At the end of last month, Singapore Airlines (SIA) announced that it will buy 20 new Airbus 350s and five new Airbus 380s valued at US$7.5 billion (S$9.2 billion). Deliveries will begin in 2017. The last huge capital outlay was in June 2006 when it bought 29 planes worth the same amount of US$7.5 billion.
US$7.5 billion is a major capital expenditure and it is characteristic of many airline companies. Fleet renewal is essential to remain competitive, especially for SIA. If SIA were not to inject capital to acquire new planes, it would lose its edge as being one of the best airlines in the world. Also, no thanks to increasing competition from no-frills airlines, SIA has to be on its toes.
SIA currently operates 101 aircraft. The average age of the fleet is six years and five months (as of 1st Nov 2012). The fleet is one of the youngest in the world. Thus, every six years, the profits that can be returned to shareholders has to be used to acquire new planes and the capital outlay is humongous too. In the future, the price of new aircraft will increase due to inflation and rising manufacturing costs. With the advent of more budget airlines offering cheaper airfare, you can realise why investing in airline companies is not a terrific idea but more of a “terrorific” idea.
The following data shows the cash flow from operations, capital expenditure and free cash flow of SIA from 2000 – 2012.
The cash flow from operations and free cash flow are erratic. The free cash flow for five out of 13 years was negative. Shareholders have not been getting good returns from the business. Free cash flow mandates how well a business does. The erratic free cash flow shows that SIA is operating in a very competitive industry and airline industry is indeed competitive, as many would agree.
It is not surprising that the share price of SIA has been going nowhere since 2001, just like the free cash flow. In fact, one would have been better off buying the market instead of SIA. In the following chart, the blue line shows SIA’s share price performance and the green line shows the Straits Times Index (STI). It can be seen that the STI gave better returns of +20% compared to returns of SIA of -45%.
You might say using SIA as a sole example is not representative of the whole airline industry. What if Warren Buffett also agrees that airline industry is competitive? In a 2002 interview, Warren said the following: “If a capitalist had been present at Kitty Hawk back in the early 1900s, he should have shot Orville Wright. He would have saved his progeny money. But seriously, the airline business has been extraordinary. It has eaten up capital over the past century like almost no other business because people seem to keep coming back to it and putting fresh money in. I have an 800 number now that I call if I get the urge to buy an airline stock. I call at 2 in the morning and I say: ‘My name is Warren, and I’m an aeroholic.’ And then they talk me down.”
To illustrate how free cash flow is important for a company to do well, let us compare SIA with another local company, Vicom, which is the vehicle inspection and testing business. The following data shows the cash flow from operations, capital expenditure and free cash flow of Vicom from 2000 – 2011.
The cash flow from operations and free cash flow are increasing more consistently than SIA. Now, let us look at the share price performance of Vicom against STI.
The STI (green line) has been going sideways but Vicom (blue line) has defied gravity (albeit with a few ups and downs)!
Let me sign off with a quote by Warren Buffett – “How do you become a millionaire? Make a billion dollars and then buy an airline!”
SudhanP.com 
I feel that to compare the free cash flow of both vicom and SIA is pretty myopic in this aspect. Comparision should be between companies within the same industry.vicom is a monopoly in singapre if I am not wrong, but for SIA, competition is strong amongst LcCs, premium carriers even within Singapore.
Hi Yong Ren,
Thanks for visiting my blog and for your comments.
Yes, you are right and understand where you are coming from. FCF must be compared with companies within industry itself to have an “apple to apple” comparison. I used the FCF of SIA against Vicom for illustrative purposes only, to show that FCF of a company is important for good returns. I’m not doing a company analysis of SIA per se, which needs a thorough comparison of FCF with other airline companies. If I were to compare SIA against other airline companies for this particular post, I would not be able to put across the fact that airline companies do not make good long-term investment. Almost all airline companies would have the same erratic FCF. Maybe less so for companies which do not do as frequent a fleet renewal as SIA. Hope this helps!
Hi See Yong Ren,
I kind of think it is good comparison made by the blogger. Why? Because he is trying to showcase the difference in operating results between a business with excellent economics and a business with poor economics. Comparing SIA to other airlines would not showcase anything worthwhile because the entire industry has poor economics.
Hi Ser Jing,
Thanks for your comments. That was exactly what I was trying to put across =)
Hi, I do agree with yongren on that part. A better comparison will be SIAEC to show the huge difference the business model can have for 2 players in similar industry. One is under constant competition and have to constantly spend capex to renew it fleet though the return is limited. The other is able to maintain asset light strategy by simply servicing aircraft and riding on the competition of airline.
Hi Shan Rui,
Thanks for your input. SIAEC is an aircraft maintenance company and not an operator of an airline. It’s not really comparing apples to apples like what Yong Ren mentioned I should have done (if I understood his comment fully, apologies if I didn’t). Having said that, I agree that SIA vs SIAEC would have been a better comparison than SIA vs Vicom as it’s within the same industry but with a different business model.
I do understand where you are coming from and indeed it is very hard to have an apple to apple comparison simply because this is the economics of the whole airline industry. Similarly, other industries of poor economics like automobile and materials provider are destined to be doomed. There will certainly be exception when one is the lowest cost competitor or buoyed by regulators. On a side note, I believe that SIA has benefited from cash and profit stashed in subsidiaries like SIAEC that many other airlines do not benefit from.
From a personal basis, and not from an investor’s standpoint, I feel that the Management of SIA is still doing a commendable job. Despite the fierce competition in the industry, SIA is still able to stay in the black unlike competitors like Qantas and MAS. Who knows if you include the opportunity costs of jet fuel for middle eastern carriers, are they still in the black? The recently announced 10% investment in Virgin Australia and introduction of Scoot showed that SIA is well ready to respond to challenges. Lastly, to quote IATA CEO, “Putting regional diversity aside, the fact that airlines are making any money at all with weak markets and high fuel prices is a tribute to their strong business performance, as evidenced by maintaining global load factors close to 80% since the start of 2012” I have full faith in SIA weathering the grey skies for longer term sustainability, bringing value to all stakeholders.
Hi Si-Rong,
Thanks for your comments.
Warren Buffett said, “When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact”. No doubt SIA’s management is doing well to weather the storm but as a long-term investment, I don’t think it’s a good business to invest in.
I have a second opinion. I would think at least for SIA, short-term wise there will be no positive catalysts, thus I will not touch it unless valuation fall to an attractive level. But never write off any industry or company for the longer term. Who knows perhaps jet fuel would not be the only commodity to drive planes, Europe and us can pick themselves up faster than expected to boost aviation demand etc. Nobody knows.
Pan American World Airways, commonly known as Pan Am, was the principal and largest international air carrier in the United States from 1927 until its collapse on December 4, 1991.
How come SIA still around? And we are just a little “RED DOT” Never invest in SIA even once even when she was at peak performance. I expect it to deteriorate further down the road. In fact i am surprise it is lasting so long.
How come?