SIA — a business severely disrupted by the pandemic
How does one analyse a business so severely disrupted by the pandemic?
Well, let’s start by looking at its FY2019 annual report to see how the business has done until before the pandemic hits. This will help give sense on the business-as-usual picture.
From a financial perspective, revenues grew 3.3% but so too did expenditure. Op Ex rose by 5% op profit fell by 31%, driven in large part by the usual cost pressures that airlines face: fuel costs, depreciation of assets, staff costs and handling charges. EPS fell sharply by 48%. The income statement tells a story of a modestly growing operating business that is under intense cost pressures, leading to profitability declines. On its balance sheet, long-term liabilities grew by 103% and short-term trade payables grew 12%. Equipment grew by 22%, trade receivable by 8% and cash by 14%. Current ratio dropped to 2.93 from 3.1 a year ago. These numbers illustrate a weaker financial position, though the quasi-sovereign ownership of SIA lends some assurance to shareholders. From cash flow perspective, the business churns positive operating cash flows that is offset by capital expenditure of a size twice that of operating cash flows. This requires financing from debt issuances.
Business Lines — Passenger, Cargo, MRO.
Segment analysis — 81% of total revenues comes from SIA business, 10% from budget, remaining divided between Silk Air and SIAEC (MRO). 90% of total operating profit come from SIA business, 22% from SIAEC, budget and SIAEC are negative contributors to total operating profit. This shows a over-reliance on its long-haul full-service offering.
Geo Analysis — more than half of revenues come from East Asia. 13% from Europe, 12% from Pacific and 5% from US. There is definitely scope for SIA to expand its revenue share from Europe and US.
For FY2020 and FY2021, as expected, we see a huge drop in business performance due to the pandemic. FY2020 still not as bad as FY2021 as the first 3 quarters predate the pandemic but the effect of the last quarter can be seen by drop in operating revenues for the total year as compared to FY2019. From early 2020, SIA, like the rest of the industry, is essentially on life support as border restrictions remain in place throughout the world.
The question to ask is whether going forward, SIA is a business worth investing in.
It is facing some serious headwinds. Business travel is expected to never fully recover as the new age of zoom and virtual meetings discovered during pandemic restrictions is expected to stay. It would be naïve to say business travel will no longer happen, rather not at the same levels as we once saw before the pandemic. SIA will be hugely impacted by this as this is a core segment that they service.
Furthermore, the recent volatility and surges in price of crude oil will have impact of jet fuel prices, a major cost component for airlines. The world is struggling to cope with underinvestment in both fossil fuels and alternative sources of energy. Volatility in prices will be inevitable as we grope in the dark towards a sustainable energy mix in the years ahead. This will make fuel price hedging a tricky exercise. In short, margin pressures will remain strong on profitability of airline companies even as travel restrictions eases.
Demand for travel is also not expected to fully recover until the later end of 2022 as the world struggle to live with an endemic Covid-19. Singapore itself is extending restrictions as it battles a resurging number of cases. Other countries like the UK and US are slowly opening international borders but restrictions like vaccinations and testing will put a dampener on travel. Consumers want to travel, but they either can’t or are not willing to put up with the many limitations.
From a competitive landscape perspective, SIA must contend with the gulf carriers that has state backing from sovereign funds with arguable deeper pockets than its own government backers. Furthermore, they have rivalled SIA in terms of connectivity, service quality and aircraft used. The differentiation factors are getting levelled away.
SIA has a few things going for it. For one, it has built and maintained a stellar reputation as one of the best airlines in the world with its premium aircraft quality, top-notch in-flight offerings as well as one of the best connectivity in the world. Consumers have been willing to pay a premium for these factors. Furthermore, the quasi-sovereign ownership of the airline lends some form of government backing, and a fiscally strong government at that too. This has transpired during the pandemic when Temasek led a few rounds of capital injections into the airlines to help it brave through the shutdowns in international travel. It can rest assured that such backing will be there in the future too if the circumstance demand for it.
Given all these points in consideration, I would still favor owning SIA shares, but at underweight portfolio positions relative the benchmark. The share price has been trending sideways since the start of 2021. The further easing of travel in 2022 will at least start to provide some ballast to the business. SIA has a decent competitive position with solid fundamentals. Those factors at least compel one to owning the stock. The underweight position takes into account the headwinds mentioned above.
On the path forward, there are several strategic changes that SIA should consider to put its business in a better competitive position.
Firstly, it must continually maintain and improve the things that it is known for — connectivity, service and aircraft.
Secondly, it has to diversify away from its reliance on SIA business — the long-haul full-service proposition. In the years ahead, especially in Asia, air travel is going to see explosive growth with the rise of middle-class consumption. This will play out largely in the domestic intra-country air travel especially in countries with huge potential for domestic air travel like India and Indonesia. Within Asia and Southeast Asia also, the rise of mid-market travel will present significant opportunities. SIA is not currently well-placed to capture these opportunities. Granted, it has investments in Vistara in India and NokScoot in Thailand but these businesses are not serious competitors in these space. This has to change if SIA wants to see good growth in its business. The best model will be to partner with a local company that can sharply define its proposition to local tastes and preferences while leveraging on SIA’s wealth, scale and experience.
Thirdly, the air cargo segment should get some serious attention now. Emerging from the pandemic, the world will be looking to seriously reconfigure its supply chains and trade lines. Port shutdowns has wreaked havoc to many businesses’ inventory timetables. Furthermore, the shutdown has seen a surge in e-commerce, some of which will persists beyond the pandemic. If SIA can get its offering for air cargo right, this will be an adjacent revenue growth engine to its business.
Lastly, SIA should be an aviation pioneer in a post-fossil fuel world. The world’s march towards decarbonization and net-zero emission is gathering pace. As an industry that is one of the major emitters of carbon emissions, airlines need to start seriously thinking how it can survive in a world that will impose a heavy carbon tax. Admittedly, this is some years away, but this is exactly the opportune time for SIA to be industry leaders and think how it can offer an increasing environmentally-conscious consumer base a carbon-neutral way to travel the world.
