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Air Arabia Co.

Source: Shuaa Capital

Air Arabia has managed to retain a strong pace of growth in its operations, as its fleet expanded from 11 aircraft at end of 2007 to 15 aircraft presently, while it established two secondary hubs in joint ventures with local partners. Despite this aggressive growth, the carrier remained one of the most profitable low cost carriers in terms of margins and has proven more flexible to increases in its cost structure compared to global peers. However, increasing competition from new entrants, as well as surging fuel prices, may have started to encroach upon the profitability margins of Air Arabia.

Higher fuel costs have a higher impact on Air Arabia’s cost structure and margins than that for conventional airlines in the region, and fuel surcharges have meant that fare savings for consumers on LCCs have shrunk in relative terms. However, due to a high pure elasticity of demand on air travel, higher industry prices mean a higher load factor and RPK for Air Arabia. The fact that new entrants to the market in the Middle East seem to be scaling back on their growth due to adverse industry conditions will likely mean less competitive pressure on Air Arabia for the time being, and continued low penetration rate for LCCs in the region.

We revise our estimates on Air Arabia, to reflect higher achieved and anticipated growth as well as the impact of new industry developments on costs and margins. As a result, we raise our fair value estimate to AED 2.17 per share, and maintain our BUY recommendation, with an implied upside of 13.6% from the current levels of AED 1.91. While the anticipated upside has become limited, we believe that it is significant enough at this stage to warrant a maintenance of our Buy recommendation, given the above average growth prospects of the carrier and the Middle East aviation market in general, and limited other alternatives to access this theme. However, our estimates and outlook on the company remain sensitive to any large and sustained fluctuations in oil prices.

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