29-Jul-2013 6:08 PM

Singapore Airlines short to medium term outlook remains bleak as yields and load factors drop again

Analysis

Singapore Airlines (SIA) has reported improvements in profits for the three months ending 30-Jun-2013 but its short-term outlook remains bleak as yields continue to slip. The group would have incurred a drop in operating profit and revenues were it not for a settlement related to aircraft delivery delays.

SIA is hoping its strategic shift to focus more on the regional and low-cost markets, along with new investment in its long-haul premium product, will drive improvements in profitability over the medium to long-term. But SIA faces challenges on all fronts.

In the long-haul passenger market, competition continues to intensify and market conditions remain unfavourable. Conditions are better regionally within the Asia-Pacific region, but recent capacity increases at SIA and full-service short-haul subsidiary SilkAir have outstripped demand, leading to lower load factors. Long-haul low-cost subsidiary Scoot and short-haul low-cost affiliate Tigerair remain unprofitable. The cargo sector, which has traditionally been an important business for SIA, is also a concern.

Summary

Singapore Airlines (SIA) has reported improvements in profits for the three months ending 30-Jun-2013, but its short-term outlook remains bleak as yields continue to slip.
SIA is focusing more on the regional and low-cost markets, along with new investment in its long-haul premium product, to drive improvements in profitability over the medium to long-term.
Competition in the long-haul passenger market is intensifying, while regional capacity increases have outstripped demand, leading to lower load factors.
SIA's passenger yields have been declining since 3QFY2012, reaching levels near those during the global financial crisis of 2009.
SIA's break-even load factor has been increasing, reaching 82% in 1QFY2014, compared to 80.7% in 1QFY2013 and 78% in 1QFY2012.
SIA's load factor on Southwest Pacific routes, including Australia, has been slipping, indicating that the market has not been able to absorb the surge in capacity.

SIA financials take another tumble when factoring in one-time items

On the surface SIA figures seem to be improving, albeit modestly. Group operating profits for the quarter ending 30-Jun-2013 (1QFY2014) were up 14% to SGD82 million (USD65 million). Net profits were up 56% to SGD122 million (USD97 million) and group revenues were up 2% to SGD3.84 billion (USD3.05 billion).

But the net profit was driven by one-off items including the sale of its 49% stake in Virgin Atlantic to Delta Air Lines (see background information). These gains were only partially offset by a write-down on four 747-400 freighters, which have been removed from service and are now for sale.

The increase in group revenues was driven by a SGD75 million (USD59 million) settlement agreement that was reached during the quarter and pertains to changes in aircraft delivery slots. Without these revenues, which came from an undisclosed manufacturer and relate to delivery slot changes in prior as well as current or future years, SIA would have seen its group revenues drop by SGD12 million (USD10 million) to SGD3.759 billion (USD2.98 billion). This would have amounted to an operating profit of only SGD7 million (USD6 million).

Prior to 1QFY2014, SIA had seen its group operating profit slip in nine out of the last 10 quarters. Since 3QFY2011 the group has only recorded an improvement in operating profit in 1QFY2013 and again in 1QFY2014 but the latter should not really be considered an improvement as it was only made possible by the SGD75 million settlement agreement.

SIA Group quarterly operating profit/loss (in SGD millions) for the last 14 quarters

Quarter	2010	2011	2012	2013
Jan to Mar	$241	$166	-$5	-$69
Apr to Jun	$251	$11	$72	$82
Jul to Sep	$345	$123	$70
Oct to Dec	$509	$157	$131

SIA passenger yields continue to fall in 1QFY2014, to SGD11.1 cents

The continuing slide in operating profits has been driven by a steady drop in passenger yields. Passenger yields at the parent airline have been down on a year-over-year basis every quarter since 3QFY2012.

In FY2013, yields were down every month and 3.4% for the full financial year. As CAPA reported in May-2013, SIA cited long-haul routes to Europe and North America as driving the decrease in FY2013.

In 1QFY2014, yields slipped further, to SGD11.1 cents (USD8.8 cents), compared to SGD11.4 cents (USD9.2 cents) in 1QFY2013 and 11.8 cents (USD9.4 cents) in 1QFY2012. Yields are now near the level they were during the global financial crisis of 2009.

SIA mainline quarterly passenger yields (SGD cents per km) for the last 10 quarters

Quarter	2011	2012	2013
Jan to Mar	12.1	11.7	11.2
Apr to Jun	11.8	11.4	11.1
Jul to Sep	11.7	11.4
Oct to Dec	9.2	9.1

The steady reduction in yields has pushed up SIA's annual break-even load factor from 74.8% in FY2011, to 77.4% in FY2012 and 79.3% in FY2013. The carrier's break-even load factor reached 82% in 1QFY2014, compared to 80.7% in 1QFY2013 and 78% in 1QFY2012.

SIA mainline quarterly break-even load factor (%) for the last 10 quarters

Quarter	2011	2012	2013
Jan to Mar	75.2	80.3	83.9
Apr to Jun	78.0	80.7	82.0
Jul to Sep	78.6	79.8
Oct to Dec	76.0	79.8

Throughout FY2013 SIA was able to mitigate the impact of falling yields by improving its passenger load factor. But in 1QFY2014, the carrier saw its load factor drop by 1.5ppt to 79.5% as RPKs were up 2% while ASKs increased by 4%.

In the last four months SIA has reported a lower year-over-year load factor. This ended a streak of 13 months (beginning in Feb-2012) which SIA had reported a year-over-year improvement in load factor.

SIA monthly passenger load factor: Jan-2011 to Jun-2013

Despite the drop in load factor and yields, the parent airline company was still able to turn in 1QFY2014 an operating profit of SGD89 million (USD71 million), an improvement of 6% compared to 1QFY2013. But this was likely only made possible by the SGD75 in revenues generated from the settlement related to aircraft delivery slots.

Outlook for passenger and cargo yields remains cloudy

The pressure on yields is expected to continue, resulting in a difficult outlook for the remainder of FY2014. While SIA's streak of annual profits is probably not in jeopardy (the group has never incurred a full year loss) the combination of weak yields and lower load factors could lead to a reduction in profits below the already low levels from last year.

In reporting its 1QFY2014 figures, SIA warned: "Forward passenger bookings for the next few months are expected to be higher against the same period last year and in line with the planned increase in passenger capacity. However, yields are expected to be weaker as a result of the intense competitive environment."

The group also warned of continued weakness in the cargo market, saying, "demand is expected to remain depressed, in turn placing pressure on loads and yields".

SIA Cargo reported an operating loss of SGD40 million (USD32 million) for 1QFY2014, a slight improvement over the SGD49 million (USD39 million) loss in 1QFY2013. During the quarter the struggling subsidiary removed four more freighters from its all-747 fleet, leaving it with only nine aircraft.

SIA Engineering saw a slight reduction as its operating profit dropped from SGD34 million (SGD27 million) in 1QFY2013 to SGD28 million in 1QFY2014. SilkAir posted an operating profit of SGD14 million (USD11 million), a slight decrease compared to SGD18 million (USD14 million) in 1QFY2013.

Falling SilkAir load factor shows potential over-capacity in regional market

The SilkAir figures for 1QFY2014 are discouraging given that the carrier operates only within Asia-Pacific, a market where demand continues to grow rapidly and market conditions are thought to be relatively favourable. The SIA Group has been accelerating expansion at SilkAir over the last year as part of a strategy to focus more on the region, using SilkAir's all-narrowbody fleet, SIA and new medium/long-haul LCC Scoot.

SilkAir ASKs were up 17% year-over-year in 1QFY2013 but RPKs were up only 6%. As a result, the carrier's load factor dropped by 6.8ppt to 69.6%.

This accelerates a trend at SilkAir which started in 2HFY2013 and provides a strong indication that the market has not been able to absorb all the additional capacity.

In FY2013, to 31-Mar-2013, SilkAir's ASKs jumped by 20% while RPKs were up by 17%, resulting in a 2.1ppt drop in load factor to 73.6%. In 4QFY2013, RPKs at SilkAir were up 8% on a 16% increase in ASKs, leading to a 5ppt drop in load factor to 70.3%

SilkAir monthly load factor: Jan-2011 to Jun-2013

The SIA Group plans to continue to pursue double-digit capacity expansion at SilkAir over the medium to long term. SilkAir is slated to take by the end of FY2014 the first of 54 Boeing 737s, which will be used to support rapid expansion as well as replace the carrier's A320 fleet. SilkAir currently operates 23 A320 family aircraft, one of which was delivered in 1QFY2014.

While increasing yields have helped offset some of the recent load factor declines - SilkAir's yields reached SGD14.1 cents (USD11.2 cents) in 1QFY2014 compared to SGD13.6 cents (USD10.8 cents) the year prior - question marks are starting to emerge over the ability of SilkAir to proceed with its rapid expansion without impacting SIA Group's overall profitability.

The SIA Group needs a profitable SilkAir as prospects in the long-haul passenger market and the cargo market remain relatively bleak. It also needs traffic feed for its long-haul mainline flights and may be suffering from the same syndrome as the European network airlines, with LCCs eating into short-haul yields.

Australian market emerges as potential concern for over-capacity as load factor drop

SIA also has been focusing mainline capacity expansion in the Asia-Pacific region, particularly Australia. SIA's seat capacity to Australia was up about 17% in Jul-2013 compared to Jul-2012 levels, according to CAPA and Innovata data. But its load factor on Southwest Pacific routes has been slipping in recent months, which indicates that market has not been able to absorb the surge in capacity.

SIA mainline reported in Jun-2013 a 5.7ppt drop in its load factor for the Southwest Pacific sub-region, which includes Australia and New Zealand, to 76.8%. This follows a 1.9ppt drop in May-2013 and a 4.3ppt drop in Apr-2013.

While rival Qantas has technically dropped capacity to Singapore by about 25% year-over-year, the number of seats that the Australian carrier allocates to the local Singapore-Australia market has increased significantly as its flights to Singapore no longer continue to Europe.

Before dropping its Singapore to London and Singapore to Frankfurt flights earlier this year, approximately half of Qantas' Singapore-Australia passengers originated in Europe. With Qantas having increased by about 50% the number of seats available in the local Singapore/Southeast Asia-Australia market, competition has intensified significantly for SIA just as the carrier has added a significant amount of capacity.

Australia to Singapore capacity by carrier (one-way seats per week): 19-Sep-2011 to 19-Jan-2014

SIA's load factor and performance in Australia could come under more pressure in 2QFY2014 as the carrier in Jul-2013 introduced a fourth daily flight to Melbourne and two more weekly frequencies to Adelaide for a total of 12.

Another feature in the Australian market is the sudden, unwelcome fall in the Australian dollar of around 10% in the space of a few weeks, diluting the value of a large proportion of sales to Singapore and beyond. This will impact significantly over coming months.

Australia, India and Indonesia are the markets seeing almost all of SIA's additional mainline capacity in FY2014. While overall these markets are growing and are more attractive than markets outside Asia-Pacific, SIA will need to overcome increasing competition.

In the India market, SIA is adding a third daily flight to Delhi in Oct-2013 while SilkAir is adding a fourth weekly flight to Visakhapatnam. The additional capacity to Delhi is made possible by an updated air services agreement that increases the capacity allotment for Singapore-based carriers by 10%.

SIA Group to be impacted by 30% surge in Singapore-Indonesia capacity

In the Indonesia market, SIA introduced in Jul-2013 a ninth daily service to Jakarta and a fourth daily flight to Bali and took over one of SilkAir's two daily flights to Surabaya. SilkAir also is expanding significantly in Indonesia, adding two new markets (Semarang and Makassar) and adding capacity to Medan and Palembang.

But nearly every carrier in the Singapore-Indonesia market is also increasing capacity, using traffic rights made available by the signing of a new air services agreement between the two countries in early 2013. In Sep-2013, there will be about 116,000 one-way weekly seats between Singapore and Indonesia, an increase of about 30% compared to 1H2012 or Sep-2012 levels, according to CAPA and Innovata data. Capacity in the market could increase further by the end of 2013 as some carriers have not yet filed capacity increases.

Singapore to Indonesia route total and capacity by carrier (one-way seats per week): 19-Sep-2011 to 19-Jan-2014

SIA needs to be patient with Scoot

Scoot is also entirely focused on the Asia-Pacific market, with all of its capacity allocated within the region including about 25% in the Australia market. But the LCC subsidiary, which launched operations in Jun-2012, plans to take a rest from expansion over the next 18 to 24 months as it waits for its new fleet of 787s.

Scoot in 1QFY2014 took delivery of its fifth 777-200 but has decided against adding more 777s, instead it is now waiting for 20 787s, which will be delivered from 3QFY2015 and be used to replace its five 777s and subsequently for growth. Scoot has been successful from a load factor and market stimulation standpoint but has had very low yields and relatively high costs because the 777 is not the ideal aircraft for the LCC model.

The SIA Group has not provided separate figures for Scoot since the quarter ending 30-Jun-2012, when the LCC incurred an operating loss of SGD12.5 million (USD10 million). Scoot and other subsidiaries collectively had an operating loss of SGD9 million (SGD7 million) in 1QFY2014 compared to SGD16 million (USD13 million) in 1QFY2013. As other subsidiaries generally are close to break even, it is safe to assume Scoot remains in the red.

Scoot, however, remains an important aspect of the new SIA Group strategy that will need time to bed down. As CAPA reported in Feb-2013:

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.

... 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.

SIA's new strategy also includes continuing investments in the long-haul market, confident market conditions in Europe and North America will eventually recover. SIA is introducing a new long-haul cabin product in Sep-2013 which the group hopes will cement is leading position in the premium end of the market. But competition at the top end of the market continues to intensify and the product gap SIA enjoyed for several years over competitors has narrowed significantly.

SIA also needs to be patient with Tiger

SIA is also now competing against intensifying competition at the bottom end of the market. Southeast Asia's LCC fleet is projected to expand in 2013 by about 25%, reaching over 500-plus aircraft by Dec-2013. This huge influx of additional aircraft risks leading to over-capacity in certain markets.

The SIA Group has increased its involvement in the short-haul LCC market by investing SGD228 million (USD181 million) during 1QFY2014 in a rights issue at Tiger Airways Holdings. SIA already had a 33% stake in Tiger Airways Holdings, which includes 100% subsidiary Tigerair Singapore and has minority stakes in affiliate carriers in Australia, Indonesia and the Philippines.

As CAPA recently reported, Tigerair Singapore is adding six A320s in FY2014, representing 30% growth. The accelerated expansion at Tigerair Singapore will lead to more rapid capacity expansion in Singapore's already relative mature LCC market. Tigerair Singapore turned a very small profit in 1QFY2014 while the group was again in the red due to losses at all three affiliate carriers.

Things could get worse for SIA Group before they get better

The additional capacity from Tigerair Singapore is mainly being allocated to existing short-haul routes which are also served by SIA or SilkAir. The SIA Group strategy of focusing growth within Asia-Pacific using two budget brands (Tiger and Scoot) and two full-service brands (SIA and SilkAir) is logical.

But the expansion risks leading to losses to what is now the most profitable market for the group.

With SIA unlikely to see any near-term improvement in the cargo or long-haul passenger sector, losses within Asia-Pacific would turn into losses overall for the group. While the group's medium and long-term position remains relatively strong, FY2014 could prove to be a challenging year for SIA.

(Exchange rate used 1USD=1.26SGD)

Background information

SIA Group financial highlights: 1QFY2014 vs 1QFY2013

SIA Group operating highlights: 1QFY2014 vs 1QFY2013