www.hc-si.com
Flight of Fancy � Air Arabia is set to benefit in the near-term from a substitution of
travelers from conventional to low-cost carriers (LCCs) in light of weak economic conditions, leveraging on its position as the region’s first and
leading LCC.
� Low CAPEX requirements in the short-term and a strong balance sheet will allow the company to maintain its debt-free position and a strong
dividend payout in the near-term (an average dividend yield of 11% based on 2008 and 2009 earnings).
� We initiate coverage with a ‘Buy’ recommendation, based on a price
target of AED1.28 per share, implying an upside of 35%.
Air Arabia, the MENA region’s first and leading LCC, shall benefit from an expected shift by travelers from conventional to LCCs impacted by the global economic slowdown.
Although the global airline industry is expected to come under pressure, we believe Middle East traffic will be less affected due to relatively strong economic fundamentals,
favorable demographics and strong expansions by regional airlines and airports. We expect Air Arabia to post passenger traffic growth of 17% YoY in 2009 but a tamer
increase in revenues of 9% YoY as we expect yields to fall on lower fares. Sustained
revenue growth coupled with a substantial decline in fuel costs would allow for strong EBITDAR and net income growth of 46% and 21% YoY, respectively, in 2009. We
expect a significant improvement in EBITDAR margins from 25.2% in 2008 to 33.6% in 2009.
Air Arabia entered into an agreement with Airbus to acquire 44 A320s with the first
deliveries due by the end of 2010. We believe that the carrier will not need any debt before 2013. Any financing needs before that can be provided internally supported by its
large cash balance of AED1.8 billion (30% of total assets) and investments of AED1.5 billion (26% of total assets). The carrier also has the capacity to pay generous dividends
in the short-term. Air Arabia’s BoD has approved a DPS of AED0.1 based on 2008 results, which implies a dividend payout ratio of 92% and an attractive dividend yield of
11%.
We initiate coverage on Air Arabia with a "Buy" recommendation. Our DCF fair value of AED1.28 per share, implies an upside of 35% to the current market price. Our valuation
assumes a long-term oil price of USD70/bbl, a sustainable load factor of 80% and an
average annual increase in fares of 2%. Possible stock price catalysts include a strong start of Air Arabia’s second hub at Morocco (not included in our forecasts), which is set
to begin in 2Q09, as well as a near-term announcement of a third hub. Key risk relates to stronger-than-expected impact of competition building up in the region.
Buy
Price Performance Chart
0.4
0.7
0.9
1.2
1.4
1.7
1.9
2.2
J-08 F-08 M-08 A-08 M-08 J-08 J-08 A-08 S-08 O-08 N-08 D-08 J-09 F-09
AIRA
DFMGI
Target Price (AED) 1.28 Market Price (AED) 0.95
Upside 34.5%
Listed On DFM
Bloomberg Code AIRARABI UH RIC AIRA.DU
Enterprise Value (AEDm) 2748
Net Debt (AEDm) (1,686) Market Cap. (AEDm) 4,433
Market Cap. (USDm) 1,207 Number of Shares (m) 4,666.7
Foreign Ownership Limit 49.0%
Foreign Ownership Level 22.0%
Daily Turnover (AEDm) 87.4
Daily Turnover (USDm) 23.8
Ownership Structure
Free Float 63.4% Sharjah Civil Aviation Dep 17.4%
Al Maha Holding 8.7% Others 10.5%
Key Performance Indicators
A = Actual; E/F = HC's Estimate/Forecasts; C = Reuters Consensus Estimates
Fiscal Year 08A 09E 09C 10F 10C Revenues (AEDm) 2,066 2,259 2,274 2,680 2,771 EBIT (AEDm) 290 498 482 552 494 EBIT Margin 14.0% 22.1% 21.0% 20.6% 18.0% Net Income (AEDm) 510 618 630 653 653 EPS (AEDm) 0.11 0.13 0.14 0.14 0.14 EPS Growth 36% 21% 24% 6% 3% DPS 0.10 0.11 0.03 0.07 0.03 P/E 8.70x 7.18x 7.09x 6.78x 6.78x EV/EBITDA 8.18x 5.00x 4.96x 5.07x 3.94x P/BV 0.90x 0.88x 0.77x 0.83x 0.72x Dividend Yield 10.5% 11.1% 2.6% 7.4% 2.7% Free Cash Flow Yield -5.4% 6.7% -- -1.0% --
Hatem Alaa +2 02 3749 6008 (Ext. 453)
Mai Nehad +2 02 3749 6008 (Ext. 454)
Sara Serour +2 02 3749 6008 (Ext. 457)
*Disclaimer See Page 23
UAE – Transportation Research Department
25 February 2009 Company Report
Air Arabia
UAE – Transportation
2
Financial Statements and Ratios
AED Million 2008a 2009e 2010f 2011f 2012f 2013f
Income Statement Number of Passengers (000) 3,561 4,180 4,900 5,782 6,727 8,098
Passenger Revenue 1,937 2,100 2,489 2,996 3,555 4,365
Other Revenue 129 159 190 229 272 334
Total Revenue 2,066 2,259 2,680 3,225 3,827 4,699
Revenue Growth 61% 9% 19% 20% 19% 23%
Staff Costs (282) (331) (402) (488) (582) (714)
Fuel Costs (814) (656) (777) (963) (1,176) (1,486)
Maintenance (146) (180) (212) (253) (298) (362)
Handling, Landing and Overflying Charges (189) (208) (245) (291) (342) (415)
Other Operating Costs (115) (125) (143) (177) (215) (272)
EBITDAR 521 758 902 1,054 1,215 1,451
EBITDAR Growth 23% 46% 19% 17% 15% 19%
EBITDAR Margin 25.2% 33.6% 33.6% 32.7% 31.7% 30.9%
Lease Rentals (195) (209) (264) (281) (298) (315)
EBITDA 326 550 637 773 917 1,135
Depreciation and Amortization (36) (52) (86) (143) (202) (307)
EBIT 290 498 552 630 715 829
Net Interest Income (Expense) 164 115 97 62 42 (43)
Other Income (Expense) 56 5 5 5 6 7
Net Income 510 618 653 697 763 793
Net Income Growth 35.7% 21.2% 5.8% 6.7% 9.5% 3.8% Net Margin 24.7% 27.3% 24.4% 21.6% 19.9% 16.9%
Balance Sheet
Cash and Equivalents 1,767 1,686 1,204 649 609 971
Other Current Assets 243 245 248 252 257 263
Total Current Assets 2,010 1,931 1,452 901 866 1,234
Net Property, Plant & Equipment 972 1,194 1,825 3,251 4,633 7,252
Investments 1,523 1,523 1,523 1,015 254 127
Goodwill and Other Intangibles 1,282 1,282 1,282 1,282 1,282 1,282
Other Non-Current Assets 74 102 133 168 207 253
Total Non-Current Assets 3,851 4,100 4,763 5,715 6,376 8,913
Total Assets 5,862 6,030 6,224 6,617 7,242 10,147
Total Current Liabilities 930 968 823 699 747 800
Total Non-Current Liabilities 14 22 24 28 32 2,290
Total Shareholders' Equity 4,917 5,040 5,367 5,890 6,463 7,057
Cash Flow Statement
Net Income 510 618 653 697 763 793
Non-Cash Items 41 57 86 144 204 309
Net Change in Working Capital 112 9 19 24 27 39
Operating Cash Flow 662 683 758 866 994 1,141
Net CAPEX (678) (262) (703) (1,548) (1,558) (2,891)
Other Investments (1,082) (36) (43) 455 699 49
Investing Cash Flow (1,760) (298) (746) (1,093) (860) (2,842)
Financing Cash Flow 0 (467) (494) (327) (174) 2,063 Change in Cash (1,098) (81) (482) (555) (40) 362
UAE – Transportation
3
Valuation
We initiate coverage on Air Arabia with a “Buy” recommendation
We have arrived at a DCF fair value for Air Arabia of AED1.28, which offers an upside of 35% to the current market
price. We have forecasted the company’s results and performance over ten years and applied a perpetual growth
rate of 3% thereafter given the company’s high growth profile as expansions are expected to continue at least until
2016. We have applied a WACC of 10.8% based on a risk free rate of 4.5% (the 10-year UAE swap rate), a beta of
0.9 and an equity risk premium of 7.5%, which we currently apply to all DFM-listed stocks.
Table 1: Air Arabia’s WACC Calculation
Debt Weight 0.0%
Equity Weight 100.0%
Risk Free Rate 4.5%
Beta 0.9
Equity Risk Premium 7.5%
Cost of Equity 10.8%
WACC 10.8%Source: HC Brokerage
Table 2: Air Arabia’s Discounted Cash Flow Calculation
AED Million 2009f 2010f 2011f 2012f 2013f
EBITDA 550 637 773 917 1,135
Change in Working Capital 9 19 24 27 39
Net CAPEX (262) (703) (1,548) (1,558) (2,891)
Free Cash Flow to Firm 296 (47) (751) (614) (1,717)
Present Value of FCFs 272 (39) (562) (415) (1,047)
Terminal Value 7,282
Enterprise Value 4,276
Less: Net Debt (1,686)
Equity Value 5,962
Price Target (AED) 1.28
Source: HC Brokerage
Table 3: Sensitivity Analysis of Value Per Share to WACC and Perpetual Growth Rate
WACC (%) Perpetual
Growth Rate (%) 9.8 10.8 11.8
2.0 1.47 1.16 0.94
3.0 1.64 1.28 1.02
4.0 1.88 1.42 1.12
Source: HC Brokerage
Our valuation is sensitive to oil prices, sustainable load factors and average fare growth
Our valuation is negatively correlated to oil prices. We have assumed an long-term sustainable oil (Brent) price of
USD70 per barrel. Fluctuations in long-term oil prices over the range of USD60-80 per barrel result in fluctuations
from our base case fair value of +27% to -28%.
UAE – Transportation
4
Our valuation is positively correlated to both long-term load factors (see Appendix II for a definition of key aviation
terms) and average growth in fares. We have assumed a sustainable load factor of 80%. Fluctuations in load factors
over the range of 75-85% result in fluctuations from our base case fair value of -11% to +11%. We have also
assumed an average growth in fares of 2%. Fluctuations in average fare growth over the range of 0-4% result in
fluctuations from our base case fair value of -19% to +19%.
Table 4: Sensitivity of Air Arabia’s Valuation to Oil Prices, Load Factors and Fare Growth*
Sustainable Oil Price AED Load Factor AED Average Fare Growth AED
Oil Price @ USD60/bbl 1.63 75% 1.14 0% 1.04
Oil Price @ USD70/bbl 1.28 80% 1.28 2% 1.28
Oil Price @ USD80/bbl 0.92 85% 1.42 4% 1.52
* Sensitivities assume a change in only one variable at a time
Source: HC Brokerage
Table 5: Air Arabia on Multiples in Comparison to LCC Peers
Airline Country Mkt. Cap. (USDm)
Net Debt (USDm)
EV/EBITDA (x) P/E (x) P/BV (x)
2008 2008 2009 2010 2008 2009 2010 2008 AirAsia Malaysia 636 796 14.05 9.16 6.63 - 8.62 6.02 1.21 easyJet UK 1,826 (37) 4.70 9.85 5.26 13.40 32.03 10.92 0.96 Gol Brazil 820 207 110.02 3.80 3.05 - 8.76 6.04 1.20 Jazeera Airways Kuwait 234 152 10.50 6.05 5.01 3.04 0.89 4.25 2.43 Jet Airways India 251 2,291 14.74 -- 13.18 -- -- -- 0.29 JetBlue Airways USA 1,163 2,584 11.93 5.14 5.45 -- 6.46 7.19 -- Norwegian AS Norway 156 (92) -- 2.33 1.32 -- 24.44 8.23 -- Ryanair Ireland 5,815 766 7.04 15.64 7.67 9.75 59.13 13.03 1.83 Southwest Airlines USA 4,774 1,858 5.37 4.05 4.05 16.13 10.29 9.71 0.96 Spicejet Ltd. India 70 (45) -- -- 4.82 -- -- 7.05 0.67 Virgin Blue Australia 185 570 3.24 5.32 3.34 2.06 0.52 6.25 0.31 vueling Spain 107 (109) -- 4.54 -- -- 25.38 126.73 2.08 Air Arabia UAE 1,207 (2,970) 8.18 5.00 5.07 8.70 7.18 6.78 0.88 Source: Reuters, Airline Financials, HC Brokerage
Key downside risks
Key downside risks to our valuation include: (i) stronger than expected competition from flydubai, other regional
LCCs and Indian LCCs, which could negatively impact Air Arabia’s load factors; (ii) higher than expected fuel prices;
(iii) a more severe drop in average fares in the short-term; and (iv) a shrinking population in the UAE that could
negatively affect air traffic.
UAE – Transportation
5
Middle East LCCs To Withstand Tough Times
� Middle East aviation passenger traffic witnesses growth in 2008 in spite of a decline in global
traffic.
� Middle East traffic to sustain growth in 2009 driven by favorable population demographics,
relatively strong economics, and regional airline and airport expansions.
� Low-cost carriers (LCCs) are set to outperform conventional airlines as the economic slowdown
entices passengers to shift to lower-priced alternatives.
Global economic woes to hurt global airline industry…
2008 was generally a tough year for the global airline industry as airlines struggled with skyrocketing fuel prices in
the earlier part of the year, peaking above USD140 per barrel in August, but once fuel prices tumbled so did
demand as the global economic crisis took its toll on passenger traffic. Accordingly, global passenger traffic fell by
0.6% YoY in 2008. The International Air Transport Association (IATA) estimates global passenger traffic to fall by
3% YoY in 2009 as the economic crisis deepens.
Chart 1: Global Monthly Passenger Traffic (2008)
100
120
140
160
180
200
220
240
260
280
300
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Passengers (m)
Source: International Air Transport Association (IATA), HC Brokerage
…but Middle East air traffic remains relatively strong
The Middle East was the best performing region in 2008 with healthy passenger traffic growth of 7% YoY (down
from 18% in 2007). The region remained somewhat resistant to a poor global economy, showing positive growth
and outperforming the global industry throughout 2008. IATA forecasts Middle Eastern traffic to grow by 1% in
2009 but it is worth noting that IATA’s growth estimate is understated as LCCs are not IATA members and are thus
not included in their numbers. We believe that Middle East passenger air traffic will continue to grow in 2009 due
to:
(i) favorable population demographics given a large GCC expatriate population especially in the UAE.
Nearly 80% of the UAE’s population are expatriates. The UAE expatriate population has grown at a 10-
year CAGR of 7% versus 4% for its national population. Although the expatriate population is
expected to slowdown in growth or even decline given the large layoffs taking place in the UAE, we
expect the ratio of nationals-to-expatriates to remain relatively unchanged. The UAE’s favorable
demographics ensure that a large portion of its air traffic is driven by visiting friends and relatives,
expatriates visiting their home countries and repeat business visitors (employees of companies
headquartered or with subsidiaries in the UAE), which are areas we believe will be minimally affected
by the economic slowdown;
(ii) the aggressive fleet expansion plans of Middle East carriers, with nearly no order cancellations so far.
The Middle East is expected to receive 8% and 9% of the worldwide aircraft deliveries in 2009 and
2010, respectively (see table 6 below);
UAE – Transportation
6
(iii) major Middle East airport expansions (see table 7 for details);
(iv) sustained economic growth with estimated MENA GDP growth of 4% in 2009 versus estimated world
GDP growth of 1%;
(v) the region’s unparalleled location given its geographic centrality, which makes the region independent
of particular routes for its development and a popular traffic diversion destination;
(vi) aviation industry deregulation and liberalization of Middle Eastern skies, which is opening up
opportunities for new destinations and routes, which have been previously protected by restrictive
bilateral agreements. Such industry trend has opted more countries to open up their skies to airlines
other than flag carriers. Iran, for instance, has granted 215 weekly flights to UAE carriers (including
Air Arabia) in December 2008.
Chart 2: Middle East Versus Global Monthly Passenger Traffic YoY Growth (2008)
13.9%
8.4%
6.5%
2.4%8.0%
13.1%13.6%9.6% 14.7%
17.3%15.3%
14.7%
-5.8%-7.8%
-3.4%
-2.1%
-4.2%
2.1%2.9%3.5%
6.1%
3.5%
0.6%-0.3%
-8%
-3%
2%
7%
12%
17%
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Middle East Passenger Traffic Global Passenger Traffic
Source: IATA, HC Brokerage
Chart 3: UAE Population by Origin
South Asians,
50%
Others, 8%UAE Nationals, 19%
Arabs &
Iranians, 23%
Source: CIA World Factbook, HC Brokerage
UAE – Transportation
7
Table 6: Worldwide Aircraft Deliveries by Region in 2009 and 2010
2009 2010
Region
Aircrafts % of Total Aircrafts % of Total
Asia Pacific 419 31% 480 34% Europe 437 32% 417 30% North America 199 15% 239 17% Middle East 114 8% 122 9% Other 203 15% 155 11% Total 1,372 100% 1,413 100% Source: Center for Asia Pacific Aviation, HC Brokerage
Table 7: Middle East Airport Expansions
Airport
Country
Capacity (in Passengers)
Expansions
Abu Dhabi International Airport
UAE
12 Mil.
New terminal to handle up to 50 mil. passengers by 2012
Al Maktoum International Airport UAE Under Construction To be fully operational by 2015 with a capacity of up to 120 mil. passengers
Cairo International Airport
Egypt
11 Mil.
New terminal completed in 4Q08 to double capacity once operational
Dubai International Airport
UAE
60 Mil.
Capacity doubled in 2008 and expected to reach 70 mil. by 2016 and 100 mil. by 2025
King Abdul Aziz Intl. Airport KSA 13 Mil. Capacity to increase to 21 mil. by late 2010 Source: Airport Technology, Zawya Dow Jones, HC Brokerage
LCCs shall demonstrate more resilience than conventional carriers
LCCs should fare better than conventional carriers in times of economic downturn thanks to a more efficient cost-
structure and lower break-even load factors. More importantly, business and leisure travelers normally shift from
conventional airlines to LCCs in bad economic times, as travelers seek strong value propositions. We believe that
Middle Eastern LCCs have been, and will continue to be, a strong stimulus to the region’s passenger traffic growth
especially given the region’s low LCC penetration estimated at around 2%. The fleet of regional LCCs is expected to
increase nearly five-times over the coming ten years, proving the strong appetite for the LCC model in the region.
Chart 4: LCC Penetration by Region
Middle East Asia Pacific Europe North America
98%
2%
87%
13%
84%
16%
75%
25%
Source: Euro Control, Center for Asia Pacific Aviation, HC Brokerage
UAE – Transportation
8
Table 8: Key MENA Low-Cost Carriers
Airline
Country Start
Date
Current
Fleet Orders*
Target
Fleet
Target
Date Destinations
AirArabia UAE – Sharjah 2003 16 44 60 2016 MENA/India/Europe Atlas Blue Morocco 2004 11 13 24 2012 Domestic/Europe Jazeera Airways Kuwait 2005 8 32 40 2013 MENA/India/Europe Jet4you Morocco 2006 5 5 10 2010 Domestic/Europe Bahrain Air Bahrain 2007 3 4 7 2009 MENA/India Nas Air Saudi Arabia 2007 9 0 0 -- Domestic/MENA EaseOn Air Iran 2008 5 7 14 2012 Domestic Sama Air Saudi Arabia 2008 7 24 30 2010 Domestic/MENA/India flydubai UAE – Dubai 2009 0 54 54 2015 International *Only purchase orders excluding new leases
Source: Airline Disclosures, Airbus, HC Brokerage
UAE – Transportation
9
Air Arabia: First Mover Advantage
� Air Arabia is set to benefit from a shift to LCCs, being the region’s first and leading LCC.
� An aggressive fleet expansion plan to support growth. No deliveries before end of 2010, enabling
the carrier to maintain its debt free position and a strong dividend payout in the short-term (an
average dividend yield of 11% based on 2008 and 2009 earnings).
� Expanding outside of Sharjah into other hubs will provide needed diversification and to minimize
the impact of growing competition.
Air Arabia is the region’s first and number one LCC
Air Arabia, the region’s first and leading low-cost carrier (LCC) and the official airline of the emirate of Sharjah,
commenced operations in October 2003 with a two-aircraft fleet and flights to five destinations. The carrier took
Sharjah International Airport as its hub operating frequent commercial flights on short- and medium-haul point-to-
point routes in the Indian subcontinent (47% of Air Arabia’s traffic currently) and the MENA region. The airline
operates a single aircraft type, the Airbus A320, with a single economy cabin configuration. Air Arabia had an
AED2.5 billion IPO and was listed on the DFM in July 2007. The carrier currently operates a fleet of 16 aircrafts and
flies to 44 destinations, and offers an average of 5% of weekly available aircraft seats in the UAE. Air Arabia’s
dominant position in the UAE and within the LCC segment ensures that it will benefit from an expected shift by
travelers to LCCs as the economy slows.
Table 9: Air Arabia’s Historical Milestones
Date Event
March 2003 Official Launch
October 2003 First Air Arabia flight to Bahrain
February 2005 Announcement of financial breakeven for 2004
June 2005 1-million passenger milestone reached
April 2007 Announcement of 300-room budget hotel project in Sharjah
April 2007 AED2.5 billion IPO closes attracting 40,000 subscribers
July 2007 Listing of Air Arabia’s shares on the DFM
Aug 2007 Launch of call center service
November 2007 Announcement of plan to open a new hub in Morocco
November 2007 Signature of USD3.5 billion agreement with Airbus to acquire 49 A320 aircrafts
January 2008 Launch of Air Arabia’s second hub in Nepal
March 2008 Acquisition of two new Airbus aircrafts
July 2008 Termination of Air Arabia’s second hub in Nepal
Source: Air Arabia, HC Brokerage
Chart 5: Geographic Distribution of Air Arabia’s Passenger Traffic
Ind ian Subcont inent
4 7%
GCC
2 7%
M idd le East ( Ex-
GCC )
15%
Nort h A f r ica
10%
Cent ral A sia
1%
Source: Air Arabia, HC Brokerage
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10
Chart 6: Air Arabia’s Flight Network*
*At November 2008
Source: Air Arabia, HC Brokerage
Chart 7: Share of Available Aircraft Seats Per Week in the UAE by Carrier
Emirates Airlines,
43%
Etihad Airways,
13%
Air Arabia, 5%
Air India Express,
3%
Others, 34%
Source: Center for Asia Pacific Aviation, HC Brokerage
Joint ventures to provide some diversification in the medium-term
Air Arabia operates a number of joint ventures. The two most significant JVs at the moment are: (i) Sharjah
Aviation Services (3% of revenues and 2% of net income in 2008), which provides aircraft handling services; and
(ii) Alpha Flight Services (1% of revenues and 1% of net income in 2008), which provides catering for flights
landing at Sharjah International Airport.
An anticipated JV with Sharjah International Airport is the 50%-owned “Air Arabia Centro Hotel”. The 300-room
hotel, which will be located near the airport, is expected to be completed in early 2010. The hotel will be managed
by Rotana hotels. Air Arabia’s share of the hotel’s investment cost is estimated at AED60 million, the bulk of which
will be paid in 2009. We expect the hotel to be successful as there are no hotels close to the airport and would thus
cater to transit passengers, cabin crew, and visiting friends and relatives (especially with a free zone and a
university near the airport). Income from the hotel will most likely be recognized using the equity method. We have
not included income from the Air Arabia Centro Hotel in our forecasts.
UAE – Transportation
11
Table 10: Air Arabia’s Joint Ventures and Subsidiaries (2008)
Joint Venture
% Owned
Activities
Red Marketing Communications 100% Marketing and advertising services Information System Associates 51% Trading and providing IT products and services Sharjah Aviation Services 50% Aircraft handling and passenger services Sharjah Airport Travel Agency 50% Travel & tourist agencies & air cargo Alpha Flight Services 51% In-flight catering within Sharjah Airport Source: Air Arabia, HC Brokerage
Aggressive fleet expansion plans…
Air Arabia currently operates a fleet of 16 A320 aircrafts. All existing aircrafts are leased with the exception of three
aircrafts that were purchased in 2008 due to favorable prices.
In November 2007, the carrier signed an agreement with Airbus for the acquisition of up to 49 A320 aircrafts with
an estimated book value then of USD3.5 billion. Air Arabia currently has firm orders for 44 aircrafts with deliveries
beginning in 2010 and are phased until 2016. Coupled with occasional additions of newly leased aircrafts, we
estimate that Air Arabia’s fleet will reach 80 aircrafts by 2018.
In 2009, the carrier will likely see its fleet grow to 19 aircrafts with the addition of four new leases and the return of
one. Two newly leased aircrafts are expected to be received in 2Q09 with the remaining two to enter Air Arabia’s
fleet in 4Q09. It is worth noting that fleet expansion plans can and are likely to change with market conditions as
the carrier has the option to add more (or fewer) aircrafts to its fleet. Regarding the 44 A320 firm orders, we are
skeptical that Air Arabia will reduce its firm orders but can alter its delivery schedule depending on market
conditions.
Chart 8: Air Arabia’s Fleet
3 3 59
1323
34 44 48 48 48
11
13 16
2021
2222 23 25 28 32
19
0%
20%
40%
60%
80%
100%
2007 2008 2009e 2010f 2011f 2012f 2013f 2014f 2015f 2016f 2017f 2018f
Owned Leased
Source: Air Arabia, HC Brokerage
UAE – Transportation
12
Chart 9: Air Arabia’s CAPEX and CAPEX/Sales
48%
33%
12%
26%
41%
62%
200
700
1200
1700
2200
2700
2008 2009e 2010f 2011f 2012f 2013f
0%
10%
20%
30%
40%
50%
60%
CAPEX (AED Mil.) CAPEX/Sales
Source: Air Arabia, HC Brokerage
…but no debt requirement before 2013
We believe that Air Arabia will sustain its debt-free position until 2013 as the hefty CAPEX begins in 2011. Any
CAPEX before 2013 can be financed internally. Air Arabia’s cash balance, which is mostly from the IPO proceeds,
stood at AED1.8 billion (30% of total assets) in 2008. Additionally, the carrier holds AED1.5 billion (26% of total
assets) in mostly unquoted available-for-sale investments, which we believe will be gradually liquidated to finance
its expanding fleet. Management has been discrete with regards to the nature of the investments but highlighted
that they are of a low risk profile. Our debt assumptions are a function of the CAPEX for the year.
Minor short-term financing needs allow for generous dividends
The Board of Directors of Air Arabia has proposed a dividend of AED0.1 per share, which implies a generous
dividend payout ratio of 92% and an attractive dividend yield of 11%. We expect the dividend to be distributed
sometime in the second half of April 2009 following the approval of the GAM to be held on March 23rd, 2009. The
reason for such a strong dividend is the lack of short-term major financing needs and the carrier’s strong balance
sheet. Although we view such generous dividends as not sustainable when the large CAPEX payments begin, we
believe there is room for a similar dividend based on 2009 earnings as well. We have assumed that the carrier will
maintain its minimum dividend payout ratio of 25% during the high CAPEX period from 2011-2015.
Sharing and contributing to the growth of its Sharjah Hub…
Located around 15 kilometers from Dubai and 10 kilometers from the Sharjah city center and with an annual
capacity of 8 million passengers, Sharjah International Airport, Air Arabia's hub, benefits from its geographic
centrality. The airport is easily accessible by residents of the different Emirates, and is well-connected to all major
international destinations. Sharjah International Airport recorded an impressive passenger growth in 2008 of 22%
YoY to 5.28 million in 2008. Air Arabia constitutes around 66% of available seat capacities at Sharjah International
Airport.
Chart 10: Sharjah International Airport Monthly Airport Traffic
490
441423407
491488
437
404
436431
392
440
366
460
386
342
393372
341339368
331
295
332
250
300
350
400
450
500
550
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Passenger Traffic ('000s)
2008 2007
Source: Sharjah International Airport, HC Brokerage
UAE – Transportation
13
Chart 11: Sharjah International Airport’s Capacity Breakdown by Carrier*
Air Arabia,
66%
Others, 10%
Air India
Express, 12%
Indian Airlines,
13%
*For the week commencing January 19th, 2009
Source: Center for Asia Pacific Aviation, HC Brokerage
…but growing competition is a threat
Air Arabia’s major competitive threat in our view is flydubai, Dubai’s own LCC which is set to commence operations
in 2Q09 and targets a fleet of 54 aircrafts by 2015. Although we do not have exact numbers, the threat pertains to
any Dubai business that Air Arabia has. There is also threat of transfer of Sharjah business if flydubai offers more
competitive rates. In general, we believe the impact of competition from flydubai will not be evident before 2010 as
it gradually builds its fleet and expand its destination offering. We are also skeptical that flydubai will offer more
competitive rates than Air Arabia given that it will initially operate at Dubai International Airport, which we believe is
more costly to operate from than Sharjah. flydubai will move its hub to Al Maktoum International Airport once it is
completed by 2010. There is also competition from regional LCCs (see table 8 above), particularly the rapidly-
expanding Kuwait’s Jazeera Airways that has Dubai as a secondary hub, and Indian LCCs since the Indian
subcontinent is Air Arabia’s most popular destination (see chart 5 above). India currently has six LCCs, but most fly
domestically with limited or no flights to the UAE. The clear exception is Air India Express, which captures 3% of the
available seat capacity in the UAE (and 12% of Sharjah’s capacity). The UAE represents around 42% of Air India
Express’ weekly flights. Additionally, the Indian carrier has been competing in the UAE for at least two years with no
significant impact on Air Arabia. The other Indian LCCs are expected to compete more heavily on UAE routes as
more permissions are granted to operate on international routes.
Table 11: Key Indian Low Cost Carriers
Airline Inception Current Fleet Orders No. of Destinations Destinations
JetLite 1991 24 10 28 Subcontinent
Kingfisher Red 2003 33 68 69 Domestic
SpiceJet 2005 19 17 17 Domestic
Air India Express 2005 21 4 32 Domestic/International
IndiGo 2006 19 -- 17 Domestic
Source: Airline Disclosures, HC Brokerage
Morocco hub to start operations in 2Q09
Air Arabia will launch operations at its second hub in Casablanca, Morocco in 2Q09. The 29%-owned joint venture
with Morocco’s Regional Airlines will be through a newly formed airline called “Air Arabia Maroc”. Air Arabia has
management control of the JV. The first destinations the new airline will fly to will include France, Italy, Spain and
the UK. Casablanca’s airport, known as Mohammed V International Airport, represented around 48% of Morocco’s
passenger traffic in 2008. The airport had larger passenger traffic than the Sharjah Airport in 2008 of 6.21 million
passengers, but demonstrated tamer growth of 6% YoY.
Although Morocco is somewhat competitive with two conventional airlines, two LCCs and one charter airline, we like
the expansion as it will provide exposure to destinations in Europe and North Africa that complement Air Arabia’s
current destinations. Key competition comes from Jet4u, a LCC that also has the Casablanca airport as its hub. “Air
UAE – Transportation
14
Arabia Maroc” will start off with 2 aircrafts (other than the 2009 target of 19 aircrafts for the Sharjah base). The JV
will be proportionately consolidated by Air Arabia given management control. Given Air Arabia’s small stake in the JV
and that it is a start-up, we believe the JV will not have a major financial impact before 2010. Given minor expected
material short-term impact and little management guidance, we have not included “Air Arabia Maroc” in our
forecasts.
Chart 12: Casablanca (Mohamed V) Airport Versus Total Moroccan Passenger Traffic
37.9%
39.3% 39.3%38.6% 39.3%
48.3% 48.3%
0
2
4
6
8
10
12
14
2002 2003 2004 2005 2006 2007 2008
30.0%
35.0%
40.0%
45.0%
50.0%
Morocco's Passenger Traffic (Mil.) Mohammed V's Passenger Traffic (Mil.) Mohamed V's Share of Moroccan Traffic (%)
Source: Office Nationale Des Aeroports (ONDA), HC Brokerage
Table 12: Moroccan Airline Industry Competitive Landscape
Airline Inception Type Hub Fleet Destinations
Royal Air Maroc 1957 Conventional Casablanca 46 86
Casa Air Service 1995 Charter Casablanca 3 N/A
Regional Air Lines 1996 Conventional Casablanca 10 18
Atlas Blue* 2004 LCC Marrakech 11 23
Jet4U 2006 LCC Casablanca 5 13
*LCC subsidiary of Royal Air Maroc
Source: Airline Websites, HC Brokerage
An impending announcement of a third hub
Air Arabia is expected to announce a third hub in early 2009. The likely options are Egypt and the Levant region.
We view the Egypt option as favorable as it is the Arab world’s most populous country and the LCC concept is
nearly non existent there. EgyptAir has a six-fleet LCC arm called EgyptAir Express, but only flies domestic flights
and is not well-advertised in the country. India is another option as it represents around 47% of the airline’s traffic.
Worth noting is that Air Arabia suspended operations at a hub in Kathmandu, Nepal in mid 2008 due to political
reasons. We like Air Arabia’s hub expansion strategy as it provides a diversification of routes and would help reduce
the impact of growing competition. The announcement of a third hub should serve as a short-term price catalyst.
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15
Air Arabia: Among the Best in Class
� We expect Air Arabia to deliver sales growth of 9% in 2009 despite declining yields.
� EBITDAR and net income are expected to grow in 2009 by 46% and 21% YoY, respectively,
helped by falling fuel prices.
� Revenue and EBITDAR to grow at a 5-year CAGR of 18% and 22%, respectively, driven by fleet
expansion plans.
We forecast strong passenger growth in 2009 but declining yields tame revenue growth
We expect Air Arabia’s passenger traffic to grow in 2009 by 17%, benefiting from a shift of travelers from
conventional to LCCs, a net increase of 3 aircrafts and the addition of new destinations. Air Arabia is expected to fly
to Athens, Iran and more India destinations in 2Q09. We also forecast a strong average load factor of 84% for
2009. But revenue growth is to come under pressure as yields (passenger revenue per available seat kilometers)
decline as we expect Air Arabia to reduce its fares due to lower fuel surcharges and to spur demand. A big chunk of
the 20% YoY increase in Air Arabia’s average fares in 2008 was due to high fuel surcharges to match the escalating
fuel prices. We expect a rebound in yields in 2010. It is worth noting that Air Arabia’s pricing strategy is strictly
demand-driven. The base fare is 40% below those offered by conventional carriers for the same route but if all
other airlines have no free seats for a particular destination at a particular time, it can charge even higher than
conventional carriers. Also, fares rise as the bookings are made closer to a flight’s date.
Chart 13: Change in Air Arabia’s Yields (Passenger Revenue per ASK)
-15%
-5%
5%
15%
25%
35%
2006 2007 2008 2009e 2010f
Source: Air Arabia, HC Brokerage
Long-term revenue forecasts are a function of fleet additions and load factors
Our passenger traffic forecasts post 2009 are strictly a function of the aircraft additions. We assume a sustainable
load factor of 80%, which is lower than the 85% achieved in 2009 but still at a significant premium to its LCC peers
(see chart 15 below). Our load factors capture growing competition particularly in the UAE. flydubai, Dubai’s own
LCC , which is set to begin operations in 2Q09, could prove a threat in the medium-term. We have assumed an
average annual increase in fares of 2% in the medium- to long-term.
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16
Chart 14: Air Arabia’s Passenger Traffic Forecasts
4.18
4.90
5.78
6.73
8.10
20%
18%
17%17%
16%
0
2
4
6
8
10
2009e 2010f 2011f 2012f 2013f
15%
17%
19%
21%
23%Number of Passengers (Mil.) Passenger Growth (%)
Source: HC Brokerage
Chart 15: Air Arabia’s Current Load Factors in Comparison to Other LCCs
81% 81%
79%78%
75%
71%70% 70%
62%
85%
60%
65%
70%
75%
80%
85%
Air Arabia easyJet Ryanair JetBlue vueling Air Asia Southwest Jazeera Jet Airways Gol
Source: Air Arabia, Airline Disclosures, HC Brokerage
Air Arabia’s wise fuel hedging to bear favorably on 2009 results
A major challenge that the airline industry and Air Arabia faced in 2008 was record-high fuel costs with oil
exceeding USD140 per barrel. Air Arabia was not hedged throughout the period of escalating oil costs but managed
to deliver a solid set of results for 2008, remaining one of the most cost-efficient LCCs (see chart 18), as it passed
on the cost increases to its passengers through its fuel surcharges. When oil prices started to fall, many carriers
started to hedge but few were able to predict how low prices would go. Many airlines hedged in the USD100 per
barrel range, which, coupled with slower demand, deems 2009 a particularly difficult year. Going into 2009, Air
Arabia hedged 55% of its needs at around USD62 per barrel. We do not believe the company will do further
hedging for the year given the low levels that oil prices are settling at. We expect Air Arabia’s average oil price for
2009 to be USD59 per barrel (around USD597 per ton in jet fuel terms).
Accordingly, we forecast fuel costs to drop from 39% of sales (and 46% of costs) in 2008 to 29% of sales (and
37% of costs) in 2009 bearing favorably on Air Arabia’s margins. We forecast an impressive EBITDAR growth of
46% YoY for Air Arabia and a significant improvement in EBITDAR margin from 25.2% in 2008 to 33.6% in 2009.
Net income is estimated to grow at a strong but tamer 21% YoY as 2008 results were partly inflated by AED56
million in non-recurring dividend income.
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17
EBITDAR growth is set to slow as oil prices rise again. Our forecasts assume a long-term (post the fifth forecast
year) oil price of USD70 per barrel and a sustainable EBITDAR margin of 30%. Net income growth is to come under
pressure as Air Arabia books higher depreciation expense as it takes delivery of its aircrafts starting 2010 as well as
higher interest charges upon taking debt, which we assumed to take place in 2013. But the fleet expansion is to
bear fruit as we anticipate a 5-year CAGR of 18% for revenues and 23% for EBITDAR.
Table 13: Air Arabia’s Fuel Costs and Fuel Hedging Versus LCC Peers
Airline Fuel Cost as a % of Sales* Fuel as a % of Costs* % of Fuel Hedged Hedging Price
Air Arabia 38% 46% FY09 – 55% USD62/bbl
Air Asia 63% 61% No Hedging
easyJet 30% FY09 – 73% FY10 – 27%
USD107/bbl USD91/bbl
GOL 43% 49% To Start Hedging in April 2009 Jet Airways 38% 39% FY09 - 25% Not Disclosed
Norwegian AS 34% 36% 1Q09
Post 1Q09 USD107/bbl USD108/bbl
Ryanair 30% 37% 1H09 – 75% 3Q09 – 50%
USD64/bbl USD65/bbl
Southwest Airlines 26% 28%
FY09 – 75% FY10 – 50% FY11 – 40% FY12 – 35%
USD73/bbl USD90/bbl USD93/bbl USD90/bbl
Vueling 32% 45% No Hedging *As per the airlines’ latest financials
Source: Airline Disclosures, HC Brokerage
Chart 16: Evolution of Brent and Jet Fuel Prices (January 2007-Februaury 2009)
30
50
70
90
110
130
150
170
J-07 F-07 M-07 A-07 M-07 J-07 J-07 A-07 S-07 O-07 N-07 D-07 J-08 F-08 M-08 A-08 M-08 J-08 J-08 A-08 S-08 O-08 N-08 D-08 J-09 F-09
Brent (USD/bbl) Jet Fuel Med FOB (Restated)
Source: Reuters, HC Brokerage
Chart 17: Air Arabia’s Cost Breakdown in 2008 and 2009
2008a 2009e
Land ing 5%Hand ling ,
5%
Fuel, 4 6 %
M aint -
enance,8%
Lease
Rent als,
11%
St af f , 16%
Others* , 8%
Land ing 6%Handling ,
6%
Fuel, 3 7%
M aint -
enance,10%
Lease
Rent als,
12%
St af f , 19%
Others* ,
10%
*Other costs include depreciation and amortization (2% in 2008 and 3% in 2009)
Source: Air Arabia, HC Brokerage
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18
Chart 18: Air Arabia’s Cost/ASK (in USD) Versus Other LCCs*
0.00
0.01
0.02
0.03
0.04
0.05
0.06
0.07
0.08
0.09
0.10
0.11
Air Asia Air Arabia Jazeera
Airways
Easy Jet GOL JetAirways Vueling Norwegian Southwest
*As of airlines’ latest financials
Source: Air Arabia, Airline Disclosures, HC Brokerage
Chart 19: Air Arabia’s Forecasted Revenue and EBITDAR Growth During Fleet Expansion Period
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
2010f 2011f 2012f 2013f 2014f 2015f 2016f
Revenue Growth EBITDAR Growth
Source: HC Brokerage
Chart 20: Air Arabia’s EBITDAR and EBITDAR Margin Forecasts
31%
32%
34%34%
25%
33%
500
700
900
1,100
1,300
1,500
2008 2009e 2010f 2011f 2012f 2013f
25%
27%
29%
31%
33%
35%EBITDAR (AED Mil.) EBITDAR Margin
Source: HC Brokerage
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19
Chart 21: Air Arabia’s 2009e EBIT Margin in Comparison to Other LCCs
14% 14% 14%
9% 9%
2%
7%
2%
22%
0%
5%
10%
15%
20%
Air Arabia AirAsia JetBlue Ryanair Jazeera Southwest Gol vueling easyJet
Source: Air Arabia, Reuters, HC Brokerage
Ancillary revenue to remain a modest growth driver for Air Arabia
Air Arabia’s other revenue constituted 7% of total revenue in 2008. But not all of the carrier’s other revenue are
strictly ancillary revenue. 38% of other revenue is represented in airport handling revenue, as part of the
proportionate consolidation of its JV Sharjah Aviation Services, which is not in essence ancillary revenue. Core
ancillary revenue represented less than 4% of 2008 revenues, which is low compared to other LCCs. The main
source of ancillary revenue for Air Arabia is related to excess baggage. We believe that the level of ancillary revenue
is low for Air Arabia compared to other LCCs due to the relatively small variety of ancillary services offered and mild
management focus in that area. Thus, we forecast that other revenue (including airport handling) to remain at an
average of 7% of sales over our forecast horizon.
Chart 22: Air Arabia’s Other Revenue Breakdown (2008)
Airport Handling,
38%
Baggage, 22%
Catering, 14%
Cargo, 12%
Service, 6%
Other, 8%
Source: Air Arabia, HC Brokerage
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Chart 22: Air Arabia’s Ancillary Revenue/Total Revenues in Comparison to Other LCCs
15%14%
9%
7%
6%
4%3%
18%
0%
5%
10%
15%
20%
Ryanair Easyjet vueling Air Asia JetBlue Norwegian Air Arabia* Southwest
*Air Arabia’s ancillary revenue excludes airport handling revenues
Source: Air Arabia, Airline Disclosures, Boeing, HC Brokerage
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Appendix I: The Low-Cost Carrier (LCC) Business Model
A low-cost carrier is an airline that offers relatively low airfares while eliminating many conventionally offered
passenger amenities. The concept was pioneered in the United States in the 1940s by Pacific Southwest Airlines and
gradually evolved to its current form in the 1970s. The model later penetrated Europe with the most notable
success stories being Ireland’s Ryanair (1985) and London’s easyJet (1995). It then spread into Asia in the 2000s
and the Middle East in 2003 pioneered by Air Arabia. The cornerstones of the LCC model include:
(i) eliminating unnecessary costs and “frills”, which characterize conventional airlines such as free on-board
catering, pre-assigned seating, cargo/freight carriage, lounges, air miles, etc. These services are offered
for a fee thus generating “ancillary revenue”;
(ii) a single-type aircraft fleet, which allows for operational savings in the areas of maintenance, flight
operations, and crew training;
(iii) a single passenger class;
(iv) maximizing aircraft utilization through reducing turnaround times (keeping aircrafts in the air for the
longest time possible) as well as maintaining high seating density and load factors;
(v) a simple pricing system through: (1) offering low fares that only rise as flights fill up (i.e. cheaper fares
for earlier reservation); (2) having adjustable price bands based on demand; and/or (3) charging one-
way fares;
(vi) eliminating/reducing sales commissions by relying on direct booking through the internet and/or call
centers;
(vii) simplifying routes through using point-to-point networks instead of transferring through hubs, which also
maximizes aircraft utilization;
(viii) “paperless” operations, to significantly reduce the cost of issuing, processing and distributing millions of
tickets a year.
It is worth noting that it is rare to find a single LCC applying all the abovementioned cornerstones. Each LCC offers
variations on these points based on its management strategy.
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Appendix II: Key Aviation Industry Terms
Ancillary Revenue Airline revenue from sources other than ticket sales.
LCCs are typically highly dependent on ancillary
revenue. Examples include in-flight meals, excess
baggage, etc.
Available Seat Kilometers (ASK) Total available seats x kilometers flown. A measure of
an airline’s total capacity.
Block Hours Time an aircraft stays in the air on average from its
departure to landing.
Long-Haul Flights Flights longer than six hours.
Medium-Haul Flights Flights that are between three and six hours. LCCs
typically fly short- and medium-haul.
Passenger Load Factor RPK/ASK. A measure of an airline’s capacity utilization.
Short-Haul Flights Flights that are shorter than three hours. LCCs typically
fly short- and medium-haul.
Revenue Passenger Kilometers (RPK) Number of passengers x kilometers flown. A measure of
an airline’s production.
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23
Rating Scale
Recommendation Upside
Buy Greater than 25%
Hold 0-25%
Sell Less than 0%
Disclaimer
This memorandum is based on information available to the public. This memorandum is not an offer to buy or sell, or a solicitation of an offer to buy or sell the securities mentioned. The information and opinions in this memorandum were prepared by HC Brokerage from sources it believes to be reliable and from
information available to the public. HC Brokerage makes no guarantee or warranty to the accuracy and thoroughness of the information mentioned in this memorandum, and accepts no responsibility or liability for losses or damages incurred as a result of opinions formed and decisions made based on information presented in this memorandum. HC Brokerage does not undertake to advise you of changes in its opinion or information. HC Brokerage and its affiliates and/or
its directors and employees may own or have positions in, and effect transactions of companies mentioned in this memorandum. HC Brokerage and its affiliates may also seek to perform or have performed investment-banking services for companies mentioned in this memorandum.
UAE – Transportation
24
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