Tuesday, March 24, 2020

Singapore Airlines Ltd (SGX: C6L) Is In Deep Shit And Rights Issue Call Is Imminent

The Covid-19 situation has hit the aviation industry really hard and in particular the airlines since they are highly capitalized business which needs constant cashflow to fund their operating costs, capex and fixed costs.

In the scenario where they have to cut capacity like where we are in this situation now, the company may be able to "save" on their operating costs since they do not have to incur charges like handling and ground charges that are related to the operating business.

But, they do have to continue paying for parking charges to the airport, levies as well as fixed costs such as salaries and rental that will continue to bleed the business.

Cashflow Simulation Run

I've run a simulation run where the left hand side shows their latest Q3 results for the year ending 31 Dec 2019, while the middle portion reflects what the situation is today. On the right side, I've accounted for movement that is related to cashflow, so things like depreciation is taken out of context because they are non-cashflow related items.

The middle portion reflects the current scenario we have today. 

For example, the topline sees a 95% capacity cut which was announced just a few days ago since Singapore is on semi-lockdown situation. Consequently, I've adjusted the same for operating costs related such as fuel, inflight meals and handling charges.

For staff costs, I've used a 20% haircut across the payroll while for other fixed costs I've taken a 50% haircut.

The resulting loss coming in from this simulation is a negative $(1,998m) for the quarter. If we divide this by months, it means incurring a net loss of $(666m) / month.

What this means from a cashflow point of view is that should the situation prevails, the company is burning approximately $1,461m in cash every quarter, or $487m every month.

Now, this might look okay if you are in a good standing order in terms of your balance sheet but let's see what they have today.

The company's balance sheet is in precarious condition by having only $1.5b in cash while having a borrowings that is almost 4 times the amount.

Out of those borrowings, $3.75b belongs to the bond issuance which they did over the years while the rest of the $2.35 belongs to bank borrowings.

The bond issuance ranges between 3.03% to 3.75% per annum and they have to continue paying bond interests quarterly amounting to about $40m each quarter to the bond holders. Failure to deliver and pay on time will be fatal to the credit ratings.

What is more worrying at this point is that the company have a $500m bond that is maturing in Jul 2020 this year, which is simply just 3 months away from today. The next call will mature in Apr 2021, amounting to a smaller amount of $200m.

Under normal circumstances, they can simply just issue another bonds to the public to refinance the one that is maturing (kicking the can down the road).

But under today's scenario, it is unlikely that it will be possible.

If we look at the current bond that is on the market 3.03% maturing in 2024, the bond is currently trading below the par at 86 cents. For any bonds that is trading below the par, it signals a credibility of going concern, especially in a hard hit situation like this today.

The other way the company can do is to extend their credit facility with the banks who are willing to lend them further to tide over this cashflow. But there is a ripple effect to this because of the lower revenue hence lower credit ratings which will lead to higher borrowings rate and cap the maximum amount of loan to collateral ratio.

This will be made even worse by the time they report FY2020 numbers when they had to book in a hedge loss of nearly $2.5b, which will push down their nav down by a further $2, on top of recording a Q4 loss.

Simply put, the NAV you see in Q3 is not a reflection of what their nav will be 3 months from now. We are seeing a NAV that is closer to $6.

Temasek Come To The Rescue

I struggle to understand whenever someone bought a stock and they reasoned because the company is too big to fail because of strong backing behind.

I don't think most people truly understand what it means by strong backing behind.

You see, when a company is too big to fail, there will usually be intervention or bailout in the form of "cash grants". But government don't usually activate these cash grants simply by just giving cash to these companies because these reserves are also our nation's taxpayer's money at the end of the day.

What most likely will happen is the company issuing a rights call, which in this case Temasek being the largest shareholder for the company will then pump in more cash in exchange for higher equity issuance. This will be fair to both the existing shareholder as well as all the other people who has no stakes in the industry because no one will be diluted. Existing shareholder can choose to subscribe in order not to be diluted while the rest of us will be happy that Temasek is taking a bigger stake in the company.

If that is true, then we are likely to see SIA issuing an equity call about 1 or 2 months max from today simply because their current cash balance is unable to sustain their costs for more than 3 months running. The equity issuance has to be attractive in order to allow existing shareholders to participate so it is likely that it will be issued at a wide discounted price to what the mother share is being traded on the market.

From a perspective of liquidity from point of reference, we had DBS raising capital at the depth of the GFC by issuing a rights issue to raise SGD4b back then. And we are talking about banks doing that where they were supposed to have a strong CET ratio (ok, the stress test for CET ratio is levelled up now given the GFC crisis).

If you are buying today simply because SIA is at the 21 year low and has never been this low even during the gfc, then you should be able to deduce how they are going to fund their upcoming expenses with the existing cashflow that they have.

Simply relying on strong Temasek backing or reversion to the post-covid situation is unlikely to be the answer and it is hard to be a hero during these times where almost every industry is struggling.

P.S: I don't have a long/short position as of writing but may initiate a position in the next 48 hours.

Thanks for reading.

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  1. Hey Brian, thanks for the analysis. Just want to point out that there is still cargo/freight revenue to factor in. 522m according to the last presentation.

    The most immediate concern would be the margin call for the hedge done all the way to 2025 :/

    1. Thanks, how does the margin call works for the hedging done up till 2025? Will that simply be book fair value loss or they will have to "top" up via cash on the difference.

      I don't understand why would the company hedge up till 2025 at such a high price.

    2. They most likely entered long futures contract for fuel hedging. So if the current market price for jet fuel and brent is below their entry price, then their broker will do a margin call for the shortfall. Eg. long at $70, current price at $40, then they will have to top up $30 margin in cash.

      It will not be a realized loss yet until they close off the positions.

      Yeah i really don't get why they hedge all the way to 2025. Probably predicting higher oil prices. Risk management gone wrong.

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  3. Great analysis! Agree with you that recapitalisation via rights is the most likely here, based on historical patterns from Temasek.

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  6. uncle168,

    i think temasek and air china going to take sia private @ S$8.88

    sia has a lot of intangible asset in its branding story

    just like spc taken over by petrochina

    temasek realise by having more than 50% of its equity holdings in private meaning not listed, it is able to reduce the fluctuation of its portfolio in times like this

    by taking sia private, its borrowing cost will reduce due to temasek aaa ratings just like what happened to olam

    olam is not as good as sia so temasek will just hold a passive stake


  7. uncle168,

    temasek bail out sia leh

    no more deep shit


  8. Wow. Sure hope you saw this coming and did not short this counter.

  9. uncle168,

    3 for 2 rights issue @ $3

    ex-right price $4.4

    convertible bond worthless as convert to share > $4.84 0% coupon for 10 years

    i think all the sia shareholders would throw their rights and cb to temasek

    no underwriter temasek eat all