07-Nov-2012 10:10 PM

Singapore Airlines Group aims to improve long-term outlook following its biggest ever strategy shift

Analysis

Typically conservative and slow-moving Singapore Airlines (SIA) has quietly but confidently completed the implementation of a new strategy aimed at ushering in a new era of faster growth and higher profitability. SIA's short-term outlook remains bleak as challenging global conditions continue to impact profitability of its full-service passenger and cargo units while its new low-cost long-haul carrier is unlikely to approach break-even until after it takes delivery of more efficient aircraft in 2014. But the SIA Group believes it has improved its medium to long-term position through a series of new projects, initiatives and investments.

Time will tell if SIA can graduate, potentially in 2014 or 2015, to a new phase of growth and higher profitability. But after reporting yet another drop in quarterly profits, it is clear change at SIA is needed and the strategic adjustments that have now been implemented by CEO Goh Choon Phong are a step in the right direction.

Summary

Singapore Airlines (SIA) has implemented a new strategy aimed at faster growth and higher profitability.
SIA's short-term outlook remains bleak due to challenging global conditions impacting profitability.
SilkAir, SIA's regional subsidiary, continues to be the Group's strongest unit on a margin basis.
SIA has launched low-cost long-haul carrier Scoot and increased its involvement in Tiger Airways as part of its new four-brand strategy.
Scoot is unlikely to be profitable until it introduces smaller, more efficient widebody aircraft.
SIA is pursuing new partnerships to expand its network and improve connectivity.

After reporting a rare loss in its fiscal quarter ending 31-Mar-2012, the SIA Group has been back in the black the last two quarters. But profits for the Group's fiscal first half ending 30-Sep-2012, 1HFY2012/13, were very modest and represented a further decline from the prior year's subpar performance.

The SIA Group turned a net profit of SGD168 million (USD137 million) in 1HFY2012/13, a 30% drop compared to the SGD239 million (USD195 million) profit in 1HFY2011/12 and a 73% drop compared to the SGD633 million net profit (USD518 million) in 1HFY2010/11.

The Group's operating profit for the six months came in at SGD142 million (USD116 million), which included profits at SIA mainline, regional subsidiary SilkAir and maintenance unit SIA Engineering. This represented a slight improvement over the SGD134 million (USD110 million) operating profit from 1HFY2011/12 but a 76% drop compared to the SGD596 million (USD487 million) operating profit from 1HFY2010/11.

SIA Group operating profit for select units: 1HFY2012/13 vs 1HFY2011/12

SIA mainline has seen its profits increase over the last year but the business is still suffering from the global economic downturn, particularly in Europe where SIA is highly exposed. The operating profit margin of the parent airline company, which historically has been in the double digits, was only 2.7% in both 1QFY2012/13 and 2QFY2012/13.

Another solid half year for SilkAir

SilkAir continues to be the Group's strongest unit on a margin basis. Accelerating expansion at SilkAir and pursuing closer collaboration between SilkAir and SIA has been one of several major initiatives implemented by Mr Goh over the last year. SilkAir recorded a 23% increase in RPKs and ASKs in 1HFY2012/13 as the carrier opened new routes and added capacity in several existing markets, including markets where it has started operating alongside SIA.

As previously reported by CAPA, SIA has been increasingly using lower-cost SilkAir on routes within the Asia-Pacific region where demand remains relatively strong compared to other regions but competition with low-cost carriers has intensified. SilkAir has proven to be a more effective competitor than SIA mainline in the short-haul point-to-point market (owing to SilkAir operating narrowbodies while SIA only operates widebodies), while maintaining and growing the number of connections available to SIA's medium-haul and long-haul passengers.

SilkAir has been particularly used by SIA to grow the Group's network and improve connectivity in the three key markets of China, India and Indonesia. Over the last two years, the Group has grown its operation in China from eight to 13 destinations and from 73 to 116 weekly frequencies. The Group's India operation has grown from 10 to 11 destinations and from 77 to 96 weekly frequencies while the Indonesian operation has grown from nine to 11 destinations and from 118 to 136 weekly frequencies.

Mr Goh told analysts and media during an 05-Nov-2012 briefing to discuss the SIA Group's fiscal first half results that the Group has already started to reap financial benefits from the increased collaboration between its two full service units. He said efforts to promote "greater integration and cooperation, particularly at the planning and sales and marketing fronts," has led to greater connectivity and cost efficiency between SIA and SilkAir.

Cross-selling between Singapore Airlines and SilkAir increased 25% on a year-over-year basis. "That has gone very well and we'll continue to see what else and what more can we do," Mr Goh said.

He added that "because of that combination and integration, we're able to provide a higher rate of growth for the combination of the two airlines". SIA and SilkAir combined grew capacity by almost 6% through the first five months of FY2012/13. While SilKAir has been growing ASKs at a clip exceeding 20%, the ASK growth at ASK mainline has been about 5% so far this year.

Singapore Airlines/SilkAir combined ASK year-over-year growth (%): FY2010/11 to FY2012/13*

SIA finally starts to tap into growth at budget end of market

While the SIA Group is now again pursuing expansion at the full service end of the market, after several years of flat or very modest growth, Mr Goh recognises the lower end of the market is growing faster. He therefore sees the value of having a diverse portfolio with multiple products for different segments.

The launch of low-cost long-haul carrier Scoot in 1QFY2012/13 represents the single biggest strategy shift for the Group since Mr Goh took over as CEO just under two years ago. Scoot and SIA's minority stake in short-haul LCC Tiger Airways is part of the Group's new four-brand strategy, aimed at covering all segments of the market. With Scoot and its increased involvement in Tiger, the SIA Group now has a more balanced portfolio which Mr Goh says is important as during certain periods market conditions can be positive in one sector of the market while negative in another.

The SIA Group has been promoting closer ties between its two low-cost brands, resulting in the Oct-2012 partnership announcement from Tiger and Scoot. The two carriers have started selling joint itineraries on several city pairs and the SIA Group believes the partnership could potentially be expanded to include a codeshare.

As CAPA previously reported, the SIA Group envisions close cooperation between Scoot and Tiger as well as continued close cooperation between SIA and SilkAir but it is not interested in pursuing codeshares or any types of partnerships between its budget and full service units. This contradicts the multi-brand strategy at other airline groups such as Qantas, which has pursued close and successful cooperation between its full service and budget brands including codesharing.

In speaking to analysts on 05-Nov-2012, Mr Goh explained: "We have deliberately positioned the SilkAir, SIA and the Scoot propositions very distinctly. So we make a clear distinction that the SilkAir-SIA propositions are for premier service and we hold it up there. And that Scoot stays true to its mission of providing affordable, budget travel. And that is important. We do not want any confusion in the value propositions, nor in the branding of either of these carriers."

He added: "The distinct market positioning is also important as we believe that it would actually lower the risk of cannibalisation, which of course is something that has been pointed out by many people. So if there is any cannibalisation, we believe that firstly, other LCCs would be cannibalised by Scoot and its preferred partner. And then because of the distinct and deliberate positioning, we believe that the next level of cannibalisation will affect other full service carriers who might not be at as premium a position as SIA's own positioning. And also that it would also channel some of the traffic that's currently going through other hubs for budget reason to also come through Singapore and to connect through [a] Tiger-Scoot type of co-operation."

SIA Group four-brand portfolio/strategy

While having four brands is unusual (two or three brands is more common among Asian full service airline groups with multi-brand strategies), SIA Group does not see a need to combine its two low-cost or its two full service brands. The four brands now collectively account for about 50% of total capacity at Singapore, giving the SIA Group a strong position in its home market. Tiger and Scoot combined account for about 35% of LCC capacity in Singapore while the SIA-SilkAir combination account for about 56% of FSC capacity.

Singapore capacity share (% of seats) by brand: 05-Nov-2012 to 11-Nov-2012

Tiger has struggled financially, particularly since the six-week grounding of its Australian subsidiary in mid-2011. The Tiger Airways Group was once again in the red in 1QFY2012/13 and 2QFY2012/13, recording a net loss of SGD32 million (USD26 million) for the fiscal first half.

But Tiger, with increased involvement from 33% shareholder SIA, has been working on a turnaround and is confident it will return to profitability. The co-operation with Scoot should help further boost the profitability of Tiger's Singapore unit, which is back in the black after incurring losses in 2HFY2011/12. The outlook of Tiger's unprofitable Australia unit also improves following an agreement with SIA partner Virgin Australia that will see Virgin acquire 60% of Tiger Australia and the LCC pursue dramatic expansion.

Scoot unlikely to be profitable in near-term

Scoot also has so far had a negative contribution on SIA's financials, which is not surprising as SIA's new fully-owned subsidiary only launched operations in Jun-2012. Scoot currently operates four Boeing 777-200s and will soon have a network of eight destinations.

For 1QFY2012/13, the SIA Group reported an operating loss at Scoot of SGD12.5 million (USD10.2 million). But the Group decided not to reveal a figure for Scoot for 2QFY2012/13, which was Scoot's first full quarter in operation. The Group says Scoot figures will not be reported until the new carrier reaches a material size.

SIA has several associate companies including Tiger as well as several small fully-owned subsidiaries. The fully-owned subsidiaries including Scoot incurred an operating loss of SGD31 million (USD25.4 million) in 1HFY2012/13. Given that SGD16.4 million of this SGD31 million loss was incurred in the fiscal first quarter (SGD12.5 million for Scoot and SGD3.9 million for other units), Scoot's loss was probably approximately SGD10 million (USD8 million) in the fiscal second quarter.

SIA Group operating profit by unit for three months ending 30-Jun-2012: 1QFY2012/13 vs 1QFY2011/12

Mr Goh during the analyst briefing declined to provide much detail on Scoot's performance for the quarter ending 30-Sep-2012, only saying that "Scoot has been performing up to expectation and it has been achieving a passenger load factor in the region of 80%, and we are generally happy with the way it is progressing".

But as CAPA reported in early Oct-2012, Scoot is likely to struggle to achieve profitability until it introduces smaller more efficient widebody aircraft. On 24-Oct-2012, the SIA Group announced it had decided to allocate to Scoot the 20 787-9s it ordered back in 2006. The aircraft should allow Scoot to improve operating economics on its existing routes and launch new routes which would not be viable with the slightly larger 777-200.

Scoot will begin taking delivery of the 787-9s in 2014 and the carrier is now talking to Boeing about configuration options. Mr Goh said it is undecided how many 777s Scoot will now add beyond its current fleet of four before 787 deliveries begin in 2014. But Scoot is not likely to pursue significant expansion of its 777-200 fleet and will probably prefer to wait for the more efficient 787 before pursuing ambitious expansion.

The original business plan for Scoot envisioned the carrier gradually expanding its 777-200 fleet to 14 aircraft by the end of 2016. But these aircraft, all of which are coming out of SIA's mainline fleet, were only tentatively earmarked for Scoot. The original fleet plan for Scoot included two additional 777s in mid 2013 and two more in mid 2014. The carrier will most likely only take one or two of these aircraft and operate at most six 777-200s before transitioning to the more efficient 787s.

New 787 fleet should help Scoot achieve profitability

Moving the 787s to Scoot shows that Scoot is no short-term experiment and the SIA Group is serious about competing in the emerging long-haul low-cost sector. Rival Jetstar currently has 15 787-8s on order for delivery from 2013, which will be used primarily to replace its fleet of 11 A330-300s.

Three of Jetstar's A330s are now based in Singapore. SIA is keen to have Scoot be competitive on a unit cost basis with Jetstar as well as Malaysia-based long-haul LCC AirAsia X, which currently operates A330s and has A350s on order.

In explaining to analysts the decision to allocate the 20 787-9s to Scoot and order 20 additional A350-900s for SIA mainline, Mr Goh said: "The importance of the 787 is very well suited to Scoot's type of operation ... and the 787 with its kind of capacity and with the kind of configuration that Scoot has in mind is one aircraft that has been deemed from our internal analysis to be best suited for Scoot's operations."

He added: "The A350 with its greater capacity than the 787 correspondingly, is also better suited for SIA's configuration with its premium positioning in terms of products. So that's how it was arrived at. But certainly, whatever it is each of the airlines must be provided with the best, modern efficient aircraft for it to be able to compete effectively. That's our belief."

While Mr Goh is not yet ready to concede that Scoot cannot be profitable with 777s, it is unlikely the carrier will be in the black until its fleet consists entirely or predominately of 787s. SIA's short-term outlook remains bleak partly because it is unlikely to see any profits from its LCC brands until at least 2014 despite the fact that LCCs are generally more profitable than FSCs in the current market conditions. Tiger needs time to complete its attempted turnaround and Scoot is too small and has the wrong fleet type to be profitable.

Short-term outlook for SIA mainline is bleak

Meanwhile, short-term market conditions for the full service end of the market, particularly long-haul routes, remain bleak. SIA is the largest Asian carrier in Europe, where demand is particularly under pressure. It also has a large cargo operation, which is unlikely to return to the black until the cargo market improves.

Mr Goh warned that "going forward the economy will continue to be very challenging, or perhaps even more challenging than it is now and we don't see any reprieve in terms of improvement, especially from economies such as Europe". He added, the Group's fiscal second half "will be very challenging" and as a result the carrier "will continue to be very vigilant in the way we manage our cost. But also importantly, to be very flexible and nimble in the way we react to the market changes."

Under Mr Goh, SIA has become a more flexible and less conservative company. Mr Goh believes the changes he implemented do not indicate that SIA was overdue for change but simply that the market is more volatile now. "It's a reflection of the change in times and things are changing faster than before," he said.

The SIA Group's decision to launch Scoot, increase its involvement in Tiger and accelerate expansion at SilkAir should improve the company's position in the medium to long-term. SIA is also making the necessary investments to its mainline product to ensure it remains a leading player in the premium space. These investments should pay off, particularly if market conditions on long-haul routes to Europe and North America eventually improve.

SIA earlier this year unveiled plans for new business and first class cabins, which will debut in 2H2013 on the carrier's next batch of eight 777-300ERs. SIA also has initiated a SGD20 million (USD16 million) upgrade project for all its lounges, starting with its Sydney lounge in mid-2013.

Growth at SIA mainline to remain subdued

SIA, as always, is committed to having one of the industry's youngest fleets. SIA mainline, which will end FY2012/13 with a fleet of 102 aircraft, is now committed to acquiring 68 additional aircraft, including 15 additional A330s, eight additional 777-300ERs, five additional A380s and 40 A350-900s.

SIA talked up growth when announcing its order on 24-Oct-2012 for 20 additional A350s, raising its commitment to 40 for the new type. But in reality almost all the aircraft the Group has ordered for its mainline unit will be used for replacement, in line with its strategy to operate the newest and most efficient aircraft.

The 40 A350s, which are to be delivered from 2015, will be used mainly to replace the carrier's A330s and 777-200s/200ERs/300s. SIA now operates 19 A330s, which along with the 15 additional A330s have been acquired through leases for an initial term of only six years. The A330s were always considered interim aircraft to bridge the gap until the delayed A350s or 787s were finally delivered.

The five additional A380s could bring capacity growth but are not slated for delivery until 2017. SIA has no plans to expand its current fleet of 19 A380s in the 2013 to 2016 timeframe. But the carrier, as part its A380 purchase, has accelerated the retirement of its five A340-500s, which are used to operate non-stop flights to Newark and Los Angeles. Airbus has agreed to take back the aircraft in 4Q2013, allowing SIA to terminate the unprofitable ultra long-range flights.

SIA still has some flexibility to grow its mainline fleet if it chooses to extend A330 leases or continue to operate its older 777 variants. But in reality almost all the Group's growth will continue to be directed to SilkAir and Scoot.

SilkAir currently operates a fleet of 22 A320s with two more A320s to be delivered in 2013. The regional carrier committed earlier this year to acquire 54 737-800/MAX 8 aircraft from Boeing, which will be delivered from 2014 and ensures that SilkAir at least doubles the size of its fleet over the next several years.

New SIA strategy includes new and deepened partnerships

With limited growth likely in the long-haul market, the SIA Group will continue to look for new partnerships to expand its network virtually. Mr Goh has been actively pursuing partnerships over the last two years outside the Star Alliance as part of a strategy to fill in gaps in its network and compete better against partnerships forged by rival carriers such as Emirates-Qantas.

Since Mr Goh became CEO he has forged five partnerships with unaligned carriers - Gol, JetBlue, Transaero, Virgin America and Virgin Australia. While they are interline rather than codeshare partnerships, the deals with Gol, JetBlue and Virgin America are significant because they represent the first time SIA has worked with foreign low-cost carriers.

SIA's new and deepened partnerships since 2011

SIA also recently announced the acquisition of a 10% stake in Virgin Australia. The two carriers already codeshare, having secured earlier this year anti-trust immunity for a partnership that was initially forged in mid-2011.

Mr Goh said that SIA "certainly will push for more cooperation" with Virgin Australia following its investment, which "demonstrated we are really committed" to broader co-operation.

"Australia is a very, very important market for us," Mr Goh explained. "We intend to have 124 services a week to Australia by the end of this financial year and that of course includes all three airlines in the portfolio. And I think one has to appreciate that within Australia, there are many secondary points and it's important for us to reach those many secondary points to be effective and to provide that convenience for connectivity, both for our customers going to Australia, and also for our Australian customers coming out to other parts of our network."

He added: "Our investment in Virgin cements our relationship with Virgin Australia. Virgin Australia is a partner that we've chosen to provide the kind of connectivity to the domestic points in Australia. And you can be rest assured that the benefits one can expect from this very tight synergy that we can have with Virgin more than outweighs the investments that we put in there."

SIA also recently announced it had received approval from the Singapore Competition Commission for a joint venture with Scandinavian Airlines (SAS). Mr Goh says the JV enables SIA to add grow its Singapore-Copenhagen route in Mar-2013 from three to five weekly flights. "But it's not going to stop there, we're going to push ahead and see what else we can do to serve to either increase more frequency to the same points or increase points or both in Scandinavia," he added.

SIA needs to pursue more robust partnerships

While the Virgin Australia and SAS partnerships represent a new level of partnerships for SIA, they still do not go as far as other joint ventures forged in recent years by carriers in North America, Europe and North Asia. The new generation of partnerships typically involve metal neutrality along with anti-trust immunity. But metal neutrality has not yet been pursued by SIA as Virgin Australia and SAS do not operate into Singapore.

Of the 12 partnerships SIA has added or deepened over the last two years, 10 are with carriers that do not serve Singapore. SIA historically has shied away from robust partnerships, particularly with carriers that operate to Singapore, and from full participation in the Star Alliance. As the industry ushers in a new era of partnerships, SIA will inevitably have to pursue more partnerships, closer partnerships and potentially joint venture metal neutral tie-ups with carriers that actually serve Singapore. This is one part of the Group's strategy that still needs some fine-tuning.

For now Mr Goh will not reveal the Group's full intention when it comes to potential new partnerships, saying "if it makes sense we are open to it". While the first section of this new, more exciting chapter in SIA's history has now been written, Mr Goh is not about to sit still. As Mr Goh points out, the industry is now more volatile than it has ever been before and airlines need to be flexible when managing through volatile periods. SIA remains a relatively conservative airline group compared to its peers but the recent changes in strategy are refreshing and should prepare the SIA Group better for whatever challenges that lie ahead.

Note: currency exchange rate used 1SGD=USD0.8178

Background Information

SIA Group net profit: 1HFY2012/13 vs 1HFY2011/12

SIA parent airline company financial highlights: 2QFY2012/13 and 1HFY2012/13 vs 2QFY2011/12 and 1HFY2011/12