Singapore Airlines (SIA SP) - UOB Kay Hian 2018-01-03: Upgrade To BUY On Expected Pax Yield And Cargo Recovery

SINGAPORE AIRLINES LTD C6L.SI

Singapore Airlines (SIA SP) - Upgrade To BUY On Expected Pax Yield And Cargo Recovery

Singapore Airlines (SIA) underperformed the FSSTI by 7ppt in 2017, amid persistent concerns over weak yields, brought about by rising competition. However, capacity growth is expected to abate in 2018, and with that, yields should improve.
Already, there are signs of improving pax yields for several North Asian carriers in 4Q17. This, coupled with a significant recovery in cargo earnings, mandates a re-rating.

We upgrade SIA to BUY from HOLD and raise our fair value target price from S$11.10 to S$11.90.
Our upgrade is underpinned by the following factors.

IATA has forecast Asia Pacific carriers’ 2018’s capacity growth at 6.8% for 2018, 2.5ppt lower than 2017’s. This will be conducive to pax yield growth. Already there are signs of stronger pax yield growth among Asia Pacific carriers, with several North Asian carriers registering > 5% pax yield growth in 4Q17.
We believe that markets have yet to price this positive inflexion point.
We expect SIA’s yields to similarly improve in 3QFY18 and expect a favourable yield environment for 2018. Implicitly, we now expect 2HFY18’s pax yield to rise by 2.7% and estimate a further 1.6% rise in FY19.

In mid-December, SIA announced revisions to its advanced seat selection, frequent flyer mileage accrual, baggage allowance and ticket refund/change flexibility.
We expect the changes to be revenue accretive. Assuming a 20-30% take-up rate on the advanced seat selection under the “lite” ticketing, we estimate that the advanced seat selection alone could lead to S$6m-9m in incremental revenue/PBT.

SIA’s pax load factor rose 3.1ppt yoy in Nov 17, the highest yoy ppt increase in five months. In addition, both October’s and November’s pax load factors were at the highest level for eight years, underscoring strong demand, which is likely to underpin yield recovery.
In 2QFY18, SIA’s pax load factors improved by 1.7ppt yoy, leading to a 115% increase in parent airline’s operating profit. In comparison, October’s and November’s load factor rose by 3ppt, yoy and thus parent airline’s 3Q operating profit could potentially register similar growth.
We also note that for the past two years, parent airline’s operating profits in 3Q have been almost double that of 2Q’s.

During the past five years, cargo operations had been a drag on group profitability, but this is now reversing as both volume and yields improve. Rising pharmaceutical exports, higher e-commerce transactions and strong Asia Pacific to North American rates are underpinning the improving profitability.
Most large air cargo operators such as Fed Ex and UPS have guided for continued growth in 2018. We expect the same for SIA. In November, SIA’s Cargo load factor increased by 3.9 ppt yoy, the highest yoy ppt change in five months, while October’s and November’s cargo load factors were the highest in 12 years.
Like the pax business, this holds scope for higher yoy and qoq profitability in 3QFY17.

SIA has hedged approximately 41% of its fuel requirements for 2HFY18 at about US$65/bbl on jet fuel (including Brent contracts) and has long-dated Brent contracts till FY23 at US$53-59/bbl. Thus, despite the relatively firm fuel prices, SIA will not be adversely impacted by higher jet fuel costs as part of the increase will be offset by hedging gains. Even so, we have assumed a 16% hoh rise in jet fuel costs in 2HFY18.
SIA is also likely to book in unrealised MTM gains in reserves if Brent prices stay at US$60 or higher. At the parent airline level, into-plane fuel cost is estimated to account for 30.5% of pax yield in FY18, vs 30% in FY17, implying a partial cost pass-through. For FY19 and FY20, we have assumed that yields relative to fuel cost will remain relatively flat.

SIA is trading below expected FY18 book value of S$11.07 and FY19’s book value of $11.72. We believe the street is still sceptical of earnings growth, despite numerous indications of a recovery in air cargo rates and earnings. We expect the street to eventually re-rate SIA as 3Q earnings surprise.
We also believe that there are lesser uncertainties over the next 6-9 months, compared with the start of 2017.
All in all, we expect SIA’s core net profit to double to S$627m in FY18 and rise by a further 15% in FY19 to S$724m. We also expect SIA to generate core ex-cash ROE of 6.5% in FY18.

We raise our FY18 net profit estimates by 7.6% as we assume better-than-expected load factors for pax and cargo operations for 2HFY18.
For FY19, we have also assumed higher ancillary revenue and pax yields and hence raise our estimates by 26%.

We raise our fair value P/B for SIA-ex SIAEC from 0.8x P/B to 0.9x P/B. Based on that, we derive a fair value of $11.90 for the group.

K Ajith UOB Kay Hian | http://research.uobkayhian.com/ 2018-01-03

UOB Kay Hian SGX Stock Analyst Report BUY Upgrade HOLD 11.90 Up 11.100