Supply crunch boosts air cargo
One bright spot shining for SIA throughout the pandemic is its cargo segment. In 1HFY2021, the segment posted record revenue of $1.875 billion, up 51.2% y-o-y, with the progressive resumption of passenger flights contributing to the increase in cargo capacity and loads carried.
With shipping lines struggling to cope with demand amid widespread constraints in handling capacity, many companies were forced to deliver their goods by air instead.
To be sure, the sturdy demand for air cargo is not limited to SIA. In October, global shipping firm DHL reported that “there is little to suggest that demand for air cargo services will dim any time soon. Indeed, all indicators point toward a hectic few months ahead”.
Referring to the International Air Transport Association’s (IATA) latest air cargo market analysis, DHL says that supply chain conditions “continue to be supportive of air cargo” when compared to other modes of transport.
IATA also references the current high cost and limited availability of container slots and boxes for shippers seeking to move cargo from Asia to North America and Europe as another boost for air cargo demand.
In a separate report in September, DHL noted in its Airfreight State of the Industry report that air freight rates were 77% higher in July than the 2019 baseline and 18% more than the 2020 baseline.
As manufacturers continue to replenish stocks by tapping air freight, rates are expected to remain high due to “huge demand growth against limited capacity.” With the year-end peak season coming, DHL expects demand to be pushed even higher.
At the SIA briefing, Lee said that “globally, the total availability of air freight is still far below what it was pre-Covid-19. Passenger services, which contribute a huge amount of capacity in the belly hold, still have not resumed to what it was like pre-Covid-19 at this time.”
When asked if SIA was worried about an oversupply once flights have normalised, Lee is of the view that the airline is “certainly not anywhere close to that situation”.
Rivals also gearing up However, SIA is not the only carrier reporting a recovery, given that strong cargo demand is an industry-wide trend. Middle Eastern carrier Emirates Airlines reported an 86% rise in revenue to US$5.9 billion ($7.99 billion) in its 1HFY2021 ended Sept 30 while net loss decreased y-o-y to US$1.6 billion from US$3.4 billion. Similar to SIA, the improvement was due to higher passenger numbers and continuously strong cargo business. In a release, Emirates says it is “clearly on the path to recovery”, adding that the substantially improved results reflect recovery across all business segments as well as the easing of Covid-19 pandemic travel restrictions worldwide. Emirates chairman and CEO Sheikh Ahmed bin Saeed Al Maktoum says the carrier saw operations and demand pick up as countries started to ease travel restrictions and vaccine rollout continued worldwide. During the six months from March to September, Emirates took delivery of two new A380s and retired two older aircraft from its fleet, and worked to restore its network and connections through Dubai. It said it “responded with agility whenever travel restrictions lifted to restart services or layer on additional flights,” highlighting its new services to Miami in July as well as activating codeshare and interline partnerships to expand connectivity options for customers. By September 30, the airline was operating passenger and cargo services to 139 airports, using its entire Boeing 777 fleet and 37 A380s.
Will SIA’s stock fly?
With what has been happening, investors will ask if this is a good time to buy into SIA, given that the worst is already behind the airline and the only way seems to be up for its share price. From the bottom of $3.31 on Aug 3, 2020, SIA shares have gained 61.3% to close at $5.34 on Nov 17, valuing the company at $16.5 billion. Before the pandemic, SIA was trading at around $8–$9.
Morgan Stanley research analysts Wilson Ng and Derek Chang are not so optimistic. They acknowledge that there will likely be a stark improvement in earnings for travel-related stocks next year — albeit off a low base — although much of the recovery has already been priced in.
They note that stocks like SIA, casino operator Genting Singapore and hotel owners CDL Hospitality Trusts and Ascott Residence Trust, are trading at share prices averaging 14% below pre-Covid levels but two-year forward expected earnings have fallen by more.
“Put another way, the P/E multiples have expanded by 20%–30%. This is more so than other stocks suggesting that valuations are relatively unattractive”, the analysts wrote in their Nov 15 report.
For these stocks, Ng and Chang think that any further progress might trigger a near-term positive market reaction but they advise investors to leave more room for earnings to disappoint expectations which are already elevated.
Separately, DBS analysts said in a Nov 15 report: “We are turning more optimistic on travel-related plays, given greater visibility on Singapore’s reopening course and the restoration of connectivity in the region.”
For now, they are the most bullish on ST Engineering and Genting Singapore, given that they are primed for strong earnings rebound in 2HFY2022 and cheap valuations.
“We also favour Sats, but remain on the sidelines for SIA, whose longer-term prospects are already priced in, in our view,” the analysts add. They have a “hold” call and a $4.90 target price for SIA.
CGS-CIMB analyst Raymond Yap, in his Nov 12 note, agreed that prospects for the airline are “brighter” on the back of the VTLs and record revenue in its cargo segment. Yap, who has a “hold” call and a $5.81 price target on the stock, believes that the year-end peak for cargo may help further narrow losses in 3QFY2022.
Furthermore, he expects VTL schemes will likely make a bigger contribution, with more destinations coming into play in 4QFY2021.
He also notes that Australia, which he calls a “very important market for SIA”, has permitted its residents to travel overseas from Nov 1 and will reopen to vaccinated Singaporean travellers from Nov 21.
However, despite the optimistic travel outlook, Yap has widened his FY2022 core net loss forecast “as we assume a slower pace of capacity restoration and higher Brent cost forecast of US$73 per barrel vs US$70 per barrel previously”.
His profit forecast for FY2023 is downgraded to a loss and his forecast for FY2024 is slashed by 44% due to higher fuel cost assumptions.
Jet fuel is highlighted by Yap after the airline revealed it had exited a large portion of its hedges in the past six months. He thinks that as a result of this, the airline will be exposed to higher fuel cost volatility due to reduced hedge cover.
“We previously estimated that SIA had 100% fuel hedge cover for FY2022, 73% for FY2023 and 60% for FY2024, based on legacy contracts.”
SIA now has fuel hedge cover for 2HFY2022 of only 30% (at a Brent strike price of US$57 per barrel) and of 40% from 1QFY2023 to 1QFY2024 (at a strike price of US$60 per barrel), beyond which there are no further hedges.
While derivative profits of US$24 million will be booked in 2HFY2022 and US$208 million beyond that, Yap is of the view that the lower hedge cover “is a surprise development that may increase SIA’s fuel cost risk”.
This is especially important to note, especially as SIA has revealed that net fuel costs do go up as more activity resumes, and with the passenger capacity at 34% of pre-pandemic demand as of October, the airline will have many more flights to mount, which could drive up consumption and, in turn, costs.
SIA is clearly aware of the need to keep a close eye on potentially rising costs that might not necessarily be covered by a corresponding growth in revenue, however quick the pickup might be. Further flare-ups in infection that could lead to the possible shutting down travel once again, is also something that has to be kept in mind.
“We fully anticipate that during this period, things can still be volatile and that the profile could be patchy but we are fully prepared for that,” says Goh. And as of now, it’s all systems go for SIA.
