Downgrade to Reduce on valuation grounds
- Downgrade from Hold to Reduce on valuation grounds as SIA is trading at 1.30x historical P/BV, almost +3 s.d. above the mean since 2011.
- Our TP is raised to S$6.53 (CY23F P/BV of 1.04x); the shares will trade exfinal DPS of 28 Scts on 1 Aug, potentially removing a key support.
- Despite forecast earnings strength for FY24F, competition in FY25F will likely intensify; we think there is more downside risk for investors than upside risk.
Outlook for FY3/24F still looks very strong…
SIA group’s passenger airline business continued to see very strong load factors of c.88% in both Apr and May 2023, which are historical highs. These high load factors suggest that average ticket pricing is also likely to remain at very high levels, as SIA has no issue filling up its planes and hence has no incentive to cut prices. We think that passengers are likely to plan forward and book ahead for the year-end holidays, as well as for Lunar New Year travel in early-2024. These forward bookings at the current high ticket prices will likely extend SIA’s run of strong profitability for FY24F, in our view. Our belief is backed up by data which shows that SIA remains one of the Asia-Pacific airlines that has restored its seat capacity by the greatest degree in late-Jun 2023, but also up to the end of the Northern Summer schedule in late-Oct 2023. As a result, we think that SIA remains in a strong competitive position to capture underlying travel demand in Asia-Pacific and beyond.
…but competition could intensity in FY25F
Between late-Jun and late-Oct 2023, forward airline schedules suggest that SIA will only increase its seat capacity restoration by 3% pts (against 2019), compared to +12.1% pts for Cathay Pacific, +8.2% pts for SE Asian carriers, +7.8% pts for Korean carriers, and +7% pts for Australian carriers. SIA’s seat capacity restoration is now slowing down for three reasons: 1) seat capacity is already at a high level; 2) deliveries of SIA’s 787-10 orders have been delayed; while 3) the SIA group is experiencing regulatory approval delays to Indonesia and China. On the balance of probability, SIA’s competitors will likely continue to restore their seat capacities at a faster pace than SIA next year because they still have so much potential, especially Cathay Pacific and the Chinese airlines. For instance, Cathay Pacific has set a target to restore 70% of its 2019 ASK capacity by end2023, and 100% by end-2024. While the Chinese airlines so far appear to be reticent in international capacity restoration, this could very well change in the future if Chinese outbound travel demand picks up. Key derating catalysts: 1) greater international seat capacity restoration by SIA’s competitors could increase regional competition for the SIA group, particularly in FY25F, and we think that passenger yields may come under greater pressure compared to FY24F; and 2) SIA’s cargo load factors are trending at their lowest levels in the past five years, while air freight rates are down more than 40% yoy for the latest May 2023 reading. Upside risks: 1) faster-than-expected recovery in SIA’s passenger traffic from North Asia, particularly from Chinese outbound travel to Singapore; and 2)
unexpected decline in jet fuel prices.
Abbreviations used in this report
SIA: Representing the SIA group, which includes the passenger airlines (and
cargo), as well as SIA Engineering.
SQ: SIA mainline carrier, which is now combined with SilkAir, the short-haul fullservice carrier (FSC)
TR: Scoot, the low-cost carrier (LCC), wholly owned by SIA
SIE: SIA Engineering, an 80.7% subsidiary of SIA
ASK: Available seat kilometre capacity, measure of passenger capacity
RPK: Revenue passenger kilometre demand, measure of passenger demand
PLF: Passenger load factor, RPK divided by ASK
Passenger yield: Revenue per RPK demand
RASK: Revenue per ASK capacity
CASK: Cost per ASK capacity
AFTK: Available freight tonne kilometres, measure of air freight capacity
FTK: Freight tonne kilometres, measure of air freight demand
CLF: Cargo load factor, FTK divided by AFTK
Group passenger airline business continuing its strong performance
SIA group’s passenger airline business continued to see very strong load factors of c.88% in both April and May 2023, which are historical highs. Higher ASK capacity has been matched with higher demand. SQ has been seeing PLF of 87- 88%, while TR has been seeing PLF of almost 91%.
These high load factors suggest that average ticket pricing is also likely to remain at very high levels, as SIA has no issue filling up its planes and hence, has no incentive to cut prices.
We think that passengers are likely to plan forward and book ahead for the yearend holidays, as well as for Lunar New Year travel in early-2024. These forward bookings at the current high ticket prices will likely extend SIA’s run of strong profitability for FY3/24F, in our view.
Most Asia-Pacific carriers continue to lag behind SIA group in international capacity restoration
SIA was one of the first airlines off the block in restoring capacity when Singapore’s international borders reopened in April 2022, because its balance sheet was well capitalised and it had kept its fleet active by flying during the pandemic even at low passenger loads; SIA also retained all of its pilots, albeit at reduced pay.
Figure 4 below shows the percentage of international seat capacity in late-June 2022 vs. the equivalent levels in late-June 2019 for various airlines in the Asia-Pacific region (domestic seat capacities are not considered). ‘Australian carriers’ include the Qantas group and Jetstar Australia; ‘Japanese carriers’ include Japan Airlines and ANA; ‘Southeast Asian carriers’ include Capital A (the AirAsia group of airlines), Malaysia Airlines, Garuda group and Thai Airways; ‘Taiwanese carriers’ include Air China and EVA Air; ‘Korean carriers’ include Korean Airlines and Asiana Airlines; ‘Chinese carriers’ include China Eastern, China Southern, and Air China; and finally the ‘North Asian carriers’ is a grouping that includes the Japanese, Taiwanese, Korean, and Chinese carriers mentioned above, plus Hong Kong’s Cathay Pacific group.
As at late-June 2022 (Figure 4), SIA had restored 61.3% of its pre-pandemic seat capacity, which was far above its peers in the Asia-Pacific region, except for the Australian carriers. This gave SIA a head start in capturing latent travel demand in the early days of Asia’s border reopening.
One year later as at late-June 2023 (Figure 5), SIA retained its second-place position in terms of seat capacity restoration (at 85.4% vs. late-June 2019), although the Taiwanese, Japanese and Korean carriers had narrowed the gap significantly, with Cathay Pacific and the Chinese carriers lagging behind as Hong
Kong and China were the last to reopen their international borders.
Looking forward to late-October 2023 (four months forward, Figure 6), SIA will still continue to retain its second-place position in the Asia-Pacific region in terms of seat capacity restoration (at 88.4% vs. late-June 2019), based on flight schedules declared by airlines up to the end of the Northern Summer season. Although SIA’s lead will narrow further in the next four months, SIA remains in a strong competitive position to capture underlying travel demand in Asia-Pacific and beyond, in our view.
Having said that, SIA’s seat capacity restoration is now slowing down for three reasons: 1) seat capacity is already at a high level; 2) deliveries of SIA’s 787-10 orders have been delayed due to production and technical issues; while 3) the SIA group is experiencing regulatory approval delays which have limited SQ’s flights to Jakarta (currently flying only 65% of late-June 2019 seat capacity) and delayed Scoot from flying to certain cities in China (e.g. Xiamen, Chongqing and Kunming).
Between late-June and late-October 2023 (Figure 7), forward airline schedules suggest that SIA will only increase its seat capacity restoration by 3% pts (against the 2019 schedule), compared to +12.1% pts for Cathay Pacific, +8.2% pts for Southeast Asian carriers (particularly for the AirAsia group and for Malaysia
Airlines), +7.8% pts for Korean carriers, and +7% pts for Australian carriers. Japanese and Taiwanese carriers are restoring their seat capacities slightly faster than SIA over the next four months.
However, the Chinese carriers appear slower in capacity restoration than SIA despite coming from a still-low base, although this could be due to their decision to carefully monitor demand for international travel before restoring capacity. We do not have visibility beyond late-October 2023 as airlines have generally not declared their Northern Winter schedule yet that will run to late-March 2024. On the balance of probability, SIA’s competitors will likely continue to restore their seat capacities at a faster pace than SIA next year because they still have so much potential, especially for Cathay Pacific and the Chinese airlines.
For instance, Cathay Pacific has set a target to restore 70% of its 2019 ASK capacity by end-2023, and 100% by end-2024. While the Chinese airlines so far appear to be reticent in international capacity restoration, this could very well change in the future if Chinese outbound travel demand picks up.
Greater international seat capacity restoration by SIA’s competitors could potentially increase opportunities for Singapore-based travellers to fly via other hubs to their ultimate destinations, eventually increasing regional competition for the SIA group, particularly in FY25F. We also think passenger yields may come under greater pressure compared to FY24F.
For the rest of FY24F, however, SIA’s passenger yield pressures may be very modest due to clear evidence of strong passenger loads in April and May 2023, SIA’s continuing lead in seat capacity restoration relative to its peers, and likely strong forward bookings at current high ticket prices.
Seat capacity data from the Singapore hub suggests continued yield strength for the next four months
We also analysed seat capacity data from the Singapore hub and the changes in SIA group’s market share (Figures 8 and 9). The seat market share of SIA group was very high during the pandemic in 2021 as SIA continued to fly its planes even at low passenger loads.
SIA continued to enjoy high seat market share in mid-2022 (60%) relative to mid2019 (51.6%) as SIA reactivated its capacity faster than its competitors. However, SIA’s seat market share has declined from mid-2022 to mid-2023, and is now almost equivalent to the mid-2019 level. This normalisation of SIA’s market share ex-SIN hub is unlikely to have dented pax yields over the past 6-9 months, as SIA’s passenger load factors continue to be at historical highs due to strong and rising demand.
Looking forward to the next four months, the total absolute number of seats from the Singapore hub to all the major route regions may only increase a modest 3.1% from late-June (694,474 weekly seats) to late-October 2023 (716,225 weekly seats), with the SIA group’s seat capacity rising a faster 5.5%. As a result, the seat market share of the SIA group may actually increase from 51.8% in late-June to 53% in late-October 2023. This could help maintain SIA group’s yields at relatively high levels relative to pre-pandemic levels for the rest of FY24F.
SIA group’s seat market share from Singapore to Southeast Asia may hover at the 46-47% level in the next four months, higher than the mid-2019 level of 44.7%. Absolute seat capacity may only increase 1.7% over the next four months (312,217 to 317,374 weekly seats).
SIA group’s seat market share from Singapore to Northeast Asia dipped from the pre-pandemic level of 56.6% to late-June 2023’s 52.3%, as Chinese airlines have restored more than 80% of their 2019 seat capacity between Singapore and China, whereas the SIA group has only restored about 53% of the same. In the next four months to late-October 2023, the SIA group’s market share may rise to 57.4% as several Chinese airlines are planning to cut back on their flights to Singapore. Absolute seat capacity may only increase 10.1% over the next four months (152,320 to 167,581 weekly seats) despite being only 74% of the mid-2019 seat capacity. This could support the SIA group’s passenger yields to China.
SIA group’s seat market share from Singapore to South Asia has dipped to below the pre-pandemic level of 64.4% in mid-2019 to 61.3% in mid-2023, as competitors restored capacity faster than the SIA group. However, over the next four months, the SIA group will claw back market share to 62.7% via capacity increases.
Similarly, the SIA group will increase market share to the Middle East to 12.4% in late-October 2023 via capacity restoration, from 8.3% in mid-2023.
The SIA group’s market share to the Southwest Pacific region was 68% in mid2023, higher than the pre-pandemic level of 64.3% in mid-2019. The SIA group’s market share may decline slightly to 66.8% in late-October 2023, but will remain dominant.
The SIA group’s market share to Western Europe was 59.6% in mid-2023, higher than the pre-pandemic level of 57.3% in mid-2019. The SIA group’s market share may decline slightly to 58.1% in late-October 2023, but will remain significant. SIA may be reallocating some capacity from SW Pacific and Western Europe to North Asia and South Asia over the next four months.
Air cargo business continues to weaken via falling yields
SIA’s cargo load factors (CLF) are trending at their lowest levels in the past five years, as RFTK demand is historically very weak, while AFTK capacity is just 17% short of its pre-pandemic levels.
The Baltic Exchange data on air freight rates (weighted average of spot and contract rates by freight forwarders) shows that the Hong Kong to Europe and Hong Kong to US rates are down more than 40% yoy for the latest May 2023 reading. Air freight rates have corrected significantly because 1) global passenger bellyhold capacity continues to recover as airlines reactivate their passenger fleets; 2) global demand for goods remains weak due to poor consumer spending power as a result of inflation; and 3) the significant correction in container shipping freight rates and the decongestion of the global container shipping network has led to sea freight regaining its traditional market share against air freight.
Valuation and recommendation
We downgrade our call on SIA from Hold to Reduce, as we think that valuations are now stretched. Even though the fundamental dynamics of the passenger airline business remain robust for the next 6-9 months, these appear to be priced in.
The two key potential de-rating catalysts are:
- Rising of competition from other airlines that are picking up speed in their capacity restoration programmes in FY25F onwards.
- Also, weakening air cargo markets on a sequential basis have seen cargo yields decline rapidly, and there is the risk that the pace of decline may exceed our expectations. We have factored in a 40% yoy drop in SIA’s cargo yields for the whole of FY24F, but the Baltic Exchange’s cargo freight rates have already dropped by more than 40% yoy for the latest May 2023 reading. Upside risks include a faster-than-expected recovery in SIA’s international passenger traffic from North Asia. Outbound Chinese passenger travel to Singapore and elsewhere has only recovered very gradually due to high ticket prices and weak economic growth in China which has curbed the propensity for consumer spending.
P/BV valuations very expensive
P/BV valuations for SIA are very expensive using historical trading ranges. At today’s closing price of S$7.33, SIA’s P/BV multiple traded at 1.30x, using the 31 March 2023 book value but deducting the S$3.1bn partial redemption of the Mandatory Convertible Bonds (MCB) on 26 June 2023 that reduced SIA’s BVPS since the MCBs are treated as equity on the balance sheet. SIA’s share price typically peaks when historical P/BV valuations hit +1 s.d. above the mean (P/BV of 1.04x), but valuations have now almost reached +3 s.d. above the mean (P/BV of 1.32x). The last time SIA’s P/BV multiples breached +2 s.d. above the mean was in 2HCY14, when the-then oil price collapse temporarily lifted profits of the entire aviation industry.
After the S$3.1bn partial MCB redemption, SIA has another S$3.1bn in remaining MCBs. SIA will have to redeem all of the remaining MCBs by the fourth anniversary of its issue, i.e. by 24 June 2025, in order to avoid an escalation in the MCBs’ yield to maturity from 4% to 5% p.a. In our view, it is plausible that SIA
may redeem the final portion of the MCBs sometime during CY24F given that its operating cashflows will likely remain very strong over the next year.
Assuming that SIA had redeemed the latter final remaining MCBs by 30 June 2023, SIA would trade at 1.59x P/BV, which is +5 s.d. above the mean. Eventually, we think that SIA’s elevated valuations once the MCBs are redeemed will make it more difficult for investors to justify the high share price, especially if aviation industry fundamentals deteriorate in the future with rising competition.
Target price computation
We raise our end-CY23F target price to S$6.53 (from S$6.15 previously) on account of a 30% upgrade to our FY24F core net profit forecasts, using a higher target P/BV multiple of 1.04x (+1 s.d. above the mean) applied to the end-FY24F BVPS, from P/BV of 1x previously.
SIA declared a final DPS of 28 Scts with respect to the FY23 results that will be paid on 18 August 2023. SIA’s shares will trade ex-dividend on 1 August 2023, after which, this strong immediate-term support for the share price will no longer be present.
SIA’s share price weakened 4.67% last Friday (30 June 2023) after Temasek sold 55m SIA shares at S$7.21, representing a discount of 3.9% from the closing price on 29 June 2023. Given the elevated share price, it is not surprising that investors will be very sensitive to news that may not be perceived positively; we expect that SIA’s share price will react more viscerally to less-than-positive developments in the future, but respond in a more muted way to any positive news. In essence, at the current high share price and lofty valuations, there is more downside risk for investors than upside risk.
Our adjusted BVPS calculations
SIA issued the first S$3.5bn tranche of the mandatory convertible bonds (MCBs) on 8 June 2020, and issued a second S$6.2bn MCB tranche on 24 June 2021, for a total of S$9.7bn.
On 8 December 2022, SIA redeemed the entre first tranche of S$3.5bn together with accreted interest up to the date of redemption, leaving only the second tranche MCBs of S$6.2bn outstanding at the moment.
On 10 May 2023, SIA announced that it will redeem a further S$3.1bn of the MCBs on 26 June 2023, representing half of the second MCB tranche, at a cumulative yield of 4% p.a. from the time of issue. This redemption has been completed, and SIA has redeemed a cumulative S$6.6bn, or 68% of the original MCB issuance of S$9.7bn.
After 24 June 2023, there will remain only S$3.1bn MCBs outstanding:
- If redeemed before its 4th anniversary on 24 June 2025, SIA will pay a yield of 4% p.a. from the time of issue;
- If redeemed before the 7th anniversary on 24 June 2028, SIA will pay a yield of 5% p.a. from the time of issue; and
- If redeemed before 8 June 2030 (approximately the 9th anniversary), SIA will pay a yield of 6% p.a. from the time of issue.
Scenario 1 is the base case that we have used to calculate SIA’s BVPS and therefore our target price, in which we treat the remaining S$3.1bn second tranche MCB (post-24 June 2023) as wholly equity, in line with the accounting treatment adopted by SIA.
Our Scenario 2 BVPS calculations:
- Treat the remaining S$3.1bn MCBs (post-24 June 2023) as wholly debt (although the accounting treatment sees it as wholly equity) on the assumption that SIA will endeavour to redeem the MCBs before their 4th anniversaries (but certainly before their maturities on 8 June 2030), or will refinance them using other sources of debt; and
- Deduct an assumed 4% yield-to-maturity (YTM) on the MCBs since they are treated as debt.
We ignore potential dilution from conversion of MCBs into new ordinary shares
While the MCBs are potentially EPS- and BVPS-dilutive because they entail a potential future issue of new ordinary shares (at the conversion price of S$4.84), we have not factored in an increase in the number of shares for the purposes of deriving our target price for SIA under Scenario 1. This is because the MCBs can only be converted on one specific day, i.e. 8 June 2030, which is the maturity date of both tranches of MCBs; a conversion date that is seven years away is beyond the decision-making horizon of many investors, in our view.
Our core net profit forecast of S$1,712m in FY24F includes an estimated S$527m share of Air India’ net loss (none in FY23), on the basis that SIA will complete the sale of its 49% interest in Vistara to Air India in exchange for a 25% stake in Air India and then write-off its equity contribution to Air India and unaccounted equity losses in Vistara. Without this S$527m share of loss, our forecast of SIA’s core net profit in FY24F is S$2.2bn, higher than FY23’s S$1.9bn, as RPK demand growth and lower jet fuel prices offset pax yield moderation and decline in cargo profits. Our reported net profit forecast in FY24F is S$2,948m, after including S$1.1bn in estimated exceptional gain from the sale of Vistara to Air India.
Our assumptions for SIA mainline (SQ) have been changed as follows:
- FY24F PLF increased from 85% to 86%; and
- FY24F passenger yield assumptions increased from 12.07 to 12.32 Scts/RPK.
Our assumptions for Scoot (TR) have been changed as follows:
- FY24F ASK increased from 102% to 105% of the CY19 base;
- FY25F ASK increased from 104% to 105% of the CY19 base;
- FY26F ASK increased from 106% to 107% of the CY19 base;
- FY24F PLF increased from 85% to 88%;
- FY25F PLF increased from 85% to 86%;
Consequently, our assumptions for the SIA group of passenger airlines have been changed as follows:
- FY24F ASK capacity increased 0.7% to 160,442m;
- FY24F RPK demand increased 2.4% to 138,727, with PLF increased from 85% to 86.5%; and
- FY24F pax yield increased 1.4% to 11.15 Scts/RPK.
Our assumptions for the cargo business for FY24F have been left unchanged; we are assuming a 40% yoy decline in cargo yields.
Our fuel price assumptions remain unchanged in this report, with spot Brent prices assumed at US$80/bbl in FY24F and US$78/bbl for FY25-26F.
We have retained our assumption of a US$15/bbl crack spread between Brent and jet fuel, leading to spot jet fuel price assumptions of US$95/bbl in FY24F and US$93/bbl for FY25-26F.
The ‘hedged jet fuel price’ (last line of the table above) of c.US$97/bbl for all forecast years is our assumption of the all-in cost of jet fuel for SIA, taking into account the hedging position, as well as commissions to be paid to jet fuel suppliers.
For 1QFY24F, SIA hedged 40% of its expected fuel consumption at an exercise price of US$60/bbl Brent.
For 2QFY24F to 4QFY24F, SIA hedged 10% of its expected fuel consumption at an exercise price of US$79/bbl Brent, and a further 29% at an exercise price of US$93/bbl Mean of Platts Singapore (MOPS) jet fuel.
For 1QFY25F to 3QFY25F, SIA hedged 10% of its expected fuel consumption at an exercise price of US$75/bbl Brent, and a further 2% at an exercise price of US$88/bbl Mean of Platts Singapore (MOPS) jet fuel.