Singapore Airlines Limited - MANAGEMENT REPLY: Will it change its fuel hedging strategy?

26/1/2015 – On January 13, oil price dropped to US$45 per barrel after making a high of about US$107 in June 2014.

At the same time, Singapore Airlines' share price has appreciated by more than 6% to S$12.40.

And why not when fuel cost accounts for about 40% of company's cost.

However, 65% of its H2 FY15 fuel needs are already hedged as at end H1 FY15, so the effects will be very much muted on its H2 results, says OCBC Research.

It believes SIA will still capture the effects from FY16 onwards.

Hence, it reduced assumption on SIA’s FY16 jet fuel cost from US$112 per barrel to US$100 per barrel, which increase its operating margin from 2.8% to 3.5%.

While lower oil prices should improve SIA’s profitability significantly, OCBC believes there are several factors at work that partly negate the positive impact.

First, SIA has always hedged a large proportion of each year’s jet fuel needs and the resultant hedging losses offset savings from lower jet fuel costs.

Second, yields are likely to be depressed due to overcapacity as it continue to see deliveries of new aircraft due in 2015 for Asia Pacific region.

Third, it is likely to pass on the savings to consumers through lower fuel surcharges in order to remain competitive.

And last, SIA will record in its books a larger share, from 40% to 55%, of Tigerair’s expected losses for the next few quarters.

The House increased SIA's fair value estimate from S$10.12 to S$10.80 but maintained its HOLD rating.

Deutsche Bank has upgraded SIA from SELL to HOLD and raised its price target from S$8.80 to S$11.30.

The changes follow upward revisions to its earnings estimates to reflect cheaper jet fuel, prices of which have declined to US$64 a barrel from US$122 a barrel in July year.

The analyst now expects the carrier to earn S$436 mln in FY15, S$880 mln in FY16 and S$994 mln in FY17, up from its previous forecasts of S$295 mln, S$374 mln and S$401 mln respectively.

DBS Vickers has provided some interesting reasons for upgrading SIA to BUY with a target price of S$12.90.

It is now assuming jet fuel prices to average US$95 per barrel in FY16 versus US$125 per barrel previously, but cost savings would be partially offset by a stronger US Dollar, which will make fuel more expensive in Singapore Dollar terms, and lower yield assumptions.

It increased FY16 earnings estimates by 30% and expects SIA's return on equity (ROE) to rebound strongly to 7.3% in FY16 and 9% in FY17.

Also, higher dividends for FY16 are likely given improved profit outlook and strong balance sheet.

Investor Central. Asian insights for global investors. We ask the tough questions of Asian companies which global investors need answers to.

Question

1. Will it change its fuel hedging strategy?

SIA has hedged about two-thirds or 65% of its fuel requirement for the second half of this fiscal year at US$116 per barrel.

CEO Goh Choon Phong, mentioned during Q2 analysts briefing that hedges will mute the effect of lower fuel prices.

On the other hand it will protect earnings from the full effects of a bounce if that were to happen.

The FY13 annual report states that the group manages fuel price risk by using swap, option and collar contracts and hedging up to eight quarters forward using jet fuel swap, option and collar, Brent swap and crack swap contracts.

A sensitivity analysis on page 192 in the same report highlights that a change of US$1 per barrel in fuel price impacts its equity by about S$31 mln.

So, what changes in hedging policy can we expect from lower fuel prices?

In other words, how does SIA plan to capture the current low jet fuel price of about 65 per barrel?

Management Reply: Our hedging policy remains unchanged, under which we hedge on a declining wedge profile where the hedged volume is progressively built up over time. We use a combination of hedging instruments including swaps, collars and call options.

Please note that we disclose hedging guidance twice per year, at the time of the release of half-year earnings and full-year earnings. Guidance on FY15/16 hedging will therefore be disclosed in May at the release of our FY14/15 full-year earnings.

Question

2. What are the chances that we could see double digit profit margin for SIA?

SIA's net profit margin was about 1.7% in H1 FY15 and 2.4% in FY14.

The last time we saw a double digit margin of 12.8% was in 2008, a period that witnessed a similar catastrophic fall in oil price.

Management Reply: No reply.

(Read the full story to get all 6 questions)

We thank Gina Foo from SIA's Public Affairs Department for her response.

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