SIA Engineering - DBS Research 2017-05-16: Special Dividend Euphoria Should Dissipate

SIA ENGINEERING CO LTD S59.SI

SIA Engineering - Special Dividend Euphoria Should Dissipate

4QFY17 PATMI above expectations, boosted by better profits from engine JV Eagle Services Asia.
Line maintenance only growth area, overall growth outlook not exciting in near term.
Special dividend of 5 Scts shows caution amidst persistent structural challenges in industry.

While the stock has risen almost 18% YTD in 2017, largely on the premise of special dividends, the 5-Sct special dividend declared may be somewhat underwhelming and shows due caution from management amidst structural challenges in the MRO industry.
SIE’s line maintenance segment is the only growth area at present, helping offset the structural weakness in other segments (heavy maintenance/engine repair under pressure from lower work content and longer intervals between checks on newer aircraft/engine models; fleet management facing competitive pressure). But this has not been sufficient to stem a 1%/10% yo-y decline in revenues and core operating profits respectively in FY17.
SIE’s strategic tie-ups with OEMs and other related companies are a step in the right direction but will not be earnings-accretive in the near term.
Given the lack of near-term earnings drivers, we maintain our HOLD call on the stock.

4Q-FY17 PATMI came in at S$45.9m – up 11% y-o-y but down 13% q-o-q – slightly above our expectations owing to a better showing from the associates line, as engine JV Eagle Services Asia secured higher workload on PW4000 engines.
For the full year, we estimate FY17 core net profit to be S$173.5m, down 4% y-o-y. Headline net profit was boosted by a gain on divestment of SIE’s 10% stake in HAESL of c.S$178m.

We tweak our earnings forecasts for FY18/FY19 upward by around 5-6% to account for better-than-expected associate/JV profits and stronger top-line growth at the line maintenance segment. We now expect full-year dividend of 13 Scts in FY17/18, in line with SIE’s payout policy of 85-90% of core earnings.

In line with our earnings revision and factoring in the special dividend, our TP is adjusted upwards to S$3.84.
Our TP is based on a blended valuation framework (PE, EV/EBITDA, dividend yield and DCF), and includes a 20% M&A/ privatisation premium.

We cannot rule out a lengthy period of weak MRO demand amid structural changes in the industry. Increasing competition could also lead to renewed stress on the margin front. Upside risk exists in the form of potential privatisation/M&A.

4Q-FY17 PATMI came in at S$45.9m – up 11% y-o-y but down 13% q-o-q – slightly above our expectations owing to a better showing from the associates line.
FY17 headline net profit of S$332.4m is up 88% y-o-y but includes one-off divestment gains and dividends related to the disposal of SIE’s stake in Hong Kong Aero Engine Services Ltd (HAESL).
Excluding one-offs, we estimate FY17 core net profit would have come in at S$173.5m, down 4% y-o-y. This is on the back of a 1% decline in revenue to S$1,104m in FY17.

Operating margin for 4Q17 came in at 8.1%, down from the 9.3% level seen in the last couple of quarters, as staff costs increased and subcontract costs were up q-o-q. Operating margin for full-year FY17 was also down by 0.9ppts from 9.4% in FY16 to 8.5% overall in FY17.
Salary increments and an increase in overtime as more staff were released for training on new aircraft types contributed to the increase in staff costs.

Segment-wise, the repair and overhaul segment (which includes both heavy maintenance and fleet management) remained in an operating loss of S$10m (excluding the effects of the HAESL divestment) for full-year FY17, while the line maintenance segment saw an operating profit of S$94.4m.
On the revenue front, line maintenance was also the only segment showing yo-y growth of 11.4% to S$513m (though some of this is due to internal restructuring, which shifted the cabin interiors business from component & overhaul to line maintenance).
Heavy maintenance recorded a y-o-y revenue decline of 1.6% and fleet management saw a y-o-y revenue decline of 26.8% as the total fleet under management fell from a peak of 193 in 1HFY16 to 129 as of 2HFY17.

Profit from JVs and Associates for full-year FY17 was up marginally to S$96.5m compared to S$94.2m in FY16. Similarly, contribution from JV/associates in 4Q17 was up 48% y-o-y to S$27m.
Eagle Services Asia – SIE’s engine MRO joint venture with Pratt & Whitney (P&W) – was cited as a key reason for the better showing, especially during the second half of FY17, as there has been more demand for maintenance for the PW4000 engines. Airlines keeping certain older aircraft models in the air for longer (the PW4000 is a mature family of engines), encouraged by lower fuel prices, as well as a cyclical peak year for PW4000 maintenance (MRO Network has said that that the PW4000 would see peak maintenance demand in 2016 and 2018) were the likely drivers behind the uptick.
Eagle Services’ stronger profits were partially offset by lower contributions from the other key engine JV company SAESL (specialising in Rolls-Royce engines).

SIE has proposed a final ordinary dividend of 9 Scts for FY17. Including interim dividend of 4 Scts, total ordinary dividend of 13 Scts was down compared to the 14-Sct payout in FY16, in line with decline in core PATMI.
A special dividend of 5 Scts was also declared along with the final dividend, in lieu of the cash windfall from divestment gains in FY17, but management chose to be cautious and keep buffer to invest in future capabilities and tie-ups amidst competitive market conditions for the MRO industry.
To put things in perspective, if SIE had decided to pay out the full gain on the HAESL sale, and applied an 80% payout ratio, the potential special dividend payout could have been as high as c.13 Scts per share. The fact that management has chosen to be cautious with the special dividend payout demonstrates prudence in the face of structural challenges in the industry

Suvro SARKAR DBS Vickers | Glenn Ng DBS Vickers | http://www.dbsvickers.com/ 2017-05-16

DBS Vickers SGX Stock Analyst Report HOLD Maintain HOLD 3.84 Up 3.580