• SIA's 1HFY3/20 core NP of S$196m underperformed at only 30% of our previous FY20F forecast (25% of consensus).
• This was due to higher-than-expected share of associate losses and weaker-than-expected cargo yields.
• Maintain HOLD, but reduce our target price to S$10 on the back of a cut to our FY20F core EPS forecast, still based on 0.9x P/BV, rolling forward to CY20F.

Highlights of 2QFY3/20 Results

• SINGAPORE AIRLINES (SIA, SGX:C6L)’s 2QFY20 core net profit fell 48% y-o-y due to a higher share of associate losses, smaller profits at its cargo arm, and larger losses at Scoot, though this was partially offset by better earnings from SIA mainline. See Singapore Airlines Announcements; Singapore Airlines Latest News.
• SIA’s share of associate losses amounted to S$40m in 2QFY20 which may have been caused by Virgin Australia and Vistara, against S$2m share of loss in 2QFY19 (with the latter figure excluding S$116m share of Virgin Australia’s deferred tax asset write-off which we had reclassified into the exceptional line).
• The cargo arm suffered its second consecutive quarter of yield decline, following global demand weakness since late-2018.
• Scoot was impacted by competition with Chinese carriers which reduced its yields and RASK, while its CASK rose as it had to scale back aircraft utilisation to tackle schedule reliability problems caused by the TRENT 1000 engines on its 9 x 787-9 fleet.
• Thankfully, SIA mainline grew its operating profits on the back of passenger growth, higher RASK, and flat unit costs, while SIA Engineering (SGX:S59) also delivered higher profit.
• SilkAir’s operating losses were unchanged y-o-y despite higher RASK, as its non-scheduled services revenue and incidental revenue declined and it had to endure the costs associated with the 737 MAX 8 grounding.

Outlook for SIA Mainline Appears Positive

• SIA’s revenue management system has successfully delivered RASK expansion for SIA mainline over the past two years, with strong premium cabin traffic supporting yields and bookings. So far, SIA mainline has not seen weaker premium demand despite slowing global economic momentum.
• Non-stop A350 services to Seattle were launched in Sep, boosting SIA mainline’s US offerings. For jet fuel, SIA group has locked in 78% of its jet fuel requirements for 2HFY20F at US$76/bbl strike price, and 64% of its FY21F jet fuel needs at US$75/bbl, assuming jet fuel crack spread of US$15/bbl for the Brent hedges.

Challenges to be Overcome at SilkAir, Scoot, Cargo and Virgin

• SilkAir moved its six MAX 8s to Alice Springs, Australia for long-term storage in Oct, indicating that it does not expect the model to resume flights soon. Until the TRENT 1000 engine issues are sorted out, Scoot will maintain lower utilisation of 11+hours/day (from 13+ hours previously) and maintain 3½ spare planes (from the typical 1½ planes).
• The seasonal peak in airfreight during Oct-Dec may remain weaker y-o-y due to the demand slowdown in the US and Europe, even though a partial US-China trade deal may trigger a short-term fillip.
• Finally, Virgin Australia may continue to make provisions of one sort or another, of which SIA will account for its 20% share. These issues consume in part the achievements of SIA mainline and may restrain the group’s earnings performance.

Hold

• Our HOLD call is premised on weakening global GDP growth and the US-China trade war which have been negatively affecting SIA’s airfreight demand and yield since late-CY18. See Singapore Airlines Share Price; Singapore Airlines Target Price.
• There is a historical lagged correlation between cargo demand and demand for premium-cabin and business-related travel, which pose a downside risk.
• Upside risks include the potential for SilkAir to rethink its long-term capacity growth by renegotiating the 737 MAX 8 orders with Boeing.

Source: CGS-CIMB Research - 6 Nov 2019