Jeju Air : Cost competitiveness to translate into earnings

● 1Q17 preview: OP to come in well above consensus at W20.2bn

For 1Q17, we forecast Jeju Air to report revenue of W211.6bn (+22.2% YoY). Available seat kilometers (ASK) likely expanded 19.4% YoY, while load factor likely improved YoY to 86.3% (vs. 85.9% in 1Q16). We believe yield, which has been a source of concern, also stabilized in the quarter. In the international segment, passenger traffic likely jumped 21.9% YoY, driving overall revenue growth.

We expect 1Q17 operating profit to come in at W20.2bn (+29.2% YoY), 27.8% above the consensus (W15.8bn). While fuel costs likely increased 74.2% YoY as a result of higher oil prices and increased consumption, we believe margins improved thanks to: 1) won appreciation, 2) leverage effects from higher load factor, and 3) steady growth in ancillary revenue.

On the non-operating side, we see F/X losses of W2.5bn due to a lower US$/W rate at the end of the quarter, but estimate net profit expanded 23.9% YoY to W14.9bn on robust operating profit growth.

● Strong cost competitiveness to boost market position

1) Cost decline to continue: Jeju Air`s unit cost (W/ASK) has fallen roughly 5% annually in the past three years (2014-16). Even after excluding more volatile components like oil and maintenance, the airline`s unit cost has dropped 1-2%, underscoring its improving cost competitiveness. In 2017, we project unit cost to fall 5.1% YoY on a stronger won, helping the airline to maintain its relative price advantage and gain further market share.

2) THAAD-related risks: Tensions with China over the THAAD issue are likely to dampen passenger growth on China routes. At the current rate, we think demand on China routes will begin to decline full swing in 2Q17.

That said, we note that Jeju Air`s exposure to China routes is limited, at around 5%, and overall outbound demand is unlikely to drop dramatically as travelers turn to other destinations. Adjustments to supply routes could intensify competition in some areas, but we believe the airline`s cost competitiveness makes it well positioned to further expand its market position.

● Maintain Buy and Raise TP to W40,000

We remain Buy on Jeju Air and raise our target price to W40,000 (from W36,000). Our target price is based on a RIM methodology (COE of 8.2%) and corresponds to a 2017F P/E of 14.5x. We view our target valuation as rather conservative, given the airline`s strong growth potential (three-year CAGR forecast: 20%) and ROE (threeyear average forecast: 22%). We believe Jeju Air`s increasing market position (backed by cost competitiveness and capacity growth) and resulting strength in earnings will support sustained multiple expansion.