SIA Engineering (SIE SP) - UOB Kay Hian 2017-11-07: 2QFY18 Associate Earnings Come To The Rescue. Upgrade To HOLD


SIA Engineering (SIE SP) - UOB Kay Hian 2017-11-07: 2QFY18: Associate Earnings Come To The Rescue. Upgrade To HOLD SIA ENGINEERING CO LTD S59.SI

SIA Engineering (SIE SP) - 2QFY18: Associate Earnings Come To The Rescue. Upgrade To HOLD

  • SIAEC's 2QFY18’s earnings were within expectations. Increase in staff costs and subcontract costs along with losses at the repair and overhaul divisions are key concerns.
  • Earnings growth over the next two years depends largely on line maintenance earnings and commencement of GE90 engine maintenance works. PE valuations are less extreme now. 
  • We upgrade the stock to HOLD with a reduced target price of S$3.50. Suggested entry price at $3.10-3.15.



RESULTS


2QFY18 earnings broadly in line with consensus, with 1HFY18 amounting to 49% of consensus estimate. 

  • SIA Engineering (SIAEC) fared poorly at operating level due to:
    1. high staff costs (+5.3% yoy),
    2. high subcontract costs (+8.0%),
    3. 32% rise in other expenses (due mainly to exchange losses and provision for doubtful debts. 
  • At the non-operating level, associate and JV profits was bolstered by higher contribution from non-engine maintenance and repair (MRO) JVs. In 1HFY18, the repair and overhaul division’s losses widened by 30% to S$11.3m, primarily due to the loss of a key fleet maintenance customer. 
  • SIAEC declared 4 S cents in dividend, unchanged from 1HFY17.

Line maintenance the main earnings contributor at operating level.

  • The number of line checks at Changi rose 3.8% yoy in 1HFY18, marginally lower than the 5.0% yoy increase in aircraft movements at Changi. Operating margin also declined by 3.3ppt yoy, due to higher wage costs related to expansion at Kansai and JFK airports. 
  • SIAEC indicated that line maintenance revenue in these airports will only contribute several quarters down the road.

SIAEC is unsure of the sustainability of associate engine earnings over the next few quarters. 

  • Share of earnings from associates rose 48% in 2QFY18 and SIAEC indicated that this was mainly due to strong contribution from Pratt and Whitney associate, whose PW4000 engine saw an increase in shop visits. However, this is a mature engine type used on ageing 747-400s, and such shop visits will taper off.

SIAEC is optimistic of its 49:51% JV with GE. 

  • The JV will establish a state-of-the-art facility that will provide maintenance services to GE90 and GE9x engines. The engines are used on the Boeing 777-300ER and 777-9s. SIAEC could also benefit from an increase in GE90 checks in FY19 and FY20.


STOCK IMPACT


Neutral on the results; SIAEC faces substantial challenges in curtailing staff cost increases and reversing losses at the repair and overhaul segment.

  • SIAEC indicated that given cost pressures and competitive pricing in the region, it ferries aircraft to its hangar in the Philippines. However, there is a limit to such solutions as it would impede turnaround time. 
  • As for its engine MRO, we do not expect a significant increase from the Rolls Royce engine JV and also expect the Pratt & Whitney PW4000 engine shop visits to taper off. Earnings will thus be highly dependent on GE90 shop visits over the next two years.


EARNINGS REVISION/RISK

  • We raise our FY18 net profit by 4% to S$176.8m to take into account disposal gains of S$14.3m. 
  • Our core earnings is however reduced by 4.4%, primarily on higher-than-expected staff costs.


VALUATION/RECOMMENDATION

  • Upgrade to HOLD with a lowered target price of S$3.50. 
  • We continue to value SIAEC using DCF (WACC: 5.6%, g: 1.4%). At our fair value, SIAEC will be trading at 22x FY18’s earnings and 21.8x FY19 earnings. We prefer to be buyers near S$3.10-3.15.


SHARE PRICE CATALYST

  • No immediate catalyst.




K Ajith UOB Kay Hian | http://research.uobkayhian.com/ 2017-11-07
UOB Kay Hian SGX Stock Analyst Report HOLD Upgrade SELL 3.50 Down 3.600



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