To The Moon

The aviation sector may have underperformed the market over the past month owing to mixed earnings, but the outlook for the sector remains upbeat, say DBS Group Research analysts Jason Sum, Tabitha Foo and Paul Yong.

The DBS analysts think top picks like $SINGAPORE TECH ENGINEERING LTD(S63.SI)$ Singapore Technologies Engineering (ST Engineering) and $SINGAPORE AIRLINES LTD(C6L.SI)$ Singapore Airlines (SIA) C6L 0.00% are “flying under investors’ radars”, with improving fundamentals yet to be reflected in their share prices and valuations.

“Our optimistic outlook on the aviation sector was reinforced by the latest earnings season, which saw a noticeable change in the tone of management commentary, and companies expressing more optimism on the recovery trajectory,” they add in a March 10 note.

The DBS analysts have “buy” calls on SIA, ST Engineering and SIA Engineering (SIAEC) S59 0.9% with target prices of $6.80, $4.20 and $2.80 respectively.

They think SIA’s “impressive earnings momentum” appears to be sustainable for a while, while STE and SIAEC are well-positioned to see an inflection in earnings as maintenance, repair and overhaul (MRO) demand accelerates with airlines eager to clear the backlog of deferred maintenance and the normalisation of global flight activity.

“Although investors may be wary of the sector due to its high sensitivity to changes in macroeconomic growth outlook amid tightening financial conditions, we remain constructive due to the nascent recovery in Asia Pacific and promising forward booking data,” say the analysts. “With several tailwinds in play, we are confident that the sector will deliver strong earnings growth over the next few years.”

Insulated from interest rates

The sector is relatively insulated against rising interest rates, say the analysts. Healthy leverage levels among SIA and SIAEC mean that higher interest rates will have minimal impact on them, they add.

SIA’s adjusted net gearing, by treating mandatory convertible bonds (MCBs) as debt, was at 0.5x as of December 2022, down from 0.9x as of March 2022, while SIAEC continues to sit on a “substantial” net cash hoard of around $576.8 million in the same period, note the analysts.

On the other hand, ST Engineering’s earnings will be negatively impacted by rising interest rates, given the substantial increase in the group’s debt burden and exposure to floating interest rates, which make up 47% of total debt as of December 2022.

Tentative estimates provided by ST Engineering point to an increase in its cost of borrowing to 3.2% - 3.3% in FY2023, up from 2.4% in FY2022. “Nonetheless, ST Engineering is expected to achieve an improvement in core operating profits that will more than offset the increase in finance costs,” say the analysts.

Attractive entry point

Apart from SIA, the performance of other aviation counters like ST Engineering and SIAEC trailed the broader market over the past six months, say Sum, Foo and Yong.

The sector’s current share price levels are attractive entry points with favourable risk-to-reward, they add. “While SIA’s share price has held firm in the past month, the share prices of ST Engineering and SIAEC corrected following disappointing earnings performance. We view the share price weakness as overdone, given that the earnings outlook on the MRO sector continues to be bright. Hence, current valuations present a good buying opportunity, in our view,”

SIA aside, the performance of Singapore aviation counters has fallen behind the broader market over the past six months primarily due to underwhelming earnings, they add. “We believe that this is unwarranted and suggest that investors should not be deterred by this quarter’s results, as the earnings outlook for the sector remains promising.”

In addition, the analysts see buying opportunities as valuations are now more enticing following the share price corrections in the past month.

ST Engineering is their preferred choice in the sector, with the group’s earnings expected to grow at a solid 14% CAGR over the next two years, and undemanding valuation at a forward P/E of 18.6x, which is at around the -1.2 standard deviation level.

SIA is another top pick, as the airline’s valuation remains undemanding, they add. “We believe that the street is still severely underestimating the airline’s earnings potential.”

Meanwhile, SIAEC should make a strong comeback to profitability from 1HFY2024 ended September, say the analysts. That said, their optimism towards the stock is somewhat tempered due to its valuation compared to industry peers.

Singapore to lead air travel recovery in Asia Pacific

Further to their report, the analysts predict that air passenger traffic in Asia Pacific will catch up with other regions in 2023, as most travel and pandemic-related restrictions have been lifted.

Singapore is also expected to keep its lead over the rest of the countries in the region with air traffic to and from the country returning to normal by the end of 2023. This is in part thanks to Singapore’s “more successful efforts” to restore its flights to China.

As of January 2023, Changi Airport saw passenger traffic surging to 77% of its 2019 levels compared to the 13% that was seen in January 2022.

As at 10.23am, shares in $SINGAPORE AIRLINES LTD(C6L.SI)$ SIA are trading 1 cent lower, or 0.18% down, at $5.65; while shares in $SINGAPORE TECH ENGINEERING LTD(S63.SI)$ STE are trading 6 cents higher, or 1.79% up, at $3.42; and shares in SIAEC are trading 1 cent higher, or 0.45% up, at $2.23.

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