Recovery On Track But Outlook Not All Rosy; Interest Hikes Weigh On Valuations
The May 22 operation data of SIA reaffirms the sector’s strong recovery momentum
in the near term. However, beyond the near-term optimism, high fuel costs and
uncertainties of COVID-19 policies in China may limit the extent of the sector’s
recovery. The aggressive rate hikes by the Fed and the resultant higher risk-free
rates would weigh on companies’ valuations. Maintain MARKET WEIGHT and lower
our DCF-based target prices for SIA Engineering and SATS.
• Strong May air traffic statistics underscore strong near-term recovery momentum.
National carrier Singapore Airlines (SIA) saw its pax load (RPK) rising 15.1% mom in May
22, on the back of a 7.0% mom increase in pax capacity (ASK) and a 5.5ppt mom
improvement in pax load factor (May 22: 78.2%, drawing close to its pre-pandemic levels
of over 80%). SIA’s pax capacity and pax load in May 22 were at 61.0% and 56.4% of
their respective pre-pandemic levels.
• High jet fuel prices may dampen long-term travel demand. On the back of global
inflationary pressures and the supply concerns due to Russia-Ukraine War, crude oil
prices have been on a sharply rising trend. Fuelled by a widened crack spread, the
increase in jet fuel price was even steeper, now standing at over US$180/bbl and
matching the historical high last seen in 2008. The high jet fuel prices are expected to
lead airfares to stabilise at a higher equilibrium level. While we believe that the strong
pent-up air travel demand being fulfilled currently and in the upcoming months would be
relatively more inelastic to higher airfares, a sustained high jet fuel price (and the resultant
high airfares) may eventually dampen the air travel demand in the longer term.
• Northeast Asia remains a drag. Based on SIA’s statistics, the air traffic recovery in the
recent months has been mainly driven by the Americas, Europe and Southwest Pacific
routes, but we note that for air travel in Singapore to recover to its full potential, traffic
from/to Northeast Asia is required (China, Taiwan and Japan collectively formed about
20% of Changi airport throughput in 2019). China, sticking to its “Dynamic Zero-COVID”
policies, is still in a largely locked down state today. Japan and Taiwan are gradually
opening up their borders but at a cautious pace. Japan has reopened its borders to
travellers on guided tours from 10 Jun 22, but remains closed to individual travellers.
Taiwan has also loosened its border control recently, allowing entry by international travellers from 15 Jun 22, but with a cap of 25,000 visitors per week. Pre-departure and
on-arrival tests, as well as quarantines (though shortened), are still required.
• Rising interest rates… Since the start of 2022, the US Fed has conducted three rate
hikes totalling 150 bps (the most recent one announced on 16 Jun 22 was a hike of 75
bps), raising the federal funds rate to 1.5-1.75%. The central bank also guided to raise the
benchmark rate further to 3.25-3.50% by end-22, implying additional hikes totalling 175
bps in the remaining four Fed meetings of 2022. The interest rate hikes by the Fed are
driving up borrowing costs in all open economies globally.
• … have limited impacts on earnings… Fortunately, for all the three Singapore aviation
plays under our coverage, their direct earnings exposure to the rising interest rate is
rather limited. First and foremost, all three companies were in net cash positions as of
Mar 22, meaning they can easily pay off their outstanding debts with their cash position
(or liquid investments) on their balance sheet. Second, out of the gross amount of debts
outstanding, a substantial portion, if not all, is based on fixed interest rates. Lastly, for the
part of gross debts on fixed interest rates, only a limited portion or none are due for
repayment (refinancing) in 2022-24. As such, we expect the rising interest rates to have
very limited impact on the earnings of the three aviation plays in the next three years.
• …but still weigh on valuations. Despite the very limited earnings impact, the rate hikes
(leading to higher risk-free rates and discount rates, ie WACC) would still have negative
implications on the valuation of aviation plays. Since our initiation on the Singapore
aviation sector in end-Mar 22, the yield of the US government’s 10-year bond has
increased from 2.46% (as of 28 Mar 22) to 3.25% (as of 17 Jun 22) and the yield of the
Singapore government’s 10-year bond has increased from 2.43% (as of 28 Mar 22) to
3.11% (as of 17 Jun 22).
• The table below shows the sensitivity of DCF-based fair values of the three aviation
companies by hiking their respective WACC by the same absolute quantum (50 or 100
bps) while holding other factors constant. Among the three, fair value of SIA (the lowest
WACC implied by our current target price) is the most susceptible to rate hikes, followed
by SATS. Fair value of SIA Engineering is the least sensitive, as the previous 8.5%
WACC applied was already on a high base (the highest among the three).
EARNINGS REVISION
• No change.
RECOMMENDATION
• Maintain MARKET WEIGHT on the Singapore aviation sector. We have retained the
respective ratings for the three individual stocks while lowering the target prices for SIA
Engineering and SATS.
• SIA Engineering (top pick) – BUY with lower target price of S$2.70 (from S$2.90).
Our DCF-based target price for SIA Engineering has been adjusted lower as we have
hiked the WACC applied on SIA Engineering by 50 bps to 9.0% (previously 8.5%). SIA
Engineering is our sector top pick. We like it for: a) the good visibility of business volume
recovery (directly geared to increasing flight activities at Changi airport), b) its strong balance sheet (net cash position of S$623m at end-Mar 22 is equivalent to 23.2% of its
market cap), and c) already cheap valuation (and hence the lowest valuation sensitivity to
interest rate hikes) – current price of S$2.37 implies an FY25F (normalised year) PE of
14.2x (10.9x if excluding net cash), 2.4SD below its average of 23.2x during the prepandemic years of FY14-19.
• SATS – BUY with lower target price of S$4.20 (from S$4.75). Our DCF-based target
price for SATS has been adjusted lower as we have hiked the WACC applied on SATS by
50 bps to 7.5% (previously 7.0%). SATS would benefit from the regional air travel
recovery but its near-term earnings performance is expected to be weighed down by the
keener cost pressure from: a) headcount build-up ahead of the business volume recovery,
and b) inflationary pressure on labour and raw material costs. Current price of S$3.97
implies an FY25F (normalised year) PE of 16.6x, 1.1SD below its average of 19.9x during
the pre-pandemic years of FY14-19.
• SIA – HOLD with unchanged target price of S$4.88. As illustrated earlier, theoretically,
SIA’s fair value (if using DCF valuation) would be the most sensitive to interest rate hikes.
However, we note the speculative sentiment towards SIA could be high in the near term
and we do not rule out the possibility of SIA trading higher on positive sentiments
triggered by the likely exceptionally strong earnings in the next two quarters. As such, we
see SIA as a trading play and hence have applied the P/B valuation method which is
more short-term based in nature and offers a better sense on SIA’s trading price relative
to its historical trading range. Our target price of S$4.88 is pegged to 1.12x FY23F P/B
(we estimate SIA’s adjusted book value per share at S$4.36 at end-FY23), 2.0SD above
its historical average of 0.96x during the pre-pandemic years. We recommend investors to
offload SIA into share price strengths.
SECTOR CATALYSTS
• Key sector catalysts include: a) positive news flow of Singapore air travel recovery, b)
faster pace of border measure relaxations in Japan and Taiwan, and c) possible shifts in
stance on treating COVD-19 by China.
RISKS
• Key risks include: a) inflationary cost pressures weighing on aviation companies’ earnings
recovery, b) a possible recession impacting air travel demand, and c) a more
infectious/fatal COVID-19 variant leading to rollback of the global economic reopening.