A Tale of Two Airlines’ Fuel Hedging Strategy – SIA to beat Cathay

Singapore Airlines (SIA:SP) Fair value: S$13
Singapore Airlines (SIA:SP) Rating: Outperform

Cathay Pacific (293:HK) Fair value: HK$14
Cathay Pacific (293:HK) Rating: Outperform

21 May 2018, Asia Pacific – Only time will tell whose fuel hedging strategy is better but consistency is key and this will differentiate Singapore Airlines’ financial results from Cathay Pacific and most of its Asia Pacific airlines peers’ earnings this year. We expect Singapore Airlines’ share price performance to beat Cathay Pacific and the sector if oil prices stay at current levels or rise further. SIA’s fuel hedges are now US$24/bbl deep in the money while Cathay’s are still US$2/bbl out of money this year.

A TALE OF TWO AIRLINES’ FUEL HEDGING STRATEGY – BOTH SIA AND CATHAY HAVE HEDGED 45% OF THEIR CURRENT FINANCIAL YEAR’S FUEL CONSUMPTION BUT THE SIMILARITY STOPS HERE

Year-to-date, the spot jet fuel and Brent crude oil prices have risen 24% and 27% compared to their average levels in 2017.

Chart: Spot jet kerosene and Brent crude oil prices (2013 to 2018)

Chart: Spot jet kerosene and Brent crude oil prices (2013 to 2018)

Both Singapore Airlines (SIA:SP) and Cathay Pacific (293:HK) have hedged nearly half of their fuel consumption for the current financial year (45.2% and 45% respectively to be exact), well ahead of the average Asia Pacific airline sector’s average hedging ratio of only 15% this year, but the similarity stops here.

See our previous report for more details on the impact of higher oil prices on the entire Asia Pacific airline sector:

Assessing Asia Pacific airline earnings sensitivity to oil price spike

At the current fuel price level, Singapore Airlines’ fuel hedges are already deep in the money, a result of its more consistent and pragmatic long-term fuel hedging strategy. Cathay Pacific, on the other hand, will still incur a small fuel hedging loss this year albeit much lesser than its huge losses in the past 3 years as it has been plagued by expensive legacy fuel hedging contracts due to its more haphazard fuel hedging strategy historically.

Chart: Singapore Airlines’ potential fuel hedging gain versus Cathay Pacific’s potential fuel hedging loss in US$ per barrel based on current fuel prices in this financial year (2018)

Chart: Singapore Airlines’ potential fuel hedging gain versus Cathay Pacific’s potential fuel hedging loss in US$ per barrel based on current fuel prices in this financial year (2018)

SINGAPORE AIRLINES’ FUEL HEDGES ARE NOW DEEP IN THE MONEY, AVERAGING US$24/BBL BELOW THE CURRENT SPOT FUEL PRICE

For the full year FY19 (April 2018 to March 2019 period), Singapore Airlines has hedged 45.2% of its fuel consumption – 20.0% via jet fuel contracts at an average price of US$65/bbl and 25.2% via Brent crude oil contracts at an average price of US$54/bbl. These hedges are US$23/bbl and US$25/bbl below the current spot jet kerosene and Brent crude oil prices respectively.

Based on our estimates, Singapore Airlines could potentially book US$464 million (or S$626m) fuel hedging gains in its FY19 (year to March) financial results if spot fuel prices stay at current levels for the year. This will help to significantly mitigate the negative impact of higher spot fuel prices for Singapore Airlines, providing a competitive cost advantage versus peers given their limited fuel hedging in place.

IN CONTRAST, CATHAY PACIFIC WILL STILL INCUR FUEL HEDGING LOSSES THIS YEAR ALBEIT MARKEDLY LESS THAN ITS HUGE HEDGING LOSSES IN THE PAST 3 YEARS

Cathay Pacific has hedged 45% of its 2018 fuel consumption at US$81/bbl on average based on Brent crude oil prices. This is still US$2/bbl above the current spot price. As such, Cathay Pacific could potentially book US$34 million (or HK$265m) fuel hedging losses in its 2018 financial results based on our estimates. This is much lower than its substantial annual fuel hedging losses in the past 3 years – HK$8.5B in 2015, HK$8.5B in 2016 and HK$6.4B in 2017.

Chart: Cathay Pacific fuel hedging loss (2014 to 2017)

Chart: Cathay Pacific fuel hedging loss (2014 to 2017)

CATHAY PACIFIC WILL FINALLY START BOOKING FUEL HEDGING GAINS FROM 2019 BUT ITS LEVEL AND DURATION OF HEDGING HAS SHRUNK AND IS MUCH LOWER THAN SINGAPORE AIRLINES’

Following its substantial fuel hedging losses in the past 3 years, Cathay Pacific has shortened its fuel hedging contract duration from 4 years to 2 years. Cathay Pacific has so far hedged only 18% of its fuel consumption for 2019 as mentioned during management’s briefing on 14th March 2018.

For 2019, Cathay Pacific’s average hedged price is US$65/bbl (Brent crude oil) on average. This is US$14/bbl below the current spot price and we expect Cathay Pacific to book meaningful fuel hedging gains amounting to US$123 million (or HK$964m) based on our estimates. This will help Cathay Pacific’s earnings improve significantly from 2019 as its expensive fuel hedges finally roll over.We expect Cathay Pacific to increase its fuel hedging position for 2019 and 1H2020 but the average hedging prices are likely to be less favourable.

Chart: Cathay Pacific’s fuel hedging position  

Chart: Cathay Pacific’s fuel hedging position  

YOUNGER AIRCRAFT FLEET AND EXTENDED FUEL HEDGING DURATION WILL KEEP SINGAPORE AIRLINES MORE WELL-PROTECTED FROM HIGHER OIL PRICES COMPARED TO ITS COMPETITORS

In contrast, since last year, Singapore Airlines had, to many investors’ surprise, extended its fuel hedging duration to 5 years.During Singapore Airlines’ results briefing on 18th May 2018, management commented that Singapore Airlines has hedged up to 46% of its fuel consumption for the next 5 years until FY23 (year to March).

To elaborate, Singapore Airlines has hedged up to 46% of its fuel consumption up to FY23 (year to March 2023) at US$55/bbl to US$58/bbl (Brent crude oil). These hedges are US$21/bbl to US$24/bbl below the current spot price. 

Chart: Singapore Airlines’ fuel hedging position

Chart: Singapore Airlines’ fuel hedging position

Only time will tell whose fuel hedging strategy is better but at this moment, it looks like Singapore Airlines’ more consistent fuel hedging policy is paying off.

Singapore Airlines also has a younger aircraft fleet averaging 7 years compared to Cathay Pacific’s 9 year old average fleet age; the increased fuel efficiency of newer planes also helps to mitigate the negative impact of higher fuel prices.

CATHAY PACIFIC’S EARNINGS ARE MORE LEVERAGED TO HIGHER FUEL PRICES THAN SINGAPORE AIRLINES’

Cathay Pacific’s earnings are more leveraged to higher fuel prices than Singapore Airlines’. Fuel costs constituted 31% of Cathay Pacific’s operating cost and 32% of its total revenue in 2017. In comparison, fuel costs constituted 26% of Singapore Airlines’ operating cost and 25% of its total revenue in FY18 (year to March).

Chart: Airline fuel cost exposure (2017)

Chart: Airline fuel cost exposure (2017)

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. 

Related Reports:

Cathay Pacific Airways (293:HK) Initiation Research Report 2017 – Cathay Pacific outlook to stay gloomy?

Cathay Pacific (293:HK) upgraded to Outperform: Takeover by Air China (753:HK) likely

Singapore Airlines Initiation Research Report 2017: Will SIA be a “sexy” stock again?

 Assessing Asia Pacific airline earnings sensitivity to oil price spike

 

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