Here’s why Singapore Airlines Ltd Is a Blue Chip Investors May Want to Avoid

In Singapore, the term “blue chip” is used to describe the 30 components of the market barometer, the Straits Times Index (SGX: ^STI). It’s also something which often carries highly positive connotations amongst investors.

But, a blue chip can still be a risky investment. Case in point: Neptune Orient Lines Ltd (SGX: N03). The shipping firm had been a blue chip (since at least January 2008) until it was removed from the Straits Times Index on 24 September 2014 2012.

Yet, investors who had bought shares five years prior to 24 September 2012 – on 24 September 2007 – would have seen Neptune Orient Lines’ price decline by nearly 80% from S$5.10 to S$1.135. Even after it ceased to be an index component, Neptune Orient Lines’ shares did not stop falling and now sits at S$0.945.

So, keeping in mind the thought that blue chips can still be risky investments, what are some of the current blue chips which investors may want to avoid, or at the very least, tread carefully with?

For answers, we can perhaps turn toward a checklist developed by investor Pat Dorsey in his book Five Rules for Successful Stock Investing. Here’re the criteria for the nine-point checklist:

  1. The firm provides regular financial updates, has a long track record as a publicly-listed entity, and has a market capitalisation that isn’t too small.
  2. It has consistently earned an operating profit.
  3. It has generated consistent operating cashflow.
  4. The firm earns a good return on equity.
  5. It has been able to grow its earnings consistently.
  6. It possess a clean balance sheet.
  7. The firm can generate lots of free cash flow.
  8. There are infrequent appearances of one-time charges.
  9. There has not been major dilution of shareholders’ stakes in the firm.

Dorsey’s checklist was actually designed to be completed in 10 minutes and is meant to help investors quickly and effectively come up with a list of companies which are worthy of a deeper study.

On that note, a company which scores a “no” response to most or all of the criteria would likely not make for a good investing opportunity. For an elaboration as to why these criteria make sense, my colleague Chin Hui Leong’s work will be a great place to start. It’s a three-part series, so here they are: Part 1Part 2, and Part 3.

If we run the checklist through the Straits Times Index’s current crop of 30 blue chips, Singapore Airlines Ltd (SGX: C6L) would unfortunately be one of the companies which have a mass of “No” scores.

Singapore Airlines, listed since 1992, flies both passengers and cargo around the world. The firm has quarterly earnings releases and a large market cap of S$13.6 billion. Given these, Singapore Airlines deserves a “Yes” in Dorsey’s first criterion.

But as we move further down the list, cracks begin to appear. The chart below plots Singapore Airlines’ changes in operating income, net income, operating cash flow, and free cash flow over the 10 year period ended 31 March 2014.

As you can probably tell, Singapore Airlines hasn’t been able to showcase any sustained growth in all four financial metrics. In addition, the airline’s history with generating free cash flow has also been spotty.

As a result, criterion 2, 3, 5, and 7 would best have the “No” box checked.

Singapore Airlines' operating income, operating cashflow, free cashflow, and net income

Source: S&P Capital IQ

The next chart below shows Singapore Airlines’ returns on equity and key balance sheet figures over the same decade as above. Although the airline’s balance sheet has been strong (there’s been more cash than debt for the most part), its returns on equity have been poor, spending most of its time below 8%.

These would give the airline a “no” answer for criterion 4 but a “yes” for 6.

Singapore Airlines' return on equity (ROE), total cash, and total borrowings

Source: S&P Capital IQ

We’ve reached the penultimate criterion in Dorsey’s checklist and this is where Singapore Airlines does shine as it has not logged any significant one-off “other” charges over its past 10 financial years.

Singapore Airlines' share count

Source: S&P Capital IQ

Coming to the last criterion on Dorsey’s checklist, Singapore Airlines actually does score well here too. Over the past decade between the financial year ended 31 March 2004 (FY2004) and FY2014, the airline has managed to reduce its share count. You can see this in the chart just above.

A Fool’s take

In a final tally, Singapore Airlines has fallen short with five of Dorsey’s nine criteria.

It’s worth pointing out though that Dorsey’s checklist is not the final word on whether a share is a good or bad investment. Other important factors, like say a change in management or the share’s valuation, would have to come into play too.

But that said, given the history we’ve seen with Singapore Airlines’ business, investors interested in the firm would need to tread carefully and be fully aware of the risks involved.

For more investing analyses and important updates about the stock market, sign up to The Motley Fool Singapore's free weekly investing newsletter, Take Stock Singapore. Written by David Kuo, it can help you grow your wealth in the years ahead.

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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 writer Chong Ser Jing doesn't own shares in any companies mentioned.