Singapore Airlines: Artificially Breaking Even

Singapore Airlines (SIA) posted its first quarterly loss since the SARS epidemic, which came in 15.7% and 22.7% below of our and consensus expectations at the core-profit level. This prompts us to retain our bearish view on the company. While the proposal to distribute SATS shares is net positive to SIA’s valuation, the new fair value of SG$8.80, which is derived from 0.68x FY10 book, or a -2 standard deviation from its historical trading band plus the SATS share entitlement, implies a downside of 26%. Maintain SELL.

First core loss since SARS. At first glance, SIA’s reported headline net profit of SG$1.06bn was spot on with our original estimates. However, after excluding the one-off differed tax liability write-back amounting to SG$138m and the surplus on disposal of assets, the company reported a first core net loss (since the SARS epidemic in 2003). While full-year revenue was flat, it was 20.2% lower q-o-q as traffic, load factor and yield numbers all contracted. SIA’s cargo division operating loss of SG$224m also pulled down the other subsidiaries’ contributions although SATS Group, SIA Engineering and SilkAir reported decent earnings.

Outlook still gloomy. While the plunge in jet fuel prices helped to reduce fuel expenditure by S$666m in 4Q, this was offset by losses in hedging of S$543m. These included a $112m loss resulting from the early termination of several fuel hedging contracts before maturity date. While jet fuel price has corrected, but it may be offset by progressive settlement of fuel hedges contracted at higher prices. Advance bookings were lacklustre and there was another setback in the form of uncertainties arising from the Influenza A epidemic. Aggressive promotions, reduced business travel and possible down-trading activities may also worsen the situation.

Strategic move for SATS shares distribution. SIA proposed to distribute in specie 870m SATS shares on the basis of up to 0.73 SATS Shares for every 1 share in the company. Post distribution, SIA will concentrate on airline and aircraft MRO businesses, while SATS can reduces its dependence on the aviation business. Without making any other changes in our key assumption, we assume the proposal to be completed by end of 2QFY10 and our profit estimates of SG$125m and SG$135m for FY10 and FY11 at SATS level, we tweak our earning estimates downwards to SG$383m for FY10 and SG$765.7m for FY100 or 11.7% and 12.3% respectively. While the distribution is net positive to SIA’s valuation after adding in the SATS entitlement to our BV based methodology, is still insufficient to warrant an upgrade thus SELL maintain.

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