Singapore Airlines Limited - Initiate with BUY - Catch a safe flight (OCBC)

Initiating Coverage

BUY

Current Price: S$11.40

Fair Value: S$12.59

Cutthroat competition has intensified. Positioned as a premium airline, SIA has always faced tough competition in the aviation industry. Middle Eastern carriers, such as Emirates, Qatar Airways and Etihad Airways, are now competing head-on with SIA in premium air travel. Yet despite SIA’s status as a premium airline, it is also susceptible to the competition from rapidly growing low-cost carriers (LCCs) around the region. To top it all, Qantas is now planning a new Asia-based full-service carrier. Qantas is deciding between Kuala Lumpur and Singapore as the new carrier’s base. If Singapore is chosen as the base for this new airline, SIA will face new competition in its core segment at its backyard.

Competition is not new to SIA. SIA has faced competition from global legacy airlines, LCCs and Middle Eastern carriers for years and it has emerged relatively unscathed. For example, despite the presence of competition the Group in FY11 made earnings of S$0.90 per share, up more than 400% from the crisis-hit FY10. Looking back further, FY11 net earnings was also 2.9% higher than in FY09. In addition, SIA has successfully maintained its standing as a premium carrier and has probably the strongest balance sheet among airlines to weather downturns.

Potential growth from new wholly-owned LCC. SIA has not experienced much growth over the last few years. This is most evident by a falling capital expenditure as a percentage of sales and a rising dividend payout ratio. SIA is currently planning the launch of a wholly-owned subsidiary LCC in May 2012. The new carrier will be operated independently and managed separately from the flagship Singapore Airlines and it will operate medium-to-long haul flights. This new venture could provide the group its next leg of growth, if cannibalisation effects can be minimised. With Singapore-based LCCs mostly focused on short-to-medium haul flights to regional destinations, SIA could potentially develop a new business segment with its new LCC.

Initiate with a BUY. SIA’s share price has fallen 27% from this year’s peak in Jan 2011, along with the rest of the aviation sector. While the threat of recession is very real, the market seems overly eager to price a recession into SIA’s share price. Instead, we believe that a fairer approach is to use an adjusted ex-net cash P/B multiple of 1.01x, or one standard deviation below historical average, to derive a fair value of S$12.59 per share, representing an upside of 10.5%. And we initiate coverage on SIA with a BUY.