UOB Kay Hian analyst Roy Chen has maintained his “market weight” recommendation on the Singapore aviation sector as he sees the recovery of the sector as being “well on track”.
“The consensus among aviation experts indicates that the sector is likely to recover to the pre-Covid-19 level towards end-2024 (FY2025 for Singapore-listed players),” writes Chen in his March 29 report.
To be sure, the International Air Transport Association (IATA) has estimated global air travel passenger volume to recover to 103% of its pre-Covid-19 levels by 2024, with the Asia Pacific (APAC) region trailing behind at 97% of its pre-Covid-19 levels in 2024.
“Our conversations with the management of the three listed Singapore aviation companies (Singapore Airlines or SIA, SATS and SIA Engineering Company or SIAEC) have revealed a similar timeline – the consensus is that the Singapore aviation sector is likely to fully recover by FY2025,” the analyst says.
“We expect positive news flow on air traffic recovery and Singapore’s further opening up to keep sentiment towards the aviation sector buoyant in the medium term,” he adds.
The recent relaxation of international restrictions by the Singapore government is also a positive development for the Singapore aviation sector, notes Chen.
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“[We] expect it to help Singapore move closer towards its goal to restore the passenger volume at Changi Airport to at least 50% of the pre-Covid-19 level in 2022,” he adds.
Within the sector itself, however, Chen sees varying paces of recovery among the counters, with SIAEC being the fastest, followed by SATS.
“Due to airlines’ proactive capacity re-activation plans (SIA will re-activate a flight as long as the operation is cash-generative), we expect flight activities to recover relatively faster than passenger volume,” the analyst says.
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“As such, revenue of businesses directly geared to flight activities, including SIAEC’s line maintenance services (about 50% of its pre-Covid-19 revenue) and SATS’ ground handling services (30%) should recover faster than revenue of businesses linked to relatively lagged passenger volume, such as SIA’s passenger flown revenue (80%) and SATS’ infight catering revenue (40%),” he adds.
Chen also expects SIAEC and SATS, which are both in net cash positions, to resume paying dividends in FY2023, when they would have returned to core net profits, according to his estimates.
“SIAEC’s dividend outlook is further raised by its 77.6% shareholder SIA’s cash needs for [the redemption of its mandatory convertible bonds (MCBs), which is likely to be in early FY2025]. As such, we do not rule out the possibility of a special payout by SIAEC by FY2024,” says Chen.
With this, the analyst has identified SIAEC as his preferred proxy to the recovery of the aviation industry, with SATS coming in second.
He has re-initiated “buy” calls on SIAEC and SATS with target prices of $2.80 and $4.65 respectively.
“SIAEC has made good progress in its business developments during the pandemic, including deepening relationships with some of the world’s leading engine original equipment manufacturers (OEMs). These developments are expected to contribute to SIAEC’s growth in the long term,” says Chen.
“SIAEC is currently trading at 14.4x FY2025 P/E, which is 2.3 standard deviation below its five-year mean of 23.2x in a normal market (FY2014-2019),” he adds.
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“We like SATS for its regional market leadership in inflight catering and aviation gateway services, making it a primary beneficiary of the air traffic recovery in the APAC region. We also applaud the company’s efforts to diversify into the non-aviation segment and expect it to become another growth engine for SATS in the longer term,” writes the analyst.
“Having said that, we note some of its recent greenfield investments (e.g. the central kitchen investments in India and Singapore) may take a gestation period of two to three years before bearing fruit,” he adds.
Furthermore, Chen feels SATS would face keener cost pressure from inflation and headcount build-up in the near term, although he sees these pressures being passed down to its customers as business conditions for SATS continue to recover.
“SATS is currently trading at 17.6x FY2025 P/E, which is 0.8 standard deviation below its five-year mean of 19.9x in a normal market (FY2014-2019),” says Chen.
On SIA, Chen notes that its MCBs have to be redeemed earlier before the airlines’ earnings recovery can deliver meaningful value accretion to SIA’s shareholders. Besides, the MCBs would turn out to be “highly dilutive” if they are held to maturity and then converted, he adds.
“The impact of Covid-19 on SIAEC and SATS is largely transient (manifested by goodwill/property, plant and equipment or PPE impairments, one-off in nature),” says the analyst.
“We caution that SIA, the largest listed proxy to Singapore aviation, has had its valuation run beyond the justified level by traditional valuation metrics,” he adds.
Chen has also re-initiated coverage on SIA with a “hold” recommendation and a target price of $4.80.
“[SIA] is currently trading at 1.50x FY2023 P/B, an unprecedentedly high level or 4.2 standard deviation above its long-term historical mean of 0.79x. This could be due to the market: not fully comprehending the impact from the MCBs (and their distortion on SIA’s financials), and/or trying to speculate on the strong market sentiment from the positive news flow,” the analyst writes.
“We have recommended ‘hold’ on SIA in light of the anticipated buoyant sentiment to the company. However, we highlight that we have applied very favourable assumptions for SIA, with our target price aggressively based on a discounted cash flow (DCF) value three years down the road. Investors are recommended to sell SIA into further share price strength,” he adds.
Despite the positive sentiment on the sector, which includes catalysts such as a faster-than-expected pace of global opening up and travel relaxation, Chen warns that newer Covid-19 variants that are more fatal or infectious may disrupt the process of opening up.
The further escalation of the Russia-Ukraine war may also dampen travel sentiment.
Shares in SIAEC, SATS and SIA closed $2.47, $4.34 and $5.50 on March 29.
