May traffic numbers continued to worsen with passenger traffic falling 23.0%, vs -17.7% in April. Cargo traffic fell 21%, matching April’s 21% yoy change. We expect more capacity cuts.

Singapore Airlines’ (SIA) traffic numbers continued to deteriorate as passenger traffic fell 23% and cargo 21%. Passenger load factor (PLF) fell 7.8ppt to 66.9 % as traffic decline outpaced capacity cuts. However load factors for cargo traffic improved 0.5% as capacity cuts were slightly larger than the traffic decline.

SIA’s relatively weak traffic numbers vindicate our negative stance. We have opined for some time that SIA’s passenger traffic is unlikely to stage a significant rebound, given competitive pressure. The weak April and May traffic numbers which show a collective 20% drop in traffic support our bearish stance. SIA also indicated that the spread of the Influenza A virus will impinge on demand for air travel.

PLF at lowest level since June 2003. May’s load factor at 67% suggests that airline operations are making a loss. In 1Q09, breakeven PLF was 70.5%. Assuming the same breakeven level, SIA would have lost 3.6cents for every passenger km flown, which works out to be S$213m. Traffic or breakeven load factor has to improve in the coming months or we would have to lower our estimates further.

Why hasn’t SIA raised fuel surcharges? SIA typically adjusts its fuel surcharges as fuel prices rise. The airline has hedged 25% of FY10’s fuel requirements at US$125, thus the recent increase in fuel prices would add to an already high base. There is a possibility that SIA is adopting a more cautious stance and does not want to affect demand further. However, we think SIA would just as well adjust ticket prices without risking unnecessary attention on surcharges.

Expect the airline to ground more aircraft. Given the weak load factors, we believe SIA will announce the grounding of more aircraft or sharp capacity cuts in the coming weeks. SIA Engineering (SIAEC), which derives two-thirds of its revenue from SIA, would be at risk. We have a HOLD recommendation on SIAEC with a fair price of S$2.48. Our recommendation on SIA remains a SELL with a $9.80 price target.