SIA Engineering (SIE SP) - UOB Kay Hian 2017-07-26: 1QFY18 Below Expectations On Higher-than-expected Staff Costs

SIA ENGINEERING CO LTD S59.SI

SIA Engineering (SIE SP) - 1QFY18: Below Expectations On Higher-than-expected Staff Costs

SIA Engineering (SIAEC)'s earnings were below expectations, with core net profit declining by 13% yoy.
At the operating level, a 6% rise in staff costs (ex-prior year’s EI), along with higher D&A and subcontract costs, led to the decline in operating profit. The higher costs in the weak revenue environment highlight the challenges that SIAEC faces.

SIAEC also guided that recent initiatives and investments are unlikely to be accretive in the near term.
Valuations remain rich at 26x FY18F PE, above MRO peers’.
Maintain SELL. Target price: S$3.60.

Consensus was expecting core earnings growth for FY18, however excluding the prior year’s EI, SIA Engineering’s (SIAEC) core net profit declined 13% yoy in 1QFY18.
At the operating level, staff costs would have risen by 6% yoy (ex prior year’s EI). This, along with higher D&A and subcontract costs, led to an 8% decline in core operating profit.
At the non-operating level, associate and JV profits was bolstered by higher profits from Eagle Services Asia (ESA) resulting in a 1.9% rise in associate and JV income. However, this was unable to offset the decline at the operating level, leading to the 13% decline in core earnings.
Top-line was flat yoy, although we believe that line maintenance revenue would likely have increased during the period, in line with Changi Airport’s aircraft movements, which rose 3.5% yoy from Apr-May 17 (Changi Airport Group has yet to release June numbers). If so, airframe and fleet management revenue would have declined yoy.
Going by previous segmental operating margins, we reckon that the airframe and fleet management segment would have also been in the red for the period.

We reckon that the 49%-owned fleet management associate with Boeing (BAPAS) could potentially have contributed in 1QFY18. However, ESA’s profits are unlikely to be sustainable over the next three years, as the PW4000 engine is gradually being phased out.
We note that associate income declined 24% qoq, which suggests that the boost from maintenance on older and less fuel efficient aircraft could be tapering off.
Meanwhile, JV profits declined due to lower profits at its Trent engine JV, SAESL, which SIAEC attributed to lower work content of engines shipped.

Ex-EI, staff costs and subcontract costs would have risen 5% yoy despite just a 0.4% growth in revenue. This highlights the challenges and the tight labour environment that SIAEC operates in. SIAEC’s wage cost increase contrasts with SATS’ (SATS SP) relatively flat wage cost for the same period.
In addition, SIAEC also indicated that the recent initiatives and investments are “not expected to be accretive in the near term”.
Over the medium term, we expect the JV with GE Aviation to begin contributing as it provides maintenance for the more mature B777-200LR and B777-300ER, which SIA operates, but this could be towards 2HFY18 or 1HFY19, given that the JV is pending regulatory approvals.
Meanwhile, valuations remain rich at 26x FY18F PE, above MRO peers’.

We lower our FY18 net profit estimates by 3% as we factor in higher staff costs.

Maintain SELL and target price of S$3.60. We continue to value SIAEC using DCF (WACC: 5.4%, g: 1.4%).
While the new JVs are positive, we do not expect these to be game-changing events, mainly due to high labour costs and the rise of alternate MRO shops in the Asia Pacific region. At S$3.87, SIAEC offers a FY18 yield of 3.3%.
Meanwhile, our target price implies a core FY18 dividend yield of 3.6% and PE of 23.7x.

K Ajith UOB Kay Hian | Sophie Leong UOB Kay Hian | http://research.uobkayhian.com/ 2017-07-26

UOB Kay Hian SGX Stock Analyst Report SELL Maintain SELL 3.600 Same 3.600