It was lunchtime.
Frank walked into the canteen of the airport terminal, sat down at the counter and ordered a sandwich.
Moments later, a pilot walked in, sat down right beside him.
Soon, more crew attendants filled up the empty seats in the canteen.
This was the 1970s.
Frank Abagnale was convicted of cheque frauds, stole millions of dollars and at one point, posed as a Pan American Airways pilot.
Back then, pilots and flight crews from different airlines thought of themselves as a close-knitted community — No matter which airlines you were from.
And this was before the US airlines’ deregulation.
“Pilots and crew attendants didn’t hesitate to talk to one another.” Frank said. “They all see themselves as one big family.”
All that changed.
The Airline Deregulation Act was enforced in 1978. Overnight, control of ticket prices, flight routes, new entrants of airlines were removed.
It was a dream for new airline entrants. It was a nightmare for airline monopolies.
More countries later on, followed the US Deregulation Act.
Singapore Airlines and the Airlines Industry
Back in October 2001, Singapore Airline (SIA) shares suffered a 50% loss due to the September 11 Terrorist Attack.
In the six years following the Sept 11 crisis, SIA shares soared 123% to S$19 per share.
SIA began operations in 1972. It’s the airline carrier of Singapore.
SIA has ranked as the world’s best airlines four times. SIA has done what many airlines couldn’t do — produced steady revenues, consistent profits and grew a strong brand.
In fact, the Singapore Girl was a notable figure in the airline’s corporate branding.
Since then, Singapore’s blue-chip has produced an annual average of S$15 billion of revenues, net profit margins of 5-6% and an annual average S$2.5 billion of operating cash flow. For an airline, these numbers are impressive.
But they hardly tell the full story.
And despite its strong reputation in the world, SIA shares have continued to fall from its peak in 2007.
Today, SIA sits at less than S$6 per share.
Source: ShareInvestor Webpro
When I invest, I want to first know what the industry is like.
Then, I want to know if the business in the industry has these three things:
- A business must have a habit-forming product
- A business must be “capital-efficient”
- A business must have pricing power
Airlines sells a habit-forming service — People love travelling. Some travel for work. Some travel for leisure. Air travel has transformed so many lives you cannot simply take air travel away.
But of the three things, what SIA lacks is “capital-efficiency” and pricing power. Both are like the Siamese twins
What’s capital-efficiency? Look for companies with an unusually high returns on your assets, even in the face of competition. And these returns don’t need large, ongoing capital investments. It’s the secret engine that drives successful businesses.
Even though SIA produces strong operating cash flow, it has also produced negative free cash flow (operating cash flow minus capital investments) every other year, over the last 10 years. SIA pours in heavy capital investments, but yields a small return on its capital.
That’s why its net profit margins are a low single-digit.
Air ticket pricing has an “Elastic Demand”
SIA cannot escape the next crucial thing: pricing power.
Air ticket prices are what economists like to call: elastic demand. For a small change in ticket prices, there’s a huge change in demand.
If you travel for holiday, and air ticket price drops — wouldn’t you rush to find that cheaper alternative, for the same standard of flight?
Many people would. I would.
Travelers are more sensitive to air ticket prices.
And they try to fly less when prices are high than when they are low.
This is how low-cost carriers easily disrupts big giants like SIA for the same flight routes.
That’s why the airline industry suffers from a near-perfect competition.
Starbucks versus Singapore Airlines
Starbucks raise its fresh cup of latter by 20%, people still buy.
Air ticket prices go up by 20%? People are going to compare prices. Air tickets are an elastic good.
Here’s a litmus test: what products and services would you not buy if prices were raised? That’s a sign that the product or service lacks pricing power.
That’s why low cost carriers could dominate the market over time — market share grew from 15% to 35%.
SIA shares: short-term play or long-term investment?
I wrote this right after I walked out of an interview over the weekend about SIA shares. I wanted to pen down my afterthoughts.
The thing is, SIA looks to me more of a speculative stock than a long-term investment.
Even if SIA financial numbers recovers to pre-COVID levels, it still has to deal with the entrants of low cost carriers.
As aircraft sizes get bigger over time, these LCCs can charge a far lower ticket price (more scalable) with more passengers carried in bigger, cheaper aircrafts.
SIA makes more a good short-term trade because air travel is opening up and already we’re seeing strong recoveries of this Singapore blue-chip.
But the long term game? There are, in my opinion, other good stocks to pick.
Sometimes investing can be simple.
Willie Keng, CFA
Founder, Dividend Titan