Tug-Of-Fools : Singapore Airlines – The Bear Argument

I am Peter Ng and this is my Bear Case for Singapore Airlines (SGX: C6L).

Singapore Airlines (SIA) is a name which Singaporeans would more likely than not be familiar with. Dressed in traditional “Sarong Kebaya” uniforms, the air stewardesses of SIA have not only become an iconic element of the company known to Singaporeans, but also one which has garnered global recognition.

Beyond its hugely successful marketing endeavours, the national carrier has bagged the award of “World’s Best Cabin Crew Service” for numerous years and has frequently been named as one of the top airlines in the world.

Behind its prestige, however, the airlines industry has to manoeuvre through cut-throat competition to survive; underpinned by several factors such as an ultra-competitive market and a large pool of competitors, where profits of carriers are continuously bleeding off from increasing operating expenses and an ongoing price war.

Weak profitability remains in airline segment

SIA derives revenue from four major business segments, with airline operations comprising more than 80 percent of the company’s revenue, that includes two other low-cost carrier subsidiaries, Scoot and SilkAir.

On its top line, SIA’s revenue registered an average growth rate of 4.8 % over a five-year period (FY10 to FY14). However, the company’s operating profit margin is an area that requires closer attention, where it ranged from 0.5% to 8.8% within the same five-year period.

Revenue and operating profit margin

Source: Company annual reports

The two extreme ranges of 0.5% and 8.8% were outliers caused by the Global Financial Crisis in 2008, where global corporations including SIA took a huge hit in operating performance but subsequently recovered to their original levels at an inflated rate.

When removed, operating margin is muted to an average of 1.7% for the three-year period. Putting SIA side by side with its competitors, disparity in operating margins are apparent as competitors such as Garuda Indonesia and Cathay Pacific Airways are recording an average of 3.1% and 3.7% respectively.

Indeed, there are challenges faced in the company’s profitability, albeit not unanticipated, given that the airlines industry has remained as a highly competitive space for a long time where players undercut one another’s prices to stay in the game.

With little room to raise prices, reducing expenses is the next best alternative to alleviate the pressure on profit margins, given that operating expenses have been increasing at an average growth rate of 4.4 percent over the most recent five-year period. Nonetheless, this task is nothing short of daunting as more than half of SIA’s operating expenses are tied into fuel and staff costs.

Breakdown of operating expenses

Source: Company annual reports

Fuel prices are highly variable since they are driven by externalities and to a large degree, are not within the control of the company. Although they represent a large proportion of SIA’s operating expenses, there are limited options towards how much cost savings the company can generate since fuel costs need to be incurred in order to provide its services.

While staff costs may appear to be an area more intrinsic to a company, the avenue for reductions is limited and unapt. This is because it may be counterproductive to SIA’s core strategy to differentiate itself by providing exceptional levels of services, which are often tied together with staff remuneration.

Further to this, the company’s future performance could be adversely affected, eradicating any benefits created from the cost savings.

Declining and rocky free cash flow

Despite the healthy and growing cash flow from operations (CFO) for the past five years, SIA’s free cash flow (FCF) position appears to paint a different picture.

Within the observed five-year period, excluding FY11, FCF appears to be inconsistent and on a downtrend.

Relationship between FCF, CFO, and net CAPEX


Source: Company annual reports

Magnifying SIA’s cash flow from investing activities sheds further light as it appears to be weighed down by a growing capital expenditure (CAPEX) base. Net CAPEX (including disposals) has grown more than three times between FY11 and FY14.

However, the hefty growth in capital expenditure is not a shortfall caused by SIA’s managers. Rather, the move is in line with the company’s commitment of maintaining a young fleet of aircraft, which boosts several advantages such as an overall better in-flight experience, lower maintenance expenses as well as new aircraft which are more fuel efficient.

More importantly, it is mandatory for SIA to upkeep the current rate of capital expenditure to maintain its competitive advantage and as mentioned above, new aircraft are more cost efficient.

With a shrinking FCF that is not expected to reverse anytime soon, SIA could turn to its cash pile to sustain dividend payout. As its cash position reduces, the company could be forced to finance its operations with debt instead.

As a result, an investor would require a higher rate of return to compensate for the lower dividend yield and increased leverage position of SIA. This could potentially lead to lower valuations of the company and hamper future share price performance.

An expensive competitive advantage

In the face of ever growing expenses and the need to inject frequent investments into the purchase of aircraft, SIA’s competitive advantage to differentiate itself from its competitors is one which comes at an expensive price tag. Above all, margin compressions are expected to persist.

That’s my bear case. You can read the bull argument here.

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