Singapore Airlines Ltd - Wealth creation stalls for SIA (CIMB)

UNDERPERFORM Maintained

S$14.32 Target: S$11.80

Mkt.Cap: S$16,950m/US$14,079m

Uncertainties beyond the seasonal lift

A plethora of troubles. SIA explained the multiple reasons for its weak passenger and cargo yields in the past three months during its briefing yesterday. Seasonally better performances are expected for the next six months, but this is not a reason to buy the stock, in our opinion, as the cyclical headwinds hurting SIA’s performance will remain concerns. We believe SIA will remain beset by an inability to pass through fuelcost increases fully via substantive yield increases due to weaker load factors, competition in air freight from the availability of container shipping space, and weaker economic dynamics affecting cargo demand. Potential de-rating catalysts include continued weaker-than-expected performances relative to consensus expectations. Hence, we maintain UNDERPERFORM, but reduce our target price to S$11.80 (from S$13), still based on 1.1x P/BV as SIA trades ex-dividend from today.

Analysts’ meeting highlights

Weak yield environment for passenger business. The weak revenue environment had been reflected in the sequential qoq drop in passenger yields from 12.10 Scts to 11.80 Scts per revenue passenger kilometre (RPK). This was caused by the following, in order of importance:

• The appreciation of the S$ against revenue currencies like US$, € and ₤, which affected S$-equivalent revenues from the US, Eurozone and the UK; and

• The impact of the Japanese earthquake, tsunami and nuclear crisis on air travel demand and loads to North Asia, which remained below year-ago levels. This was partially offset by:

• Higher fuel surcharges, as SIA had raised surcharges four times from December 2010 by 55-70%; and

• A better passenger mix, with more front-end passengers.

Despite working hard throughout 2010 to push yields higher, SIA could not escape the weaker macro-economic environment in 2011. Nevertheless, the South-East Asian region was doing comparatively better, as reflected in SilkAir’s good performance.

Long-haul routes to Europe and the US are suffering disproportionately more than short-haul routes in an environment of high fuel prices, because longer-haul routes tend to burn more fuel. European and US routes are also doing less well in terms of demand, in view of their weaker economic growth.

As a consequence of the difficulties, SIA has trimmed its passenger ASK capacity growth projection for FY12 from 6% to 5%. Nevertheless, with advance bookings over the next three months flat against the same period last year, passenger load factors should remain lower than year-ago levels.

Cargo business affected by weak demand. The cargo business was also affected by weak demand for all geographies.

• China was a major culprit, with tighter financing and monetary conditions in China affecting the ability of factories to obtain working-capital financing. Secular factors also contributed to the weakness in air freight demand, such as the tightness of labour availability and higher costs of labour affecting the financial performances of various companies.

• The Japanese earthquake and accompanying supply-chain disruptions also had a big impact on outbound cargoes from Japan. There was broad weakness in outbound cargoes from the US and Europe across various product exports.

As a result, cargo AFTK capacity growth has been cut from 11% (as guided three months ago) to 8.9% for FY12. However, AFTK capacity growth could be reduced even further if demand fails to materialise as expected; conversely, capacity growth can be revised up to match demand quickly. Response time for SIA Cargo is almost immediate, although passenger capacity could require a minimum of one month to a maximum of three months to adjust, given the presence of forward bookings.

The cargo peak season is supposed to start in September, and SIA Cargo expects (or hopes) that there would be a big increase in air freight demand from September onwards. Some recovery in outbound Japanese air freight is already visible from this quarter onwards.

Comments

Expect sequentially better performance, but still significantly weaker yoy. SIA is moving into its seasonal peak for both the passenger and cargo businesses. With the northern summer in full swing and year-end school holidays in the next 4-5 months, the passenger business should see sequentially higher yields, more demand and higher seat factors than in the preceding three months (April-June), typically the weakest quarter in the year. Meanwhile, the cargo business should also benefit from higher demand from expected pre-Christmas restocking. Nevertheless, there is no doubt that the rest of FY12 would remain weaker than a year ago.

Passenger load factor to be lower this year. We expect PLF to average just 76% this year, from 78.5% last year, due to industry-wide overcapacity. However, cargo load factor may still rise slightly, as SIA Cargo appears very responsive and has been matching demand with capacity very well.

Based on operating statistics up until June, we see no evidence of a recovery in passenger travel demand to Japan apart from seasonal variations.

Availability of container shipping space may blunt impact of peak season for air freight. The air freight business globally has lost market share to container shipping this year because of the greater availability of container shipping space. Our analysis of container shipping dynamics suggests that space is not likely to be a constraint even in the upcoming peak season, and that a large portion of cargoes will still likely be carried via container ships rather than airplanes. While we believe that air freight demand will be stronger seasonally over the next three months, we believe the intensity, duration and quantum of the improvements may disappoint airlines.

Yields not compensatory despite high fuel prices. In an environment where the average jet fuel price is expected to rise 24% to US$129.30/barrel in FY12, passenger and cargo yields need to rise to counter the effect of higher costs, but we expect passenger yields to rise only 0.4% yoy to 11.97 Scts, and cargo yields to stay flat. This would have a negative impact on the bottom line, with net profit expected to fall from S$1,092m in FY11 (EPS: 91.4 Scts) to just S$362m in FY12 (EPS: 30.2 Scts).

Valuation and recommendation

Maintain UNDERPERFORM. We lower our target price from S$13 cum-dividend to S$11.80, still based on 1.1x P/BV, as SIA trades ex-dividend from today. The P/BV multiple of 1.1x is based on SIA’s average historical multiple over the past 10 years. We previously added S$1.20/share in final and special dividends to our ex-dividend target price to obtain our cum-dividend target.

We retain our EPS forecasts and Underperform rating. We believe that SIA will remain beset by high fuel prices, an inability to pass through cost increases fully via substantive yield increases due to weaker load factors, competition for air freight from container shipping space availability, and the weaker economic dynamics affecting cargo demand from China, Japan, the US and Europe. Seasonally better performances are not a reason to buy the stock, in our opinion, as the cyclical headwinds hurting SIA’s performance will remain concerns in the months to come. Potential de-rating catalysts include continued weaker-than-expected performances relative to consensus expectations.