SINGAPORE (Sept 23): UOB KayHian is maintaining Singapore Airlines (SIA) at “hold” with an unchanged fair value of $9.50 and a suggested entry price of between $8.70 and $8.80.

The recommendation comes on the back of signs of a slowing global economy, a volatile cargo and passenger yield environment, rising Middle East geopolitical tensions and potential risk of a near-term Brexit.

In August, cargo traffic for the SIA group registered the steepest decline since March, with cargo load factor falling 6ppt y-o-y.

See: All SIA group airlines see improved passenger load factors; cargo load factor falls on lower traffic

See also: SIA posts 20.7% fall in 1Q earnings to $111 mil on higher losses from Virgin Australia

“The decline in cargo traffic underscores heightened risk for the parent airline at the operating level,” says UOB analyst K Ajith in a Sept 19 report.

An IATA survey had already shown 41% of airlines’ heads of cargo expect deteriorating cargo volume and yields over the next 12 months.

Since April, group cargo traffic has declined 5.9% y-o-y with load factor standing at 58.2%.

“This bodes ill for SIA’s cargo business in 2Q20 ending Sept as cargo revenue fell by $44.6 million in 1Q20 ended June,” says Ajith.

And although underlying demand for passenger traffic remained strong, Ajith says this might have come at the expense of yields.

Since April, pax traffic has risen by 8.5% y-o-y with pax load factor (PLF) rising by 1.2ppt on broad-based improvement in PLF across all route regions except East Asia and the Americas.

“The key uncertainty is whether this was achieved on the back of weaker pax yields,” says Ajith, “In 1Q20, pax yields rose 1% y-o-y and we have estimated a 1.1% y-o-y increase in FY20.”

Meanwhile, increased geopolitical tensions in the Middle East have raised fuel price volatility and risks for SIA and its associates.

UOB estimates that every US$1/bbl increase in fuel price from our base assumption would lower SIA’s profit before tax by $12.8 million, net of fuel hedging.

“Our jet fuel price assumptions are maintained at US$83.4/bbl for FY20. A greater concern is the impact of higher jet fuel prices on SIA’s airline associates, Vistara and Virgin Australia, which are struggling with profitability,” says Ajith.

Given the London Heathrow-Singapore route was SIA’s most profitable in FY19, the prospect of a near-term Brexit also poses risks to SIA’s profitability as demand for business class travel could be affected as a result of companies shifting operations out of UK and potentially fewer connecting flights from the UK to other parts of Europe post-Brexit.

“We continue to value SIA on an SOTP basis, with the airline operations valued at 0.75x book value and SIA Engineering valued at $2.55,” says Ajith.

As at 12.58 pm, shares in SIA are down 11 cents at $9.13 or 15.4 times FY20F earnings.