Fuel hedging gain saves SIA from losing all its profits in 1QFY18/19

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Singapore Airlines Ltd (C6L:SGX)

Price Target: S$13.00 | Rating: Buy

26 July 2018, Singapore – SIA Group's 1QFY18/19 (Apr-Jun 2018) financial results are in line with our expectations but likely disappointing to the market. Prior to the financial results announcement today, our full year FY18/19 net profit forecast of S$766 million is already more conservative than the Street, 12% below the average estimate of analyst forecasts compiled by Bloomberg. Here are our key takeaways and views on SIA Group's operating outlook:

If not for its fuel hedging gains, SIA Group would have been barely profitable

SIA Group reported a net profit of S$139.6 million during 1QFY18/19 (Apr-Jun 2018). If not for its fuel hedging gains of S$132.2m which helped to mitigate the significantly higher fuel prices, SIA Group would have been barely profitable during the quarter.

Excluding one-off items (as last year’s financial results were boosted by S$175m non-recurring revenue arising from Krisflyer breakage rate adjustments and compensation for aircraft delivery slot changes), SIA Group’s recurring operating profit and net profit fell 16% and 28% y/y in 1QFY18/19, largely driven by higher fuel costs.

We expect SIA Group’s recurring profit decline to be smaller compared to most of its Asian airline peers, helped by its fuel hedging. SIA’s fuel costs rose only 17% y/y even though spot jet fuel prices were 39% higher y/y during the quarter.

Cost efficiency has improved, reflecting that SIA’s Transformation Programme is bearing fruit

SIA Group’s non-fuel unit cost fell 3% y/y during the quarter based on our estimates, driven by lower aircraft leasing expenses as well as the results from its Transformation Programme.

However, the recent weakening of the Singapore Dollar will be a headwind for SIA Group going forward as they have more USD-denomoinated costs than USD-denominated revenue and USD capex. 

Passenger yield decline suggests limited ability to pass on higher fuel costs

SIA, SilkAir and Scoot's passenger yields fell 1.0%, 10.3% and 1.8% y/y respectively, implying that the airlines have not had much overall pricing power nor success in passing on the higher fuel costs to customers, resulting in profit margin squeeze.

Passenger yields could remain under pressure given SIA Group’s more aggressive capacity expansion this year, especially on long-haul routes to Europe and North America.

SIA Cargo managed to lift yields and revenue despite lower traffic but escalating trade tensions could dampen demand

In contrast, SIA Cargo’s cargo yield improved meaningfully by 10% y/y which more than offset the negative impact of lower cargo traffic during the quarter. A key risk is escalating trade tensions could dampen global air cargo demand in the longer term.

Low seat capacity growth to/from Singapore in the coming months can help stabilize passenger yields but long-haul routes are a challenge

The overall airline industry seat capacity growth to/from Singapore is low at only 2% in the coming months and will be matched by travel demand growth, in our view. Qatar Airways has cut its capacity to/from Singapore by 2% y/y while Emirates’ capacity to/from Singapore is growing only 1% y/y which will ease competitive pressure on Singapore Airlines.

The main competitive pressure will be in the European route region where capacity is growing too aggressively at 14% y/y. The 50% y/y increase in direct flights between Singapore and the United States will also take some traffic away from the European hubs and it could be challenging for SIA to fill up the increased non-stop flights at desirable yield levels as well, in our view.

The economics of long-haul and ultra-long-haul flights have weakened in the current high fuel price environment, although Singapore Airlines is in a better position than its competitors given that it has hedged nearly half of its fuel requirements for the next 5 years.

SIA Group’s average hedged fuel price for July 2018 - March 2019 is US$20/bbl below current spot price, giving it a competitive cost advantage versus sector peers

Unlike the rest of the Asian airline industry which have either reduced their fuel hedging or shortened their hedging duration, Singapore Airlines surprised the market by extending their fuel hedging duration from 2 to 5 years when oil prices were low. This is turning out to be a good strategic move on hindsight and we expect SIA to reap substantial fuel hedging gains throughout this year.

For the remaining 9 months of its current financial year FY18/19, SIA Group has hedged 46.3% (MOPS 21.8% + Brent crude 24.5%) of its fuel needs at an average price of US$65/bbl (MOPS) and US$54/bbl (Brent) respectively, US$20/bbl below the current spot price.

SIA also has long-dated Brent hedges with maturities extending to FY22/23 covering up to 46% of the Group’s projected annual fuel consumption at US$55/bbl to US$58/bbl (based on its May 2018 results disclosure). These are favourable hedge prices well below the current Brent crude oil price of US$74/bbl and Jet kerosene price of US$85/bbl.

This will not only keep SIA well-protected against higher oil prices but also enable the airline to gain a cost advantage against its competitors. Only one-quarter of the Asia Pacific airlines are well-hedged and the average fuel hedging ratio of the Asia Pacific airline sector is a paltry 15%. See our previous report for more details:

Assessing Asia Pacific airline earnings sensitivity to oil price spike                                 

Launch of KrisPay, the world’s first blockchain-based airline loyalty digital wallet moves SIA one step closer to greater data monetization and profit enhancement

SIA Group has just launched KrisPay, the world’s first blockchain-based airline loyalty digital wallet as part of its digital blueprint. There are currently only a small group of merchants in the programme but we believe that expansion should be fairly rapid with hotels, high end retailers and even medical service providers being keen to tap into SIA Group's customer base, especially the premium leisure and  business passengers who are a highly valuable demographic group.

We believe Singapore Airlines has the deepest and most comprehensive digitalization program in the airline industry. SIA can potentially boost its net profit by S$800 million per year if it can successfully collect and monetize its Passenger Data based on our estimates which would be a significant positive share price driver for the stock. See our previous reports for more details:

Singapore Airlines Embraces Passenger Data Monetization to Escape Value Trap Label

Airlines are sitting on US$100 Billion Inflight Big Data goldmine


Note: Stocks with upside of more than 10% based on our fair value are assigned an Outperform rating. Stocks with downside of more than 10% based on our fair value are assigned an Underperform rating. Stocks with upside or downside of less than 10% based on our fair value are assigned an In-line rating. These are Crucial Perspective’s proprietary rating classifications and by no means serve as investment recommendations.

Independent Research Declaration: Crucial Perspective does not own any position in the equities featured in this report nor have we received any compensation for writing this report. 

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