Dual turbulence – navigating pricing and cost pressures
- Continued downward pressure on passenger yields and rising costs likely to impact SIA’s profitability
- Cut FY24-26F core net profit by 8%-14% following disappointing 3QFY24 results
- Risk-to-reward appears neutral with current valuation closely aligning with less optimistic earnings outlook
- Maintain HOLD with revised TP of S$6.10
3QFY24 was a significant miss. SIA reported 3QFY24 headline net profit of S$659m (-6.8% q-o-q, +4.9% y-o-y). The sequential decline in net profits for the quarter was unexpected, given the reduction in jet fuel prices and the fact that the Oct-Dec quarter is a peak season for both travel and cargo. Additionally, the group recognised a one-off tax credit (estimated to be around S$60m based on our calculations; the amount is not disclosed) that resulted in materially lower tax expenses for the quarter. Without this, the core net profit would likely have been between S$575m and S$625m. 9MFY24 core net profit of S$2016m to S$2066m accounted for about 76% of the consensus and DBS’s full-year estimate.
3QFY24 revenue was S$5,082m (+8.5% q-o-q and +4.9% y-o-y), setting a record for quarterly revenue for the group. This was driven by passenger traffic growth, though it was partially offset by softer passenger yields (-7.4% y-o-y) and cargo yields (-37.4% y-o-y). Group passenger traffic grew by 3.6% q-o-q and 19.1% y-o-y to approximately 95% of 2019’s level in 3QFY24 (up from 80% in 3QFY23), with overall passenger load factors remaining at an elevated level of 88.2%. Passenger yields for both SIA and Scoot declined more rapidly than anticipated (SIA: -4.6% y-o-y, Scoot: -15.3% y-o-y). Meanwhile, the cargo segment saw a slight increase in volumes (+5.0% q-o-q, +3.9% y-o-y) due to robust e-commerce demand, though cargo yields demonstrated limited improvement (+2.5% q-o-q) on a sequential basis.
The sequential decline in the group’s operating profits and margins in a seasonally stronger quarter is concerning. Operating profits sank by 19.3% y-o-y to S$609m in 3QFY24, as marginally lower unit costs (group cost per ATK: -1.8% y-o-y) and traffic growth were insufficient to offset pricing pressures and a lower cargo contribution (-35.1% y-o-y to S$559.4m). As a recap, the group booked close to S$190m of FX losses as an operating expense in 3QFY23, excluding which, would have translated into a considerably more acute y-o-y deterioration in its operating profits. On a sequential basis, operating profits fell by an even wider margin of 23.8%, despite higher passenger traffic and a q-o-q increase in passenger yields and cargo revenue, as unit costs spiked by 11.9% q-o-q. Consequently, SIA’s operating margin contracted to 12.0% in 3QFY24, down from 17.1% in 2QFY24 and 15.6% in 3QFY23.
Scoot is bearing the brunt of fierce competition from regional LCCs. While Scoot is still performing better relative to pre-pandemic levels, the low-cost carrier saw a substantial 70.5% y-o-y decline in its operating profits in 3QFY24, largely due to acute yield compression amid intense competition. The group is taking several measures to improve Scoot’s profitability, including adding smaller regional Embraer jets from April 2024 to operate in new destinations and serve existing ones that can be better served by smaller aircraft, and to step up cross-selling efforts between Scoot and SIA by leveraging SIA’s distribution channels.
Forward bookings remain strong, while load factors are likely to stay elevated; the main issue is pricing. Management highlighted that air travel demand appears robust ahead, bolstered by the upcoming March school holidays, the Easter holiday season, and the typical peak summer season, with passenger load factors anticipated to remain high across all cabin classes. While corporate travel has yet to recover to pre-pandemic levels, leisure travellers have been upgrading to premium cabins, with load factors in premium cabins surpassing pre-pandemic levels. Despite the uncertain macroeconomic environment, management highlighted that they do not see any signs of weakness in demand from any sector or country. However, a normlisation of travel patterns (gradual diminishing of pent-up travel demand), coupled with the continued reinstatement of capacity by peers, will continue to challenge passenger yields.
Bleak prospect for cargo yields, SIA could see limited support from ongoing Red Sea disruptions. Despite potential challenges in sea freight due to the Red Sea attacks, management mentioned that there has been no positive spillover effect to air freight, which is a stark contrast to what North Asian airlines are reporting. SIA’s cargo operations primarily consist of transshipment, involving goods originating from China and other regional manufacturing hubs being transported via Singapore to Europe. This trade route continues to experience fierce competition as regional airlines rapidly increase their capacity. Hence, SIA’s cargo yields will likely continue to trend lower as more capacity returns to the market.
The inflationary environment is expected to negatively impact margins; there is limited scope to drive unit costs down with capacity build-up. Management highlighted sticky inflation, especially in handling costs at overseas stations due to a lack of manpower, as well as rising passenger costs (such as in-flight meal costs) and maintenance costs. Unit staff costs could be slightly erratic on a q-o-q basis due to timing issues with the provision of bonuses, but there have been no material swings on a h-o-h basis. With passenger capacity already at a high base of around 90% of pre-pandemic levels in 3QFY24, we do not see much scope to further reduce unit costs as the group progressively ramps up capacity to 100% by 3QFY25.
Divergence in market jet fuel prices and all-in jet fuel price is likely due to timing issues; expect lower fuel hedging gains going forward as existing hedges are closer to prevailing spot prices. SIA indicated that its reported all-in jet fuel costs are higher than MOPS due to two reasons: 1) different benchmarks are used when they uplift jet fuel from multiple airports around the world; and 2) there is a lag effect based on actual billing. There has been no change to SIA’s fuel hedging strategy, which is for a declining wedge over an 18-month period, meaning it is more heavily hedged in the short-term, at around 40% in the nearer quarters, with the level of hedging tapering off over time. The group is likely to book lower fuel hedging gains going forward as advantageous hedges secured prior to the pandemic had mostly expired. Hence, existing hedges in place are anticipated to align much more closely with the prevailing jet fuel prices.
Maintain HOLD with revised TP of S$6.10; cut FY24-26F core net profit estimates by 8%-14%. We moderate our FY24F net profit estimate, and now expect to see a more significant decline in SIA’s FY25-26F core net profits, largely reflecting a faster moderation in passenger yields and higher unit costs due to sustained inflationary pressures. With the merger between Vistara and Air India unlikely to be completed by FY24F as it is still pending authority approvals, the S$1.1bn one-off non-cash accounting gain is expected to be recorded in FY25F instead. As Vistara’s financials are undisclosed, we have decided to be conservative and assume ongoing losses at the airline over FY25-26, which will weigh on profits in those two years. We maintain our HOLD call for SIA with a lower target price of S$6.10, based on 5.0x EV/EBITDA (blended FY24F/FY25F), which is 0.5 standard deviation (SD) above its five-year pre-COVID-19 average.
