Jump on board while Air Arabia stock takes off

When sentiment toward a stock is so glum that all news is bad news, it's time to take inventory of the ways the company might not be getting its due.

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Shareholders in Air Arabia are two-time losers. The stock was sold early last year as the price of oil soared, apparently in recognition that fuel accounts for much of an airline's costs. But when oil dropped out of sight after that, Air Arabia sank even faster and farther as investors seemed to conclude that business prospects in the oil-dependent Middle East would suffer. When sentiment toward a stock is so glum that all news is bad news, it's time to take inventory of the ways the company might not be getting its due. There are plenty in the case of the low-cost airline - enough to persuade several investment advisers that it will not remain a low-cost stock for long.

One of those is a rare commodity in business: a good idea at the right time. The skies above the western world are swarming with planes operated by budget carriers. They account for 23 per cent of available airline seats in the US and 27 per cent in Europe, according to an HSBC report. The corresponding figure for the Middle East and North Africa is a mere 4.5 per cent. That should allow Air Arabia to beat the national flagships, such as Emirates Airline, on price without getting into a dogfight with rivals trying the same business model.

As David Lepper, HSBC's head of UAE research and the report's author, sees it, the Middle East is fertile territory for budget airlines, particularly Air Arabia. The number of expatriates working in the Middle East - including a substantial majority of the UAE's population - is a steady source of demand, he noted. The bleak economic times work in the airline's favour, too, he said. They persuade passengers to switch to budget carriers, allowing them to increase market share.

Air Arabia, which has its main hub in Sharjah and flies to about 40 destinations, is also taking advantage of the grim backdrop to expand its fleet. With credit scarce and growth slow, it's a buyer's market, and when conditions improve and traffic picks up, Air Arabia will be well placed to cater to those passengers' needs. "Although the Middle East is set to face a challenging demand environment, we believe it should fare better than most, with established low-cost carriers likely to benefit from trading-down by cost-conscious consumers and also better regional economic metrics relative to other parts of the world," Mr Lepper writes.

"Carriers with a core focus on network, cost and asset base should outperform the market and the global sector." Air Arabia seems to be doing just that, as far as its financial performance is concerned. Earnings were 32.2 per cent higher in the first quarter, compared with the same period last year, as traffic rose 25.6 per cent. The average ticket price fell 3 per cent, but that's not bad considering all that happened in the world in the intervening year.

Shareholders apparently didn't get the memo. The stock got cut roughly in half over the same period, even as Air Arabia's business was blossoming. Mr Lepper expects that discrepancy to be reversed, at least somewhat. He has an "overweight" rating on the stock and a target price of Dh1.3, compared to its close on Tuesday Dh1.05. Andrew Light, Citigroup's global airline analyst, is also a fan. He has an equivalent "buy" rating and a target of Dh1.5.

Mr Light, in a report of his own, lauded Air Arabia for its "entrepreneurial and experienced management team" and expressed confidence in its ability to execute an ambitious programme to expand into Europe - a recently opened hub in Casablanca is a key to that part of the plan - as well as Central Asia and the Far East. So what could go wrong? Chronic economic weakness, especially if it leads to persistently lower oil prices, likely would hurt demand. Then there is the prospect of heightened competition.

Research by Penelope Butcher at Morgan Stanley, who has a neutral assessment on the stock and a Dh1.2 target, warns that Emirates Airline and some Indian carriers could cut fares and put pressure on Air Arabia. The imminent launch of another budget airline, flydubai, could have the same effect. Mr Light acknowledges some of these risks, and his report notes that he had the same buy rating on the stock all the way down from Dh2 or more early last year. But he maintains that the stock's losing streak reflects how the airline is perceived, not how it's run.

"Air Arabia was one of the most profitable airlines globally in 2007 and 2008," he said. "We expect its profitability to be upheld or even increased as it attracts more business travellers, achieves scale, reduces distribution cost and pursues profitable ancillary revenue opportunities." Conrad de Aenlle, who is based in Los Angeles, has covered business and investment topics for nearly 20 years.