• SIA’s 1QFY3/19 core net profit was in line, with depreciation lower than expected, compensating for EBITDA that was below forecast due to cost and yield pressures.
• We cut our FY19F core EBITDA forecast by 8% by lowering passenger yields as the industry has been slow in passing on the higher fuel costs, constraining SIA.
• Our overall core net profit forecasts have not been changed significantly as the impact of IFRS1 has been to reduce depreciation costs to below our earlier estimates.
• We maintain ADD with a target price (S$11.75) based on 1.05x CY18F P/BV, as there are tentative signs that SIA’s competitors are starting to pass through higher fuel costs.

Highlights of 1QFY19

SIA reported a group core net profit of S$135m, down 8% from 1QFY18’s S$146m that has been retrospectively adjusted higher to reflect lower depreciation charges upon the adoption of IFRS1 from 1 Apr 2018.

The passenger airlines saw lower operating profits y-o-y, on account of higher fuel costs and continued yield declines despite higher demand and load factors. However, the cargo business continued to report higher y-o-y profits on the back of robust global demand that has permitted SIA to raise its cargo yields.

SIA Mainline Did Well in a Tough Environment

With the merger of SIA mainline and SIA Cargo, the entire combined entity saw its operating profit fall 11% y-o-y to RM180m in 1QFY19. 

We believe that the mainline carrier saw profits fall y-o-y on the back of a 1% y-o-y yield decline (reversing 4QFY18’s hopeful 1% y-o-y yield rise) which partially offset the 2% pts rise in loads and resulted in a minor 1.5% y-o-y rise in revenue per unit of ASK capacity (RASK). This was too little to offset the 2.5% y-o-y rise in cost per ASK (CASK), which would have been greater had SIA group’s fuel hedges not succeeded in offsetting half of the 40% rise in average fuel price.

SIA’s Cargo Operations Continued to Deliver Higher Profits

The cargo business still succeeded in delivering 10% y-o-y higher cargo yields in 1QFY19 on the back of continued robust global demand for airfreight. "+"SIA"+"’s own cargo business saw 3.5% lower freight tonne kilo-meter (FTK) demand and lower loads for reasons that are not immediately clear to us. 

We estimate that the cargo business doubled its profits y-o-y, and provided the vital cushion against lower SIA mainline profits.

SilkAir and Scoot Delivered Breakeven Results

• Scoot managed to grow its RASK for three consecutive quarters despite lower yields, and demand was robust.
• SilkAir suffered from excess capacity and had to discount heavily.

Forward Guidance Cautiously Optimistic

SIA said that passenger traffic was expected to continue growing, even as competition persists, and cargo demand was steady in the near term despite longer-term risk from the US-China trade war.

With North Asian carriers raising their fuel surcharges recently, we hold out hope that SIA’s yields can recover in future quarters. SIA is very cost competitive against its peers with 46% of its fuel requirements for the rest of FY19F hedged at an average jet fuel price of US$65/bbl, vs. US$85/bbl in the spot market.

Structural Initiatives Gathering Pace

SIA’s yield management initiatives helped SIA mainline’s RASK grow y-o-y for three consecutive quarters, despite lower yields. Direct, long-haul flights to New York and Los Angeles will start from Oct/Nov 2018F with A350ULRs, allowing SIA to offer an attractive one-stop product to US-bound connecting traffic from India and ASEAN.

Intra-group route restructuring continues with SilkAir transferring lower yielding routes to Scoot, while SilkAir will pare its growth ambitions by gradually transferring its 17 x 737-800s to Scoot to focus on the upgrade of its 737 MAX 8 product and eventual merger with SIA mainline.

Downside Risks

Faster-than-expected rise in oil prices and inability to pass through higher fuel surcharges due to heavy competition.

Source: CGS-CIMB Research - 27 Jul 2018