Jeju Air (089590 KS ) Fears of rights issue come to pass Airlines W170bn rights offering to cause 32% share dilution Company Report Yesterday, Jeju Air announced its decision to issue 12.14mn new shares, representing May 22, 2020 46% of its current shares outstanding. The new shares will be offered to e xisting shareholders (20% to the employee stock ownership association) on a basis of 0.37 th th shares for each share held. The subscription period will run from July 14 to July 15 , and any shares unsubscribed by existing shareholders will be offered to the public. The record date for the rights offering will be June 10th , 2020 , and the new shares will be (Downgrade) Sell listed on August 4, 2020. Target Price (12M, W) 17,000 The offering is expected to raise roughly W170bn, of which W67.8bn will be used on debt repayment and W102.2bn on working capital. The expected offering price is Share Price (05/21/20, W) 19,600 W14,000 per share, but the final price will be determined based on the first reference price (June 5 th ) and the second reference price (July 9 th ). Expected Return -13% More fundraising may be needed by year-end if current conditions continue As of end-1Q20, Jeju Air held cash and cash equivalents of W68bn (W99bn when OP (20F, Wbn) -174 including short-term financial assets). We believe the carrier has reduced its monthly Consensus OP (20F, Wbn) -181 cash outflow from over W50bn to W30-40bn currently by deferring some payments (leases, etc.) and furloughing its employees. Nevertheless, we still expect the carri er to EPS Growth (20F, %) - essentially run out of cash by the end of 2Q20. Market EPS Growth (20F, %) 27.1 P/E (20F, x) - The airline industry is currently suffering from the worst downturn in its history. In Market P/E (20F, x) 13.4 2Q20, we forecast Jeju Air’s international passenger traffic to plunge 87.6% YoY, driving KOSPI 1,998.31 down overall revenue to W84.1bn (-73.1% YoY). While the rate of revenue decline is likely to slow beginning in 3Q20, the carrier could face renewed funding pressures by Market Cap (Wbn) 517 the end of the year if current travel restrictions continue. Shares Outstanding (mn) 26 Free Float (%) 33.0 Key points to watch going forward include: 1) a recovery in industry conditions; 2) Foreign Ownership (%) 3.1 additional stress following the Eastar Jet acquisition; and 3) the success of the rights Beta (12M) 1.86 offering, which could determine additional support from the government. In light of industry conditions and the carrier’s earnin gs outlook, we would not rule out the 52-Week Low 12,000 possibility of some shares going unsubscribed. The Eastar Jet acquisition could also put 52-Week High 36,900 further pressure on consolidated earnings in the near term (a factor we have not (%) 1M 6M 12M reflected in our estimates). Jeju Air is currently set to receive W170bn in government Absolute -1.0 -16.1 -43.1 funds for the acquisition. If the carrier’s rights offering proves a success, it is unlikely Relative -6.9 -11.9 -41.3 that the government would provide massive aid to fund working capital for some time. 120 Jeju Air KOSPI Downgrade to Sell; TP of W17,000 100 We present a target price of W17,000 (based on RIM valuation), which accounts for the 80 dilution caused by the rights offering. With our target price implying 13.2% downside 60 to the current share price, we downgrade our rating from Hold to Sell. Even based on 40 earnings estimates for 2022, which is when operating conditions are expected to fully 20 return to normal, we estimate the stock’s P/E would expand from 10x to 15x following 5.19 9.19 1.20 5.20 the share issue, which could spark worries about valuation. Mirae Asset Daewoo Co., Ltd. [ Transport/Energy ] FY (Dec.) 12/17 12/18 12/19 12/20F 12/21F 12/22F Revenue (Wbn) 996 1,259 1,384 809 1,080 1,183 Jay JH Ryu +822 -3774 -1738 OP (Wbn) 101 101 -33 -174 67 101 [email protected] OP margin (%) 10.1 8.0 -2.4 -21.5 6.2 8.5 NP (Wbn) 78 71 -33 -221 29 58 EPS (W) 2,954 2,689 -1,257 -6,827 753 1,505 ROE (%) 25.8 19.9 -9.4 -73.9 10.1 17.5 P/E (x) 12.0 12.5 - - 26.0 13.0 P/B (x) 2.8 2.3 2.2 2.7 2.5 2.1 Dividend yield (%) 1.7 1.9 0.0 0.0 0.0 0.0 Note: All figures are based on consolidated K-IFRS; NP refers to net profit attributable to controlling interests Source: Company data, Mirae Asset Daewoo Research estimates May 22, 2020 Jeju Air Table 1. Earnings forecast revisions (Wbn, %) Previous Revised % chg. Notes 20F 21F 20F 21F 20F 21F Revenue 809 1,080 809 1,080 - - Operating profit -174 67 -174 67 RR - Pretax profit -262 28 -255 39 RR 38.5 Net profit -227 21 -221 29 RR 38.5 Lower interest expenses following rights offering EPS (KRW) -8,602 794 -6,827 753 RR -5.2 Notes: Based on consolidated K-IFRS; net profit is attributable to controlling interests Source: Mirae Asset Daewoo Research estimates Table 2. Quarterly and annual earnings (Wbn, %) 1Q19 2Q19 3Q19 4Q19 1Q20 2Q20F 3Q20F 4Q20F 2019 2020F 2021F 2022F Revenue 393 313 369 309 229 84 223 273 1,384 809 1,080 1,183 Domestic 49 61 62 58 36 34 50 52 229 171 200 196 International 315 221 271 220 193 24 167 189 1,027 572 790 888 Other 29 31 36 32 0 26 6 32 127 65 90 98 Operating profit 57 -27 -17 -45 -66 1.0 -50 -4 -33 -174 67 101 Pretax profit 55 -39 -40 -24 -114 -72 -57 -12 -47 -255 39 77 Net profit (controlling) 42 -29 -30 -17 -101 -65 -46 -10 -33 -221 29 58 OP margin (%) 14.5 -8.8 -4.7 -14.6 -28.7 -64.8 -22.3 -1.5 -2.4 -21.5 6.2 8.5 Pretax margin (%) 14.1 -12.4 -10.9 -7.7 -49.9 -85.5 -25.8 -4.4 -3.4 -31.6 3.6 6.5 Net margin (%) 10.7 -9.4 -8.2 -5.3 -49.9 -85.5 -25.8 -4.4 -3.4 -31.6 3.6 6.5 International RPK growth (%, YoY) 30.9 20.0 27.6 18.2 -42.6 -87.6 -38.3 -18.7 24.1 -45.7 25.1 10.4 International ASK growth (%, YoY) 34.0 30.8 30.2 18.4 -26.5 -83.3 -30.0 -20.0 28.0 -39.4 13.7 12.0 International L/F (%,) 88.3 81.3 83.1 82.8 68.8 60.0 75.0 85.6 84.5 75.7 83.4 82.2 International yield growth (%, YoY) -4.9 -5.3 -17.2 -19.7 -0.6 -20.0 -10.0 -5.0 -10.5 -8.5 11.2 2.0 Domestic RPK growth (%, YoY) 3.8 1.6 8.4 7.8 -29.0 -39.9 -17.5 -12.6 5.4 -24.5 12.8 -0.6 Domestic ASK growth (%, YoY) 2.3 4.1 9.0 6.5 -20.3 -30.0 -10.0 -10.0 5.5 -17.4 5.0 0.0 Domestic L/F (%) 94.8 93.3 92.6 94.7 84.6 80.0 85.0 92.0 93.9 85.8 92.2 91.6 Domestic yield growth (%, YoY) 3.1 -3.9 -6.4 -0.2 -5.3 -15.0 -10.0 -5.0 -2.1 -9.0 3.6 -1.5 Jet fuel (U S$/bbl) 77 80 77 76 57 41 57 57 78 53 57 57 US$/W rate 1,125 1,167 1,193 1,176 1,195 1,200 1,200 1,200 1,165 1,199 1,200 1,200 Notes: Yield growth is based on won-denominated yield; based on consolidated K-IFRS; net profit refers to net profit attributable to controlling interests Source: Company data, Mirae Asset Daewoo Research Table 3. Valuation: RIM (Wbn) 2020F 2021F 2022F 2023F 2024F 2025F 2026F Revenue 809 1,080 1,183 1,183 1,242 1,304 1,404 (Growth) -41.6% 33.5% 9.5% 0.0% 5.0% 5.0% 7.7% Net profit (ex-minority interest) -221 29 58 58 61 65 70 (% of revenue) -27.4% 2.7% 4.9% 4.9% 4.9% 5.0% 5.0% Equity (ex-minority interest) 274 303 361 407 456 508 564 (Growth) -15.8% 10.6% 19.1% 12.9% 12.0% 11.4% 11.1% Forecast ROE -73.9% 10.1% 17.5% 15.1% 14.1% 13.5% 13.1% COE 8.2% 8.2% 8.2% 8.2% 8.2% 8.2% 8.2% ROE spread -82.1% 1.9% 9.3% 6.9% 6.0% 5.3% 4.9% Residual income -225 6 34 28 27 27 28 Terminal value 385 NPV of FCFF -63 Beta 1.0 PV of terminal value 175 Risk premium 6.0% Current book value 325 Risk-free rate 2.0% Equity value 451 COE 8.2% Shares outstanding 26,357 Target P/B (12MF) 2.4 TP (W) 17,000 Current price (W) 19,600 Source: Mirae Asset Daewoo Research Mirae Asset Daewoo Research 2 May 22, 2020 Jeju Air Figure 1.