Jeju Air (089590.KS) Reason to pay attention! Company Note │Dec 30, 2019 Although Jeju Air is expected to record a large-scale deficit for 4Q19, we believe the firm’s share price already reflects the likely earnings disappointment. Going forward, Jeju Air’s share price should move in accordance with downsizing efforts following the anticipated acquisition of Hold (maintain) Eastar Jet. In particular, we believe that resolving oversupply issues in the market via fleet reductions is to be a key factor. TP W26,000 (maintain) CP (’19/12/27) W27,000 Sector Air transportation Kospi/Kosdaq 2,204.21 / 661.24 4Q19 preview: Large-scale deficit expected; disappointing results to Market cap (common) US$613.66mn sustain in 1Q20 Outstanding shares (common) 26.4mn 52W high ('19/04/15) W42,300 We maintain a Hold rating with a TP of W26,000 on Jeju Air. low ('19/10/10) W22,800 Average trading value (60D) US$3.33mn Expecting a large-scale operating deficit, we forecast Jeju Air’s 4Q19 sales at Dividend yield (2019E) 0.0% W312bn (-1.9% y-y) with an operating loss of W51.4bn (TTL y-y; OPM of Foreign ownership 6.6% -16.5%). Although Jeju Air’s 4Q19 international flight RPK is likely to show an Major shareholders increase of 11.9% y-y, international passenger traffic sales will likely show AK Holdings & 3 others 58.9% decline of 3.9% y-y, with intense freight competition pushing down dollar-based Jeju Self-Governing Province 7.8% freight rates by an estimated 25% y-y. Share perf 3M 6M 12M Having remained in a negative growth phase since November, passenger demand is Absolute (%) 10.9 -18.4 -21.1 Relative (%p) 3.1 -21.0 -27.3 expected to continue shrinking y-y in 1Q20 due to high-base effect. While China route expansion (1H20) and the Japan Summer Olympics (Jul 2020) promise to 2018 2019E 2020F 2021F boost demand somewhat, the extent of improvement is likely to be limited. Sales 1,259 1,386 1,500 1,531 Chg 26.4 10.1 8.2 2.1 OP 101 -39.3 6.0 45.7 Focus on air transportation industry reorganization rather than earnings Chg -0.1 TTL TTP 666.8 With 2020 international demand growth estimated at 5.6% and supply growth at OPM 8.0 -2.8 0.4 3.0 4.7%, oversupply issues are unlikely to be resolved next year. However, we view it NP 71 -51.3 -1.4 43.5 as positive that: 1) domestic carriers are reducing their introduction of new aircraft; EPS 2,689 -1,946 -54 1,650 and 2) the rate of supply growth may slow going forward due to prolonged delays in Chg -9.0 TTL RR TTP the introduction of such models as the B737 MAX and A321 NEO. P/E 12.5 N/A N/A 16.4 P/B 2.3 2.1 2.2 1.9 While its earnings are forecast to come in sluggish, we expect Jeju Air’s share EV/EBITDA 5.3 11.2 5.6 4.2 price to largely depend on its business strategy following the anticipated ROE 19.9 -14.4 -0.4 12.5 acquisition of Eastar Jet. Once the acquisition is confirmed, the gap between Jeju Debt/equity 169.8 313.5 300.8 272.8 Air and second-tier LCCs should widen significantly. As its scale of operations Net debt -153 -126 -120 -67 expands, Jeju Air’s route, aircraft, and manpower management strategies are to Unit: Wbn, %, won, x become increasingly important. In particular, decisions regarding whether to Note 1: NP excludes minority interests reduce its number of operating aircraft are to greatly affect market conditions. Note 2: EPS, P/E, P/B, ROE based on NP (excl minority interests) Source: NH I&S Research Center estimates International seat oversupply: Reduction in Eastar Jet fleet to improve supply- demand conditions (mn seats) 21 Oversupply 20 19 Supply- 18 demand conditions to 17 improve upon 16 Eastar Jet's fleet reduction 15 by up to 70% 14 Ys Jung, Analyst '11 '12 '13 '14 '15 '16 '17 '18 '19E '20F 822)768-7882, [email protected] Source: IIA, KAC, Airportal, NH I&S Research Center estimates Jeju Air www.nhqv.com Summary Established in Jan 2005, Jeju Air stands as the top LCC in Korea. Having obtained a regular air transport business license in Aug 2005, the company now operates around 79 routes across the world. As of 2018, Jeju Air’s sales came in at W1.25tn, breaking down by business as: 1) international passenger sales (74.1%); 2) domestic passenger sales (17.8%); 3) additional sales (7.9%); and 4) cargo sales (0.5%). Through 3Q19, the firm’s M/S stood at 9.4% in terms of international passenger demand. Based on its solid financials, we expect Jeju Air to further expand its M/S amid ongoing restructuring in the airline industry. Share price drivers/earnings momentum Downside risks Resolving of oversupply issues following airline industry Falling airfares due to reduced passenger traffic and restructuring intensifying competition Cost reduction on dollar/won forex rate decline Unfavorable forex rates and oil prices Rise in passenger demand thanks to new Chinese routes Falling aircraft utilization rates L/F recovery for Japanese routes thanks to improvement in Korea-Japan relations Cross valuations (Unit: x, %) Historical valuations (Unit: x, %) P/E P/B ROE Company Valuations 2017 2018 2019E 2020F 2021F 2019E 2020F 2019E 2020F 2019E 2020F Jin Air N/A N/A 2.0 2.3 -13.3 -7.0 P/E 12.0 12.5 N/A N/A 16.6 T’way Air N/A N/A 1.5 1.7 -19.6 -15.6 P/B 2.8 2.3 2.3 2.4 2.2 Air Busan N/A N/A 3.5 5.3 -47.7 -33.9 P/S 0.9 0.7 0.5 0.5 0.5 Ryan Air Holdings 15.1 18.1 2.5 2.9 18.3 15.8 ROE 25.8 19.9 -14.9 -0.5 13.6 Southwest Airlines 12.7 11.3 2.6 2.1 23.6 23.5 ROIC 332.8 37.1 -10.3 0.8 5.2 Source: Bloomberg, NH I&S Research Center Source: Bloomberg, NH I&S Research Center Historical key financials (Unit: Wbn, won, %) 2010 2011 2012 2013 2014 2015 2016 2017 2018 Sales N/A N/A N/A N/A N/A 608 748 996 1,259 OP N/A N/A N/A N/A N/A 51 58 101 101 OPM (%) N/A N/A N/A N/A N/A 8.5 7.8 10.2 8.0 Pre-tax profit N/A N/A N/A N/A N/A 53 69 101 93 NP N/A N/A N/A N/A N/A 47 53 78 71 NP (excl minority interests) N/A N/A N/A N/A N/A 47 53 78 71 EBITDA N/A N/A N/A N/A N/A 61 72 127 137 Capex N/A N/A N/A N/A N/A 41 30 133 153 Free cash flow N/A N/A N/A N/A N/A 31 80 11 -32 EPS (won) N/A N/A N/A N/A N/A 2,053 2,038 2,954 2,689 BPS (won) N/A N/A N/A N/A N/A 8,948 10,342 12,574 14,509 DPS (won) N/A N/A N/A N/A N/A 400 500 600 650 Net debt N/A N/A N/A N/A N/A -253 -326 -296 -153 ROE (%) N/A N/A N/A N/A N/A 20.3 21.0 25.8 19.9 ROIC (%) N/A N/A N/A N/A N/A N/A 277.5 332.8 37.1 DPR (%) N/A N/A N/A N/A N/A 22.0 24.8 20.2 24.1 DY (%) N/A N/A N/A N/A N/A 1.0 2.0 1.7 1.9 Net debt ratio (%) N/A N/A N/A N/A N/A -109.0 -119.9 -89.3 -40.1 Note: The company is likely to book a higher debt/equity ratio in 2019 owing to a change in accounting rules regarding aircraft lease liabilities and greater forex translation losses related to the lease liabilities Source: Jeju Air, NH I&S Research Center 2 Jeju Air www.nhqv.com 1. Earnings to deteriorate on greater fixed cost burden Number of In Aug 2019, the number of outbound travelers decreased 3.7% y-y, showing negative outbound travelers growth for the first time since Jan 2012. With the number sliding 9.0% y-y in Nov 2019, declining since LCCs, whose earnings are mainly determined by outbound travel demand, are seeing August limited top-line growth and heavier fixed cost burden. RPK to up 12% y-y; We note that Jeju Air’s international passenger growth declined 4% y-y in Nov 2019, yields (US$) to drop showing negative growth for the first time. In addition, passenger demand growth 25% y-y in 4Q19 (including domestic passenger demand) fell 1.4% y-y. Although Jeju Air’s 4Q19 international flight RPK is likely to show expansion of 12% y-y (backed by an increase in fleet and distance traveled), international passenger traffic sales will likely drop for the To book 4Q19 first time in 4Q19, with intense freight competition pushing down dollar-based freight operating loss of rates by an estimated 25% y-y.