09-Feb-2013 12:45 AM

Singapore Airlines looks to ride out the storm as profits continue to slide

Analysis

Singapore Airlines (SIA) has reported another drop in operating profits as the airline group continues to face challenging market conditions in the cargo and long-haul passenger markets. But the group remains in the black and its incredible record of never incurring an annual loss will almost certainly stay intact for at least the foreseeable future.

The SIA Group saw its operating profit drop by 17% to SGD131 million (USD162 million) in its third fiscal quarter ending 31-Dec-2012. SIA has now seen its operating profit drop in seven of the last eight quarters. Pressure on profits will continue in 2013 but the group should be able to continue to eke out small profits.

Over the medium to long term the outlook is brighter as SIA's new strategy, which features a more balanced portfolio with an increased focus on the faster-growing budget and regional markets, beds down. The profitability of SIA's long-haul operation should also get a boost in late 2013 after the carrier eliminates unprofitable non-stop flights to the US. For now it's about battening down the hatches with a focus on cost containment and patiently waiting until all the recent major strategic changes can be fully implemented.

Summary

Singapore Airlines (SIA) has reported a drop in operating profits for the third fiscal quarter, continuing a trend of declining profits over the past two years.
The drop in profits is primarily due to challenging market conditions in the cargo and long-haul passenger markets.
SIA's new strategy, which focuses on the budget and regional markets, is expected to improve profitability in the medium to long term.
SIA Cargo reported an operating loss, while other subsidiaries including SIA, SilkAir, and SIA Engineering remained profitable.
The launch of low-cost subsidiary Scoot and increased involvement in short-haul low-cost carrier Tiger are important components of SIA's new strategy.
SIA's long-haul passenger markets, particularly in Europe and the US, remain bleak, but the discontinuation of non-stop flights to the US is expected to improve profitability in the long-haul network.

SIA profits have been in steady decline for the last two years

SIA's glory days of consistent industry-leading profits ended in fiscal 2007/08, when the group turned net and operating profits exceeding SGD2 billion (USD2.5 billon). Profits rebounded to above the SGD1 billion (USD1.24 billion) mark in fiscal 2010/11 after two years of smaller annual profits and a few rare quarters of losses due to the global financial crisis (see background information). But over the last two years profits have again been in a steady decline.

SIA has reported lower group operating profits for every quarter except one during calendar 2011 and 2012. The only exception was the quarter ending 30-Jun-2012, when the group's operating profit increased from SGD11 million (USD14 million) to a still modest SGD72 million (USD89 million).

SIA Group operating profit/loss for the last 12 quarters (in SGD million)

Quarter	2010	2011	2012
Oct to Dec	$509	$157	$131
Jul to Sep	$345	$123	$70
Apr to Jun	$251	$11	$72
Jan to Mar	$241	$166	-$5

The group reported a rare quarterly operating loss of SGD5 million (USD6 million) in the three months ending 31-Mar-2012, or 4QFY2011/12. Market conditions have only slightly improved in the new fiscal year, with operating profits through the first nine months of FY2012/13 at SGD273 million (USD339 million), a reduction of 6% compared to the already meagre figures for the first nine months of FY2011/12.

But SIA has done fairly well given the market conditions it faces and has remained in the black while other airlines, including its biggest rivals in Southeast Asia, have fallen into the red. SIA will almost certainly again post net and operating full-year profits for FY2012/13, and will most likely report an increase - albeit a modest one - compared to the SGD336 million (USD417 million) net profit and SGD286 million (USD355 million) operating profits from FY2011/12.

Through the first three quarters of FY2012/13, SIA had a net profit of SGD311 million (USD386 million), including a net profit of SGD143 million (USD177 million) in 3QFY2012/13. The figure for the quarter represents a 6% increase while the figure for the nine months represents a 17% decrease but these include one-time items which resulted in a higher profit for the quarter but a lower profit for the nine month period.

SIA Group financial highlights: 3QFY2012/13 vs 3QFY2011/12 and 9MFY2012/13 vs 9MFY2011/12

Cargo remains a weak spot for SIA while SilkAir remains strong

Group revenues for 3QFY2012/13 were down less than 1% to SGD3.86 billion (USD4.79 billion) while costs were up by less than 1% to SGD3.73 billion (USD4.63 billion). The decline in revenues was primarily due to the poor performance at SIA Cargo, which reported a 10% drop in FTKs and a 4% drop in cargo yields. Group passenger traffic grew by 8% but the yield dropped 6% as SIA engaged in "promotional activities" to keep its aircraft full.

SIA Cargo reported an operating loss of SGD29 million (USD36 million) for 3QFY2012/13 while the group's other four main subsidiaries were profitable - SIA the parent airline with an operating profit of SGD87 million (USD108 million), regional carrier SilkAir with an operating profit of SGD34 million (USD42 million) and SIA Engineering with an operating profit of SGD31 million (USD38 million). Of the four subsidiaries, the results represented an improvement over 3QFY2011/12 except for the parent airline, which highlights the weakness of the passenger markets SIA serves.

SilkAir has been more profitable than SIA mainline on a margin basis in recent years as it only operates within the stronger Asia-Pacific market and has a lower cost structure than SIA mainline. The SIA Group has started to pursue rapid growth at SilkAir as part of its new strategy to focus more on the regional and budget markets, thereby reducing its exposure to the weaker cargo and long-haul passenger markets.

SilkAir, which operates 22 A320 family aircraft, grew capacity (ASKs) by 19% in 3QFY2012/13. RPKs were up only 14%, resulting in a 3.5ppts decrease in load factor to 75.3%. But with a break-even load factor of 67.1%, compared to a break-even load factor of 79.8% at SIA mainline, SilkAir can afford to have lower loads while remaining profitable and providing critical feed to SIA.

SilkAir will continue to expand rapidly in 2013, with capacity additions planned for nine of its existing destinations from the end of Mar-2013. This includes the introduction of a fifth daily flight on SilkAir's biggest two routes, Singapore to Penang and Phuket. SilkAir has been able to steadily grow in both these markets despite intense competition from low-cost carriers, which over the last decade have grown in Singapore from being virtually non-existent to accounting for 30% of the total market and over 50% of the market within Southeast Asia. SilkAir's continued success in the fast-growing but highly competitive regional market is an important component of the SIA Group's new medium to long-term strategy.

SIA needs Scoot to restore growth although profits are unlikely to come anytime soon

The launch of new long-haul low-cost subsidiary Scoot and increased involvement in short-haul low-cost carrier Tiger, which SIA owns a 33% stake in, are also important components of SIA's new strategy as the group sees a need to participate in the rapid growth in the lower end of the market. Scoot launched services in Jun-2012 and currently operates a fleet of four 777s with a fifth aircraft to be added in 2013.

SIA is not yet providing traffic or financial figures for Scoot. But the new carrier is unlikely to make positive contributions to the group until at least 2015, when it transitions to a new fleet of smaller and more efficient 787s. As CAPA reported in Jan-2013:

Scoot's original business plan envisioned operating a fleet of 14 777-200/200ERs by the end of 2016. But the aircraft was always considered an interim solution and the SIA Group quickly realised Scoot needed to switch to smaller and new-generation widebody aircraft sooner rather than later.

The introduction of 787s, combined with a large group of partners, changes the dynamics significantly. Scoot is unlikely to be profitable until both these components are fully in place and the carrier is operating a fleet of several 787s.

The real test for Scoot will not come until the fiscal year beginning Apr-2015, when the carrier should have the fleet, network and strategy to start making positive contributions to the SIA Group. Having a likely initial loss-making period of three years is rather long but SIA Group has the financial backing to withstand three years of losses at Scoot and be patient as the new carrier slowly implements its business model.

Outlook in long-haul passenger markets remains bleak

While budget carriers have grown rapidly in Singapore, SIA has seen its annual passenger traffic grow by only two million, or about 13%, since the turn of the century, giving it an average growth rate of 1% per annum. As conditions are still not ripe for growth in most of SIA's long-haul markets, the group needs Scoot and a bigger SilkAir if it is to usher in a new era of growth.

As SIA acknowledged in releasing its 3QFY2012/13 results on 07-Feb-2013, the outlook for the cargo and European and US passenger markets remains bleak. "The outlook for international air travel demand continues to be challenging and the cargo market remains depressed amid the troubled European economy and the weak recovery in the United States," SIA stated. "Loads and yields of both passenger and cargo businesses are expected to remain under pressure, while the price of jet fuel continues to be at a historical high. The depreciation of revenue-generating currencies against the Singapore dollar poses yet another challenge."

SIA remains heavily exposed to cargo and the Europe and US markets. SIA currently serves 13 destinations in Europe according to Innovata data, giving it a bigger European network than any other Asian carrier. Europe currently accounts for 27% of SIA's ASKs while US flights account for another 6%. (For the five one-stop routes to the US operated by SIA, only the ASKs on the second leg are counted.)

Singapore Airlines capacity share (% of ASKs) by region: 04-Feb-2013 to 10-Feb-2013

Discontinuation of non-stop US flights to improve profitability of SIA's long-haul network

In a bid to improve the profitability of its European network, SIA dropped service to Athens during 3QFY2012/13. SIA also announced during the quarter plans to drop non-stop flights from Singapore to Los Angeles and Newark. The last non-stop service to Los Angeles will operate on 20-Oct-2013 and the last non-stop service to Newark will operate on 23-Nov-2013 as SIA phases out its fleet of five A340-500s, which are in all-premium configuration with 100 business class seats.

The all-premium Los Angeles and Newark flights are high profile and are an important differentiator, particularly for corporate accounts, as no other carrier operates non-stop flights between the US and Southeast Asia. But they are extremely expensive to operate and have required a special sub-fleet of aircraft dedicated for the operation. As other airlines have discovered, the economics of operating flights of over 16 hours are extremely challenging, particularly in an environment of high fuel costs. The flights were the longest non-stop in the world when launched in 2004 and today they are still the longest by a relatively wide margin.

While load factors on SIA's non-stop flights have been reasonable since the end of the global financial crisis, when frequencies had to be reduced and promotions had to be offered in response to a sudden drop in demand, it is virtually impossible to make money on the routes. Eliminating the flights and phasing out the A340-500s should instantly improve the profitability of SIA's long-haul operation.

Newark has been served daily since Jan-2010, ending a period of about a year in which the service was only operated with five weekly frequencies. The Los Angeles-Singapore service was restored to daily in late 2010 but was cut back to five weekly flights in May-2011 and has since stayed at that level. Both services were initially offered in a two-class configuration with premium economy and business but SIA opted to reconfigure its A340s in 2008 to all-business after discovering it could not make money on such long flights with an economy or premium economy product.

Monthly load factor on SIA's Los Angeles-Singapore service: Jan-2010 to Jul-2012

Monthly load factor on SIA's Newark-Singapore service: Jan-2010 to Jul-2012

SIA will end up losing some Los Angeles and New York premium passengers to other carriers as SIA's one-stop product in these markets is similar to the one-stop product offered by several other Asian and US carriers. But SIA's use of its flagship A380 in these markets should help mitigate the loss of the non-stop flights. SIA began using the A380 on its daily Singapore-Frankfurt-New York JFK service in Jan-2012 while its daily Singapore-Tokyo-Los Angeles service was upgraded to the A380 in Jul-2011.

SIA also now operates the A380 on a daily service to San Francisco via Hong Kong. It also operates a daily 777-300ER service to San Francisco via Seoul and a 777-300ER service to Houston via Moscow which will return to daily between 20-May-2013 and 11-Aug-2013. Houston was served daily from Nov-2010 to Mar-2012, when the service was reduced to five weekly frequencies.

It is unlikely SIA, which also previously served Chicago and Las Vegas, will add further capacity to the US given the current economic conditions and intense competition on trans-Pacific routes. But SIA does have the option of switching the type of A380 it uses to New York and Los Angeles should it find it lacks premium seats after the last non-stop flights in these markets operate. SIA currently has two configurations for the A380, one of which features 60 business class seats and the other with 86 business class seats.

SIA to focus capacity expansion on Asia-Pacific market

Expansion in Europe is also unlikely in the current environment with the exception of Scandinavia, where SIA is looking to exploit the synergies from a new joint venture with fellow Star Alliance member Scandinavian Airlines (SAS). SIA is increasing Singapore-Copenhagen services on 31-Mar-2013 from three to five weekly frequencies and more flights to Copenhagen and potential new flights to Stockholm are under consideration with joint venture partner SAS, which does not operate to Singapore.

Otherwise SIA is focused primarily on expanding in the stronger Asia-Pacific market. SIA is adding five weekly frequencies to Japan at the end of Mar-2013 as its increases Fukuoka to daily and Osaka to double daily. SIA at the same time is also adding a fourth daily flight to Melbourne and two additional weekly frequencies to Adelaide for a total of 12. These increases reflect SIA's strategy of focusing more on the faster-growing Asia-Pacific region with more full-service capacity from SIA and regional SilkAir brands as well as with LCC capacity from its subsidiary Scoot and its affiliate Tiger.

SIA, however, remains committed to its long-haul passenger operation and continues to invest in its long-haul premium product. SIA's fleet of 10 777-200ERs are being outfitted in 2013 with the lie-flat business class seat that has been featured over the last several years on its A380s and 777-300ERs. Once the 777-200ERs are reconfigured, SIA will offer a standard lie-flat business product across all long-haul flights.

Meanwhile SIA has already begun working on a new generation premium product, which is slated to debut on a batch of 777-300ERs due to be delivered in late 2013. BMW subsidiary DesignWorks USA and James Park Associates are now designing the new cabins, which will also eventually be outfitted in SIA's future fleet of A350s.

SIA's all-widebody fleet currently consists of 101 aircraft including 58 777s, 19 A330s, 19 A380s and five A340s. SIA will unveil its fleet and capacity plans for FY2013/14 in May-2013, when it releases its full-year earnings. But CAPA data shows the carrier has four additional 777-300ERs slated for delivery in calendar 2013 as well as four additional A330s.

Singapore Airlines projected delivery dates for aircraft on order by type: 2013 to 2020

SIA always maintains flexibility in its fleet which gives it the option of accelerating retirements to offset the impact of new deliveries should it decide against pursuing capacity growth. While SIA will likely look to continue to grow capacity modestly, with a focus on medium-haul routes within Asia-Pacific, much faster growth will be pursued at SilkAir and eventually Scoot once the LCC starts receiving 787s. Scoot has 20 787s on order for delivery starting in late 2014.

SIA looks to reduce costs as it waits out the current storm

SIA, meanwhile, is working to reduce costs as it waits for better conditions in the cargo and long-haul passenger markets. In late Jan-2013, SIA announced it is releasing over the next six months 76 or 4% of its pilots, or all pilots who are on fixed-term contracts. While SIA is still planning to grow mainline ASKs by 4% in FY2012/13, it has been carrying a surplus of pilots for the last few years due to the capacity reductions implemented during the global financial crisis and the fact its academy has continued to turn out new pilots.

SIA as part of its 3QFY2012/13 earnings announcement also said SIA and SilkAir will be implementing temporary capacity reductions in weak markets during 4QFY2012/13. SIA says a total of 138 mainline flights will be cut to 14 destinations: Bangkok, Beijing, Brisbane, Brunei, Guangzhou, Hong Kong, Kuala Lumpur, Male, Mumbai, Newark, Perth, Seoul, Sydney and Tokyo Haneda.

The traditionally well-managed and conservative airline group is positioned well to ride out the current storm. While not nearly as profitable as it was in earlier generations, SIA remains in the black and has one of the highest market caps and cash positions in the global airline industry. Comments that SIA is on a one-way street down are overblown.

As it was at the top of the industry for so long, both from a product and profit standpoint, it was inevitable SIA would eventually face choppier waters. The jury is still out on whether the major strategic changes unveiled over the last two years will be effective. But SIA needed to respond and it now has to patiently wait for a year or two for market conditions to improve and for its new long-term strategy to bed down.

Currency conversion used: USD1=SGD1.24

Background information:

SIA, SilkAir and SIA Cargo operating highlights: 3QFY2012/13 vs 3QFY2011/12 and 9MFY2012/13 vs 9MFY2011/12

SIA Group annual operating profit: FY2007/08 to FY2011/12