Singapore Airlines SIA - UOB Kay Hian 2016-01-13: Fuel Shock? SIA Is The Best Proxy Play; Upgrade To BUY

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SIA SINGAPORE AIRLINES LTD C6L.SI 

Singapore Airlines (SIA SP) Fuel Shock? SIA Is The Best Proxy Play; Upgrade To BUY 

• We believe the market has not factored in the positive impact lower of lower fuel hedges on SIA's earnings and is unduly concerned about MTM losses or yield erosion. 
• We also expect yields to stabilise in FY17 as fuel price volatility subsides. 
• On this basis, we expect SIA's ex-SIAEC ROE to reach 11% in FY17, well above its cost of equity. As such, we raise our fair value P/B multiple to 1x and raise our fair value to $14.00. 
• SIA is now our top pick within the Singapore aviation sector. 
• Upgrade to BUY. Target price S$14.00. 

WHAT’S NEW 

 We raise Singapore Airlines’ (SIA) to BUY from HOLD...

• ... and raise our target price to S$14.00 (from S$12.00) as we now value SIA's core operations at 1x P/B vs 0.85x previously. 

 Low fuel environment likely to persist. 

• The 2-year forward Brent continues to decline across the curve, ranging from US$32/bbl to US$44/bbl. 
• Meanwhile, Brent and jet fuel swaps amount to just US$13.5/bbl, suggesting that jet fuel hedging cost would amount to US$45/bbl to US$58/bbl. Under such an environment, we believe SIA should deserve to trade at a higher P/B as profits are likely to rise. 
• Every US$10/bbl decline in fuel cost will add S$570m to its PBT and S$513m to net profit. This translates into a 3.9% improvement in ROE. 

 We lower our FY17 into-plane jet fuel cost assumption from US$66/bbl to US$58/bbl. 

• We have also assumed SIA would have hedged 40% of its fuel requirements for FY17 at US$70/bbl (previously US$76/bbl). This effectively lowers our FY17 fuel cost estimate by 14%. 

 Yields are unlikely to decline much. 

• We believe that much of the decline in pax yields in the past four quarters was a response to the steep increase in fuel price volatility and aggressive price discounting by competitors. 
• In 2016, we believe ticket prices will be more stable as there is no sign of demand destruction for leisure travel. 
• For FY16 and FY17, we have assumed a 6% and 1.7% decline in pax yields to 10.5 and 10.35 S cents respectively. Comparatively, in 2009 when Brent reached a low of US$42/bbl, pax yields subsequently declined to 9.8 S cents in 2QFY10 but averaged 10.4 S cents for the year. 
• Every 0.1 S cent decline in pax yield from our base assumption for 2HFY16 will lower SIA’s 2HFY16 net profit by 5%. 
• Every 0.1 S cent decline in pax yield from our base assumption for FY17 will lower SIA’s FY17 net profit by 6%. 

STOCK IMPACT 

 BUY SIA. 

• SIA’s share price performance has been relatively resilient and outperformed the FSSTI by 11% in 2015 and 4.7% ytd. We note that in 2010, SIA ex-SIAEC traded at up to 1.2x book when profit breached S$1b. As such, we believe its P/B valuation could rise to at least 1x in FY17. 

 Fuel hedging losses expected to increase in FY16 but decline in FY17. 

• SIA is expected to post higher fuel hedging losses in 2HFY16 vs 1HFY16 due to lower fuel prices. However, we project fuel hedging losses to fall sharply in FY17. We have assumed an average of US$70/bbl in fuel hedges and 40% of fuel requirements hedged for FY17. This should lead to about S$950m decline in fuel hedging losses in FY17. 

 How we differ from consensus. 

• Our FY17 net profit estimate is 76% above consensus. The difference could be due to consensus: 
  1. has yet to adjust for fuel cost estimates, or 
  2. is factoring in a steep decline in yields. 
• We believe the latter is less likely barring a severe economic slowdown. Meanwhile for FY16, consensus may have yet to factor in the S$136m reversal in cargo price-fixing fines or the S$135m gains from SIAEC’s disposal of HAESL. 

EARNINGS REVISION/RISK 

 We raise our FY17 net profit estimate by 36% ...

• ... as we lower our FY17 into-plane fuel price assumption from US$66/bbl to US$58/bbl. We also raise our FY16 net profit estimate by 11% on a lower fuel cost assumption of US$61/bbl from US$66/bbl. 

VALUATION/RECOMMENDATION 

 Upgrade to BUY and raise our target price to S$14.00 from S$12.00. 

• We have ascribed a higher P/B multiple of 1.0x to SIA ex-SIAEC’s FY17 book, given: 
  1. the sharp decline in fuel prices, 
  2. potentially stabilising yields, 
  3. P/B valuation could rise to at least 1x, given SIA ex-SIAEC traded at 1.2x book in 2010 when earnings breached S$1b, and 
  4. ROE ex-SIAEC of 11% in FY17, well above SIA’s cost of equity of 7%. 
• Meanwhile, we expect SIA to post record net profit of S$1.5b in FY17, the highest in eight years. At current levels, SIA offers an attractive FY17 dividend yield of 7.7%. 

SHARE PRICE CATALYST 

• Greater-than-expected pax yields and lower fuel costs. 

K Ajith UOB Kay Hian | Sophie Leong UOB Kay Hian | http://research.uobkayhian.com/ 2016-01-13

UOB Kay Hian SGX Stock Analyst Report BUY Upgrad HOLD 14.00 Up 12.00