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Tug-of-Fools: SIA – The Bear Argument

250px-Bulle_und_Bär_FrankfurtRight above my computer is a shelf, and on the shelf is a 1:200 model of an Airbus 380 with the Singapore Airlines (SGX: C6L) livery. I love travelling SIA.

Whenever I fly SIA, I long to hear the arrival announcement as the plane touches down at Changi International Airport: “To all Singaporeans, welcome home” The feeling is just awesome.

However, with all due respect, when it comes to investing, I rather shun Singapore Airlines Limited.

Who says it best but Buffett?

In a 2002 interview, Buffett said the following: “If a capitalist had been present at Kitty Hawk back in the early 1900s, he should have shot Orville Wright. The airline business has eaten up capital over the past century like almost no other business”.

SIA is no exception. Here’s why.

Commodity business

It can be said that SIA is a commodity business as it is vying in a competitive industry on price. Air travel is nowadays getting cheaper with fully-fledged operators meeting the once-famed gold service standards of SIA. In 2013, Emirates was named the World’s Best Airline by Skytrax. SIA was third, behind Qatar.

Fuel prices are also rising and eating into SIA’s profits. As seen from this website, the price of jet fuel has been risen from US$0.39 per gallon in June 1998 to US$2.73 a gallon in May 2013. This is a Compounded Annual Growth Rate (CAGR) of 13.9%.

Furthermore, fuel has been taking up more and more of the percentage of operating costs for airlines as calculated by International Air Transport Association (IATA). In 2003, fuel accounted for 14% of operating costs. But in 2012, it was forecast to be 33%.

Looking at the charts below, we can get a clearer understanding of SIA’s profitability and how fuel costs eat into its profits.

SIA Profiability

(Source: Figures from DBS Vickers)

The CAGR of revenue from 2000 to 2013 was 4.2%. The CAGR of cost of goods sold such as fuel costs etc… was 8.6%. So, the cost of goods sold was rising faster than revenue growth. Consequently, the CAGR for net profit was -10.6%.

Capital Expenditure

SIA also has to spend cash to maintain a young fleet of aircraft. As of 1stt June 2013, the average age of SIA’s fleet was six years and nine months. This means that every six years or so, the profits that could be returned to shareholders have to be used to acquire new planes. The capital outlay is significant too.

The average cash flow from operations from 2000 to 2013 was S$2.33 billion. The average capital expenditure during the same period was S$2.23 billion. The average free cash flow during that period was a mere S$0.1 billion.

Let’s look at the table below to understand SIA’s free cash flow situation.

SIA FCF

(Source: Figures from DBS Vickers)

The free cash flow from 2000 to 2013 has been very erratic. Shareholders have not been getting good returns from the business. It is from this free cash flow that companies reinvest to grow their business, pay dividends, pare down debt or buyback shares.

It didn’t help the situation when at the end of May 2013 SIA announced another huge capital commitment. It announced the biggest aircraft order in Singapore Airlines’ history. It will cost them S$21.5 billion over the next few years.

Looking at Some Numbers

The net profit margin for Financial Year (FY) 2013 was 2.5%. It averaged 4.1% from 2009 to 2013.

The return on equity for FY2013 was 2.9%. It averaged 4.5% for the same period as above.

These numbers are hardly enticing.

Summing It Up

The share price comparison of SIA and the Straits Times Index (SGX: ^STI) for the past 13 years, says it all.

SIA Share Price

Click here to read James’ bull argument.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.  Motley Fool Singapore contributor Sudhan P doesn’t own shares in any companies mentioned.