Why I'm not buying SIA shares even after Temasek promised to save it

Much ink has been spilt on the whole Singapore Airlines Ltd (SGX: C6L) fiasco.

The latest news now is that Temasek, one of the Singapore government's investment arms, has stepped in to provide our country's flag carrier with much-needed capital.

This comes as Singapore Airlines (SIA) is confronting liquidity problems due to its high debt load and fixed costs, and the disruption to its business because of the Covid-19 pandemic.

The rescue

In essence, Temasek, which currently owns around 55 per cent of SIA, has underwritten a $5.3 billion equity fundraising by the airline.

Temasek has also underwritten a $9.7 billion issuance of mandatory convertible bonds (MCBs) by SIA; the MCBs will either be converted to shares in 10 years or redeemed before then.

What this means is that Temasek will not only subscribe to all the rights and relevant bonds that it's entitled to; it will also purchase any of the rights or bonds that other SIA shareholders do not want.

But despite Temasek coming in to save the day, I'm not interested in investing in SIA, even at these seemingly low prices.

How did it get into this situation in the first place?

Much like other airline companies, SIA is heavily leveraged due to the capital-intensive nature of its business.

The high cost of replacing and upgrading SIA's fleet has also led to negative free cash flow in four of the last five years.

To keep itself afloat, our flag carrier has been increasingly making use of the debt markets for its cash flow requirements.

In fact, the company issued bonds to the public just last year to raise more capital. At the end of 2019, the airline had $1.6 billion in cash, but $7.7 billion in total debt.

The aviation industry is highly competitive too and the emergence of low-cost carriers have led to thinner margins for airlines.

The Covid-19 pandemic was the straw that broke the camel's back as the significant loss of revenue (SIA recently cut 96 per cent of its flight capacity) finally led to severe cash flow problems for the company and Temasek ultimately had to step in to save the day.

Temasek saving the day but shareholders will be diluted

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Let's be clear, this is not a government bailout. It is nothing like what the American airlines got from the US government, which included a massive grant.

SIA's situation is simply a major shareholder promising to back the company when it sells new shares to raise capital.

The new shares will dilute existing shareholders if they don't take up the rights issue.

On top of that, the mandatory convertible bonds will also dilute shareholders in 10 years when they are converted, unless they are redeemed before then.

SIA shares seem cheap but it really is not

Under the rights issue portion of SIA's latest fundraising exercise, existing shareholders of the airline will be given the opportunity to buy three new shares at $3 per share for every two shares they own.

Based on SIA's current share price of $6.03, I will get shares for an average price of $4.21 each if I buy in today and subscribe to the rights issue.

That seems cheap - but it really is not.

As of 31 December 2019, SIA had a net asset value per share of $10.25. But that will drop substantially after the rights issue.

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The rights issue will increase shareholders' equity from $12.1 billion to $17.4 billion, or an increase of 43 per cent from 31 December 2019.

At the same time, the number of shares will increase from 1.2 billion to 3 billion. After the dilution, the net asset value per share will fall to around $5.80 per share based on SIA's last reported financials.

I also expect SIA's net asset value per share to fall even more than that because of the heavy losses suffered as a result of the Covid-19 pandemic.

In the quarter ended 31 December 2019, Singapore Airlines incurred about $800 million in staff costs, $210 million in aircraft maintenance expenses, and $522 million in depreciation.

Most of these fixed costs will likely still need to be accounted for during the period of near-zero flights, despite SIA grounding its planes. These costs add up to around $0.50 per share per quarter.

Together with the upcoming dilution and the heavy losses, Singapore Airlines' shares could have a net asset value of close to or even less than $5.30 per share in the future, depending on how long the pandemic lasts.

Earnings per share dilution

Earnings per share will also fall after the issuance of new shares because of the rights issue. SIA reported trailing 12 months profit of $765 million.

Even if our flag carrier can achieve similar profit after the whole pandemic passes, its earnings per share will drop substantially because of the larger number of outstanding shares.

By my calculation, normalised earnings per share will decline from $0.63 to just $0.25 after the rights issue.

I'm not buying shares just yet…

The injection of cash will put SIA in a much better financial position but I'm still not convinced.

Even if I buy shares today and subscribe to all my allotted shares in the rights issue, I don't think I'll be getting that great of a deal.

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I'll be paying an average price of around $4.21 per share, which translates to only a small discount to my calculated adjusted net asset value per share.

It is also slightly more than 16 times SIA's normalised earnings post-rights issue, which is not that cheap.

Moreover, if SIA is unable to redeem the mandatory convertible bonds before they get converted in 10 years time, they will potentially lead to further dilution to shareholders.

Let's not forget too that our flag carrier (1) has a history of inconsistent free cash flow, (2) operates in an industry that is a slave to fuel prices, and (3) has strong competition from low-cost carriers.

Given all these, despite the seemingly low share price, I still don't think Singapore Airlines shares are cheap enough for my liking.

This article was first published in The Good Investors. All content is displayed for general information purposes only and does not constitute professional financial advice.