Air Arabia Co. -Equity Report -23-05-2012

12-Month Fair Value: AED 0.51
Recommendation: Reduce – Risk Level: 5
Reason for Report: 1Q2012 Update

Operating loss for 1Q2012 is a negative surprise. Air Arabia posted an operating loss of AED 1.2 million in 1Q2012 despite headline results showing a 12% YoY increase in net profit to AED 47.7 million. Net profit was boosted by an 81% YoY increase in other income to AED 43.8 million-Included in other income are again of AED 29.8 million on derivative financial instruments and a dividend gain of AED 35 million. The non-recurring nature of the dividend gain and the volatile non- cash nature of gains on derivative financial instruments make us very cautious about Air Arabia’s profitability for 2Q2012.

We cut our fair value target by 32% to AED 0.51 per share. Most of this drop is driven by our risk rating adjustment (which led to a 100-basis-point increase in the cost of equity we use) and lower assumptions for the company’s long-term profitability. Moreover, we no longer include a value for the hubs in Morocco and Egypt. Given that our fair value is 15% lower than Air Arabia’s latest close, our new recommendation for the stock is “Reduce.”