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UOB KH sees continued recovery momentum for aviation, but warns of higher costs and uncertain outlook

Lim Hui Jie
Lim Hui Jie6/22/2022 02:36 PM GMT+08  • 4 min read
UOB KH sees continued recovery momentum for aviation, but warns of higher costs and uncertain outlook
Analyst Roy Chen has lowered his TPs for SIA Engineering and Sats. Photo: Samuel Isaac Chua/The Edge Singapore
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UOB Kay Hian’s Roy Chen has maintained his “market weight” rating on the aviation industry, saying that while its recovery is “on track”, this may be tempered by factors like high fuel costs and the uncertainty of China’s reopening.

In his report dated June 21, the analyst notes that air traffic statistics in May underscore strong near-term recovery momentum, with SIA seeing its passenger load rising 15.1% m-o-m in May 2022.

This is on the back of a 7% m-o-m increase in passenger capacity and a 5.5 percentage point improvement m-o-m in passenger load factor to 78.2% in May.

SIA’s passenger load factors pre-pandemic stood at over 80%, with Chen saying that SIA’s passenger capacity and passenger load in May 2022 were at 61% and 56.4% of their respective pre-pandemic levels.

However, the risk for SIA is that high jet fuel prices may dampen long-term travel demand.

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Chen says that due to inflation, supply concerns and the Russia-Ukraine War, crude oil prices have been on a sharply rising trend. Prices now stand at over US$180 per barrel and match the historical high last seen in 2008.

As such, the high jet fuel prices are expected to lead airfares to stabilise at a higher equilibrium level.

“While we believe that the strong pent-up air travel demand being fulfilled currently and in the upcoming months would be relatively more inelastic to higher airfares, a sustained high jet fuel price (and the resultant high airfares) may eventually dampen the air travel demand in the longer term.”

Geographically, Northeast Asia remains a drag, Chen says. Based on SIA’s statistics, the air traffic recovery in the recent months has been mainly driven by the Americas, Europe and Southwest Pacific routes.

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But he believes that for air travel in Singapore to recover to its full potential, traffic from/to Northeast Asia is required, adding that China, Taiwan and Japan collectively formed about 20% of Changi airport throughput in 2019.

Separately, he also notes the rising global interest rates, which will drive up borrowing costs in all open economies globally. These have “limited impact” on earnings for the three aviation stocks, but will still weigh on valuations.

All three companies were in net cash positions as of March, meaning they can easily pay off their outstanding debts with their cash position (or liquid investments) on their balance sheet.

In addition, Chen notes that a substantial portion of gross debt outstanding, if not all, is based on fixed interest rates, and only a limited portion are due for repayment in 2022 to 2024.

“As such, we expect the rising interest rates to have very limited impact on the earnings of the three aviation plays in the next three years.”

Despite the very limited earnings impact, the rate hikes (leading to higher risk-free rates and discount rates, i.e WACC or weighted average cost of capital) would still have negative implications on the valuation of aviation plays.

To this end, Chen has also lowered his target price on Singapore Airlines Engineering Company (SIAEC) and Sats as he raises their raised weighted average cost of capital (WACC) by 50 basis points to 9.0% and 7.5% respectively.

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Chen has kept his target price on Singapore Airlines (SIA) unchanged at $4.88.

Target prices for SIAEC was lowered from $2.90 to $2.70, while Sats’ was cut to $4.20 from $4.75.

He has kept his recommendations for all three companies unchanged at “buy” for both SIAEC and Sats and “hold” for SIA.

Some key catalysts he sees for the aviinclude a positive news flow of Singapore air travel recovery, a faster pace of border measure relaxations in Japan and Taiwan, and possible shifts China’s stance on treating Covid-19 b.

However, inflationary cost pressures weighing on aviation companies’ earnings recovery, a possible recession impacting air travel demand, and a more infectious/fatal Covid-19 variant leading to a rollback of the global economic reopening are all key risks the Chen warns about.

As at 2,34pm, shares in SIAEC, Sats and SIA are trading at $2.40, $4 and $5.14 respectively.

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