Singapore Airlines - Safest play on the cyclical recovery

Upgrade to OW: SIA is in its worst earnings cycle in history with a high probability of reporting losses for the next two quarters which explains its underperformance versus the market year-to-date. Although we remain bearish on the near term outlook and the timing and quality of the rebound remains uncertain, we believe that its potential correction in the upcoming results and/or the worsening impact from Influenza A would provide a good opportunity to accumulate in preparation for a cyclical upturn. For more risk averse investors, SIA is also the “safest” choice in the sector given its well-capitalized balance sheet, strong track record at managing costs during downturns and ability to unlock more value from subsidiaries/associates such as SIE, Tiger Air in the longer term, and M&A forays that could lift market sentiment even though they may not necessarily be value-enhancing.

Potential longer-term value in SATS: Stock is effectively trading cum dividend of S$1.77/share. Buying SIA now entitles shareholders to 0.73 SATS share for every 1 SIA share. Although shareholders may not necessarily realize the value of SATS near term due to potential share overhang as free float would rise from 19% to 45%. However, applying mid-cycle airport valuations on SATS of c.18x P/E would imply a potential fair value of c.S$2.40/share longer term.

Long-term prospects: SIA is one of the best-managed airlines with strong pricing power and a highly efficient cost structure in our view. It is also the only Asian airline with a net cash balance and has been returning more capital to shareholders in recent years. However, we believe SIA is a mature airline with more limited growth prospects than Cathay and its market share at its home base should gradually diminish as low cost carrier penetration grows. We see risks entering M&A deals that may not be value-enhancing.

PT, valuation, key risks: We have raised our PT to factor in SIA’s improving earnings outlook in the next 12 months. Our ex-div Jun 2010 PT of S$14 is based on 1.2x P/BV, SIA’s average valuation since 2003 when its competitive environment intensified with the entry of low cost carriers and Emirates' increased presence in Singapore. Key risks: 1) WHO issues travel restrictions due to Influenza A, 2) stagflation, 3) making value-destroying investments.

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