The Covid-19 situation has hit the aviation industry really hard and in particular the airlines, since they are a 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 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 borrowings that were almost 4 times the amount cash.
Out of those borrowings, $3.75b belongs to the bond issuance which they did over the years while the rest of the $2.35b were bank borrowings.
The bonds’ interest rates ranged between 3.03% and 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 their credit rating.
What is more worrying is that the company have a $500m bond that is maturing in Jul 2020 this year, which is just 3 months away. The next call will mature in Apr 2021, amounting to a smaller amount of $200m.
Under normal circumstances, they can simply just issue new bonds to the public and 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 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 – the lower revenue would lead to lower credit ratings, higher borrowings rate and limit the amount of loan-to-collateral ratio.
This will be made worse by the time they report FY2020 numbers because they would have to book in a fuel hedging loss of nearly $2.5b. This will push down their NAV down by a further $2 per share, 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 per share that is closer to $6.
Temasek Come To The Rescue
I struggled to understand whenever someone bought a stock and they reasoned that the company is too big to fail because of a strong backing.
I don’t think most people truly understand the consequences.
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 giving cash to these companies because these reserves are also our nation’s taxpayer’s money at the end of the day.
It is more likely the company would issue a rights call, which in this case Temasek being the largest shareholder for the company will pump in more cash in exchange for higher equity issuance. This will be fair to both the existing shareholders 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 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 entice existing shareholders to participate. This means that the rights will be issued at a huge discount to the mother shares being traded on the market.
From a perspective of liquidity, we had DBS raising capital at the depth of the GFC by issuing a rights issue to raise $4b. 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 has improved after GFC).
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 19 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.
Republished with permission with minor edits. Original post here.