Singapore Airlines - CGS-CIMB 2018-05-18: First SIA Mainline Yield Increase In 3 Years

Singapore Airlines - CGS-CIMB 2018-05-18: First Sia Mainline Yield Increase In Three Years SINGAPORE AIRLINES LTD SGX: C6L

Singapore Airlines - First Sia Mainline Yield Increase In Three Years

  • SIA’s FY3/18 core net profit of S$582m was 10% above our expectations due to better-than-expected yields at SIA mainline and Scoot.
  • SIA declared a 30 Scts final dividend (2.7% yield), ahead of last year’s 11 Scts, with the shares trading ex-dividend on 31 Jul, to be paid on 15 Aug.
  • We maintain ADD but reduce our target price from S$12.05 (1x CY18F P/BV) to S$11.75 (1.05x P/BV) due to the negative earnings impact from higher oil prices.
  • SIA share price catalysts include the impending final dividend and the continuation of positive yield momentum at SIA mainline during FY19F.

Significant improvements at SIA mainline…

  • SIA’s 4Q18 core net profit of S$87m was 4x higher than last year, due to material y-o-y turnarounds at SIA mainline and SIA Cargo, and higher profits at Scoot, partially offset by lower profits at SilkAir and SIAEC. FY18 core earnings rose 74% y-o-y due to the same dynamics. 
  • SIA mainline’s core EBIT has been improving over the past four quarters, as growth in RPK demand lifted loads y-o-y while ASK capacity remained flat, and as the rate of yield declines started easing and then actually rose 1% y-o-y in 4QFY18.

… as well as SIA Cargo and Scoot, but SilkAir disappointed

  • SIA Cargo reported only S$3m core EBIT for FY17 but delivered an excellent S$148m core EBIT for FY18, due to a surge in cargo yields as airfreight demand grew from strong global trade momentum and pushed up cargo loads. 
  • Scoot saw 13% y-o-y higher FY18 core EBIT as it successfully grew demand with minimal yield dilution. 
  • SilkAir reported significantly lower profits, as it had to discount heavily to fill up its expanded capacity base. 
  • SIAEC earnings fell primarily on lower fleet management revenue.

SIA mainline resuming capacity growth from FY19F

  • After five years of flat capacity, SIA mainline is guiding for 5% ASK growth in FY19F, as it is confident that it has the right aircraft to expand, i.e. the A350ULR for the resumption of non-stop Los Angeles and New York flights, and the 787-10 and the regional A350-900 for medium-haul flights. 
  • Fleet efficiency will improve as several classic 777s are removed. 
  • We are banking on SIA mainline delivering matching 5% RPK growth in FY19F, with its new A380 and 787-10 products helping to grow its pool of customers.

Yield momentum expected to continue improving in FY19F

  • For the SIA group’s passenger business as a whole, SIA guided for “strong advance passenger bookings” and “continued stabilisation in yields” despite “intense competition and cost pressures”. 
  • We expect SIA mainline to build on the 1% y-o-y increase in 4QFY18 yields (the first yield increase in three years) as we head into FY19F. 
  • Rising fuel prices would no doubt impact SIA’s unhedged competitors more than SIA itself, and may lead to an industry-wide rise in ticket prices which SIA can ride on.

Good outlook for Scoot, but somewhat concerned about SilkAir

  • During FY18, Scoot and SilkAir grew capacity at around the same rate, but to maintain loads, SilkAir had to cut yields materially while Scoot did not have to do so. 
  • With FY19F planned capacity growth of 9% at SilkAir, we wonder if SilkAir might have to struggle with yields again, even though we have pencilled in a low single-digit rise in yields to offset higher fuel costs. 
  • While Scoot is planning to step up ASK growth to 17% this year, we expect its low fares to be warmly embraced, and no yield discounts are expected.

Impact of higher oil prices muted by large hedge position

  • The SIA group is c.45% hedged at c.US$65/bbl jet fuel for the next five years, against spot jet fuel price of US$90/bbl. 
  • While SIA will still be negatively affected by pricier oil, its hedging position gives it a competitive advantage against Cathay Pacific, and the unhedged Chinese and Middle Eastern Gulf carriers.

SilkAir and SIA mainline merger

SIA’s announcement

  • SIA announced today that SilkAir will merge with SIA mainline, and will also invest more than S$100m to upgrade its cabin products to introduce new lie-flat seats in business class as well as install seat-back in-flight entertainment systems in both business class and economy class. This will ensure closer product and service consistency across the SIA group’s full-service network.
  • Aircraft cabin upgrades are expected to start in 2020F due to lead times required by seat suppliers, including completing the certification processes. The merger will take place only after a sufficient number of aircraft has been fitted with the new cabin products.
  • SilkAir operated a fleet of 9 x A320s, 3 x A319s, 17 x 737-800, and 3 x 737 MAX-8 aircraft as at 31 March 2018. It is currently transitioning to an all-737 fleet, by way of additional 737 MAX-8 deliveries, which will see the A319/320s decommissioned.
  • There will also be transfers of routes and aircraft between the different airlines in the SIA group to optimise the group’s network.

Our views

  • SilkAir began its first round of fleet renewal when it started to take delivery of the 737-800s from early-2014. All of its 17 x 737-800 orders were delivered by late- 2016. As a result, its legacy fleet of A319/320 planes, which peaked at 24-strong in late-2013, was reduced to the current size of 12 planes, leaving SilkAir with a net addition of five planes for growth.
  • The additional planes have been used to launch new destinations, such as Luang Prabang and Vientiane (Laos), Fuzhou (China) in 2016 and Colombo (Sri Lanka) in 2017. SilkAir has also taken over all or some frequencies of underperforming SIA destinations such as Kuala Lumpur and Penang that are too small for SIA’s widebody flights.
  • SilkAir’s second round of fleet renewal-cum-growth is happening now. The first three of the airline’s orders for 37 x 737 MAX-8 planes were delivered in 4QCY17. We expect all 37 to be delivered by March 2022F. We expect these planes to replace the remaining 12 x A319/320 planes that should be fully phased out by 2020F, with 25 of the MAX 8 deliveries intended for growth.
  • We view the SIA-SilkAir merger as akin to the Scoot-Tigerair merger that was completed earlier. It will save operating costs and merge the booking platforms, which are currently on two separate websites, as well as project a unified brand to customers. This is positive for the SIA group in the long term as it will have one LCC brand – Scoot – as well as one FSC brand – SIA.
  • We also see the installation of new lie-flat business class seats as well as seatback in-flight entertainment in both business and economy classes as positive for the customer proposition of the SIA group. Given that SIA is working through the asset deployments across the group by changing the service of better-performing routes to larger SIA wide-body aircraft and by deploying smaller SilkAir narrow-body planes to thinner routes to replace wide-body planes, it will be critical for SIA’s FSC business to offer a consistent product across the board. This will be especially relevant as SilkAir grows its network across Southeast Asia, India and China, and ferries connecting passengers to the long- haul SIA network.
  • When SilkAir first rolled out its new product on the 737-800 in 2014, we were disappointed that it did not upgrade its narrow-body product to include seatback in-flight entertainment, which many of its FSC competitors in the region had already introduced. We believe that customer feedback probably prompted SilkAir to finally introduce seatback IFE, which will narrow the product gap with its competitors.

Sensitivity to oil prices

  • Downside risks include the potential for higher oil prices. While we have pencilled in higher jet fuel price of US$85/bbl into our forecasts, we highlight that jet fuel prices are now at US$90/bbl in the spot market. 
  • Every US$5/bbl increase in average jet fuel prices can reduce our core net profit forecast for SIA by 19%, assuming no effort to pass through higher costs to passengers.

Valuation and core EPS changes

  • We have raised our CY18F P/BV valuation multiple slightly from 1x to 1.05x, as SIA has adopted a new accounting policy effective 1 April 2018 that will see its net book value decline by about 15%. We have not taken into account the entire 15% increase in P/BV multiple in an environment of higher oil prices, as SIA’s earnings will surely be negatively affected.
  • We have raised FY19-20F core EPS estimates by 15-19%. By factoring in a higher spot jet fuel price of US$85/bbl into our forecasts (from US$75/bbl previously), and taking into account the fact that SIA has hedged c.45% of its fuel requirements at a jet fuel strike price of c.US$65/bbl, our core EPS forecasts have been reduced by around 30%.
  • However, this is more than offset by the adoption of the Singapore Financial Reporting Standards (I), as required by the listing rules of the Singapore Exchange. SIA applied SFRS(I) with effect from 1 April 2018. If the new financial standards had been adopted on 1 April 2017, SIA will see aircraft and aircraft spares carrying values reduced by S$2,147m, as SIA is able to take advantage of first-time adoption indulgences that allow it to treat fair values of certain aircraft and aircraft spares as the new cost levels. The accounting entry would be to debit shareholders’ equity on the balance sheet, and to credit fixed assets, also on the balance sheet.
  • For illustrative purposes, assuming the above adjustment had been effected in the FY18 financial statements, the proforma financial effects would be to reduce depreciation by S$490.7m, with a tax effect of S$83.3m, hence net S$407.4m post-tax positive impact on PAT.
  • SIA guided that the estimated reduction in depreciation expense over the next three forecast years is as follows: FY19F: S$425.6m, FY20F: S$322.3m, and FY21F: S$234.5m. We have reflected lower depreciation expenses into our current forecasts, which explains why our core EPS forecasts are raised despite assuming a US$10/bbl increase in spot jet fuel prices to US$85/bbl.

Raymond YAP CFA CGS-CIMB | https://research.itradecimb.com/ 2018-05-18
SGX Stock Analyst Report ADD Maintain ADD 11.75 Down 12.050