Singapore Airlines - CIMB Research 2018-01-22: Structural Reforms Accelerate; Cyclical Tailwinds Help

SGinvestors.io

SINGAPORE AIRLINES LTD C6L.SI

Singapore Airlines - Structural Reforms Accelerate; Cyclical Tailwinds Help

• We upgrade SIA from hold to ADD as cyclical demand conditions continue to be supportive and SIA’s is accelerating its moves to transform and restructure the group.
• SIA also plans for much of its older fleet to be transitioned to new-generation aircraft in the years ahead, while exciting new product enhancements are being introduced.
• The LCC arm and its overseas businesses are seeing enhanced prospects, while we think its new revenue management and airfare pricing structure will yield dividends.
• Our target price has been raised (to S$12.05), based on 1x CY18F P/BV, from 0.9x previously.

Cyclical momentum remains positive into 2018F

• The global PMI and PMI new order data continued to be robust into December 2017, and IATA is of the view that this will continue to support the aviation industry into 1HCY18F, at the very least. 
• While oil prices have risen sharply over the past six months, we believe that robust growth of non-OPEC production will cap further price increases. 
• We expect the positive cyclicality to support a 10.2% increase in SIA’s FY19F core net profit, rising to 11% growth in FY20F as SIA’s transformation initiatives take effect.

Delivery of new-generation aircraft to improve cost efficiencies

• Right now, and over the next few years, the SIA group plans to replace most of its older- generation planes, with clear benefits for fuel and operating cost efficiencies. 
• Five new replacement A380s will be fully delivered this year, and SIA will soon commence the deliveries of its medium-haul 787-10s and A350-900s, which will replace its aged 777s on regional routes. 
• Wholly-owned subsidiary SilkAir recently commenced deliveries of its 737 MAX 8s, which will replace the legacy A319/320 fleet.

New models and new products offer new revenue opportunities

• SIA will receive all seven ultra-long-haul versions of the A350 this year, enabling it to commence non-stop flights to New York and Los Angeles. The long-haul version of the A350-900s open up longer and thinner options in Europe that cannot be economically served using its 777-300ERs. SilkAir’s MAX 8s will help it serve longer routes, which it cannot serve using its current fleet types, including to Hiroshima. 
• SIA recently unveiled its new long-haul A380 product, and a new medium-haul product will be unveiled soon.

Transformation initiatives pick up pace

• A 12-member transformation office was set up in May 2017, with a three-year mandate to fundamentally change the SIA group. 
• SIA switched to a new revenue management tool in early-2017, which helped it stabilise yields in recent quarters. 
• A new airfare pricing structure started on 20 January 2018, which improves SIA’s ability to meet the price threshold of price-sensitive customers, in our view. 
• Other future restructuring moves may involve integrating SilkAir into SIA, which would bring cost savings to the SIA group.

Scoot now a fully-integrated short- and long-haul LCC

• The integration of Scoot and Tigerair was completed on 25 July 2017, and the benefits are only beginning to flow in, such as having a unified customer interface and a unified AOC. 
• Now that the SIA group has four wholly-owned airlines under its wing, route swapping across different airlines is being pursued with rigour to ensure that the most appropriate products are deployed to routes with different demand characteristics.

Overseas units expected to do better

• In our view, the outlook for Vistara will improve from mid-2018F, when it uses its 21st aircraft to fly its maiden international route, where demand for its premium product is likely to be better. 
• Meanwhile, NokScoot has struggled since 2015, but ICAO’s recent lifting of a Thai safety concern in October 2017 will allow it to expand to Japan and South Korea, hence improving its prospects.

SINGAPORE AIRLINES SWOT ANALYSIS

How SIA is positioned to cope with the competitive situation

• In this section, we look at SIA’s particular strengths and weaknesses, as well as the opportunities and threats that it is facing as a group. 
• In this way, we aim to understand how the macro environment interacts with SIA, and make an informed assessment of how SIA will cope and perform financially.

Strengths

1. Delivery of new-generation aircraft, which will replace older planes, will help to improve its operating-cost efficiencies, and offer new revenue opportunities. 
2. Product upgrades keep SIA at the industry forefront as one of the best airlines in the world. 
3. Installation of premium economy (PEY) seats help SIA mainline to improve its weighted-average yields. 
4. SIA has dramatically reinvented itself over the past seven years under CEO Mr Goh Choon Phong. 

Weaknesses

1. SIA lost the opportunity for regional low-cost carrier (LCC) dominance with a late start and uneven execution. 
2. SIA’s geographic location in Southeast Asia precludes direct service to the US without specialised aircraft, an opportunity that its North Asian competitors are milking. 

Opportunities

1. The long-haul low-cost (LHLC) experiment with Scoot has been a success, and Scoot is planning for more expansion. 
2. Opportunities for group integration and cooperation increase after the acquisition of 100% of Tigerair, and its subsequent merger with Scoot. 
3. SIA is determined to find new areas of revenue growth and cost efficiencies via its transformation programme that was launched in May 2017. 
4. Vistara will soon take delivery of its 20th aircraft and can then fly international with its 21st aircraft, in our view. 
5. The current macroeconomic cycle is boosting demand for SIA’s premium class seats, as well as its cargo business.

Threats

1. Rapid expansion by the Middle East airlines continue unabated, with an emerging threat from the Chinese carriers.
2. Higher oil prices threaten to squeeze SIA’s profit margins, although it is partially protected by a large oil price hedge taken in 2017.

VALUATION AND RECOMMENDATION

Upgrade to ADD; target price raised to S$12.05

• We upgrade our recommendation on SIA from hold to ADD, with a higher target price of S$12.05, based on a higher CY18F P/BV of 1x, from 0.9x previously.
• Our upgrade is premised on: 
  1. the continued strength of the cyclical demand environment into 2018F, 
  2. the rapid pace of its aircraft renewal and product upgrades in the next few years, and 
  3. SIA’s accelerating efforts at strategic transformation and restructuring.

A) Continued cyclical support into 2018F

• The global PMI and PMI new orders data continued to be robust into December 2017, and IATA is of the view that this will continue to support the aviation industry into 1HCY18F, at the very least.
• The cyclical demand tailwinds commenced in 2016, and became more evident in 2017, particularly for the air freight market. Robust trade growth spilled over into demand for premium passenger travel, benefiting airlines with premium cabins to offer. The robust global stock markets may also help spur merger & acquisition and Initial Public Offering activities, which would see even more demand for business travel from financial institutions.
• While the pace of demand growth and load factor improvements in 2018F is expected to slow from the strong pace last year, IATA expects the overall profitability of the airline industry to improve this year.
• The robust demand outlook is threatened by higher jet fuel prices, which are currently trading at US$79/bbl, against an average of just US$63.60/bbl in 2017, based on a one-month lag that is consistent with SIA’s contracting arrangements. The IEA, however, expects a robust expansion of US, Canadian and Brazilian crude oil output that may limit the potential for further price increases. We are forecasting an average spot jet fuel price of US$75/bbl for FY19-20F.
• The impact of more expensive fuel on SIA is partly offset by the weaker US$:S$ exchange rate, which currently stands at S$1.32:US$1, vs. an average of S$1.38 in 2017. We are forecasting an average exchange rate of S$1.35 for FY19-20F.
• Also, in early-2017, the SIA group had entered into Brent hedges to cover 40% to 47% of its fuel requirements over the next six years, at average Brent prices of US$53-59/bbl; this will mitigate the impact of higher spot fuel prices.

B) Rapid pace of aircraft renewal and product upgrades

• SIA has a history of long-term fleet planning and product upgrades that have been planned years in advance before their announcement to the market.
• Over the past three years, the SIA group has benefited from the following moves to upgrade its fleet and product.
  1. From 2013 onwards, SIA began retrofitting its long-haul workhorse – the 777-300ERs – with brand-new products. The work was recently completed for all 27 aircraft of this type in September 2016.
     
  2. Installation of PEY seats began from early-2015, helping SIA increase its weighted-average yields. All of SIA’s long-haul aircraft (A380s, A350-900s and 777-300ERs) have been fitted with PEY, with the exception of a handful of 777-300ERs that will be completed by end-2018F.
     
  3. Twenty-one units of the new-generation A350-900 long-haul aircraft have been delivered since early-2016, and which have replaced the classic 777- 200ERs on long-haul routes, improving route economics and opening up possibilities to thin routes that the 777-300ERs are unable to serve.
     
• Over the next five years, the SIA group can look forward to even more improvements, as follows:
  1. 1. SIA is currently in the process of delivery of its five new A380 deliveries, that will replace five of its first-generation A380s that will be returned to lessors. The first two were delivered in late-CY17, and the final three will be delivered this year.
  2. Each of these new A380s are equipped with brand-new products that were launched in November 2017, and which will be rolled out to all existing 14 x A380s by end-2019F. The new configuration has fewer suites but more PEY and economy class seats, which better match the available supply with the typical demand pattern, and ensures better use of the cabin footprint.
  3. We expect a further 19 units of A350-900 planes in long-haul configuration to be delivered by March 2023F that will open up more route possibilities for SIA.
  4. SIA will take delivery of its first 787-10 aircraft in March 2018F, which are intended for medium-haul deployment. A further 20 units of the A350-900s may be delivered in medium-haul configuration over the next four years, in our view. SIA plans to launch its brand-new medium-haul product soon, replacing the products currently on its A330-300s, 777-200/300s and 777- 200ERs. The legacy aircraft will be returned to lessors or sold, and the fleet and product replacement will help make SIA’s product on medium-haul routes more attractive to customers and more cost-efficient.
  5. Seven A350-900ULR aircraft will be delivered this year, enabling SIA to restart non-stop, ultra long-haul flights to the US. This will address a major area of strategic weakness for SIA in relation to its North Asian and Middle Eastern competitors, and may help increase demand for SIA’s short- and medium-haul routes as it facilitates regional passengers’ connections to the US.
  6. From 2021F, SIA will also start replacing 777-300ERs with new 777-9s. The latter aircraft will enable fuel cost savings and higher seat density in economy class.
     
  7. SilkAir has just begun its second round of fleet renewal, after taking delivery of the first three of its 37 x 737 MAX 8 orders in 4QCY17. All 37 orders should be delivered by March 2022F. The MAX 8s will replace the legacy A319/320 fleet, with range and fuel efficiency improvements.

C) SIA’s accelerating efforts at strategic transformation and restructuring

• Since 2011, SIA’s CEO Mr Goh Choon Phong has initiated several major strategic changes at the group, including:
  1. Setting up Scoot, and taking full control of Tigerair, then merging the long- and short-haul LCCs under a single brand.
  2. Invested in hubs outside of Singapore, i.e. setting up 49%-owned Vistara in India and 49%-owned NokScoot in Thailand.
  3. Forged comprehensive partnerships with Virgin Australia and Air New Zealand in the Southwest Pacific, and with SAS and Lufthansa in Europe.
• Scoot has been profitable for the past two years, which has been a great success for the SIA group so far. Furthermore, the integration of Scoot and Tigerair was only completed on 25 July 2017, and the benefits are just beginning to flow in, such as having a unified customer interface and a unified AOC. Route swapping across different airlines in the group is also being pursued with a lot of rigour in order to ensure that the best and most appropriate products are deployed to routes with different demand characteristics.
• While Vistara is probably still struggling to sell its premium product in a price- sensitive domestic market, we believe that positive change in on the horizon. We expect the airline’s fleet size to reach 20 aircraft by March 2018F, and it is planning to take delivery of two more aircraft in mid-2018F, with which it could pursue international expansion. We think that Vistara’s premium product will see better take-up and higher yields in longer-haul international routes.
• Meanwhile, NokScoot has struggled with a sub-economic fleet of three aircraft since mid-2015, and was unable to expand to Japan and South Korea after ICAO imposed a Significant Safety Concern (SSC) rating on Thailand’s aviation regulator, also in mid-2015. However, the SSC rating was lifted in October 2017 and NokScoot has since taken delivery of its fourth aircraft. The prospects for NokScoot have brightened considerably and its losses should at least narrow in the years ahead, if not turn profitable, based on our estimates. 
• SIA’s airline partnership with Lufthansa is very important, and only took effect on 1 October 2017. We expect SIA to enjoy the benefits in 2018F onwards, which include revenue-sharing arrangements on flights to Germany and Switzerland, an expanded codeshare agreement, and also the coordination of flight schedules to facilitate seamless passenger transfers. In comparison, SIA’s partnership with Virgin Australia took effect much earlier in 2011, and was expanded in 2012 and 2013.
• The transformation office started its work in May 2017. The 12-member transformation office was set up by SIA in May 2017, with a three-year mandate to fundamentally change the SIA group.
• Recent transformation moves include SIA’s shift to a new revenue management tool in early-2017, which SIA credited for helping it stabilise yields in recent quarters. Also, SIA introduced a new airfare pricing structure from 20 January 2018 onwards, which unbundles offerings like advanced seat selection, baggage allowance and mileage claims, and offers three types of airfares to choose from, i.e. ‘Lite’, ‘Standard’ and ‘Flexi’ fares. The net result is to widen the gap between the different airfare types, which improves SIA’s ability to meet the price threshold of price-sensitive customers, in our view.
• Other future restructuring moves may involve integrating SilkAir into SIA, and managing the full-service business as a single brand with a single platform. This would bring cost savings to the SIA group. Additional announcements regarding the SIA group’s restructuring moves could help re-rate the share price, in our view.

Valuations

• We have valued SIA on a P/BV basis, as this has been a much more usable valuation metric, compared to earnings-based valuations, over time, with clear top and bottom ranges. Since 2001, the P/BV has averaged 1.1x, but since 2011, the average has dipped to around 1x.
• With the current fleet renewal and transformation initiatives picking up pace over the next 2-3 years, and coupled with the supportive macroeconomic demand drivers experienced currently, we expect that SIA’s P/BV multiple to at least move towards the 1x mark.
• Despite a gradual increase in SIA’s share price in recent months, Bloomberg consensus estimates of FY19F EPS has been rising since September 2017, resulting in a drop in its 1-year forward P/E. 
• Market confidence in SIA appears to be returning to some extent, and if SIA management surprises on the upside on its transformation moves, we should expect the share price to continue its gradual upward climb.

Raymond YAP CFA CIMB Research | http://research.itradecimb.com/ 2018-01-23

CIMB Research SGX Stock Analyst Report ADD Upgrade HOLD 12.05 Up 10.820