Singapore Airlines (SIA) is making a big move in India that will see it take a quarter stake in the loss-making Air India. However, analysts are optimistic about the prospects this enlarged footprint will bring to the airline, which has worked up an appetite for new growth after recovering sharply from the pandemic.
The market had seemingly concurred, with SIA shares up 1.65% to close at $5.55 on Dec 1 from the market close on Nov 29, when SIA announced that Vistara — its joint venture airline in India — will merge with Air India, owned by the same joint venture partner the Tata Group.
Vistara was set up in 2013, with Tata and SIA holding 51% and 49%, respectively. Still, the airline has not been profitable partly because of a lack of scale. National carrier Air India is deeply in the red, with some $2 billion in losses in the last financial year. Tata took over the airline early this year from the Indian government for US$2.4 billion ($3.2 billion).
Under the terms of the deal, SIA will swap its 49% interest in Vistara for a 19.4% stake in the enlarged Air India. It will then invest $360 million for another 5.7% in the enlarged entity, giving it a total stake of 25.1%. In addition, SIA will invest up to another $880 million post-merger.
For SIA’s 1HFY2023 ended Sept 30, its share of losses from Vistara amounted to $109 million and assuming its 25.1% share of the enlarged entity, SIA’s share of the red ink would be $256 million.
DBS Group Research’s Paul Yong says there is stiff competition in the form of domestic market leader Indigo, plus the established Middle Eastern carriers. Nevertheless, the merger “certainly makes sense for SIA.”
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By combining forces, SIA would have a meaningful share of a larger entity that has a much stronger chance at overcoming the odds in one of the world’s most competitive aviation markets,” adds Yong, who has kept his “buy” call and $6.60 target price on the stock.
He says the combined entity will have a more meaningful market share for domestic and international routes of around 23% each. In contrast, Vistara, on its own, has a market share of 9% and 2% for domestic and international markets, respectively.
Yong also says that the combined entity will operate both full-service and low-cost flights, which gives it a bigger addressable market to capture across the various segments. “The larger entity will be able to shift resources across platforms to be more nimble and responsive to changes in demand.”
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“Apart from economies of scale, Vistara, which has been struggling to gain slots at congested airports, would gain access to valuable traffic rights and airport slots at crucial domestic and international airports, while Air India can benefit from Vistara’s operational expertise and service excellence,” adds Yong.
He acknowledges that the deal will weigh on SIA’s earnings for the foreseeable future. Still, it is “certainly positive” in the long run “given the promising long-term growth prospects of the Indian aviation market.”
Key risks will be how the enlarged Air India — whose current CEO is former SIA executive Campbell Wilson — will execute its transformation plans, the subsequent calls on capital, and how soon Air India can turn profitable.
Meanwhile, SIA will recognise a one-off noncash accounting gain of $1.1 billion as part of the deal. As such, UOB Kay Hian has raised its FY2024 earnings by 81%, assuming the merger will be completed by then and the gain can be booked.
For the subsequent FY2025, UOB Kay Hian has trimmed its earnings forecast by 17% to consider possible losses from Air India. The brokerage sees Air India’s earnings improving beyond FY2025. UOB Kay Hian also rates the stock “hold” with a target price of $5.35, pegged to 1.06x FY2024 book value estimates, one standard deviation above SIA’s historical mean of 0.97x.
