I upped my stakes in Singapore Airlines on 12th June 2008

This is the only 'blue chip' company I had in my portfolio of 13 companies. The sheer amount of media coverage on any blue chip company actually does not warrant me to say anymore about it, but since I'm treating this as my diary, penning down my thoughts now would still be helpful to my learning experience when I review them several years down the road.

Rationale

Given the slowing economic growth, escalating fuel cost, falling demand due to more expensive air tickets, it is almost taken for granted that the global airline industry is facing increasing dismal days ahead. It looks almost certain that Singapore Airlines, SIA, one of the most profitable airlines in the world, will also not be spared. If so, while many airlines are already cutting back flights to stem mounting losses, why is SIA still boosting flights?

I believe it has the capability to weather the storm and emerge stronger than ever before... and I have the reasons to believe, at least I think I have :)

Revenue strength

1. Branding, SIA had put in great efforts to build up its brand that is synonymous with quality flying experience. This enables them to charge more per ticket then competing airlines. It is not surprising that they repeatedly got voted for best airline of some sort almost every year.
2. Corporate travel contributed significantly to the bottom line of SIA, particularly the business class. It is not uncommon that business class seats sold out like hot cakes on popular routes. It is hence not surprising when SIA started to launch all-business class flights.
   
3. Price insensitivity amongst client base. Most who choose to fly with SIA are either tourist who would rather pay more for the flying experience or businessman who's tickets are their companies' problem. Either way, unless the ticket becomes unreasonably expensive, they will continue to fly with SIA.
   

Cost management

1. Managing Jet Fuel. Fuel cost made up about 36.5% of total expenditure. With the strong branding and relatively price insensitive client base, it is able to partially pass on the rising fuel cost via fuel surcharges, 3 times within 3 months. Coupled with somewhat successful fuel hedgeing (at about USD $100/BBL vs current $166/BBL) and positive currency translation for fuel paid in USD, SIA seems to be managing its fuel cost well.
2. Newer planes with better fuel efficiency. SIA currently operates more fuel efficient Airbus A340, A380, Boeing 777 and disposing off less efficient Boeing 747-400. It is expecting to take delivery of Boeing 777-300ER and Airbus A330-300 later this year.
3. Staff cost accounted for 16.6%, with pilots accounting significantly. It helps (from the business perspective) that SIA operates a flying school that churns out relatively cheap pilots bonded for about 7 years commencing from 1st officer.
   

Outlook

Two major factors are threatening the profitability of SIA (others are talking about loss management). Firstly, the escalating fuel cost, if not managed properly, will definitely eat into earnings. But from my earlier post, I have reasons to believe that fuel price will not aim for the moon. It will come down, sooner or later. Secondly, the rising ticket prices are obviously hurting travel. but from the reasons above, SIA seems well positioned to ride out this storm.

Inflation --- will it get worse?

Ministry of Trade and Industry Singapore had recently revised the forecasted Consumer Price Index, CPI inflation for 2008 to be between 5.0 to 6.0%, up from 4.5 to 5.5%.
(src:http://app.mti.gov.sg/data/article/13881/doc/ESS_1Q2008_PR.pdf)

Looking at recent events unfolding before me, I would think the situation would get worse before it get better.

Stocking the fire

Current inflation resulted primarily from price spikes in commodities and oil, (the latter driving up transportation cost which further pushes up the price of the former).
While many fingers are already pointing, actions to looking for scape goats (from global warming induced poor food crop harvest to hedge funds speculation in oil market) are fast and furious but actions to remedy are slow to come by.

A few factors are already fanning the fire:

Crude Oil Production

1) Under investment in oil refining and extraction capacity due to oil price languishing at low levels in the 1990's right up to 2003.
2) Political reasons that prevented increase in supply to meet rising crude demand
3) Disruptions to crude supply from producers due to various reasons, sabotage, war, freak weather etc.

Commodities supply (esp. food)

1) Growing disparity between stable food crops and biofuel food crops. It is more logical for poor farmers to grow lucrative biofuel food crops to basic food crops.
2) Rising transportation cost
3) Freak weather destroying farms and crops
4) Underfarming due to languishing low food prices for decades

In general, due to past low prices, supply is obviously not catching up with demand (especially with the rise of the emerging economies, e.g. China, India, Brazil, Russia and ASEAN nations). Whether or not the past prices are unrealistically under priced is not the issue.The issue is at those prices, it does not make economic sense to produce more or invest in the production, resulting in the current situation.

In fact, the last 2 inflation crisis are also induced by the oil spike, once in 1973, the other in 1979:

(the figures are obtained from: http://www.singstat.gov.sg/stats/themes/economy/hist/cpi.html)

Potential consequences

Slowing economic growth

The most direct consequence of surging inflation is to drive up the cost of doing business. For the small businesses, it is a matter of survival. Not only do they have to grapple with rising cost, i.e. the problem of passing on the increase to the consumers, but also falling demand for their products and services as a result. The bigger companies could ride through the crisis with falling profits, or worse with a few quarter of losses (they've done it before in previous crisis, Asian Financial crisis in 1997, 9-11 in 2001 and SARS in 2003).

In general, for businesses, there would be falling profits, scaled back investments, restructuring to cut excesses etc. For the people on the street, they would be more belt tightening, i.e. more savings and less spending (due to pay freeze, cut or even retrenchment from restructuring). The reduction in demand for goods and services becomes a self-reinforcing cycle between business and consumer. The net effect will be a slower economic growth at its best and an out right recession at its worst.


Regional Instability

Rising inflation obviously hurts the poor more than the rich. Food, transport and utility bills accounte for most of the spending for the poor. Any increase in these categories literally send their 'real' inflation rate through the roof.

To make matter worse, most of the Asian emerging economies have heavy fuel subsidies. With surging oil price, the diversion of previous government revenue required for other national uses to feed the growing subsidies is obviously not sustainable. Countries like Indonesia and Malaysia are already cutting back the fuel subsidies and it is not going to go down well with the masses, so used the subsidies. Every government in the region, rich or poor, face the increasing pressure to tackle the inflation with each increasing percentage point in CPI, any mismanagement could cost their political survival.

Silver lining

Under the free (or pseudo free) global market economy, the market ultimately sets its price when supply and demand rebalances. Any disturbance to the system will result in a short term turbulence before setting down at a new equilibrium.

While I won't go as far as the author of the following article as to celebrate (people are suffering in this part of the world):

Commodities, Oil Bubbles Are Reason to Celebrate

I do agree with him that resource bubbles (commodity and oil) wake people up, changes habits and eventually bring about conservation and greater efficiency in usage of previous resources.

Conclusion

I care less now about my portfolio (most have strong enough balance sheets and business to ride through this storm ... anyway I'm taking a long term, 10, 20 years view on them) and more about how this current surge in inflation is going to affect my life (and that of people around me). I have no doubt that the system will ultimately find a new footing and life gets back to normal, what I'm concerned is how long it will take. I'm not optimistic.

Oil bubble or trouble?

I refer to 3 articles I came across in the latest issue of The Economist, May 31st-June 6th 2008:

1. Recoil - Painful though it is, this oil shock will eventually spur huge change. Beware the hunt for scapegoats
   
2. Energy - Double, double, oil and trouble
3. Fuel subsidies - Crude measures
   

Oil bubble?

Believers of peak oil (a point in time when oil production rate hits the maximum and go decline from there) would doubt the current surge in oil price as a bubble, pointing to the sluggish crude production last few years while demand from emerging economies (esp. China and India) powers ahead.

In contrast, others believe the high oil price would had dampened demand (signs are showing) and the current surge is just the act of speculators (traders of crude future contracts, funds and other investment institutions).

If it really is the act of speculators that result in the price surge, I'll not be so worried, since all bubbles must come to a spectacular burst one day.

Oil price --- sustainable?

Whether or not its the act of the speculators, after reading the 3 articles above and doing a bit of research myself, I do believe current sky high prices cannot be sustained for long. It would have been better if the speculators are indeed responsible because the eventual price correction when the bubble burst would be substantial and swift. Otherwise, it will be a long and painful journey ahead before any respite occurs when the demand and supply curve rebalances again.

Less demand or more supply?

Sustainability of demand

According to the 3rd article,

...
Emerging economies accounted for more than the whole increase in world oil consumption last year—because demand in the rich economies fell...


While US and Europe are fighting slowing growth (analyst, experts etc kept saying US is in recession but its GDP always manage to scrap through with a positive figure), the emerging economies continue to power ahead.

Growing economies resulting in growing demand for crude oil comes as no surprise. But most of the fuel sold in these countries are heavily subsidised. As the crude price escalates, the government subsidies balloons, diverting resources from areas that the money could have been better spent (education, health and infrastructure). Subsidies as such cannot grow indefinitely and many are already cutting back. The eventual result of a rising crude price will see a plunge in demand, even in emerging economies, either a direct result of more conservation or slowing growth.

I- Increase in supply --- more aggressive search for oil fields

The runaway price of crude oil already spur a surge in oil explorations. Announcements of oil field discoveries are not uncommon nowadays, given such intensive search. However, even with these, supply will not jump suddenly because it takes years before the first commerical drop of oil is extracted, more so for new fields that are found in deep waters or difficult locations, .e.g. the Arctics.

II- Increase in supply --- alternative sources of fuel

As the price of crude oil climbs, alternative sources of fuel become viable. A google search for "alternative sources of fuel" easily turn up 800,000+ results. Research into these areas are already underway ever since the first oil shock.

1. Tar sands
2. Oil shale
3. Coal & gas conversion
4. Thermal depolymerization
   
5. Biofuel (from sugarcane, rapeseed, soya bean, palm oil and even algae!)
   

These alternative sources of fuel are not cheap and requires a sustained crude oil price to remain feasible. If crude prices remain sticky for a sustained period (a few years???), supply from the above sources would obviously jump.

Other factors

Continue weak USD

While the plunging USD was blamed for the initial surge in crude oil price from USD $80++ per barrel to $100++, not one article mentioned about the USD devaluation now. Seems like the search for the scapegoat have moved on. I would wonder when the USD eventually strengthens, would oil price come down? I doubt so, because strengthening USD should be a result of a recovering economy, brining along an increase in fuel consumption again -- another excuse to keep the crude price up.

What this means to me

While I have no choice but taking a much passive reactive approach in my life, i.e. tighten my belt with the current oil spike induced inflation (food, transport etc), I can continue to be active in my investment.

Market sentiment is obviously bad right now and the only remaining sexy sector are the oil and gas (or related) sectors. Thus I would think the Great Singapore Sale on SGX should not come to a close anytime soon, even though it had lasted so long, from August 2007. While I'd avoid the oil and gas sector, I believe there are still bargains to look out for.