It has been known in the investing world that Singapore Airlines suffered a significant operating loss of $138m in the last quarter of its financial year 2016/2017. The overall profit fell to $360m, a drop of 55.2% compared to the last financial year. In fact, the current fate of SIA’s loss was already imminent some years ago.
Let us start by looking at the aviation scene 20 to 30 years ago in the 80s and 90s. During those days, there were no Chinese airlines or gulf airlines vying for almost the same international routes across continents. As a result, airlines like SIA, Cathay Pacific and Swiss Air were able to make their names in the aviation world. Now with airlines from the gulf such as Qatar Airways and Emirates Airlines, the routes that SIA used to fly to Europe or plying between Europe and Australia/New Zealand are immensely under threat. We all know that the fuel cost is the biggest cost driver for airlines. It takes up easily about 30%-40% of the total operating cost. With their cost of fuel almost the same as that of drinking water (maybe exaggerating!) in those oil producing countries, SIA is definitely in a disadvantaged position. Every single drop of aircraft fuel used by SIA has to be either hedged or buy via the spot market. Hedging, by itself, is a double edge sword. It can help make or break the bottom-line of the airline.
Next is the competition from the Chinese airlines. With a deep hinterland, an extremely huge population and a leaping economic progress, we can be very sure that the domestic airline industry will advance by leaps and bounds. After all, what will stop them from extending their tentacles into international routes? The experience gained from plying international routes would help improve their services for the domestic routes. In fact, even their compatriot, Cathay Pacific, has not been spared. For last financial year, Cathay Pacific suffered a loss of HK3billion. And, only just a few days ago, Cathay Pacific divulged plans to let go about 600 staff.
The developments in these two parts of the world have indeed put SIA in a ‘sandwich’ position, eking out SIA’s previous dominance. The profitable stretch from Europe to Australia/New Zealand has to be shared by these competing airlines. In fact, they are not the only ones eyeing these routes. Several airlines in Asean region such as Thai Airways, Malaysian Airlines and the Australian Airlines such Qantas have their interest this profitable stretch as well. That sums up the competitive environment in the premium airline segment.
Then there is also a huge competition from the budget airlines. About 10 to 15 years ago, we did not hear much about budget airlines. But by now, we can almost find one budget airline for every one national carrier. The no-frill segment is indeed another dog-eat-dog sector. During times when there was no budget airline, premium airlines were able to profit significantly when oil prices were at their lows. However, it is no longer the case now. When the oil price is low, we see more budget airline in operation, thus eking out the profits once enjoyed by premium airlines.
Frankly, if we follow Michael Porter’s theory on competitive advantage, we should realize that SIA’s competitive advantage may be slowly ebbing. Relying on intangible factors, such as services and branding, may not be exactly useful because, given time, good services can be trained and branding can be developed. In other words, the economic moat developed by SIA in the past 20-30 years is in effect weakening.
On the cost structure, the operating leverage on airline industry is very high. It is tantamount to operating an oil refinery or in exploration/mining industries. Before the company can start to produce the first unit of the product, it has to invest significantly in the fixed cost. Similarly for an airline operation, before it can start to carry the first passenger, there is a need for heavy investments in the upfront. A decent passenger liner would easily cost US$200m. We are not even talking about the B777-300ERs or A380s class, which are north of US$300m. While the high operating leverage forms a barrier for new entries, it also means a huge challenge for an airline to be profitable. To operate a decent fleet, we are pretty sure that the airline cannot escape from not getting into debts even with a huge war-chest. Furthermore, passenger and cargo load factors have to be consistently maintained at high levels and close to their full capacity to ensure sustainable profitability.
Then we have the changing lifestyles among travelers. Air travel is no longer considered as luxury lifestyles whereby travelers are willing to pay a premium for it. It may be seen as a means of getting from point A to point B on different parts of the world. In fact, there may be people willing to spend more for longer stays or paying more for a more luxurious experience on land than probably on air. When the global economy gets worse, business travel budget gets the cut straight away and travelers downgrade abruptly. When a region is hit by epidemics such as SARS or avian flu, or natural disasters such as earth-quakes or political turmoil, air travels to the affected regions are curtailed immediately.
Certainly, there are just too many unknowns facing airline industries. It is not an area that we could understand fully as a simple investor. Frankly, as an individual, I like to travel on SIA. At least, I am confident that I will reach my destination safely and on time based on its past travelling records. After all, it is our national carrier. If we do not support it, then who will, right? However, to invest in the stock as an investor is another consideration.
Since the last sale of my final 1000 shares at $12.62 in June 2009, I have yet to make any purchase of SIA shares till now. In fact that sale was a loss for me even though I had profited from earlier trades such as selling at prices between $17.50 and $19.00 per share in 2007. In hindsight, it was a blessing in disguise to have sold the last board lot (previously one board lot was 1,000 shares) considering that the price has fallen below $10 per share today. That said, I am not ready to buy them back considering its dicey future.
Disclaimer – The author is no expert in market research for airlines. The above information is based on his opinion and information that he gather through literatures as an investor. It is also not buy or sell recommendation on the stock.
Brennen has been investing in the stock market for 27 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy. Analyses of some individual stocks can be found in bpwlc.usefedora.com. Registration is free.