 Dividend yield (%) 0 0 3.3 2.8 EV/EBITDA (x) 6.5 5.2 4.3 6.0 Performance Over 1M 3M 12M P/B (x) 1.7 1.6 1.4 1.3 Absolute (%) -3.1 -12.7 42.5 ROE (%) 14.5 12.7 18.8 8.6 Relative (%) -6.3 -19.5 23.1 Net debt/equity (%) 11.7 5.0 39.6 103.3 Source: Company data, Thomson Reuters, Credit Suisse estimates. DISCLOSURE APPENDIX CONTAINS ANALYST CERTIFICATIONS AND THE STATUS OF NON-US ANALYSTS. U.S. Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION™ Client-Driven Solutions, Insights, and Access 01 October 2012 Focus charts Figure 1: Unit costs continue to edge down… Figure 2: …with fuel efficiency a core contributor 0.75 20.0% 4,400 0.0% -0.5% 0.70 10.0% 4,300 -1.0% 0.65 0.0% 4,200 -1.5% -2.0% 0.60 -10.0% 4,100 -2.5% 0.55 -20.0% 4,000 -3.0% 0.50 -30.0% 3,900 -3.5% 2007 2008 2009 2010 2011 2012E 2013E 2007 2008 2009 2010 2011 2012E 2013E 2014E Unit cost (USc/ATK) YoY (%) Fuel burn (l/block hr) % change Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates Figure 3: Competitors growing in secondary markets… Figure 4: …while GA’s seat growth outpaces the market 140,000 23% 100,000 13% CAGR 120,000 21% 90,000 80,000 19% 100,000 70,000 17% 80,000 60,000 15% 50,000 60,000 13% 40,000 40,000 11% 30,000 20,000 20,000 9% 10,000 0 7% 2011 2012E 2013E 2014E 2015E 2007 2008 2009 2010 2011 2012 Key hub traffic Total traffic Key hubs YoY % Total YoY% Total seats Garuda (incl. Citilink) Source: APG-dat Source: Ascend Figure 5: Key leverage ratios on the rise… Figure 6: ..but captured in T + 1 EV/EBITDAR comparison 8.0x 120% 9.0 7.0x Alarm bells start ringing 100% 8.5 APAC average 6.0x 8.0 80% 5.0x 7.5 4.0x 60% 7.0 3.0x 40% +1 Std dev 6.5 2.0x 20% 1.0x 6.0 -1 Std dev Garuda 0.0x 0% 5.5 2007 2008 2009 2010 2011 2012E 2013E 2014E 5.0 Adj. Net Debt/EBITDAR Adj. Net Debt/Total Capital 18-Feb-11 18-Jun-11 18-Oct-11 18-Feb-12 18-Jun-12 Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates PT Garuda Indonesia Tbk (GIAA.JK / GIAA IJ) 2 01 October 2012 Summary Rather than dwelling on the growth potential of Indonesia’s aviation industry (which is a fairly well-worn story of which hopefully the reader is aware of by now), we would rather focus on what GA’s management and competition are doing and what marks this company out as worthy of an OUTPERFORM rating. Cost cuts mark corporate transformation The transformation from government-run slug to tomorrow’s butterfly was started by the New equipment, new current management team in 2006 and has been characterised by swingeing cuts to the management and smarter cost base accompanied by a remarkable improvement in productivity—both from operation continue to drive equipment and from its employee base. ATKs per employee have almost doubled since unit costs down and 2007 and ex-fuel unit costs have fallen 5%, with the company now generating trip-length productivity up adjusted unit costs comparable to Cathay Pacific and better than Singapore Airlines. As new, more fuel efficient aircraft deliver and the company can take advantage of better routing, ETOPS and increased utilisation, we see unit costs falling another 3% out to 2014E. …but competition takes a bite out of revenues To a certain extent the change in corporate culture has made a virtue out of necessity— Cost cuts and new revenue GA was staring into a darkening abyss of intensifying competition across all markets and strategies are imperative to all formats, while failing to take advantage of demand growth on account of its debilitated offset the well-organised fleet and access to capital. While its new fleet plan centred around growing its LCC and and well established long-haul presence as well as creating a new pool of premium short-haul demand should competitive threats of Lion gain traction, in our view it needs to. Competition in the form of Lion Air domestically and and AirAsia AirAsia (both internationally and domestically) is unrelenting, well organised and well- funded. We think GA regains its crown as the largest airline in Indonesia in 2013 in terms of seat numbers. Its challenge will be to convert this into passenger numbers and revenues. New model increases capital intensity & ownership costs The company’s revenue model revolves around its fleet plan: new A320s for the LCC New aircraft are the lynchpin Citilink, new CRJ-1000s for the “sub-100” market and new B773ERs to support the long- of GA’s strategy, but funding haul point-to-point gateway markets. We believe that these are all credible targets, but them will pressure its Garuda has ordered aircraft worth about US$3.5 bn to achieve them, which will be funded balance sheet; we expect an through a mix of debt and operating leases. This increased leverage will put pressure on equity issue before 2014 balance sheet optics and we believe that an equity issue (probably rights) will be required before end-2014 – if only to stay within the bounds of its lending covenants. Greater interest, depreciation and rental charges will also impact NPAT growth by 2014. …although the valuation impact is already baked in To account for this, we have used a 2014E prospective capital structure as the basis for Even so, we find it difficult to our preferred EV/CFMV valuation approach and discounted this to today.