Singapore Airlines - CGS-CIMB Research 2019-05-20: Opportunistically Using Disruptions For Good

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SINGAPORE AIRLINES LTD (SGX:C6L)

Singapore Airlines - Opportunistically Using Disruptions For Good

• The disruptions wrought by the MAX 8 and TEN engines have a cost, but SINGAPORE AIRLINES LTD (SIA, SGX:C6L) may also be able to use these for both short-and long-term benefits.
• Maintain HOLD as we see cyclical headwinds from slowing global trade growth, potentially affecting both premium-cabin travel and cargo volumes.
• Higher-than-expected oil price pose a downside risk. Our target price stays at S$10.14, based on 0.9x CY19 P/BV (1 s.d. below mean).

Aircraft-related disruptions cause a myriad of problems…

• On 12 Mar 2019, SilkAir grounded its fleet of 6 x 737 MAX 8 planes in response to the Ethiopian Airlines crash of the same aircraft type on 10 Mar. Meanwhile, problems with the Rolls-Royce Trent 1000 TEN engines have caused two of SIA mainline’s 11-strong 787-10 fleet, and two of Scoot’s 19-strong fleet of 787-8/9 planes, to be grounded currently. These technical issues have caused a series of problems to the SIA group.
  • First, the groundings caused scheduling headaches and customer satisfaction issues which need to be handled delicately.
  • Second, the groundings may result in rectification costs (which may be compensated by the manufacturers), and the costs of taking on more aircraft leases to meet capacity needs.
  • Last, near-term capacity expansion plans have been affected, with the group’s ASK capacity growth plan cut slightly to 6% in FY20F (from 6.4% in FY3/19).
• SilkAir’s 6.2% ASK growth in FY19 is scheduled to fall by 3% in FY20F, and Scoot’s ASK growth of 15% in FY19 may slow to just 7% in FY20F, partially offset by SIA mainline’s planned growth of 7% in FY20F, up from 4.5% in FY19.

…requiring the SIA group to manage the situation carefully…

• In order to offset capacity losses, SIA mainline reinstated one 777-200 and one A330-300 into its operations, as well as increased the utilisation of its fleet, in order to mount supplementary flights to help SilkAir salvage its schedule, and also to make up for its own 787-10 groundings.
• Meanwhile, since the group is still pushing ahead for Scoot to take over 17 routes from SilkAir, but SilkAir will longer transfer 14 x 737-800 planes to Scoot (as SilkAIr requires them to maintain its schedule after the MAX 8 groundings), and Scoot is facing engine issues with its fleet of 787-8/9s, Scoot is looking at extending 4-6 aircraft leases, and lease in an additional 10-12 x A320s over the next two years.

…but can have positive silver linings for the group

• The silver lining is that SilkAir now has the opportunity to renegotiate with Boeing on the remaining 31 x MAX 8s on order. An order cancellation is unlikely, but in our view, SilkAir may negotiate for a hiatus in deliveries as the process of recertifying the MAX 8s may be lengthy, and decisions by multiple aviation regulator will be needed before SilkAir can reinstate its original MAX 8 schedule.
• We think SilkAir will attempt to build in a good time buffer to make sure that all issues are fully resolved before delivery resumes. Also, the remaining MAX 8 orders were to have been fully delivered over five years from CY19- 23F, but SilkAir may try to extend the deliveries over a longer period of time, in order to temper its capacity growth in view of current regional overcapacity.

Full-service carrier RASK trends

• The revenue per unit of Available Seat Kilometre (RASK) capacity for the full-service carrier (FSC) business of SIA mainline and SilkAir have been showing y-o-y growth for five consecutive quarters from the quarter ended December 2017, but then weakened on a y-o-y basis in 4QFY19 (the January-March 2019 quarter).
• Based on the explanation from SIA, we do not believe that this is reflective of underlying weakness in the demand environment. SIA noted that the February 2019 RASK was weaker y-o-y because of the shift of outbound Lunar New Year traffic from February 2018 to end-January 2019.
• Meanwhile, for March 2019, SIA said that the y-o-y drop in RASK was due to the shift in Easter from end- March 2018 to mid-April 2019. However, SIA did say that the competition in the marketplace was becoming more intense. Also, SIA noted in its recent results release that it has continued to see “growth in forward passenger bookings” and “robust premium-cabin demand”.

Low-cost carrier RASK trends

• The revenue per unit of Available Seat Kilometre (RASK) capacity for the low-cost carrier (LCC) business under Scoot has fallen for two-consecutive quarters due to excessive capacity expansion and the consequent fall in passenger load factors, but also because of the expansion of state-owned Chinese carriers into Southeast Asia (in particular to Singapore) that have caused aggressive price competition.
• The outlook on Scoot’s RASK will likely continue to be weak for the rest of FY20F, in our view, simply because of the high-base effect, because the competition’s capacity expansion only began in earnest from the quarter ended December 2018, and also because Chinese outbound travel to Southeast Asia has slowed materially in recent months.
• However, there is potential for improvement in FY20F, as Scoot terminated poorly-performing flights to Dhaka, Dalian and Honolulu in FY19, and will be terminating loss-making flights to Lucknow and Kalibo from end-June 2019F, to Quanzhou from August, and to Male from October.
• These route terminations are to make way for routes that Scoot have been designated to take over from SilkAir, the first of which was to Vientiane via Luang Prabang from 1 April 2019, followed by Thiruvananthapuram (Trivandrum) from 7 May.
• Other flights that Scoot will take over include:
  • Between May and October 2019F: Coimbatore and Visakhapatnam, India
  • Between May and June 2019F: Changsha, Fuzhou, Kunming and Wuhan, China
  • October 2019F: Chiang Mai, Thailand (which is already an existing Scoot destination)
  • December 2019F: Kota Kinabalu, Malaysia
  • Between May and June 2020F: Balikpapan, Lombok, Makassar, Manado, Semarang and Yogyakarta, Indonesia.
• We believe that these regional routes are better served using high-density LCC configuration planes, as these routes have a high penetration of competitors’ LCC services that have depressed yields to levels that may be uneconomic for SilkAir to serve, given its FSC positioning. With Scoot, however, these routes are a golden opportunity for growth.
• Scoot would not have to terminate the above routes if the planned transfers of 14 x 737-800 planes from SilkAir to Scoot take place over the next 12 months or so, but with the groundings of SilkAir’s fleet of 6 x 737 MAX 8 planes, SilkAir will now keep the 737-800 planes in its fleet. As such, the ASK capacity growth for Scoot was guided by management to be 7% in FY20F, a marked slowdown from the 15.1% growth seen in FY19.
• Hence, the issues surrounding the 737 MAX 8 planes in SilkAir’s fleet, as well as those on order, have forced Scoot to dial back its growth plans and to exercise greater selectivity on the routes that it chooses to serve – eliminating loss-making routes and focusing on those that make the most commercial sense, including the regional routes to be taken over from SilkAir. This should be positive for Scoot’s financial performance, in our view.
• Over the next two years, Scoot will need to lease in additional planes, perhaps 10-12 A320s, in place of the 14 x 737-800s that were originally scheduled for transfer from SilkAir to Scoot. Also, Scoot is looking at extending 4-6 aircraft leases, both narrow-and wide-bodied planes. This is because Scoot is still going to take over regional routes from SilkAir despite not getting any aircraft transferred from SilkAir.

Cargo business RAFTK trends

• In 3QFY19, the cargo business’ revenue per unit of Available Freight Tonne Kilometres (RAFTK) was unchanged y-o-y after rising for six-consecutive quarters, and then fell 6.2% y-o-y (and 19.7% q-o-q) due to excessive US inventories and the impact of higher US and Chinese tariffs on goods for each other.
• On a monthly basis, RAFTK had been higher y-o-y until October 2018, before being flat on a y-o-y basis in November 2018, and then falling y-o-y from December 2018 onwards, with the February 2019 RAFTK falling by as much as 10.9% y-o-y. During 2018, many importers and exporters frontloaded cargo volumes prior to the implementation of tariffs, but with US businesses now well stocked, it was not surprising that airfreight demand, and consequently cargo yields and RAFTK, fell.
• The recent escalation in the tariff rates for the US-China trade, and the global slowdown in GDP growth, portend continued airfreight weakness for the rest of CY19F, in our view.

Valuation and recommendation

• Our HOLD call is premised on weakening global GDP growth and higher tariffs that are now beleaguering the US-China trade and that is already negatively affecting SIA’s airfreight demand and yield since late-CY18. Although in “the months ahead”, SIA continues to see “growth in forward passenger bookings” and “robust premium-cabin demand”, there is a historical lagged correlation between cargo demand and demand for premium-cabin and business-related travel, which pose a downside risk.
• Upside risks include the potential for SilkAir to rethink its long-term capacity growth by renegotiating the 737 MAX 8 orders with Boeing.
• Also, spot jet fuel are now above US$80/bbl; our assumption is an average of US$75/bbl for FY20F and US$85/bbl for FY21F due to the expected heightened demand for middle distillates from the implementation of IMO 2020 from 1 Jan 2020.
• For FY20F, SIA has hedged 69% of its fuel needs at an average strike price of c.US$75/bbl of jet fuel, so downside protection is reasonably good. A US$5/bbl increase in the price of jet fuel will therefore negatively impact SIA’s core net profit forecast by only 1%.
• For FY21-25F, SIA has hedged up to 46% of its fuel needs at an average strike price of between US$58/bbl and US$63/bbl of Brent (or US$73/bbl to US$78/bbl of jet fuel, assuming crack spread of US$15/bbl), and potentially up to 14% of jet fuel at an average strike price of US$77/bbl. Again, downside protection is good.
• In recent years, SIA has traded to as low as 0.8x P/BV, and applying that multiple to SIA results implies a S$9 valuation, where the current share price approximately stands. Hence, we do not think that there is significant additional downside to SIA’s share price hereon.

Raymond YAP CFA CGS-CIMB Research | Calyne TI CGS-CIMB Research | https://research.itradecimb.com/ 2019-05-20

SGX Stock Analyst Report HOLD MAINTAIN HOLD 10.140 SAME 10.140