Published February 19, 2009

Are analysts still underestimating risks?

By R SIVANITHY

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WHEN Singapore Airlines released its third-quarter results last week, some analysts were quick to pounce on the fact that its fuel hedging loss was less than expected and they issued a 'buy' on the stock, with target prices set as high as $14.

On Monday, when the national carrier announced an 11 per cent cut in capacity, the decommissioning of 17 aircraft (from a fleet of 104) and that it was in talks with its unions to cut costs, several analysts responded with 'neutral', 'hold' and 'buy' calls. Notwithstanding these recommendations, the news sent the stock down almost 5 per cent on Tuesday to $9.98.

Of course, not all brokers were optimistic - according to analyst reports tracked by Bloomberg, eight out of 18 houses have a 'sell' or 'underweight' on SIA. However, it's worth noting that the majority - with six 'buys', two 'holds' and two 'neutrals' - are either adopting a positive view on the airline, or are doing their best to avoid using the dreaded four-letter word ('sell'), or doing both.

Moreover, two of the eight 'sells' were 'trading sells' - which essentially means 'look to sell or short the stock at the earliest opportunity but buy back quickly because although there will be near-term pressure, our view is positive and the shares will still rise later'.

Given that the stock fell sharply, there is no visibility as to when the downturn will end. Worsening numbers are a very real possibility, and this in turn raises the interesting question: Are analysts, or at least many in the broking industry, still underestimating risks while overstating earnings and returns expectations?

Granted, an analyst's job is never easy; in the first place, it is human nature to try to avoid bad news for as long as possible and, on a more practical level, to avoid being too negative on a company's prospects as you then run the risk of being denied contact with the company's senior management or being barred from analyst briefings.

Furthermore, it could be argued that the increasing number of 'sell' reports already in circulation suggests a subtle shift has taken place over the past year and that not only are brokers becoming less coy about their calls, they are also less willing to mince their words. They are thus more open to calling it like it is - a welcome development that means client interests would be much better served, both in the short term as well as the long run.

The problem, however, is that there still appears to be an underappreciation of risk, at least among the majority, because it is not enough to just address company-specific risks if global risks have increased sharply.

In SIA's case, for example, 'buy' calls this week are probably defensible if viewed in isolation; this is, after all, a profitable, world-class airline we're talking about with large cash reserves. So under ordinary circumstances or if faced with a cyclical downturn, pegging a target price to a low price-book ratio, for example, or single-digit earnings multiple would probably be good enough.

Similarly for the banks and property companies, comparing present asset or book values with those during the Sars outbreak of 2003 or the regional crisis of 1998 might be appropriate if this downturn was of the same comparable scale.

However, it is not - in 1998 or 2003, there were no huge global bankruptcies nor were the world's largest banks technically insolvent, as many are now. Neither is this an ordinary cyclical downturn; instead, it could drag on for longer than the next 12 months and, in the worst-case scenario, for a few years yet.

As a result, investors would do well to take note that although some in the broking industry have shown a greater appreciation of increased risk, this is by no means widespread. In the present environment, taking all overly bullish recommendations with a large dose of salt is therefore the only prudent thing to do.