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Difficulty: Moderate

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1) Overview of Singapore Airlines Group (SIA)

2) Analysts are currently bearish on the stock

3) But if SIA‘s profits returned to Pre-Covid levels tomorrow, would it be a “BUY” at today’s price? (Our Answer is No.)

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Appendix 1: SIA Group’s Operating Statistics

Appendix 2: Increased debt may cost SIA $45m in interest expense

Appendix 3: SIA’s Fuel Hedging Policy and Historical Gains/Losses

Appendix 4: What’s the risk of a Miles Devaluation? Likely low…

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The InvestQuest’s View

Even in 1) the most optimistic of scenarios where SIA’s profits revert back to Pre-Covid levels and 2) at today’s low share price, P/E multiples are not compelling in our view. We would prefer to have a larger margin of safety, given that P/Es from the bullish scenarios are not much of a discount from SIA’s historical P/E of 16.6x. Furthermore, additional risks need to be noted, such as the issuance of the 2^nd tranche of mandatory convertible bonds which increases the risk of further share dilution down the road, impairment losses of aircraft assets, and further losses from ineffective fuel hedges.

In PART 2 of our SIA article series, we review if the first tranche of SIA’s Mandatory Convertible Bonds (MCB) is worth investing in, at current prices.

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1) Overview of Singapore Airlines Group

• By Business Line: 81% of SIA Group’s revenue in FY2019/20 was from SIA Company operations. The rest of its revenue was contributed from its subsidiaries (Scoot, Silkair, SIA Engineering, Others).
• Passenger versus Cargo: Within SIA Company operations, 80% were derived from passengers flown and 15% from cargo.
• Fleet size: As of 30 June 2020, the Group had a fleet size of 220 aircraft, of which 72 were operational (32 for passenger services and 40 for cargo services).

Operating statistics data for SIA Group may be found in Appendix 1. As for the group’s latest monthly data for the month of August 2020:

• Passenger volumes flown was 98.3% lower than August 2019.
• Cargo volumes flown was 40.9% lower than August 2019.

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2) Analysts are bearish on the stock

Projections for revenue and net profit

The below chart shows SIA Group’s revenues and net profits from FY 2004/05 to FY 2019/20.

Analysts are projecting a slow recovery for the airline. For FY 2021/22, consensus estimates SIA Group revenues of S$11.2bn (30% below FY 2019/20 levels) and a net loss of S$0.2bn (similar to net losses in FY 2019/20).

P/B is not particularly cheap in our view

Due to its volatile earnings, many analysts are using P/B instead of P/E to value SIA. As of 30 June 2020, SIA Group disclosed a NAV per share of S$5.93, implying a current P/B of 0.57x (see chart below for SIA’s historical P/B ratio).

SIA management has warned of potential aircraft impairments amounting to S$1bn as a result of weak air travel demand, during the most recent interim results announcement.

In addition, analyst consensus projects that SIA Group will make cumulative additional losses of S$1.5bn, from now till Mar-2022.

Accounting for both of these factors, we estimate that SIA’s NAV per share could be potentially revised down to S$5.09. This would imply a forward P/B of 0.66x (using SIA’s 25th Sept closing price of S$3.39).

While a P/B of 0.66x is cheap under normal circumstances, we view it only as fair given the unique situation we are in. SIA has historically traded at an average P/B of 1.0x, with 0.8x being the trough during market corrections (see chart above). However, this time is quite different in our view. Never before have we seen such a steep decline in air travel demand, as a result of government enforcement.

Compared to assets such as land, note that aircraft assets are depreciable and will not be able to hold value over time. For context, out of SIA’s total assets of S$33.7bn (as of 31^st March 2020), over S$25bn was comprised of aircraft-related assets, which are depreciated annually and may be subject to impairment losses (which is what we expect to occur later this year). SIA currently estimates a useful life of 12-20 years for their passenger aircraft for depreciation purposes.

Analyst ratings and price targets

The unoptimistic outlook for SIA is also reflected in analyst stock ratings and target prices, which we have listed below.

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3) If Covid-19 disappears tomorrow, would SIA be a buy at the today’s price? Our answer is no.

Historical P/E of SIA (Pre-Covid Era)

SIA has historically traded at an average trailing P/E of 16.6x. The below chart has been plotted using SIA’s share price divided by the company’s past 12-months earnings, on a quarterly basis. The chart ends at Dec-19, as SIA incurred net losses subsequently.

If we went back to Pre-Covid operations tomorrow, what is the P/E at today’s share price?

For this, we assume Pre-Covid earnings at FY 2018/2019 levels of S$683m (note: the average net profit from FY 2009/10 to FY2018/19 is S$590m).

We show what the P/E levels for SIA would be under three scenarios:

1. Scenario A: Pre-Covid Earnings, at today’s share base
2. Scenario B: Pre-Covid Earnings minus the expected additional interest costs from a larger debt burden, at today’s share base
3. Scenario C: Pre-Covid Earnings, minus the expected additional interest costs from a larger debt burden, at a diluted share base due to share conversion of 1st tranche of Mandatory Convertible Bonds (MCBs)

Do see Appendix 2 for details of how we computed the additional interest costs expected, which was factored in for Scenario B and C.

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The InvestQuest’s View

Even in 1) the most optimistic of scenarios where SIA’s profits revert back to Pre-Covid levels and 2) at today’s low share price, P/E multiples are not compelling in our view. We would prefer to have a larger margin of safety, given that P/Es from the bullish scenarios are not much of a discount from SIA’s historical P/E of 16.6x. Furthermore, additional risks need to be noted, such as the issuance of the 2^nd tranche of mandatory convertible bonds which increases the risk of further share dilution down the road, impairment losses of aircraft assets, and further losses from ineffective fuel hedges.

In PART 2 of our SIA article series, we review if the first tranche of SIA’s Mandatory Convertible Bonds (MCB) is worth investing in, at current prices.

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Appendix 1: SIA Group’s Operating Statistics

From April lows, SIA Group’s cargo volume has seen a noticeable pick up while passenger demand remains lackluster. In the below chart, we have plotted the year-on-year change in passenger and cargo volumes flown by SIA Group (including Scoot and Silkair). For August 2020:

• Cargo volumes flown was 40.9% lower than August 2019.
• Passenger volumes flown was 98.3% lower than August 2019.

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Appendix 2: Increased debt may cost SIA $45m additional interest expense

SIA’s capital structure has changed since Pre-Covid and this will have a longer-term impact on earnings, even when air travel demand picks up. As of 31 Dec 2019 (pre-Covid), SIA Group had cash balances of S$1.7bn and debt of S$9.6bn.

Recall that SIA had raised S$8.8bn earlier this year via a rights issue of SIA shares and Mandatory Convertible Bonds (MCBs). Of this amount, SIA had recently disclosed that S$4.4bn cash has been used (see here and here for the disclosed use of funds).

We expect another S$3.1bn cash to be used for aircraft purchases payments, as S$3.3bn was originally earmarked for that purpose (see “Use of Proceeds” in this SIA filing).

At this point, SIA would have a cash balance of S$4.1bn and debt of S$11.1bn (see chart below for our rough estimates).

This would imply an increase of S$1.5bn debt since Pre-Covid. Using SIA’s average finance costs of 3% p.a, this would imply annual additional debt expenses of S$45m. In addition, if SIA decides to issue the 2^nd tranche of MCBs, interest expenses will be expected to increase accordingly.

Do note that SIA accounts for MCBs as equity. As a result, it is highly likely that the S$3.5bn of MCBs issued earlier this year does not show up as debt in the above chart. If you include that in, this would imply an increase of S$5bn debt since Pre-Covid and using average finance costs of 3% p.a., this would imply annual additional interest expenses of S$150mm.

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Appendix 3: SIA’s Fuel Hedging Policy and Historical Gains/Losses

Between FY 2005/06 to 1Q 2020/21, SIA Group has made cumulative fuel hedging losses amounting to S$3.3bn (see chart below for details). In our earlier Sections, we had made no attempt to forecast gains/losses from SIA’s fuel hedging policy.

As reported by Singapore Business Review earlier, SIA was hit particularly hard this year due to their high hedging ratio as of 31 December 2019. The airline had hedged 79% of its projected Q4 2020 jet fuel consumption at US$76 per barrel and 73% of its FY2021 fuel consumption at between US$58/bbl for brent (22%) and US$74/bbl for jet fuel (51%). This resulted in massive losses when travel demand evaporated and fuel prices plunged this year.

More recently, according to a research report by Nomura (published 3rd August 2020), there are no fuel hedges beyond FY22. SIA Management has also mentioned in April 2020 that it is pausing its fuel hedging activities.

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Appendix 4: For Krisflyer Members, what’s the risk of a Miles Devaluation? Likely low.

While not relevant to our investment case on SIA Group, we thought that many readers might have some concerns on this.

The Financial Times recently reported that the Krisflyer Mileage Program is worth US$5bn, which got me concerned…

Essentially, Krisflyer miles have a value to them. It is categorized as “deferred revenue”, a liability in SIA’s balance sheet and as of 31 March 2020, the liability was over S$750m. In a bid to reduce liabilities, would SIA consider devaluing Krisflyer miles?

As a Krisflyer member, my concerns were eased after reading a recently published article from The Milelion.

“…devaluations happen when there are too many miles chasing too few seats. With load factors at record lows, the opportunity cost of a redemption seat is practically zero. Devaluing now would simply threaten an airline’s revenue stream (banks may be less willing to purchase miles if their customers don’t want them), with little tangible benefit in return.”