Singapore Airlines (SIA SP) - UOB Kay Hian 2017-03-08: Lower Downside Risk; Newsflow Could Aid Upward Momentum

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SINGAPORE AIRLINES LTD C6L.SI

Singapore Airlines (SIA SP) - Lower Downside Risk; Newsflow Could Aid Upward Momentum

• SIA has underperformed the STI over the past three months but we expect the stock to at least market-perform in the near term due to: 
  1. low valuations and hence lower risk, 
  2. potentially diversionary traffic from China to Singapore, and 
  3. potential cargo recovery on stronger global PMI new orders. 
• In addition, SIA is a better beneficiary of any cargo recovery, given its lower capital cost and fuel hedges. 
• Maintain HOLD. Target price: S$10.40. Entry level: S$9.90.

WHAT’S NEW

• SIA has underperformed the FSSTI by 3.4ppt over the past three months, but we expect the stock to at least market-perform over the next three months. 
• Our reasons are as follows: 
  1. Relatively low valuations, which limit downside risk. SIA is currently trading at 0.69x FY18F book value ex-SIAEC. This is -1SD below long-term mean P/B of 0.9x. Most of the known negatives are already priced in but potential positives have yet to be.
  2. Potential beneficiary of a diversion of Chinese traffic from South Korea. According to Bloomberg, China has asked tour agencies to limit travel to South Korea, in an apparent retaliation against the South Korea’s deployment of Thaad missiles. While we are unable to verify the accuracy of the report, we think Singapore’s tourism could receive a boost if it pans out. Case in point, 2m Chinese visited Singapore in 2016 (+25% yoy), a fraction of the 8m (+35% yoy) who visited South Korea. Even a 5% diversion of South Korea’s Chinese traffic to Singapore would lead to a 20% rise in Singapore’s Chinese tourist arrivals, which could directly benefit SIA given that it has a 52% market share out of Changi.
  3. IATA is optimistic on cargo traffic; SIA could be a beneficiary. Global cargo traffic rose 6.9% in January, with Asia Pacific airlines contributing to the bulk of the growth. While February’s numbers could provide a better gauge on seasonal factors, IATA notes that global PMI new orders have been trending up and this bodes well for air cargo.
     IATA also notes that pharma and cross border e-commerce are poised to perform better. SIA’s cargo traffic rose 3.5% yoy in Jan and load factors improved by 1.0ppt. Comparatively, Cathay Pacific’s (CX) cargo traffic rose 1% yoy but load factors were mostly flat (+0.3ppt).

UK and India are in talks to liberalise air services agreement aimed towards boosting direct traffic. 

• SIA’s 49%-owned Vistara will be a beneficiary of any liberalisation of air traffic rights between the two countries. While details are sketchy, the liberalisation will likely expand the number of weekly flights for carriers of both nations, thus facilitating more direct traffic. 
• According to OAG, some 1.7m passengers (59%) flying to both countries transited at an intermediate point (generally Middle Eastern airports), enroute to end destinations in the UK or India. The agreement will provide scope for more direct traffic and enable Vistara to launch direct flights to the UK from Delhi or other cities in 2018.

STOCK IMPACT

• We expect share price to gradually head closer towards our target price of S$10.40, especially if Feb 17 operating statistics show a cyclical cargo recovery. 
• Notably, while Asia Pacific carriers’ cargo traffic rose in January, their load factors still fell, highlighting the ongoing concern over excess bellyhold capacity, a view shared by SIA. Even so, we expect cargo yields to recover marginally and have assumed a 3% increase, partly due to higher fuel cost assumptions. 
• We have also assumed a 1ppt rise in cargo load factors for FY18. SIA will have greater leverage from improving cargo traffic and loads compared with CX. SIA had written down the value of its eight dedicated freighters which would mean minimal capital costs, leaving fuel and maintenance costs to be the primary cost components. 
• On the other hand, CX has 37 freighters but more than half of which are relatively new; which would lead to higher capital costs. SIA also has an advantage over CX in terms of fuel cost, given existing hedges at attractive levels at US$53-59/bbl on Brent vs CX’s US$75-90/bbl till 2019.

EARNINGS REVISION/RISK

• No change to our earnings estimates.

VALUATION/RECOMMENDATION

• Maintain HOLD and target price of S$10.40. 
• We continue to value SIA at 0.7x FY18F core book value ex-SIAEC, or 1SD below mean P/B. Suggested entry price is S$9.90.

SHARE PRICE CATALYST

• Higher-than-expected pax yields and higher loads.

K Ajith UOB Kay Hian | Sophie Leong UOB Kay Hian | http://research.uobkayhian.com/ 2017-03-08

UOB Kay Hian SGX Stock Analyst Report HOLD Maintain HOLD 10.400 Same 10.400