SIA Engineering - CIMB Research 2017-06-27: Expensive Wingman

SIA Engineering - CIMB Research 2017-06-27: Expensive Wingman SIA ENGINEERING CO LTD S59.SI

SIA Engineering - Expensive Wingman

  • We think there is no pressing need for SIA to divest its stake in SIE as the airline tries to manage its balance sheet. Sale and leaseback could be an alternative avenue.
  • SIA’s expected FY19F net gearing of 26% is still considered the strongest vs. its regional peer average of 220%.
  • We think corporate actions at current valuations of 26x CY18F P/E are not feasible.
  • We lower some revenue growth assumptions and cut our EPS by 3-5% for FY18-20F.
  • Our target price is reduced to S$3.86, still based on DCF valuations (WACC 6.4%).
  • We downgrade SIE from Hold to Reduce and advocate switching into STE given STE’s cheaper valuations and defensive earnings.

Outperforms the market by 12% 

SIA has other avenues rather than selling stake in SIE 

  • With its new aircraft expansion and capex, SIA will turn net gearing of 5.9% by FY18F and 25.6% in FY19F. This is on the assumption that it owns 100% of all the new aircraft it is expected to acquire. 
  • Historically, SIA has had the option of leasing one-third of its aircraft fleet. Assuming 30% of the planned S$5bn capex in FY18 is converted into leased aircraft, our forecast for SIA’s net debt position of S$700m will be reversed into a net cash position. 
  • In addition, SIA’s gearing level is considered low compared to other regional full-service airlines.

Evaluating various corporate action options 

  • We evaluate the possibility of various options and conclude that status quo may still be best for now.
    1. SIA’s outright sale of its stake in SIE - unlikely. SIA accounts for c.60% of SIE’s FY17 revenue. We believe SIA still needs its wingman for state-of-the-art aircraft expansion. SIE and SIA partner to work with manufacturers and undergo training to service new aircraft types. In addition, SIE’s JVs/associates also service SIA’s fleet, which is easily S$765m of annual revenue. Therefore, an outright delinkage may lead to a deterioration in support services for SIA’s fleet, in our view.
    2. Pair down stake in SIE – possible, but who will pay now? At 26x CY18F P/E, SIE is trading above its 5-year average vs. a muted earnings growth outlook. Share placement in the market or dividend in specie to Temasek do not seem logical.
    3. STE acquires SIE – will not be well received by STE’s minority shareholders. Although acquiring SIE would expand STE’s market share in aircraft MRO and line maintenance, we do not expect STE to pay a premium above itself (STE is trading at 19x CY18F P/E).

Earnings recovery after multi-year declines, but there is risk 

  • After multi-year declines in core earnings (FY14-17), SIE could see its earnings recover in FY18F as the repair cycle returns for SIA’s fleet and associates earnings bottomed. However, we believe our previous revenue forecasts have been too bullish, hence some adjustments are made.

Line maintenance on track, tapering expectations for aircraft MRO. 

  • We had previously expected revenue growth of 7% yoy in FY18F, led by line maintenance (+7% yoy) and stronger airframe & component MRO (+9% yoy). With more light checks being carried out at apron in addition to steady increase in the number of flights into Changi airport, we expect line maintenance to be on track. 
  • There is downside risk for airframe and component MRO, if repair cycles for the A380 are pushed back in FY19, although there are five aircraft due to be de-leased in FY18. We now expect a slower revenue growth rate of 4% for FY18F.

Higher line maintenance revenue comes at the expense of lower margins. 

  • Revenue for line maintenance grew to a high of S$267m in 2H17 but operating margin shrank to 15%, lower than the historical average of 23%.
  • Given the competitive landscape and aggressive offerings from OEMs, we believe rate cuts could be on the cards to retain market share.

Will repair & overhaul breakeven in FY18? 

  • It could be a touch and go.
  • Operating losses for the division (net of staff cost incurred for divesting HAESL) was S$1.3m in 2H17 (narrower than 1H17’s S$8.7m), thanks to better yield achieved on some aircraft. The division has been in the red operationally since 1H15, with the exception of 2H16.

Share of associates earnings – how long can the old Pratt & Whitney engines last? 

  • Eagle Services has seen more engine work from Pratt & Whitney’s (P&W) PW4000 for the classic fleet of B747s, thanks to lower fuel oil prices and airlines deciding to extend the usage of older aircraft. 
  • Pratt & Whitney also appears more aggressive in their marketing efforts. However, the reality of stronger engines and the B747 being a mature market may still set in eventually, in our view. 
  • In addition, the erratic performance of SAESL may offset the strength in Eagle Services with the constant pressure from oversupply of Rolls Royce (RR) spare parts. The new Trent 1000 that just came into the market for the B787 fleet will take at least another five years to see any engine visits.

Valuations and recommendations 

  • Our EPS is reduced by 3-5% for FY18-20F to incorporate lower revenue above.
  • In view of the expensive valuations and limited catalysts, we downgrade SIE from Hold to Reduce, with a lower DCF-based (WACC: 6.4%) target price of S$3.86, from S$3.98. 
  • We advocate switching out of SIE into STE on the back of the latter’s structural sweet spot of smart nations and more defensive earnings profile with diversified business segments. 
  • Upside risk to our call is unexpected corporate actions at a premium.

LIM Siew Khee CIMB Research | 2017-06-27
CIMB Research SGX Stock Analyst Report REDUCE Downgrade HOLD 3.86 Down 3.980