Finance 101 - a Singapore Airlines Case Study

2. Overview of SINGAPORE AIRLINES (SIA)

2.1 Singapore Airlines Limited (SIA) was founded in 1947. It is the world’s largest airline by market capitalization. It was first listed on the Singapore stock exchange on the 18th of January 1985 (SGX Code C6L) and ranks 9th in terms of international passengers carried according to the international air transport association. SIA flies to 65 cities in 35 countries, primarily in the Asia/Pacific region but also in Europe and North America and has the youngest fleet in the industry totalling 108 aircrafts at February 2015 according to the civil aviation authority of Singapore.

Besides its core business of passenger airline transportation, SIA also operates through over subsidiaries airline cargo transportation (SIA Cargo), subsidiary low cost airlines (Scoot, Silk air, Trade winds tours and travel), airport terminal services, and engineering services (SIA Engineering Company). The SIA group invests in related businesses rather than seek to diversify outside of the aviation industry.

The Singapore government, through Temasek Holdings (Ptde), owns 56.26% of SIA but claims its non-involvement in the company’s management. Other big companies hold the remaining shares.1 (DBS, HSBC, Citibank, UOB, Bank of Singapore, BNP Paribas, OCBC…) (cf. Appendix)In 2009, SIA's revenue was S$16 billion (US$ 11.4 billion), up 0.1% from the year before despite the 2008 financial crisis and the slump in airline travel.

2.2 Key success drivers

In order to understand SIA management we’ve analysed its business model to find out the key success drivers of the business:

• SIA’s strength is Achieving Service Excellence Cost-Effectively
• Government support, Powerful shareholders
• SIA spends more than its competitors in key areas (aircrafts, training, labour costs on flights.) and consequently less in the cost of what it offers
• Fostering both centralized and decentralized innovation
• Being a technology leader and follower
• Using standardization for personalization
• Dual strategy: Harnessing the power of the people and  the culture and making good use of technology
• Utilizing the power of business ecosystem
• Making investment decisions strategically

1. Financial Health and operating performance

3.1 Choosing a suitable Benchmark

By using one of Singapore Airlines greatest competitors, Cathay Pacific Airways (CPA), as a benchmark for the financial ratios, we can determine how well SIA is performing and its financial health in comparison to CPA.

3.2 Financial health analysis

To analyse the financial health of the company, we chose to look into:

A. P/E Ratio

The P/E-ratio is 36.8 and compared to our benchmark of 22.93, and the average of 20-25 times earnings its clear that SIAs ratio is higher. The higher P/E-ratio indicates that investors are expecting greater growth in earnings in the future, which again suggests a bright financial future for SIA.

B. Current Ratio

From the Table 1 (cf Appendix) we notice that SIA has a current ratio of 1.27 against 0.78 for CPA. This means that SIA has a better ability to pay of current liabilities than CPA, as they’re due by liquidizing their current assets is greater. Singapore Airlines’ current assets covers 1.26 of their current liabilities.

C. Debt to Equity Ratio

The debt/equity ratio shows the proportion of equity and debt the company is using to finance its assets. A high ratio means that the assets are mainly financed by debt, which seems to be the case for CPA (1.72). SIA has a low debt to equity ratio in comparison, only 0.723 also compared to the average airline industry of 1.21. 

E. Equity Multiplier

The equity multiplier is measuring the firm’s financial leverage, and a high equity multiplier means the assets are mostly being financed by debt. As shown in the

Table 1 (cf. appendix), CPA has a lot higher equity multiplier than SIA (2.73 vs. 1.42). Weather this is a good or bad thing depends on the price of borrowing vs. issuing new shares. If it’s more expensive to issue new shares and thereby raise equity, than borrowing, the company is better of increasing their long-term loans.

3.3 Operating Performance

A. Profit Margin

The 4.3 % profit margin means that 4.3 % of every sales dollar is net profit, which is higher than CPAs profit margin of 3.9%.  

B. ROE and ROA

Looking at the management effectiveness, we see that the ROE and ROA is higher for SIA than CPA. The return on equity shows how much profit the shareholders money are generating, so a higher return on equity means higher profitability. 4.4% is greater than the benchmark (1.6%) but lower compared to the airline industry (15.16%). Return on assets is also higher than the competitor (3.1% vs. 0.6%), and this indicates that Singapore Airlines is more profitable than their competitor.  The average airline industry ROA is 3.01%, and Singapore Airlines is above this benchmark too.

  3.4 Conclusion

Singapore Airlines has a strong financial health and good operating performance because they have good liquidity and financial leverage compared to their competitor, they have a high P/E-ratio which indicates that their future is looking bright, and ROA and ROE is greater than the benchmark. The reason why SIAs ROE is so much lower than the airline industry’s average could be related to their low debt to equity ratio. Since total equity is greater than average, the net profit naturally will constitute a smaller fraction of total equity which results in a low ROE. Profitability is still good even though ROE is low. Because of SIAs high current ratio and low debt to equity and equity multiplier compared to CPA, they have a strong financial health.  

This healthy finance statement may be linked to the government ownership of the main shares of SIA despite they claim their non “direct” involvement in the company’s management.

1. Risk-Return Trade-off

The risk-return trade-off explains that the invested money can render higher profits only if there is a possibility of being lost. Also, it is associated with the levels of uncertainty, which lead to how low or high is the potential returns, so this is how the risk is explained.

1. Choosing a suitable Benchmark

How profitable Singapore Airlines is? In order to answer this question it is necessary to create a suitable benchmark, which has to include the principal competitors of Singapore Airlines: Cathay Pacific Airlines, Korea air and Malaysia air.

1. Average return

Singapore Airlines has an Average Return On Investments (AROI) of 0.146663% that implies an average percentage rate of 1.76%, which is measured according to the monthly historical prices of the enterprise since January 2000 till March 2015. Given those figures SIA has gains and can be considered as a profitable enterprise.

1. Average return volatility

In order to make an investment decision we should capture the volatility. The standard deviation captures it and tells us how tightly the price of a stock plots around the average price SIA stock has a Monthly Standard Deviation of 6.97% which is equal to a Yearly standard deviation of 24.14% that is greater than STI index volatility (19.2%).

[pic 4]

This graphs shows the risk and return trade-off of SIA stock comparatively to a risk-free asset, the market index, and SIA’s competitors. Based on risk-return trade-off, SIA underperforms its competitor Korean Air and the 10Y bond, which offer a greater return than SIA, with a much lower volatility. Though, it did better than Malaysian air, which has high volatility and low returns. So based on risk return trade-off, SIA seems to be a worse investment than the risk-free asset, which contradicts the assumption that higher volatility yields higher returns. However the company’s stock valuation based on the risk-return trade-off is incomplete.

1. Valuing Stocks

SIA stock (C6L): undervalued relative to growth potential

In this segment, we compute the CAPM and the DGM to determine the target price of SIA stock. Through this analyze, we discovered that there is a mismatch between SIA current stock price and its intrinsic value.

1. Beta

We regressed monthly returns on SIA over monthly returns on the STI index, using 60 months historical data from Yahoofinance.com. This regression yielded us a beta of 0.999, which is close to the beta of 0.98 that can be found on Reuters.com.

[pic 5]

1. Market risk premium and risk free rate

To find Rm, we’ve computed the arithmetic average of the monthly returns of STI index over 60 months and annualized it. To find Rf, we used the monthly 10-year bond yields of the Singapore government (SGS.gov), and calculated their arithmetic average over 60 months.

Thus, the risk free rate and the expected market return we apply in our model are 2.057% and 4.153% respectively.

 4.15%. Using the CAPM, we found this cost of equity: 4.151[pic 6]

1. Dividend Growth Model

To compute g, we used the average yearly growth rate of dividends over 5 years, relying on the database of yahoofinance.com. Using the DGM, we found a cost of equity Re of 4.51%, by calculating the following equation: Re= (D0 (1+g)/current P0)+g. This rate is close to the expected return of 4.15% we found using the CAPM.

Then, we used this equation to compute the target price:

P0=D0 (1+g)/(E(Ri)-g)=60.48

Using the DGM with the CAPM as the discount rate, we found that the intrinsic value of the stock is SGD$ 60.48, which is higher than the current price of SGD$ 11.62; this means that the stock is undervalued relative to its growth potential. So, according to the DGM, we would recommend to buy or hold this stock.

1. Limitations

The dividend growth rate g we found isn't the same for the capital gains. Thus, the stock price doesn't grow at the same rate than the dividends.

The results obtained with the DGM are limited, because it doesn't capture the risk of the investment, unlike the CAPM.

The DGM is also limited because results are very sensitive to g and r. We noticed that a small change in g can dramatically change the value of P0. Moreover, as the historical dividend growth rates are not constant, constant growth rate of dividends is not a very realistic assumption.

Finally, by computing the CAPM with SIA stock, which, as we saw in the previous part, doesn’t give the best risk-return trade-off, we violated one of the CAPM assumptions, which states that investors hold only portfolios of efficient securities. So, the results obtained may not be perfectly reliable.

Appendix:

1. Stock information and shareholders and financial highlights.

Notes: Based on closing price March 31, Cash earnings are defined as profit attributable to owners of the parent plus depreciation and amortization.

Source:  singaporeair.com

 Notes :

• Profit and sales for CPA is computed by the last 6 months sales multiplied by 2, to get 12 months numbers. We are also assuming that the balance sheet remains unchanged for these computations, which would not be realistic in real life.
• We use average airline industry numbers from the US market in lack of information about the Asian market (not really comparable but we wanted to compare to the industry)

Sources:

 - http://www.iata.org/whatwedo/Documents/economics/IATA-economic-briefing-financial-forecast-March-2014.pdf 

 - http://www.hoovers.com/company-information/cs/competition.SINGAPORE_AIRLINES_LIMITED.f0217fcece8a8454.html

 - http://www.investopedia.com/terms/p/price-earningsratio.asp 

 - http://www.reuters.com/finance/stocks/overview?symbol=0293.HK