Neutral EFG forecast for Air Arabia stock on rising fuel costs

EFG Hermes has downgraded its forecast for Air Arabia stock from accumulate/ buy recommendation to neutral, and also reduced its forecast for the fair price from Dh2.10 to Dh1.77.

It said in a report that this reduction in Air Arabia's fair value came due to the increasing fuel prices that would reduce the company's expected profits.

Hermes said in a report on Air Arabia that it also reviewed its forecast for oil prices for $65 per barrel to $113 per barrel this year.

"With fuel prices set to remain at unprecedented levels for at least the next few months, we have revised our assumptions for this year and beyond. We have increased our fuel price assumptions significantly, forecasting an average oil price of $113 this year, and $112 next year. Beyond 2012, in the long term, we assume a flat average oil price of $88. This has had obvious negative implications for our margin assumptions, with operating margins falling from 15.8 per cent to nine per cent this year, and 15.9 per cent to 7.8 per cent in 2009."

The report also expected that the average fair estimate of Air Arabia to increase from Dh435 to Dh470, saying that the airline will try to pass on at least some of the rising costs of fuel to passengers through surcharges.

"This has positive implications for our top line forecasts, with revenue forecasts rising by 30.5 per cent and 46.7 per cent for this year and next," the report said.

It showed that Air Arabia has grown its fleet to 15 aircraft, adding two new purchased planes in the first quarter and also adding two new destinations in India.

"However, having opened its new hub in Nepal during the first quarter, the company announced recently that it has suspended operations from mid-July due to political uncertainty. Meanwhile, Air Arabia's new hub in the Moroccan capital Rabat will become operational next year. Yet, the company is providing no further details and therefore we have not included either hub in our forecasts."

EFG Hermes also cited the negative impact of high fuel prices on the global aviation sector. "Oil prices almost doubled since October last year, leading to a huge adverse effect on the aviation industry across the globe. Coupled with a global slowdown, this led to extremely demanding industry conditions for all airlines. Consequently, a number of airlines have already gone bankrupt this year with many others making considerable losses, as passenger demand has been impacted by higher fuel surcharges."

The report said the impact was greater on low-cost carriers as fuel costs typically make up a greater proportion of their total cost. "However, given these increasing surcharges across the board in the aviation industry, we believe low-cost carriers such as Air Arabia may benefit from passengers trading down, as the cost of flying continues to spiral upwards. Moreover, in terms of competition, this rise in fuel costs has also curbed new entrants and/or other competitors from ramping up their fleets," it added.