Brahim’s to get burnt by MAS recovery plan

03 Sep 2014 / 05:39 H.

    PETALING JAYA: In-flight meal provider Brahim's Holdings Bhd's share price fell on news of plans by Malaysian Airline System Bhd (MAS) to renegotiate supply contracts.
    The stock fell 5 sen or 3.76% to RM1.28 with some 595,300 shares done when the market closed yesterday.
    Following the recovery plan announced by Khazanah last Friday, AllianceDBS Research cut Brahim's earnings for the financial year ending Dec 31, 2014-2016 by 30% to 48% after reflecting lower sales volumes and earnings before interest and tax margins.
    "We now expect earnings to contract by 22% and 11% in FY14F and FY15F," the research house said in a report yesterday.
    Following the earnings downgrade, it slashed Brahim's target price to RM1.10, pegged to 16 times that of its FY15 forecast price to earnings ratio.
    "There is now downside risk in the share price," its analyst Tan Kee Hoong said.
    Under a plan unveiled by major shareholder Khazanah Nasional Bhd, MAS is to migrate its operations to a new entity but leave the existing contract obligations with the current entity (Oldco).
    This will give MAS stronger bargaining power to renegotiate its supply contracts, including the catering contract with Brahim's Airline Catering (BAC), as the legal liability of the current contract obligations lies with the Oldco.
    "Also, there is unlikely to be compensation for any breach of supply contracts because there will be limited equity capital left in the Oldco once the selective capital repayment is completed," it said.
    The plan also requires MAS to focus on managing revenue yield, thereby reversing its current "load-active, yield passive" strategy. This could lead to higher airfares going forward which will likely reduce passenger traffic, and lead to lower sales volumes for BAC.
    "These measures will hurt BAC's sales volumes. Regional flights typically consume less meals vis-à-vis long-haul flights, while the focus on yield management will lead to higher fares and lower load factor/passenger traffic going forward,' he said.
    He cautioned that BAC is unlikely to be able to secure new contracts from other airlines to fill the void left by MAS, especially not in the near term.
    "While passengers could theoretically switch to other airlines which could in turn ramp-up capacity to gain market share, we believe this is unlikely to happen," he said.
    Tan expects other airlines to take the opportunity arising from MAS restructuring to lift fares again to more sustainable levels since MAS' aggressive fare promotion in 2013 led to industry wide yield compression which had in turn dragged airlines' profitability.
    "Also, the other airlines will feel less need to cut fares given MAS' renewed focus on yield management. However, the anticipated higher industry-wide airfares would make travel more expensive and reduce passenger traffic, and consequently, demand for BAC's in-flight meals," Tan said.
    He also noted that as with most outsourced service providers, BAC's in-flight catering business is saddled with high fixed overheads.
    "This creates significant operating leverage in the business, which was the key factor in driving up BAC's net profit by 31% year-on-year in FY13 when sales volume only increased by 13%. The reverse would happen if sales volumes were to drop," he said.
    Adding salt to the wound, Brahim's has to service a large term loan which it took in 2013 when it acquired a 34.3% effective stake in BAC. He said the group has since refinanced the loan with a lower-cost term loan, but estimated that the annual interest expense still amounts to RM11 million per annum.
    "This financial leverage will weigh on Brahim's bottomline should the in-flight catering business slow down substantially.
    "Given the high operating and financial leverage, Brahim's earnings would be disproportionately affected by changes in in-flight catering sales volumes," he said.

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