SIA Engineering - DBS Research 2018-05-17: More Bright Spots On The Horizon

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SIA ENGINEERING CO LTD SGX: S59

SIA Engineering - More Bright Spots On The Horizon

• SIA Engineering's 4QFY18 core EBIT and net profit were in line. 
• Final dividend of 9 Scts declared, bringing full-year dividend to 13 Scts – at par with FY17's dividend (excluding special dividend), but slightly lower than expected. 
• Number of aircraft under fleet management up slightly. 
• Engine shops seeing healthy workload. 

Maintain BUY on tailwinds ahead.

• SIA Engineering’s (SIAEC) forward PE and P/BV ratios are below -1SD levels, which we view as a buy-in opportunity, as there are some positive earnings drivers ahead:
  1. an upswing in the engine MRO cycle is already underway, with workload boosted further by visits from the problematic Trent 1000 engines (whose repair campaign could last up to 2-3 years);
  2. cabin retrofitting work on Singapore Airlines's (SIA) legacy A380s is expected to come in at the end of 2018;
  3. the new GE facility which should be operational in 2019 or early 2020 has the potential to be a large contributor to JV/associate income;
  4. expansion of the line maintenance segment in Japan (with a view towards other countries as well) could help drive the top line.
• We maintain our BUY call with a higher Target Price of S$3.92; together with a dividend yield of 4.0%, this implies an all-in return of c.24%. 

Downside risks are limited now.

• The adverse effect on the heavy maintenance segment of longer check intervals and lower check content of newer generation aircraft should be mostly offset by a growing fleet size, especially in Asia Pacific.
• Also, while the fleet management business is facing headwinds, with the fleet having already shrunk from 193 aircraft at its peak to the current 89 (with 2H18 actually recording a h-o-h increase of five aircraft under management), the worst could be over for that segment. 

Valuation: 

• Our Target Price of S$3.92 is based on a blended valuation framework (PE, EV/EBITDA, dividend yield and DCF), and includes a 20% M&A/privatisation premium. 

Key Risks to Our View: 

• Intensifying competition could lead to renewed stress on the margin front. A weaker-than-expected fleet management segment owing to lower economies of scale is another risk. Upside risk exists in the form of potential privatisation/M&A. 

WHAT’S NEW - Profits in line; engine shops doing well

Profits in line but dividend payout could have been more generous.

• SIA Engineering (SIAEC)'s 4QFY18 results were in line. EBIT of S$20.6m was slightly higher than expected, while core net profit (excluding c.S$15.2m of one-off items mainly relating to a gain on disposal of associate ACTS and a S$3.5m impairment of PPE) of S$43.3m matched our expected S$43.1m.
• A final dividend of 9 Scts has been declared, lower than our expectation for 9.5 Scts. With this, full-year dividend payout comes to 13 Scts, same as FY17’s amount if last year's special dividend is excluded, and translates into a dividend payout ratio of roughly 85% of core profits by our calculations.
• We had expected a high 80s or 90% payout ratio. Nonetheless dividend yield is still quite decent at 4.0%.

Associate and JV profits in line; engine shops to continue performing well.

• Associate and JV profits were in line at S$25m for the quarter. On a full-year basis, while the engine and component associates/JVs did well, with profits from these companies of S$109.9m up 15% y-o-y, the airframe and line maintenance associates/JVs saw a loss of S$0.1m for FY18 (down from a profit of S$0.9m in FY17), impacted by startup costs at an associate.
• Overall, the engine shops should continue doing well with an upswing in the engine MRO cycle – SIAEC and competitors have mentioned engine shops operating at high utilisation rates – as well as some support from workload on the problematic Trent 1000 engines. The GE engine facility, which we think is likely to begin operations in 2019 or early 2020, will be the next leg up for growth in terms of engine shop profits.

New segmental categorisation starting this quarter.

• Beginning with its FY18 results, SIAEC has changed its reported segments to: 
  1. Airframe Overhaul and Line Maintenance, 
  2. Fleet Management, and 
  3. Engine and Component 
  for revenue reporting. 
• For operating profit reporting, Fleet Management is subsumed under Airframe Overhaul and Line Maintenance.
• The key difference is we are no longer able to see the Line Maintenance segment’s standalone revenue and operating profits, nor the ‘heavy maintenance’ revenues on its own. Engine and Component revenues and losses are relatively small vs. the other reported segments. Under this new categorisation, Airframe Overhaul and Line Maintenance saw revenues rise by 1.0% y-o-y in FY18, while Fleet Management revenues were down by 15.5%.
• Operating profit for Airframe Overhaul and Line Maintenance of S$79.5m was down 16.2% vs. FY17 (excluding the one-off profit-linked component of staff remuneration related to the divestment of HAESL), while Engine and Component operating losses widened from S$1.6m in FY17 to S$3.1m in FY18.

Strong balance sheet; headroom for M&A and productivity improvements.

• SIAEC balance sheet remains in a strong net cash position with minimal gross debt (c.S$22m as of 4QFY18) and almost S$500m in cash/short-term deposits on hand. This gives headroom for M&A and/or spending on productivity improvements.
• We would view higher spending levels on these areas as positive (or alternatively, a higher dividend payout). In FY18, operating cash flow has been slightly weak at S$54m owing to a working capital drain arising from higher receivables on longer payment cycles on some of the A380s undergoing heavy maintenance, but we understand that there is no bad debt issue to be worried about.

Services Agreement signed with SilkAir for its new Boeing 737 MAX aircraft.

• SIAEC announced on 26 April that it had signed a 12-year comprehensive Services Agreement with Silkair for its latest fleet of Boeing 737 MAX aircraft, with a total contract value of S$484m over the 12-year term. The agreement covers a range of services including maintenance, repair and overhaul, and support services.
• There is also an option to renew for a further 5-year period. SIAEC has existing arrangements with SilkAir on their Airbus A320 and Boeing 737NG aircraft, so this represents a continued customer relationship as the fleet is refreshed.

Philippines footprint to expand on LOI with Cebu Air.

• SIAEC and Cebu Air announced on 29 April their entry into a non- binding Letter of Intent (LOI) to collaborate to expand MRO services in the Philippines. The two will explore potential growth opportunities for their two existing JV companies – Aviation Partnership (Philippines) Corporation, a line maintenance company, and SIA Engineering (Philippines) Corporation, a heavy maintenance company – via the expansion of line maintenance operations, growth of hangar facilities and the expansion of training academy services.
• Capex for these growth opportunities is estimated at between US$15m and US$20m.

Suvro SARKAR DBS Vickers | Glenn Ng DBS Vickers | https://www.dbsvickers.com/ 2018-05-17

SGX Stock Analyst Report BUY Maintain BUY 3.92 Up 3.860