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Singapore Airlines Scoots Into Budget Travel

Singapore Airlines, which has significant representation in the Guggenheim MSCI EAFE Equal Weight ETF (AMEX:$EWEF), has acquired 10% stake in Virgin Australia for $108 million. The Australian airline industry is currently lead by the local carrier Qantas Airways. Virgin Australia, a part of Richard Branson’s Virgin Group,is looking to capture greater market share in the Australian airline industry where it is the second biggest carrier.

Both Singapore Airlines and the Virgin Group have more than a decade old relationship that started when Singapore Airline (hereafter SingAir) acquired 49% stake in Virgin Group’s flagship carrier Virgin Atlantic in 1999 in a deal that is worth $967 million today. The current acquisition is in line with Virgin Australia’s strategy which is aimed at increasing its market share in the Australian airline industry. The company is planning to spend the $108 million (as well as its stock) on the acquisition of 60% ofthe struggling Tiger Australia from Singapore’s Tiger Airways Holdings valued at $36.35 million and a buyout of Skywest Airlines from SkyWest Inc (NASDAQ:$SKYW) for $98.7 million. Virgin Australia already competes directly with Qantas but now, after Tiger’s acquisition, the company will also compete with Qantas’s subsidiary low-cost carrier Jetstar.

These deals will completely change the market dynamics of the Australian (AMEX:$EWA) airline industry as it will end up with two operators, Virgin Australia and Qantas, holding the entire market.  This has raised eyebrows of some regulators whose prior approval is required before anything can happen. Although even after the deals are approved, Qantas will still maintain its dominance in the Australian market with 65% share and 286 jets while Virgin Australia will increase its jet count by 31 to 139 and will have the 34% market share.

On the other hand, SingAir is now backing Virgin Australia’s move into the low-cost carrier market whose importance have been magnified following the global economic slowdown particularly in the U.S. Europe and China coupled with the increasing fuel prices. Within Asia Pacific, SingAir’s five month old, low-cost subsidiary Scoot competes with Jetstar that has operations in Singapore, Vietnam and Japan. This space is becoming even more crowded with Malaysia’s (AMEX:$EWM) Lion Air coming into the market along with the rapid growth of AirAsia.  According to one estimate, these and other low cost carriers account for approximately 25% of the regional traffic. SingAir is itself putting an end to its famed eight year old world’s longest non-stop flight routes from Singapore to Newark and Los Angeles airports and the all-business-class flights after it embarked upon a cost cutting strategy. The company has also halted hiring of new cadet pilots while it has asked its serving pilots to take their unpaid leave time.

SingAir’s business is divided into four main segments: SingAir itself, the Engineering division, the Cargo Division and its subsidiary regional carrier SilkAir. Except its Cargo division, all other units have posted operating profits for the first half of its fiscal year ending September.  SilkAir’s operating profit during this period was $37 million as its capacity grew by 23%. During the first half of 2012, SingAir had 101 aircrafts while SilkAir had 22 including the one A320-200 it received in the first quarter. On the other hand, Scoot, after acquiring two B777-200, has a total of four aircrafts. While SilkAir focus on regional destinations around Singapore, it is not a budget carrier like Scoot is.

SingAir’s profits have taken a beating over the past year which have fallen from $159 million in Sep-11 to just $63 million in June-12. But this isn’t stopping the company’s aggressive expansion plans and the investors have shown confidence as its stock at the Singapore Exchange  has risen by 2.4% since January 2012. The twin problems of rising jet fuel costs and economic slowdown will continue to hamper the profits in the future.

Moreover, to attract new customers, SingAir is going to offer more promotions and price cuts that will hit its margin.

To combat this SingAir is aggressively trying to change over its fleet to reflect the changing business model that 21st century economic reality has imposed on them.  . The parent has placed gigantic orders recently:

  • $7.5 billion with Airbus for five A380 superjumbos and 20 A350s following the French Premier Jean-Marc Ayrault’s visit to Singapore
  • $2.6 billion with Rolls-Royce for aircraft engines
  • $4 billion for 20 Boeing (NYSE:BA) 787 Dreamliners to ramp-up its infant budget carrier Scoot.
  • $4.9 billion for Boeing’s 23 single-aisle 737-800 and 31 737 Max-8 planes for SilkAir which will more than treble the fleet of SingAir’s subsidiary.

The company’s dive into low-cost carriers is definitely against type for SingAir which had positioned itself as a luxury carrier catering to business travel which is rapidly going the way of the dodo.  It will ensure that it survives this reorganization of the airline industry and remain profitable in the short to medium term. However, margins will fall and growth will remain challenging. Almost 40% of its expenses are related to jet fuel, whose prices are still in the high range of over $3.00 per gallon. Air travel, in general, will continue to be a difficult business and SingAir has a difficult adjustment to make to remain competitive overall.

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Peter Pham is a capital market specialist and entrepreneur.  With expertise as a Head of Institutional Sales and Trading he closely watches the market and probes for investment opportunities utilizing a unique blend of quantitative trading experience and macro trend analysis… (read more)

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