Broker sees discount airline under pressure

HC Securities downgrades Air Arabia to "hold" because it feels the region's budget airline market is under pressure, with excess capacity and increased competition.

A year ago, HC Securities issued a "buy" recommendation for Air Arabia, saying the downturn would lead more travellers to choose budget options. This week, in a surprise move, the brokerage downgraded the stock to "hold" because it feels the region's budget airline market is under pressure, with excess capacity and increased competition. Is Air Arabia's stock running out of steam? If so, it is not because the company is inconsistent.

Air Arabia, which trades on the Dubai Financial Market, announced net profits of Dh452 million for last year, a slight drop on Dh454m for 2008, excluding exceptional items. Air Arabia said it would issue a 10 per cent dividend to shareholders for the second consecutive year. But HC Securities this week responded by cutting its target price for Air Arabia by 12 per cent to D1.11 a share, saying it did not see momentum to buy the stock continuing. "The end of lock-up period on founders' shares could place some pressure on share price and strong dividends won't sustain in coming years," HC Securities said.

"Air Arabia surprised the market with a strong dividend for a second consecutive year, but we believe this will not sustain as Dh3 billion in aircraft deliveries begin in the fourth quarter of 2010. The dividend is holding up the share price at the moment and we see limited catalysts after the stock goes ex-dividend on April 1." The brokerage also said yields, or the average price for air tickets, remained an issue. "Air Arabia's early summer fares to India (about a third of its traffic) are at heavy discounts of over 40 per cent to Emirates [Airline] and 27 per cent to Indian carriers, which highlights Air Arabia's cut-throat competition and shows that it is pricing relative to Indian carriers.

"This implies a strong likelihood of yield pressures extending to the peak summer season, where airlines typically make most of their profit." An Air Arabia spokesman replied that even though last year "saw the industry scoring its biggest loss ever, Air Arabia posted strong profits and rewarded its shareholders with a 10 per cent cash dividend. We are confident of our expansion plans and our focus at driving our profitable business forward."

Air Arabia closed yesterday down slightly at Dh1.07. [e-mail]