SIA Engineering - UOB Kay Hian 2017-05-16: 4QFY17 Briefing Takeaways ~ Earnings Growth Highly Dependent On Successful Line Maintenance Expansion And Engine Shop Visits

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SIA ENGINEERING CO LTD S59.SI

SIA Engineering (SIE SP) - 4QFY17 Briefing Takeaways: Earnings Growth Highly Dependent On Successful Line Maintenance Expansion And Engine Shop Visits

• Stock price has risen 18.5% since the start of the year on expectations of a special dividend. 
• Core earnings, however, were largely flat in FY17. Were it not for unexpected engine checks on a mature engine type, PW4000, in 4QFY17, earnings would have declined. 
• We do not see this as a sign of a cyclical recovery but have followed SIAEC’s guidance of a potential uplift in Trent engine maintenance and have thus raised our earnings forecasts. 
• Consequently, we raise our target price to S$3.50. Maintain SELL.

WHAT’S NEW

• Takeaways from the analyst briefing are as follows:

4QFY17’s 15% yoy earnings growth is not reflective of longer-term growth prospects. 

• SIA’s associate income rose by 64% in 4QFY16 and this was primarily due to unexpected checks on the P&W 4000 engine series. These engines are used on older aircraft and are only economical if fuel prices are low. 
• Fuel prices have since rebounded and odds are that such checks are unlikely to repeat. SIAEC affirmed this view by stating that the PW4000 maintenance was mature. 
• For 2HFY17, engine maintenance earnings from associates and JVs rose 15% yoy.

Key business units appear to have been reorganised; but margins unlikely to improve significantly. 

• Part of repair and overhaul operations were incorporated into the line maintenance segment as more checks were done on apron, (which comes under the ambit of line maintenance). We believe this is an effort to improve overall labour productivity, given the substantially higher ROA for the segment. However, this lowered the line maintenance unit’s operating margins by 4ppt in 2HFY17. 
• On a full year basis, excluding the impact of EI costs, group operating margins declined by almost 1ppt to 8.45%. 
• Going into FY18 and FY19, we still expect operating margins to decline as we have assumed higher staff costs. 
• In FY17, staff costs rose 6% yoy (excluding one-off payments) even as revenue declined. For the next three years, we have conservatively assumed just a 2% increase in staff costs.

Plans to boost line maintenance revenue overseas. 

• ROA for the segment is approximately 140% and it is thus a key earnings driver. SIAEC performs line maintenance in 36 countries but the bulk of earnings is still derived out of Singapore. 
• The company has indicated that it intends to commence line maintenance at the JFK airport in FY18 and this could compensate for the loss of revenue at the repair and overhaul segment due to competitive pressures.

Potentially higher engine checks from SAESL. 

• The unit is able to service the entire Trend series of Rolls Royce engines and the Singapore operations is a global centre of excellence. SIAEC indicated that Trent series of engines could see higher shop visits in FY18 but advised that it is unsure if such checks could would be minor checks or more value added refurbishments. 
• We believe that the Trent 700 (A330-300’s) and to a lesser extend Trent 800 (B777-200/300) could see greater checks or component replacements. We have thus assumed a 60% rise in associate income for FY18. Total associate and JV income is estimated to rise 5% yoy in FY18.

STOCK IMPACT

Market is pricing in a cyclical recovery but we believe it is premature to form such an opinion. 

• We have adopted a cautious view on SIAEC for three reasons: 
  1. rising labour cost pressures and increasing competition from regional MROs’ will impact SIAEC’s repair and overhaul margins; 
  2. major overhauls for the Trent 1000 and Trent XWB is still more than 5 years away and SIAEC will be more dependent on engine component MRO for older engines for which they will face greater competition; 
  3. Overall earnings growth for the next two years will be largely dependent on the successful growth of line maintenance ventures and aircraft utilisation on the A330-300 series of aircraft types.

Valuations are high. 

• Core net profit grew by just 1.8% and this was largely due to PW4000 engine maintenance earnings growth. Going into FY18 and FY19, we still expect core net profit to be flat, despite factoring in higher revenue growth. Revenue has been declining for the past three years. 
• Unless, we are wrong about demand for Trent 700 and Trent 800 engine types, we believe SIAEC’s current valuation is unlikely to be sustainable.

EARNINGS REVISION/RISK

• We have raised our FY18 net profit estimates by 3% as we factor in higher JV profits.

VALUATION/RECOMMENDATION

Maintain SELL. 

• We continue to value SIAEC using DCF with a WACC of 5.4% and terminal growth rate of 1.4%. SIAEC’s core dividend payout amounted to 85% for FY17 and assuming the same rate, DDM methodology provides a fair value of S$3.50. 
• Our target price of S$3.50 implies 26x FY18F PE and forward dividend yield of 3.3%.

SHARE PRICE CATALYST

• No immediate catalyst.

K Ajith UOB Kay Hian | Sophie Leong UOB Kay Hian | http://research.uobkayhian.com/ 2017-05-16

UOB Kay Hian SGX Stock Analyst Report SELL Maintain SELL 3.50 Up 3.300