Singapore Airlines Group has unveiled a 15.4% fall in net profit in the three months ended 30-Jun-08 – a result that was better than market expectations. But the Group’s underlying airline business was hit harder by rising fuel costs (+70.6% year-on-year), with airline operating profits sagging 30.8%, against the Group’s 25.9% fall in operating profit.

Fuel costs were well over 40% of SIA’s total operating costs in the quarter.

Group revenue rose 14.1%, on the back of rising traffic, including a 6.3% increase in RPKs. Capacity rose much faster than demand in the quarter (ASKs +9.4%), with the entry of new aircraft into service, resulting in a 2.2 ppts decline in load factor to 76.7%.

SIA still has a comfortable margin between its actual and break-even load factor (the latter rising 0.6 ppts to 70.2%), but the gap has closed considerably in recent quarters and is a key concern moving forward. Further capacity cutbacks may be required if SIA is to defend its load factors and margins.

Bright spots for the quarter included SilkAir, which reported a 79% increase in operating profit in the quarter and SIA Cargo, which turned around from a loss in the first quarter last year to a SGD5 million profit, on improved demand. However, the Group's services subsidiaries, SIA Engineering and SATS, reported 43.8% and 16.4% reductions in first quarter profitability, repectively, year-on-year.

Group passenger yield rose a creditable 7.8% in the quarter, thanks to SIA’s product upgrades and higher fares, but the boom in yield growth appears to be over. SIA noted the strains on financial markets “have not abated”, and the impact on premium travel is of key concern going forward.

Falling load factors and easing yield growth are a potentially dangerous combination for SIA.

Yield also failed to keep pace with overall unit costs (+8.7%) in the quarter (for the first time since 3QFY07), although the airline did manage a reduction in non-fuel unit costs (-2.2%).

Overall, SIA’s cost focus and strong cash balances, which rose SGD770 million to SGD6.1 billion (USD4.5 billion), give the Group an enviable position in the current “uncertain” outlook. The carrier stated the Group’s companies are “tracking trends closely and are in a good position to react nimbly”.

Investors recognise SIA’s inherent strengths, but also the risks going forward. SIA’s shares are down (just) 12% since the start of 2008, compared to the Singapore index's 16% fall and Cathay Pacific and Qantas, whose shares have slumped 24% and 36%, respectively this year.

SIA is well positioned to tackle one of its biggest ever tests this financial year.