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AIRARABI UH | Current valuation reflects recovery; Neutral

2022e P/E in line with historical industry average; Long-term yields attractive. We expect Air Arabia’s operations to gradually recover to pre-COVID-19 levels in 2022e, with the stock trading on a 2022e P/E of 12.4x, in line with its historical average of 12.0x vs. the industry’s historical average of 13.4x. That said, we see Air Arabia’s dividends also returning to pre-pandemic levels starting 2022e, yielding 5.65% vs. 0.94% for global peers and 2.50% for the UAE market.

Air Arabia to turn profitable in 2021e; Returns to normal levels in 2022e. We suppose the rollout of COVID-19 vaccines and global economic recovery will lead passenger traffic to recover by c55% and 110% in 2021e and 2022e, respectively, bringing the company’s net income to AED119mn and AED486mn. Beyond 2022e, we look for the company’s return to its mature industry-play status over 2023-26e, with: i) pax of c10mn p.a. (rising at c1% p.a.) and ii) yield of USD118/pax (rising at 1% p.a.). Our assumptions imply a 2023e net income of AED726mn, rising at a 2023-26e CAGR of 6.51%.

Capex needs to rise substantially post recovery, as company replaces aging fleet. The Group’s fleet is aging (weighted average age of nine years vs. 12-15 years of useful life), and we expect it to start a broad fleet replacement cycle in 2022e, with an estimated three new units p.a.. We look for a 2023-26e average net capex requirement of AED1.1bn p.a., implying capex/sales of c24%, 1.9x its historical average over 2011-20. The company’s balance sheet is strong (2022e net debt/EBITDA of 1.15x), with sufficient cash to fund its needs.

Valuation highly sensitive to passenger traffic, passenger yield, and oil prices. We estimate every 1% higher/lower-than-expected passenger yield and passenger traffic to increase/reduce our TP by c14% and c13%, respectively, all else constant. As of now, 75% of the Group’s short and medium-term fuel needs are hedged to oil. We assume an oil price of USD60.0/bbl in 2021e, falling and sustaining at USD55.0/bbl starting 2022e, with every 1% higher/lower oil price p.a. leading to a 3.2% lower/higher TP, all else constant. The possibility of stronger-than-expected pickup in passenger traffic in 2021e and 2022e (likely on the back of Expo 2020 [postponed to 2021]) can substantially improve Air Arabia’s short-term profitability.