Singapore Airlines – The harsh operating environment

Ask an American during the 90s whether they know Singapore Airlines (SIA), you are likely to get a confirmed yes. But when you ask him where Singapore was, you may not get a very clear answer. That spoke volumes about how SIA as a national carrier punched above its weight to put itself in the league of the top few national carriers in the world. It was a national icon and there was even an SIA training school to train batches after batches of cabin crew.

The terrorist attack on the world trade centre twin towers on 11 September 2001 that accelerated the bankruptcy of its close rival, Swissair, only affected the SIA share price for a short period of about 6 months. Even the Severe Acute Respiratory Syndrome (SARS) only affected its share price very slightly. But 20 years on, SIA, like all other airlines were suffering from a dearth of travelling passengers due to Covid-19 pandemic. Just two months ago, SIA had to ground 96% of the flight schedules and kept the newly delivered aircraft in long storage in Australian dessert. Apart from the recent rights and Mandatory Convertible Bond (MCB) issues of S$8.8b, SIA had further loans making a total amount raised to about $11 billions according to the Straits Times following a loan of $750m a few days ago. (Covid-19: Singapore Airlines raises additional $750 million, brings total sum raised so far in FY2020/21 to $11 billion.) In the month of July 2020, it has been running at about only 6% capacity and will be increasing to a miserable 7% by August 2020. This is how grave the situation is for the airline industry amidst this Covid-19 pandemic.

(More information on youtube video above.)

On reflection, SIA has been under huge external threats all the time. The Covid-19 pandemic is not the only cause of SIA’s problem. It just helped accelerated and surfaced the underlying problems. First and foremost, there is the budget airlines. It came about in the early years since the turn of the new millennium. Regionally, Mr Tony Fernandez from Malaysia started the Air Asia, and that turned the region into an arena of competition for low-cost carriers (budget airlines). By 2005, almost every regional country has at least one budget airline to its name. Most of the national carriers were under constant threats from the low-cost carriers. Even after mergers and consolidations, most of these low-cost carriers have muscled their way to become the subsidiaries of the national airlines. They were a necessary evil. In fact, I think most main carriers do not want to have them, but could not do without them. Even airports and ground facilities have now been constructed to accommodate them permanently. Definitely, they are here to stay.      

Then there is the oil price. Jet fuel takes up about 30% to 40% aircraft operating cost. Unfortunately, it came from the volatile commodity, the crude oil. In the last 20 years, the crude oil price traded in the New York Mercantile exchange can range from as high as US$140 per barrel to even sub-zero level that happened recently. The oil price volatility, together with the low-cost carriers could wreak significant havoc to the profitability of the national carriers. When the oil price is high, the operating cost balloons up, crimping the profitability of the main carriers. But when the oil price is low, the low-cost carriers become very active, thus chipping away the profitability of the lower segments of the main carriers.   

Then there are huge competitions from other main carriers. The turn of the new millennium saw the emergence of middle-eastern airlines like, Emirates and Qatar Airways as well as the Chinese airlines. To differentiate itself in this cut-throat competition, it has to continue to maintain a young fleet and competing in tooth and nail with its competitors. That led to renewing its fleet continuously. To do this reasonably well, an airline needs to have a deep pocket and a management with good financial management capabilities. In the latest 5 years of operations, SIA has been cash flow positive. However, the free cash flow has been negative except for one of the years. It does not augers well in this environment and it took a perfect storm like the Covid-19 pandemic to surface it. In the end, SIA has to beef up its balance sheet through the recent rights issue of S$8.8 billion, with another $6.2b of MCB bond as an option that can be tapped upon by mid-2021. In addition, SIA also borrowed heavily and deferred the maturity of its existing bonds to help it maintain liquidity. However, the big question of profitability still remains very unanswered because all the airlines are now competing for the hugely reduced pie of air travellers.

There are also other factors that are peculiar to the smaller economies like Singapore. We do not have domestic flights and all SIA flights are international. With many countries closing their borders or have limited access, it is really a disadvantage for SIA without domestic flights. Domestic air travels help cushion/defray the huge fixed costs during the down period and facilitate the recovery phase for airlines.

Post Covid-19, there are likely to be additional cost issue as well. With the current aircraft seats configuration of elbow-to-elbow arrangement, it certainly unable to meet the safe-distancing requirements of at least 1-m apart. With the recommendation of leaving alternative seats empty, it means that aircraft can only operate at 50% capacity at best. Personally, I do not know if operating at best 50% capacity can even cross the break-even threshold for each flight.  In addition, there is also more insurance and more cleaning cost to dabble with. All these little costs can add up to a significant amount over time.

As I try to follow the challenges facing SIA of late, I find the fuel hedging extremely unsettling. (SIA posts S$732m Q4 loss as bad hedges worsen virus woes). For FY 2019/2020, SIA could have been profitable or nearly profitable if not for the $710 million mark-to-market loss due to hedging. The average hedging price was about $73 per barrel for the year. There appeared to be no advantage using hedging instruments. A quick survey oil price seemed to suggest that the premium to process jet-fuel from crude oil is about $20 to $25 per barrel. Perhaps, by around the crude oil price of about US$55 per barrel, the US shale oil shafts would be cranking busily, thus putting a huge ceiling on the jet-fuel price to around US$75 to $80 per barrel at most. Certainly, it would take a huge war to push the crude oil price to beyond $100 per barrel given the glut situation that started in 2014. The oil hedging did not seem to protect the upside, and risking it on the downside as the oil price fell significantly. So, in the first place, why bother to hedge at all and in lengthy long position of several years down the road. It may be better off to buy on spot prices or at most for 3-month or 6-month contracts. As a user, perhaps SIA should only, hedge according to its needs than taking on a huge long position. Consequently, SIA did not get to enjoy the low oil price as a result of this global glut. In fact, it is a huge loss to SIA as it has to take the oil delivery based on their contract prices.

             

Certainly, I count myself extremely lucky to have sold my SIA shares just before the global financial crisis. In the next 13 years that followed, I was looking for opportunities to get back in again and that explained why I have been following SIA developments. However, I find it extremely difficult to do so due to the ever-changing operating environment that SIA has been subject to. In fact, in the last 10 years prior to Covid-19 pandemic, its share price has been relatively stagnant. It has been a blessing in disguise that the ‘opportunity’ to buy never came. Should I have lost my patience, and bought SIA shares, I would be dragged into taking up the recent rights shares and the MCB issues. I think it will take at least a few years down the road before things become normalise again for SIA.                   

Note: The writer does not have any SIA shares. The write-up is a personal opinion of the writer on SIA and its share price. It is not a recommendation to buy or sell the said securities.

Brennen has been investing in the stock market for 30 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is the instructor for two online courses on InvestingNote – Value Investing: The Essential Guide and Value Investing: The Ultimate Guide. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy.

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