In our view, we are near the bottom of the aviation cycle. However, the scale and pace of recovery remain uncertain and we are concerned that SIA’s recovery may be muted by company-specific challenges. Therefore, we have downgraded our rating to Neutral and reiterate our preference for Cathay Pacific (Buy, Key Call).

SIA’s FY09 results were weaker than we expected (Adj. EPS of $0.74 versus UBSe of $0.96) although this was partly due to the early termination of hedging contracts. That said, the strike price on residual fuel hedging positions is also higher than we expected (25% hedged @ c$US125/bbl) and this has contributed to a downgrade in our estimates (FY10 $S1.01 → $0.60; FY11 $1.18 → $0.94). This assumes FY10 revenue falls 20% and the jet fuel price remains c$US60/bbl.

SIA has an impressive track record of delivering a premium product while sustaining a low cost base. However, SIA’s decision to configure its Boeing 777- 300ER fleet with just 278 seats (Emirates has at least 29% more seats on this aircraft type) may prove to be a strategic mistake in the context of the difficult economic environment. We aren’t convinced that SIA can generate the yield premium required on these aircraft to ensure ongoing industry-leading margins.

The cuts to our earnings forecasts have led us to downgrade our UBS VCAM- based price target from $14.00 to $13.00. This implies a FY10 price/book of 1.1x.