SIA Engineering - UOB Kay Hian 2015-11-04: Operating Environment Remains Challenging

SIA Engineering - UOB Kay Hian 2015-11-04: Operating Environment Remains Challenging SIA ENGINEERING CO LTD S59.SI 

SIA Engineering (SIE SP) - Operating Environment Remains Challenging 

  • At the post-results briefing, SIAEC guided that the steep decline in subcontract costs was due to a high base in the previous year and that staff costs may be reduced if MRO work continues to fall. However, the pace of cost decline is unlikely to continue. 
  • Line maintenance is the only bright spot and we believe earnings will be weak due to hangar overcapacity in the region. 
  • We raise our FY16-17 net profit forecasts by 14% each as we impute lower opex. 
  • Maintain SELL but with a higher target price of S$3.30. 


WHAT’S NEW 


• Management remained cautious on MRO prospects, line maintenance remains the sole bright spot. 

  • An overcapacity in the region has led to continued losses in SIA Engineering’s (SIAEC) repair and overhaul segment. Line maintenance remains the sole bright spot with operating profit rising 20% yoy in 2QFY16 due to a 1.9% yoy increase in the number of line checks as well as more light checks (A&B) being performed at the apron. However, the repair and overhaul segment was still in the red despite cost reductions. 

• SIAEC believes that JVs with OEMs are vital for long-term growth. 

  • Management pointed out that its JVs with OEMs, particularly its fleet management programme (FMP) with Boeing, will expand its reach outside of Singapore. The FMP with Boeing is a 49% owned JV which provides fleet management services to Asia Pacific airlines operating B737, B747, B777 and B787 aircraft. The programme will involve the management of maintenance schedules for airlines as well as inventory management of parts. 
  • For SIAEC, the real upside to this JV will come from potential downstream MRO work being channelled to SIAEC’s hangars in Singapore or Philippines. 

• Good cost control in 2QFY16 but this was mainly due to a high base for subcontract costs. 

  • SIAEC typically subcontracts work in areas where it lacks in-house capability. The 27% decline in subcontract costs this quarter was due to SIAEC not needing to subcontract any work. Going forward, SIAEC indicated that subcontract costs are likely to normalise, which we infer as to approximate 2QFY16’s levels. SIAEC also pointed out that the 5% reduction in staff costs (largest cost item) for the period was due to a reduction in overtime costs as well as a change in profit-sharing formula. If MRO work falls further, SIAEC has the option of reducing contract staff to rein in staff costs. 

• Overall, third-party maintenance work continued to decline. 

  • At the operating level, third-party MRO work declined 23% in 1HFY16, the same rate as in 2HFY15, which clearly shows competitive pressure, which was exacerbated by hangar overcapacity in the region. Third-party engine maintenance work declined as well (-13.6% yoy) but at a lower rate than 2HFY15’s (-18.3% yoy). 
  • Management cited the mature phase of Pratt & Whitney PW4000 engine as a key reason for the decline. 
  • When queried as to the timing of an eventual recovery, SIAEC did not offer a timeline, but indicated that new engine types are more reliable and maintenance cycles are not only getting longer but labour hours required will also be lower. 


STOCK IMPACT 


• Little reason to be optimistic. 

  • While opex declined in 2QFY16, we do not expect the pace of decline to continue in the coming quarters. Investors should be cognisant of the challenging operating environment, which has led to five consecutive quarters of revenue decline. 
  • While maintenance work will eventually pick up as airlines add more capacity, we believe the surge in hangar capacity in the Asia Pacific region will curtail SIAEC’s top-line growth for several years. 
  • Near term, line maintenance is the sole bright spot but this again is dependent on visitor and flight arrivals, which we have forecast to grow 1.8-2.0% annually. 


EARNINGS REVISION 

  • We raise our FY16-17 net profit forecasts by 14% each, after assuming lower subcontract and material costs. 


VALUATION/RECOMMENDATION 


• Maintain SELL but raise our target price to S$3.30 (from S$3.00). 

  • We change our valuation methodology from DDM to DCF. Our target price of S$3.30 implies current and forward PE of 22.4x and 23.9x respectively. 
  • PE valuations are notably higher than its long-term mean PE of 16.9x. Our previous valuation methodology would provide a target price of S$3.20 with current operating assumptions. 


SHARE PRICE CATALYST 


  • No immediate catalyst.


K Ajith UOB Kay Hian | Sophie Leong UOB Kay Hian | http://research.uobkayhian.com/ 2015-11-04
UOB Kay Hian SGX Stock Analyst Report SELL Maintain SELL 3.30 Up 3.00


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