SIA: No joy yet from falling oil prices

SIA has hedged 65% of its 2HFY15 fuel needs at high prices. NextInsight file photoWe view the slide in oil prices to be positive on Singapore Airlines’ (SIA) profitability since jet fuel makes up ~40% of SIA’s total operating expenses but we believe the effects are visible only in the longer-term. With 65% of its 2HFY15 (ending 31 March 2015) fuel needs already hedged as at end 1HFY15, the effects will be very much muted on its 2HFY15’s results. However, we believe SIA will still capture the effects from FY16 onwards. Hence, we cut our assumption on SIA’s FY16 jet fuel cost from US$112/barrel to US$100/barrel, which increase its operating margin from 2.8% to 3.5%.

 

While lower oil prices should improve SIA’s profitability significantly, we believe there are several factors at work that negate partly the positive impact:
1) SIA has always hedged large proportion of each year’s jet fuel needs ahead and the resultant hedging losses offset savings from lower jet fuel costs,
2) yields are likely to be depressed due to overcapacity issues as we continue to see large deliveries of new aircraft due in 2015 for Asia Pacific region,
3) SIA is likely to pass on the savings to consumers through lower fuel surcharges in order to remain competitive in the region, and lastly
4) SIA will record in its books a larger share (from 40% to 55%) of Tigerair’s expected losses for the next few quarters.
 

Factoring in the new jet fuel cost assumption and other factors, our FY16 PATMI forecast increases by ~19% to S$524.6m. Consequently, rolling forward our valuations to 0.95x FY16 P/B (0.5 SD below 5-year historical average), we increase our fair value estimate from S$10.12 to S$10.80. Maintain HOLD.