SIA Transformation shows promise w/ 4QFY18 results beat

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

17 May 2018, Singapore – Singapore Airlines (SIA:SP)’s 4QFY18 (Jan-March 2018) financial results beat ours and consensus forecasts, mainly driven by firmer yields in SIA’s passenger business, stronger profit contributions from Scoot and SIA Cargo and 3% y/y decline in unit cost ex-fuel as its Transformation Program is beginning to bear fruit. We reiterate our Outperform rating and fair value of S$13. The prospects for Singapore Airlines are favourable in the new financial year FY19 – we expect market share gains and greater cost efficiency. The key competitive pressure would come from Qantas which is more than doubling its capacity out of Singapore. 

FAVOURABLE PROSPECTS IN NEW FINANCIAL YEAR FY19

What first caught our eye was the much higher sales in advance of carriage at the end of March 2018. Singapore Airlines (SIA:SP)’s sales in advance of carriage surged 48% y/y and 18% q/q. This is positive and suggests stronger traffic and revenue growth in the months ahead.

The overall capacity growth out of Singapore looks fairly benign at 5% in the coming months, albeit an acceleration from the 3% capacity expansion in Jan-March 2018, and will be matched by healthy travel demand growth. Major Gulf carriers Emirates and Qatar Airways are keeping their capacity to/from Singapore steady y/y which will ease competitive pressure on Singapore Airlines. The major Chinese airlines’ capacity expansion to/from Singapore is also moderate. SIA Group’s overall planned capacity growth is 8% for FY19 (a marked increase from its 3% capacity growth in FY18) and we expect it to gain market share in the year ahead.

The key competitive pressure for Singapore Airlines in the new financial year FY19 would come from Qantas Airways which is more than doubling its capacity out of Singapore Changi Airport y/y; AirAsia is also increasing capacity out of Singapore by 25% y/y in the coming months. Long-haul routes to North America and Europe could continue to face pricing pressure due to industry overcapacity.

Fuel hedging strategy will give SIA a competitive cost advantage versus sector peers should oil prices stay high or rise further. SIA has long-dated Brent hedges with maturities extending to FY22/23 covering up to 47% of the Group’s projected annual fuel consumption at US$53/bbl to US$59/bbl (based on its Dec 2017 results disclosure). These are favourable hedge prices, well below the current spot jet kerosene and Brent crude oil price of US$87.5/bbl and US$79.8/bbl respectively. 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. In contrast, 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                      

More information about SIA’s digitalization program needed – We believe that SIA has the deepest and most comprehensive digitalization program in the airline industry but to date, there has been no real unveiling of SIA’s digitalization roadmap with investors left guessing. If investors are to accurately value Singapore Airlines’ digitalization efforts, they will need a lot more information and assurances from top management as to where SIA is truly headed. See our previous reports for more details:

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Chart: Singapore Airlines Group Operating Profit by Business Segment (4QFY18 versus 4QFY17)

Chart: Singapore Airlines Group Operating Profit by Business Segment (4QFY18 versus 4QFY17)

4QFY18 FINANCIAL RESULTS ANALYSIS

Singapore Airlines reported net profit of S$182m for 4QFY18 (Jan-March 2018), turning around from its net loss of S$138m a year ago, raising its full year FY18 net profit to S$893m. Net profit margin more than doubled to 5.6% in FY18 from 2.4% in FY17. SIA is paying out 53% of its FY18 net profit as dividends. The airline announced a final dividend of S$0.30 per share, raising its full year DPS to S$0.40, implying a yield of 3.6%, among the highest in the Asia Pacific airline sector.

KEY POSITIVES:

Premium passenger airline business returns to profitability with S$137m operating profit after a disappointing S$41m operating loss in 4QFY17. Passenger yield improved 1% y/y versus the 5% y/y decline in 4QFY17 and passenger revenue per ASK (RASK) rose 2% y/y. This is a surprise given the stiff industry competition, particularly on long-haul routes.

Scoot is now the second largest profit contributor for SIA Group and the key earnings growth driver. Scoot’s operating profit improved 32% y/y to S$29m. Scoot’s passenger yield decline moderated to 2% y/y in 4QFY18 from 8% y/y in 4QFY17. This is better than our expectations as we had expected Scoot’s yield to decline more substantially as it steps up its expansion to new destinations and long-haul routes have lower yields due to their longer stage length.

SIA Cargo’s profitability improved significantly on the back of the strong global air cargo market even though we are already past the peak cargo season. SIA Cargo’s yields surged 9% y/y in 4QFY18, much better than its 3% y/y decline in 4QFY17. This boosted SIA Cargo’s operating profit to S$28m vs S$5m loss in 4QFY17. This is a positive read-through for Cathay Pacific (293:HK) which has even higher revenue exposure to cargo than Singapore Airlines.

Cost efficiency has improved as SIA’s Transformation Program is beginning to bear fruit – SIA’s premium passenger airline’s unit cost fell 1% y/y – better than expected, considering the higher fuel costs. In fact, excluding fuel costs, unit cost fell 3% y/y in 4QFY18.

Fuel hedging strategy is reaping rewards – SIA’s fuel costs rose only 5% y/y during 4QFY18 even though spot jet fuel prices rose 21% y/y and SIA’s capacity expanded by 4% y/y, reflecting the benefit of fuel hedging gains as well as the stronger Singapore dollar (+7% y/y) which helped to mitigate the negative impact of the fuel cost increase.

KEY CONCERNS:

SilkAir’s profitability weakened significantly. Its passenger yield decline worsened to 11% y/y versus its 5% y/y decline in 4QFY17. SilkAir’s operating profit shrank significantly by 74% y/y to only S$3m in 4QFY18 from S$27m in 4QFY17 partly due to its aggressive capacity expansion (+12%) as well as a result of stiff competition on regional routes. SilkAir is in no-man’s land – it has a high cost structure and yet, its product and service is inferior to SIA’s mainline business. SIA Group still has too many airline brands which creates confusion for consumers; we maintain our view that SIA Group should merge SIA and SilkAir and drop the SilkAir brand, keeping only two brands – SIA as the premium airline brand and Scoot to serve the budget travel segment. 

Scoot’s unit cost rose 6% y/y in 4QFY18– this will need to be managed in order to stay competitive in the budget travel market segment longer term.

Moving from net cash to small net debt position – SIA’s capex surged 32% y/y to S$5.2B during the year FY18, widening the negative free cash flow to S$2.0B versus its negative FCF of S$410m in FY17. Consequently, SIA has gone into a small net debt-equity position of 0.04x based on our estimates. This is in line with our expectations (as mentioned in our previous reports) as SIA’s fleet expansion accelerates compared to recent years and still a significantly healthier balance sheet compared to its global airline sector peers which have an average net debt-equity level of 1.1x.

 

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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