SIA Engineering - UOB Kay Hian 2016-05-12: Recent JVs Unlikely To Be Accretive In The Near Term; Valuations Remain Rich

SIA Engineering - UOB Kay Hian 2016-05-11: Recent JVs Unlikely To Be Accretive In The Near Term; Valuations Remain Rich SIA ENGINEERING CO LTD S59.SI 

SIA Engineering (SIE SP) - Recent JVs Unlikely To Be Accretive In The Near Term; Valuations Remain Rich

  • SIAEC is embarking on investments in innovation and technology in areas such as robotics and data analytics, which could boost competitiveness and lower reliance on labour. 
  • SIAEC also highlighted its recent JVs during the analyst briefing. However, the JVs are not likely to be accretive in the near term. 
  • Meanwhile, SIAEC indicates it would channel part of the funds from the divestment of HAESL towards capex, instead of distributing the entire amount to shareholders. 
  • Maintain SELL. Target price: S$3.40.



WHAT’S NEW

Takeaways from the analyst briefing are as follows:
  • The divestment of HAESL is likely to be completed in 1HFY17, but the entire amount will not be distributed to shareholders as dividend. 
  • SIA Engineering (SIAEC) indicated that part of the funds would be channelled towards capex. SIAEC also mentioned they are seeking tax exemption for the divestment gains and we have thus assumed no tax on the gains accordingly. We have also reduced our payout assumption for the special dividend to 50%.
  • SIAEC is also embarking on investments in: 
    1. innovation and technology, 
    2. improving operations and productivity, and 
    3. strategic partnerships. 
    The innovation and technology investments would involve robotics, data analytics and automation such as 3D printing, with the support of EDB. This could result in enhanced capabilities and reduced reliance on manpower, which could boost competitiveness and lower staff costs. We reckon that SIAEC is also likely to receive grants from EDB.
  • SIAEC affirmed that the JVs with OEMs would not be accretive in the near term and expects the gestation period to span about 3 years. The JV with Airbus would see a partial transfer of overheads including two aircraft maintenance lines and two hangars from SIAEC into the JV. However, the net impact would be an uptick in costs at the group level.
  • SIAEC is investing in new capabilities which could boost line maintenance profits. The recent JV with Snecma will enable SIAEC to provide on-wing services (light repair done off hangar). The JV would provide on-wing services for the LEAP-1A and LEAP-1B engines which power the A320neos and B737MAXs. Both A320neos and B737MAXs will be widely used by Asia-Pacific carriers. Thus, this has positive implications for line maintenance which commands higher margins than repair and overhaul. However, this would likely only have an impact to earnings in about 2-3 years, given that airlines are only starting to take delivery of these aircraft.
  • At the operating level, SIA and third-party work revenue rose by 6% and 5% yoy respectively in 2HFY16, with SIA portion remaining unchanged at 64% of total revenue.
  • At the associate and JV level, contributions from engine maintenance fell 2.5% in 2HFY16, offset by a 31% rise in contributions from other associates. The rise in contributions from other associates was likely boosted by the closure of unprofitable units during the period. Meanwhile, SIAEC indicated that the profitability of Eagle Services Asia (ESA), the Pratt and Whitney engine JV, would likely continue to decline given that the PW4000 engines are being phased out. However, ESA is still expected to be profitable in the near term and SIAEC alluded that there could be increased work volume in FY17.


STOCK IMPACT


Still a SELL. 

  • SIAEC’s recent JVs, while encouraging, would likely only bear fruit in 2-3 years. 
  • In the meantime, earnings would remain under pressure due to the fact that the new generation aircraft are more efficient and thus require less maintenance. 
  • Meanwhile, hangar overcapacity persists in the region and the repair and overhaul segment is likely to remain in the red in FY17. 
  • Line maintenance is the sole bright spot, but even that is highly reliant on Changi flight movements. 
  • Valuations remain rich at 24x PE, a steep 31% above peer average of 18.6x, which is unwarranted.



EARNINGS REVISION/RISK

  • We raise our FY17 core net profit estimate by 8.6% as we assume higher line maintenance profit on the back of a higher number of flights handled. 
  • We have also assumed the divestment gains would be recognised into P&L in FY17.



VALUATION/RECOMMENDATION


Maintain SELL but raise price target price by 6.6% to S$3.40. 

  • We continue to value SIAEC using recurring FCF with an unchanged WACC and long-term growth rate of 6.2% and 1.8% respectively. We have also included the proceeds from the sale of HAESL in our valuations.



SHARE PRICE CATALYST

  • No immediate catalyst.




K Ajith UOB Kay Hian | Sophie Leong UOB Kay Hian | http://research.uobkayhian.com/ 2016-05-12
UOB Kay Hian SGX Stock Analyst Report SELL Maintain SELL 3.40 Up 3.19


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