SINGAPORE AIRLINES: From highest fuel hedge ratio to the lowest

Excerpts from analysts' report

Morgan Stanley analysts: Daniel L Lau & Edward H Xu, CFA

Quick Comment – Capacity discipline bestows pricing flexibility: A strong yield environment was one of the major positives for SIA Group. SIA mainline was able to grow pax yields at 2.7% YoY, while SIlkAIr saw a 7.6% increase in pax yields.

SIA: Higher yields from capacity reduction in 2015 and 2016 as aircraft are sent for retrofitting. NextInsight file photoAccording to SIA, the yield improvement was largely due to capacity discipline, which led to the increase in base fares. In particular, premium yields fared much better compared to economy yields, suggesting a strong corporate travel demand environment.

While stronger yields came at the expense of load factors, the yield improvement more than offset the decline in passenger load factors. SIA is now trying to find a good balance between yields and loads, which reflects a healthy demand environment.
 

Maximising revenue with premium economy class: We see further yield upside as SIA introduces its premium economy class, which will be launched in August 2015. SIA will be replacing its class C economy class seats with the premium economy class, which in our view optimises the real estate on the aircraft.

This reduces direct competition with LCCs on economy seats and at the same time allows SIA to target budget-conscious corporate travellers. We expect further yield upside from current levels amid:

i) capacity reduction as SIA takes out its aircraft for retrofitting in 2015 and 2016; and
ii) contributions from premium economy and higher load factors upon successful implementation.

The only downside from introducing premium economy class is that SIA will have to take a one-time noncash provision on de-recognising its capex on existing aircraft, which will have an impact on earnings in F2016.
 

» From highest fuel hedge ratio to the lowest: SIA now has the lowest fuel hedging levels among ASEAN peers. Most ASEAN airlines we spoke to have hedged 50% of jet fuel requirements at US$85-88/bbl. SIA is now 19% hedged at US$114/bbl and 18% hedged at US$98 Brent crude/bbl. Holding the view that fuel prices remain lower for longer, we think that SIA will be likely to ensure significant fuel cost savings as it enters into F2016.   » Maintain OW: We think that investors should accumulate on weakness. Despite giving back some of its recent gains, we think that SIA has a longer term turnaround story as it executes its long-term initiatives. SIA has yet to benefit from lower fuel prices, which is likely to drive margin expansion and share price performance.