SIA Engineering - CIMB Research 2017-11-06: In Need Of Transformation

SIA Engineering - CIMB Research 2017-11-06: In Need Of Transformation SIA ENGINEERING CO LTD S59.SI

SIA Engineering - In Need Of Transformation

  • SIA Engineering (SIE)’s 2QFY3/18 is slightly below our expectations: 1HFY3/18 net profit formed about 46% of our FY3/18F forecast and 44% of consensus.
  • Airframe repair & overhaul operating losses (S$11m) continued sequentially due to the high-cost base and lacklustre revenue.
  • The high-cost base and more OEMs encroaching into the after-market service mean SIE needs a major facelift in productivity to stay in the game, in our view.
  • Interim DPS of S$0.04 was declared. Net cash stood at S$440m.
  • We cut our FY18-20 EPS forecasts by 15-20% on slower revenue growth and higher costs. We maintain our Reduce call with a lower TP of S$3.13.

Lacklustre revenue, loss of Cebu Pacific in fleet management 

  • SIA Engineering's 1HFY3/18 revenue of S$217m (-4% hoh, +2% yoy) formed about 48% of our previous forecast. The lacklustre performance was due to continuous slide in airframe repair and zero increase in line maintenance despite more work transferred from hangars to apron.
  • Fleet management (FMP) dropped 19% hoh and 16% yoy as SIA Engineering lost the contract from Cebu Pacific to a competitor due to rates. As a result, the number of aircraft under FMP dropped 35% to 84 vs. 130 in 2HFY3/17.

Expansion at the price of margin 

  • To counter structural headwinds as more OEMs are encroaching in maintenance, repair & overhaul (MRO) after-market service, SIA Engineering is transferring more work to Clark hangars, starting with narrow bodied and LCC aircraft. 
  • SIA Engineering bears the ferry costs of aircraft transfer which led to lower operating margin for line maintenance of 18% in 1HFY3/18 vs. c.22% historical. 
  • SIA Engineering is also expanding its line maintenance network to Kansai and JFK which will only start to contribute in 2018 but for now would incur costs to beef up headcount.

Associates hover at current level thanks to P&W but for how long? 

  • Associates and JV profit of S$22.9m was slightly below our expected S$26m as Singapore Aero Engine Services (SAESL) continued to see lower work content for Rolls Royce’s Trent engines. This was offset by higher contribution from Eagle Services as Pratt & Whitney’s PW4000 engines’ lifespans were extended on the back of slow-down in phasing-out of B747 aircraft. 
  • We think the higher oil price trend could restart the phase-out process of older aircraft so earnings improvement from Eagle may be cut short.

In need of transformation 

  • SIA Engineering has embarked on a “major project” to improve productivity, investing in data analytics and innovation to shorten turnaround time. There are signs of effort to battle against the structural headwinds of high costs and competition. However we think it will take time to bear fruit. 
  • Operating losses in airframe repair are likely to continue in the next few quarters, in our view.

Maintain Reduce with lower TP 

  • The stock is still expensive at 20x FY19 P/E against weak earnings growth. We would relook at the stock if SIA Engineering makes progress in narrowing its operating losses in airframe repair.
  • Our lower TP (S$3.13) is derived on DCF valuations (WACC: 6.4%, LTG: 1%). 
  • Higher-than-expected costs could de-rate the stock. 
  • Upside risk includes stronger-than-expected volume pick-up for MRO.

LIM Siew Khee CIMB Research | 2017-11-06
CIMB Research SGX Stock Analyst Report REDUCE Maintain REDUCE 3.13 Down 3.860