Singapore Airlines (SIA SP) - UOB Kay Hian 2017-06-21: Operating Environment Unlikely To Improve Amid Excess Capacity And Terror Attacks

Singapore Airlines (SIA SP) - UOB Kay Hian 2017-06-21: Operating Environment Unlikely To Improve Amid Excess Capacity And Terror Attacks SINGAPORE AIRLINES LTD C6L.SI

Singapore Airlines (SIA SP) - Operating Environment Unlikely To Improve Amid Excess Capacity And Terror Attacks

  • We believe that yields will remain challenged in FY18 as excess capacity and security concerns over terror attacks lead to capacity diversions and impact Asian network carriers. Airlines without a domestic hinterland will be most affected. This will negatively impact Singapore Airlines (SIA)
  • We also believe that a disposal of SIA Engineering is not in SIA’s shareholders’ interest, nor do we think it will be part of SIA’s transformational plan. 
  • Maintain HOLD. Target price: S$10.00. Entry price: S$9.00.



WHAT’S NEW


Don’t bet on a yield recovery. 

  • We recently met up with Singapore Airlines’ (SIA) head of investor relations and the primary feedback was that yields remain under pressure. 
  • We infer that 1QFY18 yields would have declined yoy but the pace of decline could likely be lower than 4QFY17’s -4.7%. 
  • Commenting on its May operating statistics, SIA noted that the “competitive landscape remains challenging and that promotional efforts will continue in relevant markets”. While pax load factors improved 3.9ppt in May and have risen for five consecutive months, we believe this would be largely at the expense of yields. 
  • Going forward, there are more reasons to be cautious; recent terrorist attacks in Europe are likely to worsen demand as airlines shift capacity out of Europe to other regions. For example, US carriers are said to be reducing capacity from Trans-Atlantic routes and shifting to TransPacific routes. This will exacerbate capacity pressure and consequently yields for most Asian carriers.

Qatar Airway’s flight restrictions might not necessarily benefit SIA. 

  • Qatar’s Doha hub is one of the key Middle-Eastern hubs and restrictions placed by the Gulf Cooperation Countries (GCC) have curtailed much of its originating demand/traffic. Qatar Airways (QR) has a 9% share on the Kangaroo route and is ranked number five after SIA on that route.
  • Competition for QR’s share of that traffic is likely to be keen and might not be in SIA’s favour as the three primary Middle-Eastern carriers have lowered prices, with fares substantially lower than SIA’s. 
  • While SIA’s ytd load factors to Europe have improved by an average of 9ppt yoy, this was mainly due to a low base in FY17 due to terrorist attacks. Emirates is also reducing its capacity on the North American routes and shifting capacity to Southeast Asia (+9.9% growth till Nov 17) and North East Asia (+9.8% till Nov 17).

Cost pressures likely to continue. 

  • SIA noted that the parent airline’s cost increase in 4QFY17 and in particular the 4.8% increase in labour cost was due to headcount increase relating to the delivery of A350s. SIA will take delivery of another ten A350 this year, which we believe is likely to lead to further cost pressures. 
  • SIA’s CEO in his role as the head of IATA had commented that supplier costs have risen for airlines and we believe that is the case for SIA as well.

Disposing of SIAEC not the solution to SIA’s woes. 

  • Various reports have stated that SIA could or should divest SIA Engineering (SIAEC) or integrate SIAEC with ST Aerospace as part of its transformational plans. We disagree for the following reasons: 
    1. SIAEC has a much higher ROE than the parent airline and it provides a buffer to the airline operations.
    2. About 60% of SIAEC’s revenue accrues directly from SIA and the unit is vertically integrated with SIA’s operations with regard to maintenance by-the-hour packages and sale-and-leaseback of SIA’s fleet, providing revenue and cost synergies. SIAEC also generally benefits when SIA places new orders and this can be evidenced by an engine JV with GE, following SIA’s purchase of GE9X Engines for the Boeing B777- 9s.
    3. SIAEC’s MRO is focused on wide-bodied aircraft, while ST Aerospace is focused on narrow-bodied aircraft.
    4. With checks now being done mostly on apron, it makes little sense for ST Aerospace to acquire SIAEC’s hangars. The former is better off acquiring hangar space or MRO intellectual property from a lower-cost centre.


STOCK IMPACT


No quick fix. 

  • We expect the operating environment to remain difficult over the next three years due to capacity shifts, geopolitical uncertainties and record aircraft deliveries. Much of the capacity growth is underpinned by Chinese carriers and the Middle Eastern airlines, and until we see growth slows substantially, yields will remain under pressure.
  • We also believe that SIA will provide greater details on its transformation plans by end-November.
  • Until then, we expect the stock to languish sideways.


EARNINGS REVISION/RISK

  • None.


VALUATION/RECOMMENDATION

  • Maintain HOLD and target price of S$10.00. 
  • We will be sellers at 5% above our target price, and buyers near S$9.00.


SHARE PRICE CATALYST

  • None.




K Ajith UOB Kay Hian | Sophie Leong UOB Kay Hian | http://research.uobkayhian.com/ 2017-06-21
UOB Kay Hian SGX Stock Analyst Report HOLD Maintain HOLD 10.000 Same 10.000



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