Aeroflot: Review of 9М2017 results

"Buy" recommendation with 12M TP of 190RUB per share

Andrey KozhokaruJanuary 12, 2018

Despite the growth of operating indicators for 9M2017, the Group worsened its financial results, which was reflected in the reduction of the Company's capitalization. Main factors that led to the revaluation of Aeroflot shares were a strong growth of operating expenses (+15.4% y/y), restrained by ruble appreciation, a weaker revenue growth (+6.2% y/y) due to the currency appreciation, and no full transfer of growth of costs into ticket prices. However, taking into account one-off events observed in 2016-2017, as well as considering the Company’s historical financial performance, the results for 9M2017 looks quite competitive. Moreover, recent financial results partly reflect the Group's development strategy aimed at an expansion of transit traffic and a higher presence in the international market, which require the preservation of professional air crews and investments in the development of the product and Aeroflot brand. We consider the current decline in the price of AFLT shares as excessive, considering the Company's long-term prospects. Taking into account the preservation of the dividend yield and the current price, we recommend to Buy Aeroflot shares with 12M TP of 190 rubles per share.

Medium-term investments in the development without improvement of margins. We forecast the EBITDA margin slightly above 10.5% for the period of 2018-2019 (13% earlier), and net profit margin of not more than 5% (7% earlier). Despite the fact that expected figures are much lower than the results of 2016 (EBITDA margin – 15.7%, net profit margin – 7.8%), we believe that maintenance of margins at these levels will be able to ensure a steady growth of financial metrics in case of a successful implementation of the Group's strategic plans for operating indicators. We forecast average annual growth of passenger turnover at 12% y/y for the period of 2018-2020. In the long term, we expect a convergence of growth rates of revenues and expenses.

Fuel prices, FX dynamics, and competition as main factors. The revenue in foreign currency covers around 50% of the Group's foreign currency’s expenditures. For 9M2017, the negative FX effect on revenues exceeded the positive FX effect on expenses by 7.5bn rubles. In case of a continued appreciation of the ruble, the maintenance of a negative FX effect in future results is possible and vice versa. Aeroflot currently does not hedge fuel prices. Nevertheless, this position makes the Group less competitive in case of an excessive rise of oil prices relative to airlines that hedge fuel costs, it also assumes a more favorable position in the event of a decrease or stabilization of oil prices. The increase in yields of air transportation sector, observed in 2016, largely attributed to the decline in the presence of foreign airlines in the Russian market. In 2017 foreign airlines quite quickly returned to the market, which caused an excess of supply and resulted in a decrease of profitability. Aeroflot has a strong position to successfully compete, but an exacerbation of the latter will steadily lead to a decrease in margins of the industry.

Buy recommendation with 12M TP of 190 rubles/share. In our opinion, the Aeroflot Group will continue to demonstrate a stable growth of operating results on the forecasted horizon, which, in the absence of external shocks, should ensure a stabilization of financial indicators. The air transportation market in Russia remains unsaturated, which provides a significant potential for organic growth. Considering the current price and projected dividends at the level of 10 rubles per share, we recommend to Buy AFLT, while decreasing our 12M TP from 240 to 190 rubles per share.

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