Singapore Airlines - CIMB Research 2017-08-14: Cyclical Uptick Temporarily Masks Structural Challenges

Singapore Airlines - CIMB Research 2017-08-14: Cyclical Uptick Temporarily Masks Structural Challenges SINGAPORE AIRLINES LTD C6L.SI

Singapore Airlines - Cyclical Uptick Temporarily Masks Structural Challenges

  • We upgrade SIA from Reduce to Hold after raising our EPS forecasts 19-51% on the back of a cyclical upswing in airfreight and a small recovery in business travel.
  • We maintain our target price multiple at its trough P/BV of 0.9x, as the momentum behind the cyclical upswing may have peaked, and structural competition is severe.
  • Still, with the EPS upgrades, we lift our target price slightly to S$10.42.

Cyclical upswing in air cargo demand had helped group profits… 

  • SIA Cargo has experienced yoy improvements in its earnings performance for three consecutive quarters. During 1QFY18, it reported an EBIT profit of S$6m, from an EBIT loss of S$34m in 1QFY17, which accounted for the majority of the delta in the group’s overall performance. This was driven by the recovery in global PMI new export orders which benefitted global demand for airfreight with a two-month lag.

…but has the momentum peaked? 

  • However, as the global airfreight upswing started in mid-2016, the yoy momentum should moderate from 2H17F, given the higher base. This ties in with IATA’s view that the global PMI new export orders component may have peaked, and as the momentum fades, so should the growth in airfreight demand. If this turns out to be true, the tailwind behind SIA’s recent share price outperformance could also come under pressure.

Can SIA’s share price get back to its five-year peak of S$12.65? 

  • Looking back over the past five years, SIA’s share price hit a peak of S$12.65 on 30 Jan 2015, equivalent to 1.2x historical P/BV, as investors expected SIA to perform better after the crash in oil prices. 
  • The yoy improvement in earnings did in fact materialise, but lasted for only six months between Oct 2015 and Mar 2016, as competitor airlines cut fares and business travel demand remained weak, thus the fuel cost savings were handed over to passengers. 
  • Over the next two years, SIA de-rated to a low of S$9.67, or only 0.8x P/BV.

Competition is only getting fiercer… 

  • The competition has not gone away despite the cyclical tailwind from stronger cargo demand. Capacity by the Chinese carriers across the Pacific, and down south to Australia has been increasing rapidly, and the open skies agreement between China and Australia that was signed late-2016 promises even more capacity growth. 
  • Anecdotally, we hear that the Chinese carriers have been offering very competitive pricing on transpacific routes, attracting away the marginal Singapore passenger.

…while banking and O&G remain in belt-tightening mode 

  • If the cyclical cargo rebound dissipates, the fierce competitive environment could once again be unmasked in SIA’s results. This time round, SIA is unlikely to enjoy the uplift from lower oil prices, as oil prices are likely headed up, in our view, albeit modestly. 
  • Also, we believe that the banking and oil and gas sectors, which are the bedrock of SIA’s premium class demand, are still in cost-cutting mode and therefore unlikely to provide a significant uplift to business-class demand.

Extended gestation periods for several new routes 

  • Meanwhile, although Scoot and SilkAir continue to be profitable, their profits have fallen yoy for two consecutive quarters. Their planned ASK capacity expansion of 15% each will inevitably encounter some soft spots, where demand may take some time to build up. 
  • We believe that SilkAir’s flight to Luang Prabang that was launched on 31 Oct 2016, and Scoot’s late-Jun 2017 launch to Athens, may encounter extended gestation periods.

We are keeping to our trough P/BV valuation multiple 

  • Due to the reasons outlined above, we are not convinced that SIA’s share price can trade sustainably above its trough P/BV of 0.9x, where we have set our target price.

Yoy improvement in SIA Cargo’s performance may moderate 

  • For three consecutive quarters, SIA Cargo has performed better yoy in terms of its reported quarterly EBIT. This was possible on the back of load factor improvements for the past five quarters, with the latest 1QFY18 cargo load factor at 65.7%, which was the highest load in 14 years for the April-June quarter.
  • The improvement in SIA Cargo’s performance was not necessarily unique, as it was driven primarily by cyclical factors which benefitted airfreight volumes globally. Industry Freight Tonne Kilometres (FTK) demand has followed the upswing of the global PMI new export orders component with a two-month lag.
  • The International Air Transport Association (IATA) postulated that if this PMI new export orders component remains at its June 2017 level in the months ahead, its yoy improvement will most likely moderate. While airfreight demand may remain robust, the momentum of its yoy recovery could weaken, which is highly probable, given that the global cargo upswing began in mid-2016, creating a high-base effect for 2HCY17.
  • Still, 2017F promises to be a much better year for global airfreight operators, and is one of the key reasons why we have upgraded SIA’s earnings forecasts.
  • SIA’s share price responded positively to the announcement of its 1QFY18 results on 27 July, rising from S$10.15 to a recent high of S$10.74 on 10 August.
  • The turnaround in SIA Cargo, from an EBIT loss of S$34m in 1QFY17 to an EBIT profit of S$6m in 1QFY18, accounted for the majority of the delta in the group’s overall performance. During 1QFY18, SIA reported modest group core net profits of S$43.1m, ahead of the S$22.7m loss in the previous year.
  • Given the significance of the SIA Cargo earnings turnaround to the group’s performance, we believe that a potential moderation in the pace of yoy improvement in SIA Cargo’s earnings in the quarters ahead, as IATA suggests could happen, may deflate the upside momentum in SIA’s share price, in our view.

Raymond YAP CFA CIMB Research | http://research.itradecimb.com/ 2017-08-14
CIMB Research SGX Stock Analyst Report HOLD Upgrade REDUCE 10.42 Up 10.000