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Airline stocks may fly

Nirgunan Tiruchelvam
Nirgunan Tiruchelvam • 4 min read
Airline stocks may fly
Low-cost carriers have long traded at a premium to the traditional ones. This may reverse in the Covid era.
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Most investors may have missed the movie Boeing Boeing. It was last shown in 1965.

Tony Curtis plays a bachelor in Paris who dates stewardesses from three airlines. He plots a scheme where his girlfriends never run into each other.

The schedule of the stewardess from British Airways does not overlap with the women from Air France and Lufthansa. Only one of the three is in Paris at any given time.

Working for an airline was prestigious then. Stewardesses had the aura reserved for space travellers today. In 1965, air travel was an unimaginable luxury. The cost of a return ticket from New York to Paris was US$600. That may seem cheap, but it would be US$18,100 ($24,400.43) in today’s money. Only the rich could afford it.

Today, the same route costs one-twentieth of its real cost in 1965. Bargain fares are being offered with the opening of the Vaccinated Travel Lanes (VTL) in Singapore.

A return trip to Sydney is just US$450 on Scoot, which is a 40% discount to the average fares in 2019. Investing in airlines stocks may be an even better bargain than travelling to Sydney.

Covid decimated air travel in 2020. Airline stocks nosedived. The US Global Jets ETF, which tracks airline stocks, fell 64% in three months from last February.

The reopening has reversed that. In the US and Europe, leisure travel has roared back. The US Global Jets ETF has doubled since the depths of May 2020. Asian airlines like Singapore Airlines (SIA) and Malaysian Airlines have risen by a similar degree.

Fundamental metrics like PE multiples may be the wrong route. Airline valuations are not cheap on traditional metrics. In terms of FY2022 PE multiple, the peer group average is 25 times, which is higher than in the pre-Covid era.

Instead, the value of airline stocks is in their operating leverage. Operating leverage is a powerful driver of value. It may power the airline stocks like the jets take them into the sky. Operating leverage is the degree to which operating income changes with revenue.

SIA was a sitting duck on this basis. Its ratio of fixed costs, such as labour and airline leases, to its total costs, is high. SIA’s revenue fell by 75% in FY2021, but its operating earnings declined by much more than that. When revenue rises, the impact on its operating earnings will be multiples of the increase in revenue. A 10% rise in revenue could drive operating earnings up by 30%.

Airlines slashed costs during Covid. SIA cut 4,300 jobs. This amounted to a fifth of the labour force. A further 6,000 staff members took unpaid leave. The senior executives have taken a 35% pay cut. It ran at 50% of its capacity. Costs that were anyway unjustifiable were slashed. These cost reductions may become permanent, which would widen profitability prospects.

SIA has bolstered its balance sheet in the pandemic. It raised $12 billion through rights issues and mandatory convertible bonds. This is more than any other Asian airline. It means that the airline is much more liquid than before Covid.

In FY2020, SIA had $3.1 billion in cash reserves. As at June 30, that amount had increased to $13.65 billion. SIA says its cash burn is around $100 million a month, down from $350 million last year.

This sets the stage for a handsome recovery for SIA, which is reporting its 1HFY2021 earnings on November 11. The market expects its revenue to match FY2019 levels by FY2023.

Not all airline stocks are the same. Low-cost carriers like AirAsia may seem enticing, but they are dangerous. They have poor balance sheets. In any case, they make slim profits. There are new regulations that reduce the number of passengers that can be squeezed in.

Also, the health measures that Covid requires could drive the expenses of low-cost carriers higher. Their profitability would be impacted by the surging oil prices.

Low-cost carriers have long traded at a premium to the traditional ones. This may reverse in the Covid era. The additional costs of Covid can be better borne by the big players. As SIA’s deep pockets attest, they can weather the storm better.

In Boeing Boeing, Tony Curtis was caught with his pants down. His three girlfriends eventually discovered each other. His unconventional scheme was uncovered. Investors should avoid the same fate by standing by traditional carriers. Their stock prices may fly high.

Nirgunan Tiruchelvam is head of consumer sector equity at Tellimer and author of Investing in the Covid Era. He does not hold any position in the stocks mentioned in these columns

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