as well as to outline the background behind its S$472 mn, take-over offer for the 44% of Tiger Airways (TR) that it does not already own.
● The presentation concurred with our view that most of the benefits of low oil prices have been lost in the shape of lower fares, but that traffic volumes have been stimulated as a result. Moving into 2H, however, fuel savings should accelerate meaning a substantial pick up in 2HFY3/16 earnings.
● The increased investment in TR should generate synergy benefits in excess of S$10 mn a year and will close at the end of December. Management highlights that it is about fully accessing the benefits of SQ's parentage and growing the budget network rather than just being a cost-driven process.
● Overall, we were encouraged by the company's renewed focus on growth, especially its new strategies within the long haul business. Our OUTPERFORM rating and T/P of S$14/share are unchanged.
Fuel, FX and falling fares - drivers of 2Q and 2H
Your author has been frequently disparaging of SQ's strategy (or apparent lack thereof) but was pleasantly surprised by some of its initiatives to recover revenue and earnings momentum. Acquiring the balance of TR fits into SQ's more confident view of its place in the airline world. It also complements plans to expand the parent network leveraging SQ's incoming A350, A380 and A350 ULH aircraft to wrest back (particularly premium) demand on its expanding retinue of core long-haul destinations. As far as the result was concerned, management neatly juxtaposed what it had saved in fuel with the decline in its parent company revenues – both astoundingly similar in 2Q at ~S$230 mn.
The 4.6% drop in parent yields that accounted for this revenue gap did, however, reverse traffic declines from 1Q by around 5% - reflective of the market's demand elasticity. Parent company earnings were off 35% because of the influence of a weak SGD, which added S$142 mn (prior to hedging gains of S$62 mn) to 1H operating costs, particularly in lease, MRO and handling costs, which is where the USD exposure is concentrated. These factors are all expected to feature again in 2HFY3/16. However, jet fuel surcharge reduction-led discounting is expected to abate as most of this occurred the March quarter of this year where the fall in the fuel price was most concentrated. Additionally, 50% of SQ's expensive jet fuel hedges have now been consumed, leaving it ~51% hedged at US$90/bbl for 2H vs. 65% hedged at US$116/bbl this time last year. This means that jet fuel benefits will accelerate in 2H.
Tiger – no takeover was not an option
TR is a low cost airline domiciled in a high cost location and without full access to the benefits of its SQ parentage was likely to continue limping as it completes with other LCCs in Southeast Asia with much lower cost bases. Providing the benefits ownership without controlling the vast majority of TR's equity, however, was a subsidy from SQ shareholders to TR shareholders – so runs the logic of SQ's offer for the balance of the company.
In the context of recent transactions, the premium offered to TR shareholders appears compelling and most closely approximates that made by IAG for Aer Lingus last year in scale, although SQ already has control of TR and Aer Lingus is a much more profitable company, hence the lower premium offered for TR. It is more generous than that offered to minority holders in Malaysian Airlines by Khazanah, although arguably they had even less liquidity than holders of TR. TR stockholders are being presented the opportunity to exchange their TR stock into SQ stock at the 30-day VWAP (S$11.10) if they wish to keep "skin" in the airline game. There is little change to SQ's balance sheet or P&L footings from the acquisition (as TR is already consolidated), with lower minority claims likely to offset lower interest income (we have assumed the transaction is all cash at this stage). When pressed, management conceded that the acquisition was accretive (i.e., would result in an earnings yield of 6.5% or greater, that is S$10 mn or more in annual synergy benefits).
While the full absorption of TR by SQ will end its sorry chapter as a listed company, we see it as a sign the SQ is getting its "mojo" back and that it is taking charge of its destiny (as much as any airline can make that claim) rather than letting its competitors dictate terms. (Read Report)
1) Singapore Airlines - Risks skewed to the upside by CIMB Research, published on 9 November 2015
2) Singapore Airlines - Pressures on parent airline to stay by OCBC Investment Research, published on 9 November 2015
Source : Credit Suisse Asia Pacific Equity Research