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

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I am Stanley Lim and this is my Bull Case for Singapore Airlines (SGX: C6L).

Singapore Airlines (SIA) is Singapore’s premium full-service airline company. I know what you might be thinking; billionaire investor Warren Buffett has openly said that airlines aren’t good investments. So, wouldn’t it be best for us to avoid airlines all together?

Well, I believe that’s wrong. An investment decision should always be made based on the fundamentals of each specific company. And, as investors, we shouldn’t be discriminating against an entire industry before any analysis is made for a specific company.

In fact, with airlines tending to be overlooked by many investors, it might be an indicator that undervalued companies could exist in this space. I will present three main arguments that lend credence as to why SIA would be worth looking at.

1. Creative and adaptable management

It is no doubt that airlines belong to a very competitive industry; there have been many business failures amongst airlines. What a company in a competitive industry needs the most is a creative and adaptable management team and SIA’s management has shown to have those qualities.

Many full service airlines lack the willpower to change their business models when faced with competition from the fast-growing low-cost carriers. We just have to take a look at the full-service carriers around the region; there are a number that have been losing money for years and yet there is no sign of those management teams doing anything significant to change the status quo and try and turn their companies around.

On the other hand, SIA has actively met the threat from budget carriers. For instance, it invested in Singapore-based low-cost carrier Tiger Airways Holdings (SGX: J7X) with the hope of being able to gain something from the growth of budget airlines.

In other instances, when AirAsia Berhad, the region’s largest low-cost carrier, announced that it would start expanding the number of routes for its long-haul budget flights in 2011, SIA responded with its own long-haul budget carrier, Scoot, in the same year. Although some of these ventures have yet to turn in sustainable profits for SIA, its management team’s willingness to adapt is a real positive.

SIA is now experimenting with the launch of an online shopping mall to widen its revenue stream. The creativity of the company’s management is a sign that SIA might yet see more evolution in its revenue model in the future. The company might even provide insurance coverage for passengers or start an online travel agency to improve bookings for its flights; those are just some examples of many other options the company has to improve its revenue.

2. A strong balance sheet

One of the bed-rocks for a company’s long-term success is a strong balance sheet. On that front, SIA excels and has one of the strongest balance sheets amongst airlines globally.

As of the quarter ended 31 March 2014, the company had S$4.9 billion in cash on hand. After deducting all its borrowings, the company still had net cash of S$4.1 billion. Having such a strong balance sheet is almost unheard of in the airline industry.

Although an argument can be made that SIA’s off-balance-sheet operating leases for its aircraft would constitute as ‘debt’, the company’s operating leases only amount to around $3.5 billion. Therefore, the company’s still in a strong net cash position even after accounting for its operating leases.

Such a strong balance sheet puts the company in a very favourable position. If the industry is going to consolidate in the future, SIA would have the fire power to invest in or takeover other failing airlines as a quick way to grow its market share. When an industry undergoes consolidation, the strong tends to emerge as an even stronger entity.

SIA’s strong balance sheet could partly be traced to its remarkable ability to remain profitable since 1989 – a very rare trait amongst airlines. Even during periods of extreme economic stress for Singapore, such as the Asian Financial Crisis of 1997-98 and the Global Financial Crisis of 2008-09, the airline has managed to crank out a profit.

And in addition to being able to consistently make a profit (though the amount of profit hasn’t been that consistent), SIA has even been generating free cash flow for most of its history. For instance, over its past 10 completed financial years, the airline had generated positive free cash flow in seven of those years.

It’s an amazing feat to have an airline generate free cash flow and not make losses at the same time.

3. Favourable macro outlook

Lastly, I come to the whole tourism and air travel industry in Asia. It is a general consensus that the amount of air travel should be growing over the next decade due to the rising level of affluence in Asia. Along with Asia’s rising middle class, the level of economic activity in many areas, including tourism, will increase.

Being the hub of Southeast Asia, Singapore is well-positioned to be a beneficiary of such growth. Changi Airport, one of the best and busiest airports in Asia, has already planned for additional terminals to meet the expected growth in demand for air travel in the region. And SIA, with its interests in the low-cost short-haul, low-cost long-haul, and full-service segments of the airline space, would be ready to enjoy the aforementioned potential for growth ahead.

Foolish Summary

It’s without question that SIA is operating in a highly competitive industry. However, the company is one of the best-managed airlines globally. With SIA’s creative and adaptable management, strong balance sheet, and future growth in tourism for the Asian region, the company should not be written off by investors just because of the conventional wisdom that states generically how any airline would not make for a good investment.

I think I have made my bullish case. You can read the bear argument here.

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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 Stanley Lim owns AirAsia Bhd.