2H23: Continued Recovery Amid Macro Uncertainties
Air traffic is expected to recover further in 2H23 but air cargo outlook is likely to be subdued. We expect SIA and SIAEC to show improving profitability in 1QFY24 but SATS to report losses mainly due to a negative contribution from WFS. Maintain our MARKET WEIGHT on the aviation sector. Maintain BUY on our top pick SIAEC (Target: S$2.67). We expect near-term share price volatility for SATS (BUY/Target: S$2.99). Maintain SELL on SIA (Target: S$7.07) while expecting good 1QFY24 results.
• Review of sector outlook for 2H23.
• Results preview for Singapore Airlines (SIA), SIA Engineering (SIAEC) and SATS.
• Expecting continued recovery of air travel in 2H23… As of May 23, flight activities and passenger movement at Changi Airport had recovered to 83% and 81% of their pre-pandemic levels respectively. The recovery is expected to continue in 2H23, benefitting: a) SIA’s passenger operations, b) SATS’ aviation food services and part of its gateways services, and c) SIAEC’s line maintenance and aircraft MRO businesses.
• …with air traffic from/to China as a key driver. Before the pandemic, air travel between Singapore and Mainland China was the second largest contributor to Changi Airport’s passenger volume, forming 10.9% of the total throughput in 2019 (second to Indonesia’s 12.2%). Since China’s reopening in Jan 23, air traffic between Singapore and China has seen a meaningful pick-up, standing 47% of pre-pandemic levels as of May 23, but still trailing behind the average 85% recovery levels of air traffic between Singapore and the rest of the world. As such, we expect China, being an important source market, to be a key driver of further air travel recovery of Singapore and the region.
• Subdued air cargo outlook in 2H23. Most leading economic indicators point to a weak global trade outlook. Global manufacturing PMI new export orders sub-index was 47.1 in Jun 23 (May 23: 47.3), indicating weakening global trade demand. Retail sentiment in the EU has remained in a weakening trend, with more retailers indicating that they have sufficient stocks on hand. US consumer sentiment picked up in Jun 23, but the still-high inventory-to-sales ratio means there is no urgent need for a large-scale restocking in the near term. This does not bode well for SIA’s cargo operation and SATS’ cargo handling businesses. According to IATA, global air cargo volume is projected to fall 6% yoy in 2023.
• Airlines’ cargo yields still declining, but the pace of decline slowed down recently. Based on data compiled by Drewry, as of Jun 23, global air freight rates were still about 40% higher than the same period in 2019. Given the subdued global trade outlook but increasing air cargo capacity supply due to the recovery of airlines’ bellyhold capacity, we expect air freight rates to continue to moderate/normalise during the rest of 2023. Having said that, we note that the pace of moderation slowed down qoq in 2Q23 (SIA’s 1QFY24), which would support SIA’s earnings in the near term.
• SIA: 1QFY24 net profit of S$650m-750m. We forecast SIA’s 1QFY24 net profit at S$650m750m, a significant yoy improvement compared with S$370m in 1QFY23 and a moderate qoq improvement over S$602m in 4QFY23. The strong 1QFY24 is expected to underpinned by strong forward bookings of air tickets (S$4.6b as at end-FY23, over 50% above pre-pandemic levels) and bolstered by the recent drop in jet fuel prices (-19% qoq). SIA’s 1QFY24 results are expected to be released on 27 Jul 23. For the results, the pace of pax yields moderation/normalisation is a key factor to watch out for.
• SIAEC: 1QFY24 net profit of S$25m-30m. We forecast SIAEC’s 1QFY24 net profit at S$25m-30m, compared with S$13m in 1QFY23 and S$21m in 4QFY23. We expect the yoy and qoq improvements to be driven by; a) the continued recovery of line maintenance and MRO service volume, and b) possible margin improvement following SIAEC’s recent renewal of service contracts with SIA and Scoot.
• SATS: 1QFY24 net loss of S$57m-83m; a noisy quarter with sizeable one-off and noncash expenses related to the WFS consolidation. We forecast SATS to incur a net loss of S$57m-83m in 1QFY24, compared with the reported net loss of S$22.5m in 1QFY23 and reported net profit of S$5.5m in 4QFY23. 1QFY24 is the first quarter with WFS consolidated into SATS’ reporting. We forecast SATS’ original businesses to turn around into core net profit at S$0-20m, driven by profitability improvement in inflight catering services and gateway services (we are expecting losses to narrow qoq for several air cargo handling subsidiaries, such as Asia Airfreight Terminal), compared with core net loss of S$5m (by our estimate) in 4QFY23.
We expect WFS to contribute negatively to SATS in 1QFY24, with our best-efforts guesstimates indicating negative net contribution of S$67m-93m by WFS to SATS in 1QFY24. Our guesstimate has factored in:
a) yoy slower core cargo handling volume of WFS,
b) cost of early redemption of the original debts of WFS (about S$41m, one-off),
c) the wash-off/expenses of WFS’ previously capitalised interest cost (estimated at S$20m, one-off and non-cash),
d) unfavourable P/L impacts from the conversion of WFS accounting to SFRS (about S$11m, non-cash but recurring), and
e) amortisation of intangible assets arisen from the WFS acquisition (about S$9m, non-cash but recurring).
Notably, d) and e) are based on SATS’ preliminary estimates (disclosed in the WFS acquisition circular dated 3 Jan 23) and may be subject to further adjustment after the finalisation of WFS’ purchase price allocation (PPA) and auditing exercises.
• Raise SIA’s FY24-25 net profit forecasts by 10.6% and 15.1% to S$3.17b and S$1.30b respectively, as we have incorporated slightly slower moderation/normalisation of pax and cargo yields. The FY24 estimate includes a one-off accounting gain of S$1.11b from the merger of Vistara into AirIndia, excluding which FY24 net profit estimate would have been S$2.06b.
• Lower SATS’ FY24 net profit forecast to S$22m, factoring in slower air cargo volume for FY24 and incorporating a one-off non-cash wash-off/expenditure of WFS’ previously capitalised interest costs.
• Forecasts for SIAEC are kept intact.
• Maintain MARKET WEIGHT on the Singapore aviation sector.
• Maintain SELL on SIA (Target: S$7.07). We have kept our target price for SIA. Although we like SIA for its remarkable track record, we caution that its rich valuation with FY24F P/B at about 2SD above long-term historical mean level (price reference range since 2005) is unlikely sustainable in the long run. Having said that, we note that sentiments on SIA are likely to stay strong in the near term and investors may want to stay invested with SIA until after the strong 1QFY24 results are announced and offload SIA into share price strength, if any.
• Maintain BUY on top pick SIAEC (Target: S$2.67). We like SIAEC for its: a) market leadership in line maintenance at Changi Airport (about 80% of Changi Airport’s line maintenance service volume), b) good visibility of revenue/profit recovery underpinned by flight volume recovery at Changi Airport and its major customer/parent company SIA’s pax capacity recovery plan, and c) benign valuation ? current price implies 15.9x FY25F PE, or 12.2x if excluding its sizeable net cash pile of S$630m as at end-FY23.
• Maintain BUY on SATS (Target: S$2.99); expecting near-term share price volatility. Our new target price is still based on 9.7x FY25F EV/adjusted EBITDA, pegged to SATS’ acquisition multiple for WFS. The 9.7x multiple applied is at 1.7SD below SATS FY14-19 mean EV/EBITDA of 12.8x. SATS’ current price implies a FY25F EV/adjusted EBITDA multiple of 9.0x, 2.1SD below its historical mean. Despite the undemanding valuation, we note that SATS may lack near-term re-rating catalysts, especially given the subdued air cargo outlook in the near term. In addition, we caution that there may be negative market sentiments towards SATS’ reported net losses in 1QFY24 and the overall negative contribution from WFS by our expectations. This may result in share price weakness after the 1QFY24 results, which could present better buying opportunities.
• a) Continued air traffic recovery, and b) delivery of earnings recovery.
• Sector-wise: a) A weaker economic outlook dampening air travel and air cargo demand, b) inflationary cost pressure.
a) For SIA, competition catching up faster than expected, driving a faster-than-expected moderation of pax yields;
b) For SATS, possible negative market sentiment and reaction towards our expected 1QFY24 reported losses with the WFS consolidation.