Sunday, 28 July 2019

Does SIA's 3.03% Bond Have Sufficient Margin of Safety?

Following up from last week's blog post on Will Temasek Bail Out SIA Bondholders In Event of Default?, here is the analysis on SIA's 5-year 3.03% bond based on Benjamin Graham's criteria as described in The Lost Art of Bond Investment. Surprisingly, the bond is not as strong as I initially thought based on a simple Debt-to-Equity ratio check. Below are the computation of the earnings coverage and stock value ratio based on SIA's latest financial statements for Financial Year 18/19 ending in Mar 2019.

Earnings Coverage
Profit before tax = $868.6M
Adjusted for:
- Deduct: Share of profits from joint ventures = $23.2M
- Add: Share of losses from associates = $97.4M
- Add: Rental on leased aircraft = $679.7M
- Add: Finance cost = $116.1M
Total earnings available for covering fixed charges = $1,738.6M

Current finance cost = $116.1M
Adjusted for:
- Add: Rental on leased aircraft = $679.7M
- Add: Interest for $600M @ 3.16% MTN 007 series = 3.16% x $600M

= $19.0M
- Add: Interest for $750M @ 3.03% MTN 001 series = 3.03% x $750M

= $22.7M
Total finance cost = $837.5M

Earning Coverage = $1,738.6M / $837.5M

= 2.08

Several adjustments were made to compute the total earnings available for covering fixed charges and total finance cost. The more unusual adjustment in SIA's case involves adding the rental of leased aircraft to both figures. This is because SIA leases aircraft in addition to buying them. The leases range from 6 to 12 years and cannot be cancelled, although there are options for early termination for up to 2 years before the original lease expiry. The leased aircraft do not appear on the balance sheet.

On the other hand, for aircraft that SIA owns by borrowing money from the banks, the aircraft appear as a asset and the loan appears as a liability on the balance sheet. On the income statement, there is no rental required, but SIA incurs depreciation and interest on the loan.

Hence, for the leased aircraft, even though SIA does not incur a finance cost, the rental is effectively a fixed charge that SIA has to cover, as the leases cannot be cancelled and SIA needs the aircraft to continue its operations. A similar adjustment needs to be made for the balance sheet, as discussed in the section later.

The current finance cost is also adjusted for interest on a $600M 3.16% Medium Term Note (MTN) issued on 26 Oct 2018 and the $750M 3.03% bond issued on 29 Mar 2019 which is the subject of this blog post. Although both bonds already appear on the balance sheet as at 31 Mar 2019, their first interest payments will only be made in FY19/20, Hence, their interest payments need to be added to compute the actual finance cost.

Based on the above adjusted figures, the earnings coverage is computed to be 2.08 times, which is below the minimum average earnings coverage of 3 times for industrial companies.

Stock Value Ratio

No. of shares = 1,199.9M
Share price = $9.62
Market value of shares = $11,542.6M

Current borrowings = $6,654.4M
Adjusted for:
- Add: Liability for rental aircraft = $2,200.0M
Total borrowings = $8,854.4M

Stock value ratio = $11,542.6M / $8,854.4M

= 1.30

As mentioned above, adjustments need to be made to the balance sheet for the rental aircraft. The rental aircraft is effectively an asset for SIA. Correspondingly, there should be a liability to account for the loan that SIA would have borrowed to purchase the aircraft outright. In fact, International Financial Reporting Standard (IFRS) 16 on Leases came into effective starting from Jan 2019 that requires companies like SIA to account for leased assets on their balance sheets. SIA has disclosed in its Annual Report that the assets will be increased by $1.7B while liabilities will be increased by $2.2B.

Considering the $2.2B increase in total borrowings, the stock value ratio is computed to be 1.30, which is higher than the minimum stock value ratio of 1.0 for industrial companies.

Quantitative Assessment

Thus, based on the above figures, SIA's 5-year 3.03% bond does not meet the earnings coverage criterion but meets the stock value ratio criterion. Based on Benjamin Graham's criteria, the bond does not have sufficient margin of safety.

Other Considerations

As mention in my blog post on Will Temasek Bail Out SIA Bondholders In Event of Default? last week, I believe Temasek will come to the rescue of SIA bondholders in the event that SIA could not pay interest and/or redeem the bond.

P.S. I am vested in SIA's 3.03% bond.

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