I came across this Straits Times article recently:
SIA shares surge to highest since last March
Stock up 5.9% to $4.65; observers see rise as a sign of better times ahead for carrier
I went to pull up the chart on SIA (Singapore Airlines).
And true enough, this is the highest share price since March 2020.
Don’t forget the SIA Rights Issue
Now this is slightly deceptive because of the big rights issue.
The rights adjusted price is $5.4.
Which means that if you’re a long time investor, and you took up your full entitlement when SIA did the 3 for 2 rights issue – your average price is about $5.4.
At the latest price of $4.98, that’s only about a 10% loss.
Which given all that is happening from COVID, that’s really not too bad.
And if you bought at the lows of $3.4, you would be up about 50% gain.
My last article on SIA was from May 2021, so I knew I had to re-visit SIA a year on.
Did I make a mistake in not buying SIA? Can I still buy SIA now?
Basics: What has happened to SIA since COVID?
A quick recap on what’s happened in 2020 to our national airline.
Earnings has been a complete disaster. Very few people can fly, and very few people actually want to fly with all the COVID restrictions in place.
SIA has raised a ton of financing – a total of $13.3 billion since COVID happened.
That’s almost their entire market cap at this point ($14 billion).
With all that financing, Temasek now holds 55% of SIA.
Note: The research for this article, and most of the charts here, are sourced from ShareInvestor Webpro. It’s a great way to quickly perform research on Singapore stocks, far more comprehensive and flexible than other options like Yahoo Finance. You can learn more in my review on ShareInvestor Webpro here.
SIA expect recovery to about 25% of pre-COVID capacity by April 2021.
Where did I go wrong?
But obviously, SIA’s share price has soared, despite all the bad earnings.
So what did I miss?
And I think the biggest point I missed was the sentiment.
How do you measure sentiment?
But the thing with sentiment, is that you cannot quantify it right?
So how do you trade it?
Simply put – It is rate of change of short-term figures that determines sentiment.
Think about it this way.
SIA’s earnings are down, so nobody is buying SIA on a fundamental basis.
But with the vaccine rollouts, the rate of change of SIA’s passengers goes up significantly.
And SIA’s share price responds to that rate of change short term, more so than then earnings.
So short term, the rate of change of the underlying passenger figures is a better predictor of share price than earnings.
And of course this is investing, so at some point investors will want to front run the rate of change.
If you expect the recovery to really accelerate in second half of 2021 (when vaccinations produce herd immunity), then the time to buy is in the first half of 2021, ie around now.
Why stop at SIA?
The logical extension then, is that if you’re trading sentiment, why use a boring stock like SIA?
Why not go to the US market with all the YOLO traders and HFT market makers, for better upside?
I pulled up the charts for American Airlines, and it’s up almost 100% from it’s 2020 lows. Very similar story for the others airlines like Delta and SouthWest as well.
By contrast, SIA is only up 50%.
With hindsight, would I buy SIA in 2020?
I don’t like to dwell on the past because investing is always forward looking.
But I think there are some learning points here.
Armed with this knowledge on the rate of change, and going back to 2020, would I make the SIA bet based on information available at the time?
And I think the answer is still no.
There are 2 ways to play this trade:
Information Play
The first way, is to make the bet the moment you have information on how COVID will play out.
This was what I wrote in May 2020, with SIA at $3.8:
“…my position is that it’s impossible to know for certain how air travel will play out the next 2 to 3 years.
Maybe COVID19 goes away, and everything goes back to normal. Maybe the virus mutates into a more deadly strain, and it’s the end of the world. Maybe we are just stuck in this status quo where you need a 2 week quarantine when you cross borders.
The way I see it, all of them are possible futures, and because this isn’t a financial problem, I don’t see how I can assign probabilities to each of the possible futures.
So if I buy now, I’m just making a blind bet that everything will get better, and to convince me to do that, I need a big upside, and a big margin of safety.”
The day that changed, was 9 November 2020 – when the Pfizer vaccine was announced.
On that day, the entire landscape changed overnight. And the statement I made above was immediately invalidated.
All the possible futures collapsed down into 1 or 2 possible futures.
With a vaccine with more than 90% efficacy, that signaled the beginning of the end for COVID.
So under this analysis, the correct time to place the bet was 9 November 2020. And indeed, it would have delivered great results since.
But again – with this bet the American airlines offer greater risk-reward, so it doesn’t make sense to use Singapore Airlines.
Reflation Bet
The other way to play this trade, is to bet on a fundamentals driven recovery.
You basically make the bet without knowing about the vaccine, so you pick stocks that can survive no matter how long it takes, and will offer great upside when the recovery eventually comes.
And I think the better industry for that is oil.
The reasoning is this.
The airline industry is fundamentally a commoditized industry.
Ok maybe some people love SIA, some love ANA, but the ticket basically gets you from point A to point B.
If ANA charges $1000 more for the same business class flight, people likely go to SIA instead.
But oil is also commoditized right.
A barrel of oil from the middle east has slight differences from the oil from Permian Basin in US, but it’s not fundamentally different.
Why is the oil industry better than the airline industry?
Difference between oil and airline industry
It goes back to game theory – the prisoner’s dilemma.
In a commoditized market, any single market player can increase market share by cutting prices.
Think about it this way – If SIA offers the flight to Japan 30% cheaper than ANA, people will flock to SIA. SIA gets bigger market share, and makes bigger profits.
The problem though, is that other players can too. So in this scenario, ANA will respond by cutting prices 30% as well, and both airlines are back at square one.
So there are only 2 stable states in this system:
- Scenario 1: Collaborate and make big money –ANA and SIA maintain prices at a high level. Both parties win.
- Scenario 2: Cut prices and lose big money – SIA cuts prices to gain market share, forcing ANA to eventually respond. Both parties lose.
Scenario 1 is the ideal outcome.
But Scenario 1 is not stable, because if either ANA / SIA cheats and secretly cuts prices, they benefit by gaining market share.
The lesson from game theory – Scenario 1 is only stable in the longer term if there is a punishment for the party that cheats.
And that’s the fundamental difference between the oil industry and the airline industry – OPEC.
In Oil, OPEC is the big marginal producer, who can increase or decrease supply, and control prices.
The Saudis can tell the smaller players to cut supply, and they will generally listen to a certain extent.
In the airline industry, there’s no such player.
If airlines come together and try to coordinate prices, that gets them thrown in jail under anti-trust legislation.
Airlines are not a good long term bet
I genuinely don’t think airlines are a good long term bet.
Without an OPEC like player, there’s huge incentive for the newer carriers like Emirates and China Air to cut prices to gain market share.
Longer term, it’s just very hard to maintain attractive profit margins.
So as a mid term investment to bet on the reflation play, without information advantage, I would pick oil over airlines.
This is exactly what I did, and I piled into names like Exxon and Shell in 2020. These positions are up about 50%+ today, and I still think if I had to do it over, I would pick oil over airlines.
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Is SIA (Singapore Airlines) a good buy now?
The next big question is whether SIA is a good buy now.
DBS has some harsh words:
Share price has run ahead of fundamentals. SIA’s share price has increased by over 25% in the last month on positive vaccine development news, however, we believe that at over 1x FY22F P/B with losses likely to continue in the next 12 months, its valuations are now over-extended.
The valuations back it up too, it’s at almost 2 standard deviations above its mean.
What does FH think?
But of course as we learnt, valuations are not an accurate timing tool for the short term.
It’s the rate of change / sentiment that drives the short term.
And I think short term, say 1 to 2 months, SIA’s share price may continue to ride higher.
As vaccines continue to roll out, COVID case count will drop, and the pace of pickup of airline travel will accelerate.
That could be bullish for airlines, and the reopening trade in general.
But at some point in time, this will be a “buy the rumour sell the news” for me. Even with vaccine rollouts, it’s going to take a long time to recover to pre-COVID levels.
Great chart from Bain below, which predicts:
- A meaningful recovery in 2H21 (high pace of change)
- But overall demand won’t recover to pre-COVID levels even by 2023
I think we’re seeing prices front run that quick pace of change in 2H21, so after it plays out, I really don’t see airlines as a good bet.
I’m not taking this bet
Anyway, this is definitely NOT a play I am going to make.
I don’t believe in airlines long term for the reasons described above – this is a commoditized industry with no OPEC like player to determine pricing.
Long term, the things I want to own are tech, real estate, commodities etc (shared in last week’s article).
And short term, there are better ways to play the reopening via energy stocks or banks.
So I will skip this play.
I’m very curious to hear your thoughts though. Are you guys buying airlines? I would love to revisit this in a year to see if I was wrong.
Closing Thoughts: Taper Tantrum
Couple of you have asked for my thoughts on the “Taper Tantrum”, so I wanted to share quick thoughts.
Like we shared last week, the rising yield environment is quickly spreading over to stocks. This week, tech stocks were hit very hard, as did most of the momentum plays.
The big question is when does the Feds step in to save the day, with “Yield Curve Control”.
Personal View – I don’t think it will be so soon.
Can’t see them justifying bailing out stocks when we’re down 3%? from all time highs?
If they do, it’s just going to be a complete farce for capitalism, and this ends with them buying stocks directly like the Bank of Japan.
I think we need something much bigger before the Feds step in.
And I don’t think we’ll see it until later on in 2021.
Which is going to make for a fascinating 2-3 months in investing coming up.
Lots of opportunities to make money in this market, and to build long term positions. Like I shared last week, I think this is a great time to do portfolio rebalancing – think about what you want to lock in profits for, and what you want to hold long term. 2021 is going to be a big year.
I’ve been doing a ton of rebalancing the past few weeks. My stock watch and personal portfolio are on Patron if you’re interested.
Otherwise – Buckle up boys, we’re in for a ride.
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Definitely the right choice. Some call options on the most beaten down US industries/companies, last year sometime might have been interesting. But otherwise the future for airlines looks grim. They’re low margin businesses at the best of times.
The question for me about SIA specifically is if the government is prepared to back away from their zero-covid stance. Australia, New Zealand, Singapore and others have basically eradicated the disease, but ultimately the virus will be endemic. Embracing that will be difficult for these governments. Not so the US and Europe. Once vaccines have been delivered economic life will largely go back to normal in the US and Europe whilst low level covid circulates. In Asia governments face a choice of maintaining almost complete isolation, strict border controls and quarantines, which kills airlines, or learning to live with covid.
Until people can travel freely the airline industry is in trouble.
Great point on the call options. That would have been an even better way to play this – deep OTM calls on the most beaten down US companies could have offered even superior risk-reward.
Interesting point on the Asia vs West approach towards COVID, and how it affects airlines. If this is correct – the western airlines would be a better play. But I think like we seem to agree, this is not a business to invest in long term. It’s really just a short term sentiment trade, and we may already be nearing the later stages of this play.
Great comment Matt, really enjoyed this one.
Great article and I agree with you on many points.
But charting seems to show a different picture with the golden cross forming at about $4, indicating a high likelihood of reversal into a bullish long term uptrend.
We might see $6 within this rally and as high as $8 within the next 1-2 years.
$5 is a bit of a risk now though but I would probably add on any dips.
Interesting perspective – thanks for sharing!
My view is that SIA is, ironically, benefitting from the sharp recovery in oil prices. I had anticipated before the Dec qtr results that it will perform better than the 2 preceeding qtrs since C19 because the fuel that it bought on forward contracts and the losses on them had been provided for. In 4Q20, oil prices started to recover and thus the fair value of SIA’s fuel inventory was restated higher. Since Dec, oil prices had gone up much more aggressively and if this holds, the apppreciation this qtr will be very much more substantial. I am expecting it to repirt a profit despite the low utilisation of its fleet. However because of the increase in its share units base, every $1 lost before the increase that is recovered now is only $0.40 a share!
Operating wise I’m of the view that, especially per share basis, it will be many years before we see a ‘decent’ result, even assuming Temasek doesn’t convert more of its bond holdings into more share units
Yeah interesting point – do you know if they unwound the fuel hedges last year? If they continued to hedge, they should be doing pretty well now, but my fear is that they may have hedged at a lower capacity.
Agree with you I won’t buy SIA. If I die die must invest in airlines, then US and China have big domestic markets to fall back on.
Airlines have both high Capex and Opex. Burn cash like crazy business.
For the longest time I monitored SIA, she needs above 75% passemger loading to just break even. PB average for last decade is 0.9X. Current price is too high.
Better choice will be SATS and SIA Engineering which are more diversified.
My 2 cents.
Agree with this. Airlines are a horrible business to be in long term. Trade it for the short term bounce if you want, but longer term it’s not a business I would want to own. Like you said, SATS, SIAEC, Airports – those have much better business dynamics.
Hi, I am fundamentally a fundamental investor and recently looked at SIA.
What’s interesting about SIA is the fact that they are moving away from a lease model to an own model (airlines typically lease airplanes instead of owning planes). Because of this, their depreciation will increase tremendously, but it could pave the way for cutting ticket prices while ensuring positive operating cash flow while other airlines might not be able to do so because their leases form part of their operating expense. I think this would make it interesting to see how SIA performs going forward. However, of course they have huge interest expenses going forward.
Look forward to discussing more!
That’s really interesting. Maybe I haven’t fully digested the implications, but I’m just trying to figure out how this impacts the fundamental business (leaving aside accounting treatment).
Previously SIA would have leased the plane and paid a monthly fee for it, but now they own the plane and they pay a monthly interest expense. With the former, after the lease is up they return the plane, with this model does it mean that there is a windfall at the end if they can continue using the plane or can sell it at a profit? I would imagine there are quite a few assumptions in play.
Not sure what I’m missing here though.
Great point though, thanks for raising this. Look forward to discussing.