Unpacking DBS research analysts' bullish view on SIA

(Initially, I had planned to spend some time jotting down some thoughts about how cooling measures, specifically ABSD, might have the unintended consequence of actually increasing property prices, but I shall KIV that for a later post.)

Given the assessments I had made about SIA in prior posts here, I had made a mental note to keep an eye on SIA's FY21/22 financial results, which are due to be announced tomorrow, 18 May 2022. Late this evening, I came across Business Times coverage (link, paywalled) of an analyst report (pdf link) by DBS research, giving a BUY call on the airline. I was intrigued for two reasons:

1. Timing: By no means I track research reports regularly. However, it is uncommon for research reports to be published by analysts one day before a company's FY earnings announcement. Typically, analysts try to take into consideration the latest guidance/outlook as well as financial figures, so it struck me as very odd that the DBS equity research team decided to squeeze out its company update for SIA a day prior to the airline's earnings announcement. 
   
   
2. Thesis: Readers of my previous posts would be aware of my view that the MCBs loom over SIA minority shareholders and present a significant dilution threat. In addition to being extremely bullish on SIA, DBS research also states that they "treat the MCBs as debt instead of equity, as [they] see SIA redeeming the MCBs within 10 years, and deduct the accrued interest at end-FY23/24F." This runs entirely counter to my views and made me wonder if I was missing something. 

I felt a need to jot down my thoughts in response. Here goes:

Strange Risk Assessment by DBS Analysts

The analyst report is exceptionally bullish - with "street-high earnings estimates" and valuation based on a P/BV that's 1.5 std devs above the stock's 10-year mean P/BV. I have no qualms with these, since that is their view. But look at the following paragraph (extracted from p1):

Huh, how can this be a risk? Are the DBS analysts saying that the risk to their (bullish) view is that they might not be bullish enough? Cos that's what the paragraph says. Pretty darn weird. One would expect an assessment of risks to be something like: "recession may dampen travel demand" or "new Covid variants may lead to dialling back of reopening" or "airline runs into manpower issues and unable to hire and re-train quickly enough", but no, we have the above paragraph that presents a strange, almost absurd assessment of the risks of the report team's stated view. 

Unclear how redemption of MCBs can be funded

Granted, any redemption is likely to occur closer to the conversion date of the MCBs, i.e. around 2030/2031, and this is beyond the time-frame of the report. Still, based on the analysts' FY2022/23 and FY2023/24 forecasts (net profit estimated to be $500 mil and $1 bil respectively), I believe that SIA won't be able to generate the $10 bil necessary to redeem the MCBs early, at least not from accumulated earnings between now and 2030/2031.

SIA minority shareholders should be aware that SIA is carrying the $9.7 bil of MCBs on its balance sheet as equity rather than as debt - see 1H-FY21/22 update, p4 of 37. Key implications of doing so:

• By accounting for the MCBs as equity, SIA presents more favourable ratios and financials, such as lower Debt/Assets, Debt/Equity, etc. This is likely advantageous for SIA when it seeks to raise capital, e.g. taking on more debt.  
• By accounting for the MCBs as equity, SIA ought to present key statistics, such as EPS and NAV per share, on basic as well as adjusted basis. [adjusted = assuming MCBs ultimately get converted to shares] Interestingly, SIA did not do so for the 1H-FY21/22 update (see p32) but subsequently reported both basic and adjusted figures in the 3Q-FY21/22 update (see p8 of 10). NAV per share at end-Dec 2021 was $7.45, while just $3.35 on the adjusted basis. The latter makes clear the immense dilutive effect on NAV if the MCBs were held till their mandatory conversion date. 

Notably, DBS analysts treat the MCBs as debt instead of equity, in line with their assumption that the MCBs will be redeemed rather than converted. SIA minority shareholders should pay close attention to valuations and forecasts. From what I can tell (see balance sheet on p8 of analyst report), the DBS analysts adopt SIA's accounting of the MCBs, i.e. carried on balance sheet as equity, even though they say that they treat the MCBs as debt instead of equity. 

I'll give the analysts benefit of doubt that this wasn't an oversight, after all, the redemption (if it happens) is almost certainly to be beyond 2024F. Shareholders should just bear in mind that, regardless whether carried as equity or debt, if the MCBs are to be redeemed prior to the mandatory conversion date, the cardinal accounting equation [Assets = Debt + Shareholders' Equity] still applies. So to wipe the $9.7b of Equity off the balance sheet, SIA will either need to wipe $9.7b off the Assets side of the equation, or pile on $9.7b more in Debt (or a mix of both). The DBS analysts have not shared any views as to how the MCBs will be redeemed, and it is my view that SIA will face a Herculean task in finding a lender willing to extend close to $10b of Debt to the airline for this purpose.

Dividends?? Really?!

The DBS analysts assume that SIA will resume paying a dividend as early as 2023F, with 5.06 cents DPS in 2023F and 10.8 cents DPS in 2024F. (see Forecasts and Valuation table on p1 of analyst report. Separately, note that on p8, the $150 mil expenditure in 2024F for dividends paid would refer to the 5.06 cents DPS paid on ~3 billion issued shares for the prior period 2023F)

I cannot agree with this assessment that dividend payouts will resume, since I believe it would be in SIA's interest to conserve cash if it intends to redeem the MCBs early. Resuming dividends payout simply does not gel with the analysts' view that SIA will redeem the MCBs early. 

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Overall, I find the DBS research report almost laughably bullish. Of course, DBS and SIA are both under the big T umbrella and in fact have the same Chairman of their respective Boards, so perhaps there's much that I don't know. In any case, it seems that the DBS analysts are more bearish than me for the current FY, estimating an operating loss of $516 mil, as compared to my own latest revised estimate of operating loss between $350-$400 mil. We'll find out tomorrow when SIA releases its full-year results.

In the meantime, I can only hope that SIA minority shareholders are paying close attention to the actual numbers, and not just let themselves be buoyed by bullish media coverage.

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UPDATE: 19/5/2022

Singapore Airlines released their full-year FY2021/22 earnings yesterday. Actual net loss of $962 mil compared to DBS analyst estimate of $811 mil (loss). Operating loss of $610 mil was greater than DBS analyst estimates of $516 mil as well as my own revised estimates above.

Not surprisingly, the stock price today gave up pretty much all of the boost that the bullish DBS report provided just a day before, as seen annotated below. The timing (and slant) of the analyst report is questionable.