Jeju Air (089590 KS) Ready for Takeoff
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Jeju Air (089590 KS) Ready for takeoff Initiate coverage with Buy and target price of W45,000 Airlines We initiate our coverage on Jeju Air with a Buy rating and a target price of W45,000. Our investment recommendation is premised on the following points: 1) In our view, Jeju Air is best positioned to benefit from the fast-growing low-cost carrier (LCC) Initiation Report market. 2) The carrier is expanding its market position on the back of lower pricing. 3) It November 5, 2015 is also less vulnerable to external headwinds thanks to its solid balance sheet. Our target price of W45,000 was derived by using a residual income model (COE of 8.2%) and is equivalent to a 2016F P/E of 18.8x and a 2016F P/B of 3.1x. We believe our (Initiate) Buy target valuation is highly achievable, given the stock’s high ROE (2015F-17F average of 22.3%) and EPS growth (3-year CAGR of 28.2%). Target Price (12M, W) 45,000 Key risks are 1) stiffer competition and 2) unfavorable moveme nts in oil prices and F/X. In developed markets, the entry of competitors (such as “ultra” LCCs in the US) has Share Price (11/04/15, W) - increased the size of the market, leading to stronger earnings for most carriers. Meanwhile, Jeju Air has very little foreign currency-denominate d debt and is therefore Expected Return - less vulnerable to F/X-translation losses. As for oil, we expect prices to remain stable. A perfect mix of top-line growth and cost savings OP (15F, Wbn) 58 1) Strong market growth and market share gains: We see plenty of room for growth in Consensus OP (15F, Wbn) 68 the LCC market. In terms of total available seat kilometers (ASK), the LCC segment still EPS Growth (15F, %) 60.8 accounts for less than 20% of the domestic airline market, compared to over 30% in Market EPS Growth (15F, %) 19.7 developed markets. By 2020, Jeju Air plans to expand its fleet to 40 aircraft (average o f four aircraft per annum, or 15% CAGR ) from 20 currently, which should support P/E (15F, x) - continuous market share gains. Market P/E (15F, x) 12.0 KOSPI 2049.41 2) Potential for cost savings: Jeju Air’s cost per ASK (CASK) has fallen about 7% on average annually, mainly due to economy of scale effects fr om fleet expansion. Over the Market Cap (Wbn) - long term, the rate of decline could somewhat slow as oil prices move up, but we believe Shares Outstanding (mn) - unit cost excluding fuel will drop nearly 2-3% per year. Free Float (%) - Foreign Ownership (%) - 3) Ancillary revenue growth: While Jeju Air’s fares are lower than those of traditional Beta (12M) - airliners, the carrier has seen revenue from ancillary services—such as advance seat 52-Week Low - assignments, in-flight meals, and duty-free sales—increase to 6.9% of overall revenue in 1H15. Because these services have much lower COGS ratios, higher anci llary revenue 52-Week High - should drive higher earnings. (%)(%)(%) 1M1M1M 6M6M6M 12M12M12M Focus on long-term growth rather than near-term earnings Absolute - - - Relative - - - For 3Q15, we see revenue and operating profit coming in at W157.5bn (+9.7% YoY) and W16.5bn (-1.0% YoY), respectively, weighed by 1) the continued im pact of MERS, and 2) increased heavy maintenance costs due to the return of leased aircraft. In 4Q15, however, we expect revenue to grow 18% YoY and operating profit to return to positive growth YoY (+9.9% YoY to W10.8bn). Looking to 2016, we forecast revenue growth to recover to 23%. That said, net profit is likely to stall temporarily due to higher oil prices and taxes. In the long term, we expect the carrier to maintain its status as a growth stock, generating revenue and operating profit growth of 16% and 28.9% CAGR (2014-2020), respectively. Daewoo Securities CCo.,o., Ltd. FY (Dec.) 12/12 12/13 12/14 12/15F 12/16F 12/17F Revenue (Wbn) 341 434 511 601 736 873 [Transportation/Energy] OP (Wbn) 2 17 30 58 74 88 Jay JH Ryu OP margin (%) 0.6 3.9 5.9 9.7 10.1 10.1 +822-768-4175 NP (Wbn) 5 20 32 61 62 71 [email protected] EPS (W) 239 893 1,454 2,339 2,391 2,755 ROE (%) 17.0 47.8 49.6 31.1 18.2 17.5 Choong-hyun Kim +822-768-4126 P/E (x) - - - - - - [email protected] P/B (x) - - - - - - Notes: All figures are based on consolidated K-IFRS; NP refers to net profit attributable to controlling interests Source: Company data, KDB Daewoo Securities Research estimates Analysts who prepared this report are registered as research analysts in Korea but not in any other jurisdiction, including t he U.S. PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES & DISCLAIMERS IN APPENDIX 1 AT THE END OF REPORT. November 5, 2015 Jeju Air C O N T E N T S I. Valuation 3 Initiate coverage with Buy and target price of W45,000 3 II. Airline and LCC market outlook 4 1. LCCs lead growth of airline sector; Note growth potential of Northeast Asia 4 2. LCCs’ business strategy: Low cost, high load factor 6 3. Emergence of ULCCs 9 III. Three merits of Jeju Air 11 1. Unrivalled cost improvement potential 11 2. Strong growth potential of ancillary revenue 14 3. Strong financial position 15 IV. Earnings outlook 16 Revenue to show a CAGR of 18.4% over the next three years 16 3Q15 preview: Lingering MERS impact and increased maintenance costs to affect OP 17 V. Risks 18 1. Possibility of intensifying competition 18 2. F/X and fuel costs 20 KDB Daewoo Securities Research 2 November 5, 2015 Jeju Air I. Valuation Initiate coverage with Buy and target price of W45,000 We initiate our coverage on Jeju Air with a Buy rating and a target price of W45,000. Our target price of W45,000 was derived by using a residual income model (COE of 8.2%) and is equivalent to a 2016F P/E of 18.8x and a 2016F P/B of 3.1x. We believe our target valuation is highly achievable, given the stock’s high ROE (2015F-17F average of 22.3%) and EPS growth (3-year CAGR of 28.2%). Once LCCs’ combined share of the domestic airline market (currently 16% based on ASK) reaches 30% (probably in 2020), the segment’s growth will likely slow, and Jeju Air’s earnings may gradually trend down. Nevertheless, we also see upside to the company’s growth outlook in light of China’s open-skies policy the high population density of Northeast Asian countries. Table 111.1. Valuation: Residual income method (Wbn) 2015F2015F2015F 2016F2016F2016F 2017F2017F2017F 2018F2018F2018F 2019F2019F2019F 2020F2020F2020F 2021F2021F2021F Revenue 601 736 873 997 1,122 1,246.5 1,402 (Growth) 17.7% 22.5% 18.5% 14.3% 12.5% 11.1% 12.5% Net profit 61 62 71 85 100 111.5 125 (% of revenue) 10.1% 8.4% 8.2% 8.5% 8.9% 8.9% 8.9% Equity 310 372 443 528 629 740 865 (Growth) 286.9% 20.0% 19.2% 19.2% 19.0% 17.7% 16.9% ROE forecast 31.1% 18.2% 17.5% 17.5% 17.3% 16.3% 15.5% Cost of equity 8.2% 8.2% 8.2% 8.2% 8.2% 8.2% 8.2% ROE spread 22.9% 10.0% 9.3% 9.4% 9.2% 8.1% 7.4% Residual income 71 37 41 50 58 60 64 Terminal value 985985985 NPV of FCFF 388 Beta 1.0 PV of terminal value 449 Risk premium 6.0% Current book value 80 Risk-free rate 2.0% Equity value 980 COE 8.2% Shares outstanding 22,007 Target forward P/B 3.13.13.1 Target price (W) 45,000 Target forward P/E 18.818.818.8 Current price (W) - Target PEG 0.70.70.7 Source: KDB Daewoo Securities Research KDB Daewoo Securities Research 3 November 5, 2015 Jeju Air II. Airline and LCC market outlook 1. LCCs lead growth of airline sector; Note growth potential of Northeast Asia It has been almost 10 years since LCCs first hit the Korean market. Contrary to initial concerns that LCCs would eat into the industry’s profits, they in fact played an important role in growing the size of the market. Indeed, cheaper flights attracted new customers who previously shied away from flying, with passenger traffic surging from 36mn in 2005 to 60mn in 2014. On the basis of their solid performance in the domestic market (with a stable market share of around 50% for domestic routes), LCCs are now increasingly looking to expand overseas. Their market share in short-haul international routes is around 20%, and the revenue share of international routes is likely to rise in tandem with the LCC market’s continued expansion. The main target of that expansion is Northeast Asia, due to the short route distances and LCCs’ low penetration in this region. Figure 111.1. Passenger traffic trendtrendtrend:trend : LCCLCCLCCsLCC sss vs. FSCFSCFSCsFSC sss Figure 222.2. Passenger RPK trendtrendtrend:trend : LCCLCCLCCsLCC sss vs. FSCFSCFSCsFSC sss (mn passengers) (mn RPK) FSCs 45 FSCs 120,000 LCCs LCCs 40 100,000 35 30 80,000 25 60,000 20 15 40,000 10 20,000 5 0 0 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 Source: Company data, KDB Daewoo Securities Research Source: Company data, KDB Daewoo Securities Research Figure 333.3.