Asia Airlines Bracing for a Long Winter, Assume Coverage of Singapore Airlines and Cathay Pacific at UW

Asia Pacific Equity Research 16 July 2020 Asia Airlines Bracing for a long winter, assume coverage of Singapore Airlines and Cathay Pacific at UW The global aviation industry is facing its greatest survival test, with COVID-19 Singapore, Hong Kong visibly impacting airlines' financial performance, casting doubt on the outlook for Infrastructure, Industrials & future travel demand, particularly in the premium service market segment. We Transport assume coverage of Singapore Airlines (SIA) and Cathay Pacific (CX), the two AC leading FSC in the Asia region, with UW ratings in light of: 1) zero exposure to Karen Li, CFA the domestic market, plus high exposure to international transit; and 2) additional (852) 2800-8589 funding needs in a likely long drawn-out recovery scenario, given ongoing cash [email protected] Bloomberg JPMA KLI <GO> burn and outstanding large-sized aircraft delivery plan committed pre-COVID-19. We set our Jun-21 PT for SIA and CX at S$3.1 and HK$4.8 respectively, with de- Shawn Ng Jun Jie rating to be driven by risk of additional cash calls (note SIA and CX saw BVPS (852) 2800 8570 [email protected] contract by c32% and c39% post the recent capital raising). Jenny Qiu Driver#1: Zero exposure to domestic travel and a potentially slow (852) 2800 8503 resumption of business travel clouds near-term recovery visibility. While [email protected] there was initial optimism following the flattening of the COVID-19 infection J.P. Morgan Securities (Asia Pacific) Limited curve as countries step up efforts to restart domestic air travel and experiment with ‘travel corridors’ to gradually revive cross-border travel, the recent resurgence in infection cases across the US, Japan, Beijing and Hong Kong SAR, have raised fresh concerns over recurring reinstatement of stringent travel restrictions and social distancing measures unless a vaccine solution is found. Driver#2: Point-to-point connectivity could be a more effective operating model compared to the hub-and-spoke model during the early stages of recovery. Transit passengers account for approximately 50% of total traffic at CX and SIA, higher than the overall 30% average for the two airport hubs.While their LCC entities (HK Express for CX and Scoot for SIA) could see an earlier pickup, the revenue contribution to its group remains small. Driver#3: Additional cash calls may be required in a long drawn-out recovery scenario, particularly with limited visibility on delay of aircraft delivery. SIA and CX recently raised a total of S$8.8B and HK$39B through equity issuance, which however can only sustain 14 months of ‘lifeline’ based on our calculated cash burn rate. SIA and CX have a total of 150 and 70 aircraft delivery outstanding, but it is worth noting ongoing challenges faced in reaching commercial agreements with OEMs including Boeing and Airbus. Watch out for fuel cost impact as fuel hedging strategies have gone wrong in the past. The unprecedented low oil price coupled with significant capacity re-calibration have exacerbated SIA and CX's effective hedge ratio and resulted in fuel hedging losses, despite lessons from past mistakes learned. Lessons from past aviation crises: In contrast to prior aviation crises (9/11, 2002-03 SARS and 2008-09 GFC), COVID-19's longer duration and far greater scale could lead to a much longer recovery trajectory. Equity Ratings and Price Targets Mkt Cap Price Rating Price Target Company Ticker ($ mn) CCY Price Cur Prev Cur End Prev End Date Date Singapore Airlines SIA SP 6,743 SGD 3.72 UW n/c 3.10 Jun-21 4.00 Mar-21 Cathay Pacific Airways 293 HK 3,100 HKD 6.11 UW n/c 4.80 Jun-21 6.80 Dec-20 Source: Company data, Bloomberg, J.P. Morgan estimates. n/c = no change. All prices as of 16 Jul 20. See page 25 for analyst certification and important disclosures, including non-US analyst disclosures. J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. www.jpmorganmarkets.com Karen Li, CFA Asia Pacific Equity Research (852) 2800-8589 16 July 2020 [email protected] Table of Contents Assume coverage with a cautious view .................................3 Negative driver #1: Absence of domestic travel market a key weakness ...................4 Negative driver #2: Early recovery could see more direct point-to-point flights and less transit demand..................................................................................................4 Negative driver #3: Provision of financial support reduces near-term risk of financial distress, but a potentially long drawn-out recovery could trigger additional cash calls..5 Key lessons from past aviation crises ...................................7 Sensitivity analysis: Oil exposure represents key operational risk for airlines ...................................................10 What can mitigate the negative drivers?..............................12 Valuation and share price review..........................................13 Singapore Airlines..................................................................17 Cathay Pacific Airways ..........................................................21 2 Karen Li, CFA Asia Pacific Equity Research (852) 2800-8589 16 July 2020 [email protected] Assume coverage with a cautious view The broadening scale of COVID-19 and unprecedented lockdown and cross- border restrictions have led to global paralysis in air travel, visibly impacting both Singapore Airlines (SIA) and Cathay Pacific (CX) performance and the future outlook. COVID-19, without vaccine invention, is likely to be the greatest ever stress test facing the global aviation industry, with airlines around the world scaling back capacity by grounding aircraft on a drastic scale as they cope with demand slumps amid stringent cross-border restrictions. The recent resurgence in infection cases across the US, Tokyo (Japan), Beijing and Hong Kong have raised fresh concerns over recurring reinstatement of stringent travel restrictions and social-distancing measures. All of these represent a major step back for a recovery in flight schedules, unfortunately resetting expectations for a demand recovery. We expect the near- standstill in global air travel to continue to drag on airlines’ operating and financial performance for not only months, but potentially years to come. Given the clouded recovery visibility for global air travel, we assume coverage of SIA and CX, the two leading Full Service Carriers (FSC) across Asia Pacific, with UW ratings and setting our PT for SIA and CX at S$3.1 by Jun-21 and HK$4.8 by Jun-21. While the provision of financial support from government and major shareholders help mitigate the near-term risk of financial distress, our expectations for a prolonged flight recovery trajectory vs the lack of visibility on delays of aircraft delivery may lead to additional cash calls. We lay out three underlying negative drivers that support our overall thesis as shown below. Figure 1: Weekly scheduled flights (incl. domestic and international) Figure 2: Weekly scheduled flights (incl. domestic and international) across the world (Index = 2019 average total flight schedule) across Asia Pacific (Index = 2019 average total flight schedule) 140 120 120 100 100 80 80 60 60 40 40 20 20 - - Jun-19 Jul-19 Aug-19 Sep-19 Oct-19 Nov-19 Dec-19 Jan-20 Feb-20 Mar-20 Apr-20 May-20 Jun-20 Jun-19 Jul-19 Aug-19 Sep-19 Oct-19 Nov-19 Dec-19 Jan-20 Feb-20 Mar-20 Apr-20 May-20 Jun-20 World Asia Pacific Europe North America Southeast Asia South Asia North Asia Asia Pacific Source: OAG Schedules Analyzer, J.P. Morgan. As of July 13. Source: OAG Schedules Analyzer, J.P. Morgan. As of July 13. 3 Karen Li, CFA Asia Pacific Equity Research (852) 2800-8589 16 July 2020 [email protected] Negative driver #1: Absence of domestic travel market a key weakness With Singapore (SIA’s hub) and Hong Kong (CX’s hub) not having the luxury of a robust domestic market, we expect both SIA and CX to see a much slower recovery, compared to peers such as Chinese airlines. Border restrictions may remain largely in place and may be re-imposed after opening amid concerns over a resurgence of COVID-19 infection cases, which means long-haul international flights may be a laggard along the recovery curve. Preparations for a restart in air travel have begun, with the formation of ‘travel corridors’ as a first step in cross-border travel, but the recovery path is likely to be bumpy. SIA has begun making preparations for a restart of operations, with flexibility in resource deployment a key focus, with the company keeping an eye out for potential near-term opportunities, such as a partial re-opening of certain flight routes and borders. With various countries discussing the potential formation of ‘travel corridors’ which include ‘travel bubbles’ and ‘fast-entry systems’, we expect business travel demand to see a sequential pickup within the medium term, though a revival to pre-COVID-19 levels remains some way away. Worth noting that business travel typically forms a key revenue component for FSCs such as SIA and CX on the back airlines’ cross-subsidization model (i.e. premium class (i.e. first/business) seats ‘subsidizing’ economy seats), with premium class seats historically constituting around 40% of revenue for SIA, as guided by management. Thus, we expect the likely bumpy and slow recovery in business travel to remain a drag to SIA and CX given the significance that this segment constitutes to their overall operations. Negative driver #2: Early recovery could see more direct point-to-point flights and less transit demand Transit PAX traffic could be impacted amid near-term preference for point-to- point routes The near-term recovery for point-to-point flights could result in lower transit PAX traffic and thereby impact both CX and SIA’s transit revenue particularly given that Hong Kong and Singapore represent key global transit hubs.

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