By Thomas Streater

Famed investor Warren Buffett once quipped that the best way to become a millionaire is to start as a billionaire and then buy an airline. It's a sentiment that Singapore Airlines would well appreciate.

While Singapore Airlines ( C6L.SG) has a well-earned reputation as one of Asia's better carriers, it has not covered itself in glory when it comes to investments in low cost carriers in the region. The company's first half earnings underscored the ongoing drag from its 40% stake in Tiger Airways ( J7X.SG), with the low cost carrier's loss of SGD129 million leading Singapore Airlines to unveil a profit of SGD126 million, a decline of 56% from the same time last year.

There may be more pain to come. Singapore Airline's is poised to raise its holding in Tiger Airways to 56% after the discount airline revealed it was rattling the tin for more capital. Singapore Airlines will not only convert its perpetual convertible capital securities in its troublesome investment, it will also stump up cash to take up its entitlements in Tiger's SGD234 million rights issue. It's an interesting use of shareholder funds given the discount airline has delivered cumulative losses of around SGD350 million over the past seven years.

Despite the ongoing drag from Tiger, there has been renewed enthusiasm for Singapore Airlines shares in recent weeks. The stock has popped around 5% since mid-October, bouncing off an eight month low, as some investors figure the slump in oil prices will be translated into lower fuel costs, and therefore, a boost to the company's bottom line. Jet fuel prices are down 18% from a year ago, but hedging contracts mean the company will not benefit fully from cheaper fuel, which accounts for around 40% of its cost base.

The strong U.S. dollar is another complication confronting Singapore Airlines. The carrier has about 55% of its costs in U.S. dollars, but only about 15% of its revenue linked to the greenback according to Credit Suisse. Regional rival Cathay Pacific ( 0293.HK), which is based in Hong Kong, is better sheltered from the greenback's muscular performance given it has a higher proportion of revenues generated in Hong Kong dollars -- which is pegged to the greenback -- and Chinese yuan, which varies very little against the U.S. currency month-to-month.

Singapore Airlines faces a tough operating environment. While lower fuel prices could provide lift for the airline, the reality is that Asia remains a keenly contested battleground for all carriers at a time when passenger demand is lackluster. There is also the longer term challenge presented by deep pocketed Middle East airlines such as Emirates, which is seeking to establish Dubai as a rival hub to Singapore's Changi Airport.

While Singapore Airlines confronts many challenges, one of them isn't balance sheet strength. The stock's net cash is equivalent to about one-third of its market cap, providing some comfort for investors. However, that may not be enough for investors considering exposure to an Asian airline. While Singapore Airlines and Cathay Pacific both trade at 0.9 times book value, the former's projected price-earnings multiple of 24 times is double that of its Hong Kong rival, according to J.P. Morgan. The broker also expects Cathay Pacific to generate a higher return on equity.

With numerous headwinds confronting Singapore Airlines, investors may be better served waiting for clearer skies before boarding this stock.

Email: thomas.streater@barrons.com

Comments? E-mail us at asiaeditors@barrons.com

 
 
 

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