SIA Engineering (SIE SP) - UOB Kay Hian 2017-10-10: Valuations Normalise But No Immediate Catalysts

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SIA ENGINEERING CO LTD S59.SI

SIA Engineering (SIE SP) - Valuations Normalise But No Immediate Catalysts

• We have been bearish on SIA Engineering (SIAEC) for almost three years, highlighting wage cost pressures and competitive pressures from regional maintenance firms. 
• While the stock is trading at a more reasonable 21x FY18F PE, we prefer to await better catalysts before re-rating the stock. Specifically, we would like to see stable staff costs, improving line maintenance earnings and higher JV and associate income or at least guidance along the same lines. 
• Pending the release of interim earnings in early-November, our SELL recommendation and target price are under review.

WHAT’S NEW

At three-year lows, but awaiting catalysts. 

• SIA Engineering’s (SIAEC) stock price declined sharply following the recent sell-down amid concerns over a 39m stock placement and the removal of the stock from the FSSTI. 
• At current levels, the stock is trading 12% below our target price of S$3.60. Still, we would like to see concrete improvements in certain key areas, before rerating the stock. They are as follows: 
  1. Stable staff costs. If labour cost increases narrow, this will be a catalyst for an upgrade. Ideally, we would need to see at least two quarters of stable staff costs, to make a case for an upgrade. 50% of SIAEC’s opex costs are labour-related and while such costs are billed on an hourly basis to customers, the proliferation of lower cost MRO shops in Malaysia, Indonesia and Philippines has curtailed SIAEC’s ability to pass on costs, particularly for its airframe maintenance segment. In 1QFY18, staff costs rose 6% yoy, excluding the prior period’s EI costs. For the full year, we have conservatively assumed a 4.3% yoy rise in costs vs a 0.5% increase in revenue.
  2. Higher line maintenance revenue and potentially earnings growth from Air India Engineering JV. While SIAEC performs line checks at 37 airports in 8 countries, the bulk of revenue still accrues from Singapore. Revenue growth is thus directly proportional to aircraft movement out of Changi as SIAEC has about a 77% market share on line checks performed at the airport. Aircraft arrivals out of Changi rose by 4.1% in Jul-Aug 17 and this bodes well for strong 2Q revenue. SIAEC had also begun line maintenance checks at Kansai airport in June and this could also be accretive. In addition, on 6 October, SIAEC announced that it had signed a non-binding MOU with Air India Engineering Services Limited (AIESL) to perform line maintenance and ancillary services at six airports in India.
  3. Incremental JV and associate income. Faced with greater regional competition, SIAEC has intensified its JVs over the past two quarters, forming JVs with Embraer, General Electric (GE), Moog and Pratt & Whitney. While positive, these JVs will have a relatively long gestation period. Over the next two years, we do not expect material improvement in JV and associate income. In FY17, JV and associate income rose just 2.4% yoy and growth was just under 2% in 1QFY18. For FY18, we have assumed a 10% yoy increase in JV and associate income. For now, we believe that it will be difficult for SIAEC to surpass this hurdle.

STOCK IMPACT

No immediate catalysts despite SIAEC’s efforts to expand and diversify operations. 

• While we applaud SIAEC’s latest efforts to expand into India, we believe that a concrete agreement is still some time away as the Indian government has expressed interest in divesting AIESL along with other Air India subsidiaries. Thus, barring a bid by SIAEC, there is a possibility that the MOU might not see fruition, especially if the unit is acquired by a competitor.
• We are neutral at the stage and place our recommendation under review pending the interim earnings announcement. 
• SATS is our preferred pick in the aviation support services sector, given its relatively lower PE valuation and higher ROE.

EARNINGS REVISION/RISK

• No change in earnings forecasts.

VALUATION/RECOMMENDATION

• Target price and SELL call under review. 
• Our current target price of S$3.60 is DCF based and implies 23.7x FY18F PE vs the current 21.0x. Meanwhile, our target price implies FY18F dividend yield of 3.6% and PE of 23.7x.

SHARE PRICE CATALYST

• No immediate catalyst.

K Ajith UOB Kay Hian | http://research.uobkayhian.com/ 2017-10-10

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