SIA Engineering (SIE SP) - UOB Kay Hian 2017-07-10: New Engine JVs Offer Long-term Growth Prospects But PE Valuation Unjustified

SIA Engineering (SIE SP) - UOB Kay Hian 2017-07-10: New Engine JVs Offer Long-term Growth Prospects But PE Valuation Unjustified SIA ENGINEERING CO LTD S59.SI

SIA Engineering (SIE SP) - New Engine JVs Offer Long-term Growth Prospects But PE Valuation Unjustified

  • SIAEC announced a slew of engine maintenance JVs over the past three weeks.
  • Among these, the JV with GE Aviation holds scope for near-term earnings, while the JV with Pratt & Whitney offers long-term prospects. As a result, we expect incremental engine maintenance revenue and have raised JV & associate income by 5% and 10% in FY18-19 respectively. 
  • Valuations remain high. SIAEC trades at 26x FY18F PE vs global peers’ 23x. Maintain SELL. Target price: S$3.60.



WHAT’S NEW 


New engine JVs will enhance narrow-bodied aircraft maintenance capabilities. 

  • With the appointment of Eagle Services Asia (ESA) - 49%-owned by SIA Engineering (SIAEC) - as the authorised engine maintenance provider for the PW1100G-JM GTF engines, SIAEC will have the capability to provide engine maintenance for all engine variants for the Airbus A320NEO, one of the two popular narrow-bodied aircrafts. 
  • SIAEC had also announced a JV with Snecma to provide on-wing maintenance including CFM LEAP-1A (the other engine variant for A320NEO). Thus SIAEC will have the capability to provide comprehensive engine maintenance services for all engine types of A320NEO. The aircraft has over 3,000 order backlog. The new focus on narrow-bodied aircraft will reduce SIAEC’s reliance on the SIA group, enable greater third-party work and expand its scope.
  • Overall, risk profile for SIAEC will also be reduced as narrow-bodied backlog outstrips wide-bodied backlog by 4-1. That said, the impact of these ventures will only felt in 5-6 years’ time, given that delivery for the A320NEO only began in 2016.

However, SIA does not hold exclusivity for A320NEO engine maintenance in the Asia Pacific. 

  • Unlike its previous position as the sole centre of excellence in Asia Pacific for Trent engine maintenance, SIAEC does not have exclusive rights for PW1100 and CFM LEAP-1A engine maintenance for the region. Currently, major MRO centres in Asia Pacific already provide A320CEO engine maintenance and we believe that such capabilities will be extended to the new engine types.

Engine maintenance JV with GE Aviation will have a greater impact in the near term. 

  • The newly-formed JV will see SIAEC maintain GE90 engines which are exclusively used on the more mature B777-200LR and B777-300ER. The JV will also provide maintenance to the yet-to-be-delivered B777X. SIAEC’s parent, SIA Group, operates 53 B777-200 and B777-300s, thus the JV will enable the parent to recognise cost synergies while providing an additional income stream to SIAEC. 
  • From a regional perspective though, GE90 engine shop visits are expected to decline in 2017-18 before improving.


STOCK IMPACT


Engine MRO earnings could rise in FY18-19. 

  • In FY17, engine maintenance, repair and overhaul (MRO) earnings rose 6.4% yoy due to “return of lessor checks” on PW4000 engines maintained by ESA. ESA’s revenue is expected to decline in FY18. Even so, we have assumed an optimistic scenario whereby the GE engine maintenance more than offsets that of ESA. We thus raise our JV and associate income by 5% and 10% in FY18- 19 respectively.


EARNINGS REVISION/RISK

  • We raise FY18-19 net profit forecasts by 2% and 5% respectively. Margins on engine MRO tends to be low. 
  • Overall, margins are substantially lower than that of line maintenance’s net margin of 18%.


VALUATION/RECOMMENDATION


Maintain SELL. 

  • We raise our target price marginally from S$3.50 to S$3.60 following our revised earnings estimates. We continue to value SIAEC using DCF (WACC: 5.4%, g: 1.4%). 
  • Ytd, SIAEC stock price has risen by 20%, underpinned by stock buybacks. Yet, earnings growth is not certain as margins on engine maintenance tend to be volatile and vary with the scope of checks. 
  • While the new JVs are positive, we do not expect these to be game-changing events, mainly due to high labour costs and the rise of alternate MRO shops in the Asia-Pacific region.


SHARE PRICE CATALYST

  • No immediate catalyst for the next six months.




K Ajith UOB Kay Hian | Sophie Leong UOB Kay Hian | http://research.uobkayhian.com/ 2017-07-10
UOB Kay Hian SGX Stock Analyst Report SELL Maintain SELL 3.600 Up 3.500



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