SIA sees growth at SilkAir

For the past month, business class passengers on Singapore Airlines’ (SIA) SQ 324 to Amsterdam have enjoyed the luxury of a flat bed on the 12-hour flight. They can also look forward to redesigned lounges at 15 airports worldwide and, in a few months, other SIA passengers can expect revamped seats and upgraded inflight entertainment systems.

These initiatives, part of a S$14 billion (RM35 billion) capital expenditure that includes aircraft purchases spread over five years, are part of a slew of highly anticipated product upgrades that SIA has announced this past year. For instance, renowned industrial designer Designworks USA has been engaged to enhance SIA’s first class cabins.

The firm is known for its work in seat design and ergonomics, and was acquired by the BMW group after designing new seats for the luxury carmaker. Work is already underway, SIA says, “to help further distinguish [SIA’s] first class from the competition and provide customers with a unique premium feel and experience”.

These initiatives come as SIA faces stiff competition from Middle Eastern carriers and budget airlines. And, it follows business-class upgrades by airlines such as Cathay Pacific in recent years.

Will SIA’s enhancement plans boost its business? Or, is it too little too late?

Analysts such as Citigroup’s Rigan Wong have been blunt in their assessment of SIA’s failure to overcome the mounting challenges it faces.

“SIA has not been shy to make brave shifts to its strategy, including improved cabin product, stronger network connectivity and a ‘portfolio strategy’ comprising SIA, SilkAir, Scoot and Tiger to conquer the different market sub-segments,” Wong writes in a Feb 7 note. “We view this as necessarily defensive in mitigating the structural headwinds, but not effective in overcoming them.”

Indeed, in allocating resources to the expensive revamp of products for front cabin passengers, SIA is defying the continued decline in demand for premium travel, particularly as corporate travel budgets shrink. “We believe SIA/SilkAir premium business is on a structural decline,” Wong adds, noting the low growth, weak yields and rising competition that the airlines face.

SIA’s struggle has been evident in the company’s financial performance. In its most recent quarter ended December — traditionally airlines’ strongest, given the peak holiday travel season — the SIA group posted a 17% y-o-y decline in operating profit to S$131 million. SIA Cargo was the worst performing unit, with an operating loss of S$29 million for the quarter, although this was an improvement of almost 60% from the year before.

At the parent airline, aggressive fare promotions over the past year have helped fill more seats, and the passenger load factor improved 2.1 percentage points to 79.3%. Passenger carriage improved 7.4%. Capacity increased 4.6%. With lower ticket prices, however, yields declined 5.8% to 11.4 cents per passenger kilometre. Operating profit at the main airline fell 36.5% to S$87 million.

At SilkAir, yields remained unchanged, even though there was nearly 20% more capacity, and passenger load factors fell 3.5 percentage points to 75.3%. Operating profit at the regional airline grew about 6% from a year ago to S$34 million.

Could SIA’s decision to focus on growth at the regional airline and its “portfolio strategy” work? As UOB KayHian notes, the group’s revenue was higher q-o-q, mainly because of stronger revenues at SilkAir as well as Scoot, which could have been profitable during the quarter.

Analysts are divided over whether SIA, a blue chip stock that was one of the world’s most profitable airlines, remains a good investment. There is also some concern that the group could move into a net debt position should it continue with its aggressive capital expenditure plans.

SIA’s management has reassured analysts that the group should still see opera­ting cash flows of S$3 billion to S$4 billion under “normal conditions” and with some aircraft on operating leases, says UOB KayHian. The brokerage has lowered its earnings estimates for FY12/13 ending March by 7.4%, to account for lower yields and higher jet fuel costs. It has a “sell” call on the stock, with a price target of S$10.70, or 0.7 times SIA’s forward book value excluding SIA Engineering, and adjusting for SIA’s fair value stake in the MRO (maintenance, repair and overhaul) provider.

Citigroup’s Wong says SIA will continue to face challenges, including lower demand for premium travel, a glut in short-haul capacity regionally as budget airlines and other regional carriers expand, and intense competition from Gulf carriers in long-haul sectors. “SIA’s necessarily defensive response involves aggressive capex, but coincides with weaker profitability,” he says. “With structurally lower return-on-equity, we expect SIA’s price-to-book valuations to de-rate.” Citigroup also has a “sell” call on SIA, with an even lower price target of S$9.40, which is 0.85 times its FY13 book value.

Corinne Png at JPMorgan argues, however, that the market could be underestimating SIA’s total potential return. The airline has net cash equivalent to about 29% of its market capitali­sation, and “can easily sustain a regular annual dividend yield of about 4%”.

Furthermore, it could be set to undertake capital management, as it did in FY07, FY09 and FY11. “If SIA pays out one-third of its current net cash balance, or S$1.06 a share, the yield would be about 10%,” Png writes in a Feb 7 note. She also believes SIA could be consider­ing doing a partial spin-off of its stake in SIA Engineering, which has low trading liquidity. “It could divest its stake in SIA Engineering via a dividend in specie. Reducing its 78.8% stake to 51% would imply an 11% dividend yield, based on current share prices.”

Png adds that, while SIA’s earnings outlook is expected to remain weak for now, the situation could improve next year “as the industry demand-supply growth comes into balance”, with growth driven by liberalising air traffic agreements. “We believe SIA offers the lowest risk option to play the longer-term cyclical recov­ery among the full-service airlines.

New budget carrier Scoot will help drive organic growth and help reduce SIA’s dependence on the more cyclical premium business longer term.” JPMorgan is staying “overweight” on SIA, with a price target of S$13, which is 1.1 times its book value. — The Edge Singapore


This article first appeared in The Edge Financial Daily, on February 21, 2013.


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