The narrative seems compelling. The price of oil has been falling… and falling. With the cost of fuel making up almost half of Singapore Airlines Ltd’s (SGX: C6L) expenses, it would seem that Singapore’s flagship carrier might see a strong boost to its bottom-line with cheap oil. The market seems to think so. Singapore Airlines’ share price has risen from a low of S$9.41 in October to its current level of S$12.43, representing a 32% increase in just three months. Unfortunately, the truth might be far from that. Yes – like I mentioned earlier, fuel represents the main bulk…
The narrative seems compelling. The price of oil has been falling… and falling. With the cost of fuel making up almost half of Singapore Airlines Ltd’s (SGX: C6L) expenses, it would seem that Singapore’s flagship carrier might see a strong boost to its bottom-line with cheap oil.
The market seems to think so. Singapore Airlines’ share price has risen from a low of S$9.41 in October to its current level of S$12.43, representing a 32% increase in just three months.
Unfortunately, the truth might be far from that. Yes – like I mentioned earlier, fuel represents the main bulk of an airline’s costs. Yes – Singapore Airlines might even enjoy higher profit margins for a while (even though many airlines purchase their fuel through forward contracts and so cost-savings from cheaper oil might not be felt right away).
But I emphasized “for a while” for a good reason.
Your advantage is my advantage
Jet fuel is basically a commodity product with standardized pricing. This means that all airlines would tend to experience relatively similar fuel costs in the long run (disregarding the fact that some airlines might be trying to speculate on the price of fuel through the use of financial instruments like forward contracts).
Thus, if the boon that Singapore Airlines can experience – cheaper fuel – is actually an industry-wide phenomena, then there is hardly any advantage for Singapore Airlines to speak of in the first place. As the airline industry settles into potentially cheaper fuel, competition would resume and it’s likely that any cost savings would be passed on to the consumers and not benefit the airlines. The airlines would just go back to earning their usual low profit-margins.
The fiercely competitive environment that airlines are in can be felt if we take a look at Singapore Airlines’ long-term share price and business performances and compare them with companies in other areas of the aviation sector like SIA Engineering Company Limited (SGX: S59) and SATS Ltd. (SGX: S58). The former maintains, repairs, and overhauls aircrafts for a living while the latter provides logistical services in the aviation sector, such as food catering for airlines and ground handling services for passengers, flights, and cargo.
Over the past ten years from January 2005 to January 2015, Singapore Airlines had generated total returns (inclusive of gains from reinvested dividends) of 92.4% for its shareholders. That is not a horrible performance as it translates to an annual return of around 6.7%. But over the same period, SIA Engineering and SATS have earned a total return of 207% and 142%, respectively, for their shareholders.
And as for business results, the relative out-performance of SIA Engineering and SATS becomes apparent with a glance at the table below.
Source: S&P Capital IQ
As you can see, Singapore Airlines has experienced a dramatic reduction in profits whereas SIA Engineering and SATS have more or less kept their profit levels steady.
So, Singapore Airlines has given shareholders some decent returns in the past decade. But, when compared to the performances of other companies with adjacent businesses, the returns from Singapore Airlines is nothing to cheer about. A look at their relative business performances would also lead to the same conclusion – there’s nothing to cheer about with Singapore Airlines.
There might be some valuable reasons to invest in Singapore’s flagship carrier, but investing in it because of falling oil prices might not be one of them. Unless a company can have a lasting advantage over its competitors, its profits would likely be eroded with competition over time.
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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 doesn’t own shares in any companies mentioned.