SIA Engineering - DBS Research 2017-07-26: Positive Catalysts Remain Elusive

SIA ENGINEERING CO LTD S59.SI

SIA Engineering - Positive Catalysts Remain Elusive

1QFY18 net profits of S$36.2m below.
Associate/JV income was in line with expectations.
New engine JV with GE Aviation announced in June.
Eagle Services Asia chosen as Singapore MRO provider for Pratt & Whitney PW1100G-JM engines.

1QFY18 net profits came in below expectations, which has proven to be a dampener on the stock, but developments announced during the quarter on the engine shop front (new engine JV with GE Aviation; servicing of the PW1100G-JM engines) are positive in terms of longer-term positioning, in our view.
In the near term, we see a lack of earnings drivers for SIE, with line maintenance the only growth area. Structural challenges remain with fleet management suffering from OEM encroachment and heavy maintenance seeing lower check intervals from newer aircraft models made from more durable materials.
While we see limited upside with SIE trading at c.26x FY18 PE despite earnings decline, we do not rule out potential M&A interests on the stock.

The Pratt & Whitney deal will service the PW1100G-JM engines – one of two options for the A320neo aircraft, which is expected to be the largest aircraft type (together with the A320ceo) in terms of MRO spend over the next ten years.
Meanwhile the new JV with GE Aviation will service engines for the Boeing 777 family, which is expected to be the 4th largest aircraft fleet in terms of MRO spend by 2027. Contributions will be longer-term though.

Given the lacklustre near-term earnings outlook, positive catalysts for the stock would mostly involve M&A prospects – a merger with ST Aerospace or some other MRO company, or privatisation by parent Singapore Airlines.

Our unchanged TP of S$3.84 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 (see pg4).

Headline net profits of S$36.2m was down 82% y-o-y due to large extraordinary gains in 1QFY17 mainly from SIE’s divestment of its stake in HAESL. Otherwise core net profits would be down 13% y-o-y.
1Q historically tends to be a seasonal low point for SIE in terms of profits, net profit of S$36.2m for 1QFY18 accounted for c.19% of our full-year forecast of S$168m. This was primarily due to higher-than-expected staff costs as a proportion of revenue during the quarter, at 46.8% of revenues vs. 44.4% in 1QFY17. Below-trend material costs helped to offset this.
Operating margin came in at 6.6%, lower than the 7.3% recorded in 1QFY17. Revenues of S$272.8m were in line with our forecast.

Associate/JV income of S$21.1m for 1QFY18 was in line with our expectations of a full-year S$85m contribution.
Key Pratt & Whitney engine JV Eagle Services Asia (ESA) saw stronger contributions, which were offset by a weak quarter at SIE’s key Rolls Royce JV Singapore Aero Engine Services Pte Ltd (SAESL).

We keep our earnings forecast essentially unchanged, as we believe a cyclical upswing in the remaining 9MFY18 will help to offset the below-forecasted earnings this quarter.
We continue to expect a full-year dividend of 13 Scts in FY18, in line with SIE’s payout policy of 85-90% of core earnings.

In June 2017, SIE announced a new engine overhaul JV with GE Aviation, which will provide a full range of MRO services for the GE90 and GE9X engines, which power several members of the Boeing 777 family. The partnership comes on the back of Singapore Airlines’ announcement of a letter of intent for 39 Boeing widebody aircraft in February 2017, which includes 20 777-9s powered by the GE9X engines.

Also in June, SIE’s JV engine shop ESA announced that it was selected as an MRO facility in Singapore for the maintenance, repair and overhaul of Pratt & Whitney’s PW1100G-JM PurePower® Geared Turbofan™ (“GTF”) engines.
The PW1100G-JM is one of two engine choices for the A320neo aircraft, which according to Oliver Wyman, is the top aircraft platform (together with the A320ceo) in terms of total MRO spend in 2017, and will remain so in 2027.
Engine service on the GTF units are expected to begin in 2019, so while the near-term impact is limited, SIE will be better positioned in the longer term.

Suvro SARKAR DBS Vickers | Glenn Ng DBS Vickers | http://www.dbsvickers.com/ 2017-07-26

DBS Vickers SGX Stock Analyst Report HOLD Maintain HOLD 3.840 Same 3.840