The rally in energy prices over the first 6 months of FY08 (avg. USD98/ barrel during FY08 vs. USD70/barrel in FY07) continued to pressure Air Arabia’s operating margins with the GPM declining ca. 560 bps over the associated period. Despite a difficult operating environment the company continued to execute its expansion plans, reflective in a 61% increase in the top line for FY08, culminating at AED2.1 billion vs. AED1.3 billion registered in the comparable period of the previous year. The airline recorded a net profit of AED510 million (NPM 25% in FY08 vs. 29% in FY07) and its BOD recommended a 10% cash dividend (AED466 million) which results in a dividend yield of 10.5%. Overall, we believe Air Arabia’s financial position remains robust as cash (AED1.8 billion) and AFS investments (AED1.5 billion of which ca. 50% is estimated to be in bonds) together accounted for 56% of the airlines year end assets with no material long term liability.

Since our last update on Air Arabia dated October 19, 2008, the company's destinations and fleet have both grown with FY08 reporting 44 destinations and a fleet size of 16 planes (3 purchased and 13 on lease) vs. 37 and 11 in FY07. Based on management guidance, we now expect Air Arabia to begin taking delivery of its 44 plane order effective FY10 as against FY12 assumed earlier, with the new planes to be used for the expansion in Morocco (2nd base) which is expected to begin operations from May this year. Management has also revealed that an official announcement regarding the establishment of a 3rd base in the MENA region is expected to be made within the same month and its respective operations to commence 6 months thereafter.

Based on our revised number of planes (21), avg. ticket prices (AED607) and load factors (75%) expected during FY09, we are estimating year end revenues of AED2.4 billion for FY09 (16% y-o-y growth). We are further expecting the GPM to register 28%, (vs. 21% in FY08), as fuel costs decline to 29% of revenues, offset in part by our outlook on an estimated 8% decrease in Sharjah ticket prices for the year. Over the medium term, our forecasted improvement in gross margins (31% in FY11) proves a direct function of our estimates relating to increasing ticket prices and higher load factors in tandem with higher oil price assumptions, which come in at USD61/barrel and USD78/barrel for FY10 and FY11, respectively.

Our revised valuation on Air Arabia has yielded a DCF fair value of AED1.59/ share, down 40% from our previous target price. With the share currently trading at AED0.95 per share, our fair value target provides investors with an 67% upside potential. We accordingly reassert our Strong Buy recommendation.


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