Author: Mei Ling Tan

Malaysia’s AirAsia, which operates budget flights across Southeast Asia, had a stellar 2016. But the catalysts that fueled the airline’s ascent by as much as 130% by August are no longer there. This stock could fall another 20%.

AirAsia is a play on the Malaysian ringgit. Its share price started to slip in late August, coinciding with the ringgit’s decline. Since then, the ringgit has fallen some 11%, to $4.50, and AirAsia has tumbled more than 30%. The stock still managed to return over 80% in 2016, however.

A weaker ringgit hurts AirAsia’s operating margins. Deutsche Bank ’s Joe Liew estimates that half of the airline’s operating costs last year were related to the dollar, in part because 90% of its debt is denominated in greenbacks. The airline says that two-thirds of its dollar debt was hedged at about 3.23 ringgits to the dollar. Still, Deutsche estimates that for every 5% decline in the ringgit, AirAsia’s operating profit falls by 7.1%.

More importantly, over half of AirAsia’s shareholders are foreigners, who are more likely to unload the stock when Malaysia’s currency policy gets unsteady. The ringgit “keeps us awake at night,” says Credit Suisse’s strategist Tan Ting Min, because China is Malaysia’s largest exporter and the currency is viewed as a yuan proxy. It’s also sentiment-driven because foreigners hold about half of Malaysian government bonds, 50% more of which are maturing this year. In addition, Malaysia’s central bank unnerved investors during the Trump tantrum—the selloff of emerging market bonds and currencies after the U.S. election—by asking foreign banks to stop trading ringgit in the offshore nondeliverable forwards market, a popular way for foreigners to hedge against its decline.

There are other head winds. Fuel prices have begun to rise. At the end of December, jet fuel was trading at $67 a barrel, 48% above a year ago, according to Platts. While AirAsia hedges 74% of its jet-fuel costs at $60 a barrel, expensive fuel still affects its earnings. Deutsche says that for every 5% rise in jet-fuel prices, AirAsia’s net profit falls by 6.6%.

COMPETITION IS ALSO HEATING UP

Again in Malaysia. Malindo, which started operations only in 2013, bought 16 new aircraft in 2016 and operates 42 in total, about a third the size of AirAsia Malaysia. Meanwhile, market leader Malaysia Airlines, which has been in cost-control mode for the past two years after the crash of the MH 370 in March 2014, is looking to expand again. It is starting nine new routes to China this year.

AirAsia said in August it would divest itself of Asia Aviation Capital, which provides aircraft-leasing services to the airline. AirAsia said the unit could fetch $1 billion. At the end of September, Asia Aviation had only $59 million in equity on its balance sheet. “We struggle a little to understand how that [$1 billion] number is derived, given the balance-sheet numbers,” wrote Deutsche in a note last week.

Deutsche Bank last week downgraded AirAsia to Sell with a price target of 1.75 ringgit, or another 20% downside. It values AirAsia at five times enterprise value to earnings, in line with full-service airlines Cathay Pacific (293.Hong Kong) and Singapore Airlines(C6L.Singapore). Both of these airlines are suffering from excess capacity, and Deutsche is betting that AirAsia will be operating in a similar environment a year from now.