31-Jul-2014 3:15 PM

Singapore Airlines SWOT: challenges continue as competition intensifies as shown by 1QFY2015 results

Analysis

Singapore Airlines (SIA's) profits have dropped steadily over the last several years, driven by intensifying competition and challenging market conditions. Profits were again down in the quarter ending 30-Jun-2014 (1QFY2015), with the group recording a 52% drop in operating profits to SGD39 million (USD31 million).

But SIA remains one of the most respected airlines in the world and has never incurred an annual loss in its 42 year history. There is no denying SIA has faced in recent years - and continues to face - its biggest ever challenges. But SIA has made several strategic adjustments since Goh Choon Phong took over as CEO at the beginning of 2011.

SIA's glory years of industry leading double digit profit margins are unlikely to return but once its new strategy beds down the group should be better positioned for long-term profitability and growth. SIA still has several core strengths and plenty of opportunities. But more challenges also lie ahead and all of its recent strategic adjustments come with risks. In this SWOT analysis we incorporate SIA's 1QFY2015 reporting.

Summary

Singapore Airlines (SIA) has faced challenges in recent years, resulting in a drop in profits.
SIA remains one of the most respected airlines in the world and has never incurred an annual loss.
SIA has a strong premium product and brand, which has been a key differentiator.
SIA has successfully implemented a multi-brand model, including the launch of Scoot and the growth of SilkAir.
SIA has a strong presence in the Europe and Australia/South Pacific markets, giving it a competitive advantage.
SIA faces challenges from Gulf carriers, overcapacity in the regional market, and increased competition for premium traffic leadership.

Singapore Airlines Group - Strengths

a) Premium product and brand

SIA for years has been at or near the top in premium product rankings. Its leading premium product remains an important differentiator although the gap has been closing.

SIA's brand, meanwhile, remains one of the best known - if not the best known - brand in the industry. Airlines around the world use SIA as the benchmark for product and brand; there cannot be a higher compliment.

b) Multi-brand model (including Scoot and SilkAir)

SIA has been one of the leaders of the multi-brand strategy trend which has emerged over the last decade in the Asian airline sector. SIA was not the first full-service airline group in Asia-Pacific to establish an LCC subsidiary but it was an early adapter, putting it in position to benefit from the huge growth at the bottom end of the market in Southeast Asia.

SIA launched Scoot in mid-2012, which became the world's third long-haul LCC after Jetstar and AirAsia X. Four airline groups including one in Asia have since followed with widebody low-cost subsidiaries or operations. Scoot is not yet profitable but as an early mover the SIA Group is well positioned as the long-haul LCC sector continues to evolve.

Meanwhile, full-service regional subsidiary SilkAir has been growing rapidly and been consistently profitable. A decade ago sceptics predicted SilkAir's demise as LCCs started penetrating the Singapore and Southeast Asian markets. About 60% of Singapore's short-haul market is now controlled by LCCs. But SilkAir has quadrupled in size over the last decade while mainline SIA has maintained roughly the same size.

SilkAir has been profitable for 13 consecutive years and has had a higher profit margin than the overall SIA Group for the last five years. Profits have fallen since a record profit in FY2011, it too a victim of the overcapacity that now plagues Singapore's short-haul market. SilkAir's operating profit was again down in 1QFY2015 as the carrier eked out a SGD2 million profit (USD1.6 million) compared to a profit of SGD14 million (USD11 million) in 1QFY2014. But SilkAir has remained in the black while Singapore's LCCs have slipped into the red, another example of the full-service regional carrier outperforming its competitors.

(Note: SIA short-haul LCC affiliate Tigerair is the fourth brand in SIA's brand matrix but unlike SilkAir or Scoot is not a wholly owned subsidiary and has been more of a weakness.)

c) Europe market strength

SIA remains the largest Asian airline in Europe, an important market particularly for its premium positioning. SIA now has four daily flights to London, where it has continued to expand over the last decade by introducing the A380 and more recently a fourth daily frequency. The A380, SIA's flagship, is also now used to serve Frankfurt, Paris and Zurich.

SIA has 11 other European destinations which are served with 777-300ERs and 777-200ERs. It currently has almost 70,000 weekly seats to and from Europe, more than any other Asian carrier.

SIA also has more destinations in Europe than any of its Asian competitors. Competition for Asia-Europe traffic is more intense than ever, thanks to the rapid expansion of the Gulf carriers. But SIA's bigger and stronger presence in Europe gives it scale and an advantage over its other Asian competitors.

Top 10 Asian airlines in Asia-Europe market ranked by seat capacity: 28-Jul-2014 to 3-Aug-2014

Rank	Airline		Total Seats
1	SQ	Singapore Airlines	69,361
2	TG	Thai Airways	66,476
3	CA	Air China	63,698
4	CX	Cathay Pacific	45,168
5	KE	Korean Air	36,934
6	MH	Malaysia Airlines	29,208
7	AI	Air India	26,804
8	NH	All Nippon Airways	26,474
9	CZ	China Southern Airlines	24,130
10	9W	Jet Airways	24,116

d) Australia/South Pacific market strength

SIA is also the largest Asian airline in Australia and New Zealand. The group currently has about 85,000 weekly seats on seven Australian routes (includes Scoot and SilkAir although about 85% of this capacity is flown by SIA mainline). SIA has another 11,000 weekly seats and two destinations in New Zealand. This makes SIA the second largest foreign airline in the Australian market (after Emirates) and the fourth largest in New Zealand (after Qantas, Virgin Australia and Emirates).

The Australia-Asia and broader Australia-Europe market has become extremely competitive with overcapacity in several markets, forcing SIA to make some recent adjustments. But SIA still has a strong position and well known brand in Australia and New Zealand which it should continue to be able to leverage. Strong partnerships with Virgin Australia (forged in 2011) and now Air New Zealand (to be implemented in late 2014 pending final approval from competition authorities) gives SIA a further competitive advantage in these key markets.

Southwest Pacific (Australia and New Zealand) currently accounts for over 20% of SIA's ASKs while Europe accounts for about 32% (includes Western and Eastern/Central Europe). A 21% equity holding in Virgin Australia and associated partnership also help entrench SIA's presence in the vital Australian market.

Singapore Airlines capacity (ASKs) by region: 28-Jul-2014 to 3-Aug-2014

e) The Singapore Changi hub is a premium facility

Competition for intercontinental connections passengers has intensified significantly due to the rapid rise of the Gulf carriers and their hubs. But Singapore Changi remains a leading hub for transit passengers, providing a product and network which remains at or near the top of the industry.

SIA and Changi have been transitioning their hub strategy to focus more on regional connections within Asia. This has helped offset drops in other increasingly competitive markets such as kangaroo route between Australia and Europe (for example as Qantas moved its offshore hub to Dubai as part of its partnership with Emirates).

Inbound and outbound demand for Southeast Asian is growing fast. SIA should be well positioned to tap into this growth as it remains the leading flag carrier from the region while Changi is still generally regarded as the region's leading hub.

Singapore is also investing heavily in new airport infrastructure, including a third runway and two new terminals. This should enable Changi to again get ahead of the growth curve and give Singapore (and therefore SIA) a competitive advantage over other hubs in the region, some of which have been slow to respond to growing infrastructure constraints.

f) SIA has been profitable for every year it has operated

SIA has been profitable every year since it was established over 40 years ago. This is an impressive and unmatched achievement.

SIA profits have been unusually modest four out of the last five years and have been generally below normal levels since early last decade. SIA's stock has slipped by 32% over the last four years while Cathay Pacific's stock has slipped by about 15% over the same period. Cathay's operating profit over the last four years has been roughly double SIA's operating profit.

Traditionally SIA's performance has been compared most often to Cathay Pacific. But such comparisons have become uneven as the two groups have evolved differently in recent years. Cathay has a vastly different geographic position as it is at the doorstep to China and operates in a capacity restricted market that has not yet been penetrated by LCCs.

Among Southeast Asian flag carriers, SIA continues to be the standout by a wide margin. SIA was again the most profitable flag carrier in Southeast Asia in the six months ending 30-Jun-2014. SIA and SilkAir profits have been on the decline but relative to the other full-service airlines competing in the extremely challenging Southeast Asian marketplace both are performing well.

SIA Group annual net profit (in SGD): FY2008 to FY2014

Singapore Airlines Group - Weaknesses

a) Tigerair has been a missed opportunity

SIA initially missed a chance to establish short-haul LCC group Tiger Airways (now Tigerair) as a wholly owned subsidiary, lacking the confidence to invest fully and becoming only a minority shareholder. The result has been that Tigerair was not integrated into SIA's group strategy from the start. In the absence of a complete commonality of interest, Tigerair arguably did as much damage to the mainline carrier as any other LCC which entered the Singapore market.

Tigerair has been consistently unprofitable in recent years, dragging down SIA Group results. SIA now owns a 40% stake in Tigerair, having increased its original stake after participating in a pair of rights issues which failed to generate any interest except from SIA.

Tigerair Singapore has been unprofitable for four consecutive quarters and has been the biggest contributor to the overcapacity now plaguing Singapore's short-haul market. Tigerair Singapore has become a critical part of the SIA Group brand matrix and is particularly important for Scoot, yet still has some way to go. Scoot requires short-haul feed to be sustainable. SIA has been increasing its involvement in Tigerair, now led by an SIA veteran, as the LCC attempts a turnaround. SIA cannot afford to see Tigerair simply vanish. If Tigerair is unable to right the ship SIA will likely have to take over the LCC group.

Tigerair's overseas joint ventures also have been disastrous, impacting SIA Group's overall profitability. Tigerair's focus is now on the Singapore market as its Philippine affiliate was sold and its Indonesian affiliate was closed earlier this year after incurring heavy losses. In 2013 a 60% stake in Tigerair Australia, which has been unprofitable since it was established in 2007 and was particularly impacted by a 2011 grounding, was sold to SIA partner Virgin Australia.

The new focus on Singapore is important for SIA as it clearly needs a healthy short-haul LCC in its home market. But the failure of the overseas ventures means SIA has lost out in participating in the budget boom in other Asian markets. While SIA Group is now playing in Thailand's budget market through Scoot's new long-haul LCC joint venture with Nok Air (NokScoot), it is probably too late for the group to establish itself any Southeast Asian short-haul markets outside Singapore. This is a weakness that will be extremely difficult to reverse, leaving the SIA Group out of the multi-hub strategies being woven by AirAsia and Jetstar.

b) Mainline growth opportunities are limited

Since the turn of the century SIA's passenger numbers have grown at an average rate of less than 2% per annum. SIA's passenger traffic in 2013 was also below 2008 levels (excludes SilkAir).

The opportunities for passenger growth at the SIA brand remain extremely limited. SIA's home market is relatively mature and over the last decade has seen rapid LCC passenger growth, but very slow full-service growth. SIA has traditionally relied heavily on sixth freedom traffic but transit growth across its all-widebody network has been limited by intensifying competition, particularly from Gulf carriers.

Singapore Airlines annual passenger traffic: 2008 to 2013

c) North America is a difficult market to access

SIA cut its non-stop services in 2H2013 to Los Angeles and Newark, leaving it with only 33 weekly one-stop flights to four North American destinations (New York, Houston, Los Angeles and San Francisco). While SIA is now the largest Asian carrier in Europe, it is only the ninth largest Asian airline in the US market, having slipped in the rankings by several places as it gradually cut its North American operation over the last several years. Previously SIA also served Chicago, Las Vegas and Vancouver.

SIA is at a geographic disadvantage compared to its North Asian (as well as Philippine) peers, which are able to serve North America non-stop without special ultra long-range aircraft. While its all-premium non-stop services performed relatively well from a load factor standpoint and was an important selling point in the corporate space, SIA discovered it was simply impossible for such long flights to be profitable.

The prospects of a return to non-stops to North America are virtually nil. As a result SIA will have to rely on fifth freedom rights to pursue one-stop growth. But such rights are challenging to secure as markets such as China, which would be ideal transit stops, for SIA are not open. One-stop flights are also costly, putting SIA at a further competitive disadvantage when it comes to the North American market.

d) China strategy is still incomplete and difficult to engineer

The SIA Group has a large operation to China, consisting of almost 60,000 weekly full-service seats. But growth has been relatively slow, with capacity up only about 30% over the last eight years. In the same period the Cathay Pacific group has expanded in mainland China by nearly 50% while the three main Gulf carriers meanwhile have quadrupled their capacity to China, taking away market share from SIA in connecting markets.

China is still a strategic market for SIA and the group has been able to tap new secondary markets using Scoot, which now operates 12 weekly flights to four Chinese destinations. But attempts to invest in Chinese airlines have failed significantly and the current political environment makes such deals, which are important for SIA's long-term position in the key Chinese market, nearly impossible to pull off.

SIA also has just one codeshare partner in China, Shenzhen Airlines, which covers only the Singapore-Shenzhen route. SIA does not partner with any Chinese carriers on domestic connections beyond its Chinese gateways. Its inability to find codeshare and strategic partners along with its declining market share compared to rivals means China is no longer the strength it once was.

e) Joint ventures have always been a weak point

SIA has typically been a very reluctant partner, perhaps because of fears that its brand would be diluted. It does not participate in any of the metal neutral anti-trust joint ventures which have become common in the trans-Atlantic and trans-Pacific markets and have also started to penetrate the Asia-Europe market. Several of SIA's Japanese and European competitors are participating in these ventures, giving them a competitive advantage, particularly on SIA's US routes.

So far SIA only has joint ventures with two small carriers which do not serve Singapore (SAS) or will have just one daily flight to Singapore (Air New Zealand). SIA's other close partner, Virgin Australia, also does not serve Singapore.

Singapore Airlines Group - Opportunities

a) Partnerships can be expanded

SIA has an opportunity to forge more and deeper partnerships, improving an area which traditionally has been a weakness. SIA has already evolved in this area under Mr Goh, who has forged eight new codeshare partnerships since becoming CEO, while expanding several existing partnerships.

But most of its partnerships are not comprehensive and SIA remains a relatively passive member of the Star Alliance. Of its 24 partners, currently only 11 serve Singapore.

The recent deepening of its partnerships with Air New Zealand and Turkish Airlines could be followed with other similar deals. More joint ventures are also likely as SIA now has only two rather limited joint ventures with SAS and Air NZ. SIA still does not have any partners from the Middle East and has only one limited partnership with a Chinese airline.

b) Premium economy product should boost competitiveness

SIA revealed in May-2014 that it has been working to develop a premium economy product which it aims to introduce on long-haul aircraft starting in 2H2015. After several of years of resisting joining the growing number of airlines with premium economy cabins, SIA finally recognised that a premium economy offering is necessary to be competitive, particularly in the corporate sector.

In key SIA markets such as Australia and the UK, several of its main competitors now offer a premium economy product. The premium economy market has gradually matured over the years, making it less of a niche play and a product regularly requested by corporate travel buyers.

SIA has identified specific market segments for premium economy, primarily the corporate and upmarket leisure sectors, and plan to offer it on long-haul and some medium-haul segments. The revenue upside that premium economy presents is a major opportunity although there is also always a risk of cannibalising business class.

If SIA gets the product right and chooses the right routes, yields should get a much needed boost after a period of declines. Premium economy will also enable SIA to reduce economy class seat counts at a time when intense competition has made it difficult to secure break-even yields and load factors in economy.

c) India offers unique growth promise

SIA has established a joint venture with Indian conglomerate Tata which aims to bring to market a new full-service airline by the end of 2014. India is a strategic market for SIA which the group has over the years repeatedly tried to enter. While there are huge risks in launching an airline in the Indian market, which remains generally unprofitable due to unfavourable regulations and fundamentals, there is also huge potential upside.

SIA needed to make a move and invest in an airline in one of its core markets. With China access elusive at least at this stage and India's airline sector finally opening to foreign investors, SIA took advantage of a rare window of opportunity to combine with one of India's largest companies (which was also the founder of now-nationalised Air India). The new airline should help unlock new growth opportunities for the group.

d) Long-haul low-cost operations can become core to long term evolution

The 2012 launch of Scoot opened up a new relatively untapped sector of the market with huge growth potential. Scoot has been handicapped by having to use the very large 777-200s taken from SIA's fleet; it has so far grown conservatively, recognising the limitations of its current fleet. But the upcoming delivery of the first of 20 787s will improve the economics of Scoot's operating model significantly, expanding route options, unlocking faster growth and potentially profitability.

Meanwhile, Scoot has forged a joint venture with Nok to establish a new long-haul LCC based in Thailand, the second of potentially multiple overseas markets for Scoot. NokScoot will allow Scoot and therefore the SIA Group to tap into the Bangkok market, which despite recent challenges offers bigger long-term growth prospects than Singapore. SIA sees Bangkok as a more popular destination for budget travellers than Singapore and the new Bangkok hub will be able to cater to a slightly different customer base.

e) Changi Airport's transfer limitations

Neighbouring Malaysia-based AirAsia and long-haul AirAsia X have, with their hub airport, Kuala Lumpur International Airport, have rewritten the rulebook for low cost-to-low cost transfer operations. With the help of a newly opened hybrid terminal KLIA2, long haul LCC AirAsia X is today able to claim a remarkable 46% transfer rate, either onto AirAsia or to its own services.

Changi has been working to improve its facility in supporting large scale low cost transfer, but is finding it hard to adapt from its very high quality full service role. A special purpose LCC terminal was closed in 2012, so that all LCC operations were transferred to the main terminals. If it is able to emulate KLIA's success, in tandem with a reformulated Tigerair-Scoot relationship, the SIA group should be a major beneficiary.

Singapore Airlines Group - Threats

a) Competition from Gulf carriers

The rapid rise of Gulf carriers is the largest single driver of SIA's fall in profitability and growth over the last decade. Gulf carriers have significantly impacted some of SIA's biggest markets, including Australia-Europe and Asia-Europe. It also has forced a significant cutback in SIA's Middle Eastern operation.

Gulf carrier competition will only intensify further as their networks and hubs continue to grow. SIA has responded by focusing more on regional growth and the budget end of the market. But the Gulf carriers remain huge and aggressive competitors for both premium and economy passengers in a large portion of SIA's markets.

b) Overcapacity in the regional market

The Southeast Asia market has been suffering from overcapacity for the last year. Overly ambitious expansion by SIA competitors, including both full-service flag carriers and LCCs, has led to excess supply. Demand is still on the rise in Southeast Asia, boosted by economic and middle class growth, but capacity has been added at too swift a pace across several short-haul, medium-haul and long-haul markets.

Some airlines are starting to make adjustments but competition is expected to remain intense and at times irrational (as they expand "strategically") for at least the short to medium term. Also airline groups like Indonesia's Lion Air are expanding across borders. As a result SIA's yields and load factors will continue to be under pressure.

c) Increased competition for premium traffic leadership

SIA has always been a leader in the premium space but competitors have narrowed the gap considerably in recent years. SIA still has one of the leading premium products in the industry but there are a lot more airlines at or near the top of the class.

The business class product on most of the SIA long-haul fleet was introduced back in late 2006. At the time it represented a leap beyond competing products. But several airlines in recent years have introduced similar business class products, closing the gap with SIA. Even some European and North American carriers, which had been multiple generations behind, have closed the gap.

SIA did introduce a new cabin product in 2H2013 on its latest batch of 777-300ERs. But this product only represents a small improvement beyond the earlier product, which is now on most of its 777-300ER as well as all its A380s and 777-200ERs. SIA is now working on a new premium product which will likely usher in a bigger change. But other airlines are also now developing new premium products which could emerge as the new trendsetter.

d) Rival hubs are gaining strength

While Changi is still one of the world's leading airports, other airports in the region have been growing faster and in some cases have been more innovative at pursuing growth. Kuala Lumpur International in particular has grown much faster over the last 18 months, with growth of 19% in 2013 compared to 5% for Changi and 10% in 1H2014 compared to only 1% for Changi.

Increased transit traffic, including LCC transit traffic, has driven the growth at Kuala Lumpur. As noted above, Changi has been slow to promote LCC transit traffic, which is needed to unlock growth at Tigerair and Scoot (and therefore the SIA Group).

Changi is also known to be a relatively more expensive airport (when also factoring in charges from service providers) putting it at a competitive disadvantage in Southeast Asia. Changi and the Civil Aviation Authority of Singapore are responding through a series programmes offering various rebates and incentives. But it may not be enough to stem the tide. SIA's future is interlocked with Changi and Singapore overall, so there is an imperative that suggests Singapore will not willingly fall behind. For now though, that is what is happening.

Outlook: short-term challenges following a drop in fiscal 1Q profits - but long-term opportunities

SIA on 30-Jul-2014 reported a 52% drop in group operating profit for 1QFY2015 to SGD39 (USD31 million). Net profit excluding non-operating and exceptional items was down 71% to SGD35 million (USD28 million)

The results are a further indication of the challenges SIA faces. SIA cited a weak revenue environment, which impacted yields. Both group and passenger revenues dropped despite an increase in RPKs and relatively flat load factors.

The group recorded lower operating profits at the parent airline as well as at SilkAir and SIA Engineering. Meanwhile SIA Cargo was again in the red although its loss narrowed compared to 1QFY2014.

SIA Group operating profit/loss (in SGD millions) by subsidiary: 1QFY2015 vs 1QFY2014

SilkAir's load factor for the quarter was only 69.5% while SIA's load factor was 77.7%. In both cases the load factor was marginally down compared to the same period last year.

SIA and SilkAir operating highlights: 1QFY2015 vs 1QFY2014

In its results announcement SIA warned that "aggressive fares and capacity injections from competitors will continue to place pressure on yields".

It stated the outlook has become even more challenging.

SIA is in a tough spot but still in a relatively good position compared to other full-service airline groups in Southeast Asia. SIA has remained the most profitable flag carrier in Southeast Asia and has a strong balance sheet while some key competitors in the region are now looking to restructure and recapitalise.

The short-term outlook remains bleak but SIA has opportunities to improve its position over the medium to long term. It is now responding to several of these opportunities as part of its new strategy. But it has always been a relatively conservative airline, where fundamental change came only slowly and it will take time - likely a couple of years - for there to be any tangible results. In Asia's aviation washing machine there are risks and challenges that can throw any new business plan off course.

SIA's glory days are surely behind it but it would be premature to rule out significant improvements, including increased profits and faster growth, after the dust settles on the current turbulent period.

Background information

Here is a sampling of related analysis reports CAPA has published on the SIA Group over the last couple of years (in reverse chronological order):