Aviation Services (KimEng)

Event:
The International Air Transport Association (IATA) has slashed its 2011 profit forecast for the global airline industry in half. Due to the lag factor inherent in their businesses, any slowdown will not show up immediately in the results of SATS and SIA Engineering. Sentimentally however, the damage has been done as investors will generally take a cautious view, notwithstanding the companies’ actual financial performance in the next few quarters.

Our View:
IATA’s previous forecast of US$8.6b for global airline profitability is now out the window. Instead, just US$4b (a mere profit margin of 0.7%) stands between the 230 global airlines that form its membership base and the kind of losses last seen in 2008 and 2009 (when global losses hit US$16b and US$10b, respectively). Further, IATA noted that these kinds of losses could recur if fears of a slowdown in economic growth materialise following a recent run of poor economic data from the US.

Natural disasters in Japan and unrest in the
Middle East and North Africa were blamed but the main culprit was the sharp rise in oil prices. Brent crude has risen from an average of US$80/barrel to US$110/barrel this year. Also currently forming is an unpleasant combination of slowing passenger and cargo demand but rising capacity. The IATA cut its growth forecast for passenger traffic to 4.4% from 5.6% with forecast for cargo growth also cut to 5.1% from 6.1% previously. However, capacity is expected to rise by 5.8%.

IATA is usually quite good at flagging
industry peaks and troughs even though it is a laggard at pinpointing the numbers. For instance, although it started to flag 2008 as a downturn year as early as September 2007, it did not revise its profit forecast to a loss forecast until June 2008. So when IATA makes this kind of dramatic forecast revisions when aviation-related stocks are still trading near cycle peaks, we believe investors should pay serious attention.

Action & Recommendation
We downgrade SIA Engineering from HOLD to SELL as we see it being more vulnerable to an industry downturn, and advise lightening into strength. We keep SATS as a HOLD as 40% of its revenue comes from non-aviation businesses that may offset softer aviation profits. In the short term however, upcoming dividend payments may provide support.