SIA Engineering - UOB Kay Hian 2018-11-12: 2QFY19 Flat Net Profit Masks The Weakest Top-line Growth In 5 Years

SIA ENGINEERING CO LTD (SGX:S59)

SIA Engineering - 2QFY19: Flat Net Profit Masks The Weakest Top-line Growth In Five Years

While 1HFY19 net profit was only marginally below expectation, we are concerned about the weak top-line growth, which is indicative of a tough operating environment for airframe maintenance.
Notably, an 8.5% decline in top-line led to a 44% decline in operating profit, which suggests minimal cost elasticity. Even so, we maintain our HOLD rating as we believe that earnings erosion over the next three years can be contained by higher engine maintenance and line maintenance earnings.
Suggested entry level: S$2.40 or 15x FY19 PE.

SIA Engineering (SIAEC)'s 1HFY19's net profit amounted to 44% of our and the street’s full-year estimate. Still, the 8.5% decline in revenue was a key miss.
SIA Engineering attributed the decline to lower airframe revenue and fleet management revenue. Effective May 18, SIAEC combined airframe maintenance with line maintenance and thus we are unable to truly gauge the impact of airframe maintenance. Collectively, the segment's revenue declined by 6.4% in 1HFY19 but we estimate that the airframe maintenance business’ revenue would have declined by double-digits.
The decline in operating profit in 2QFY19 was offset by stronger associate and JV income, due mainly to a surge from the engine maintenance business.
SIAEC lowered its interim dividend by 1 S cents to 3 S cents.

While revenue for the airframe and line maintenance business declined by 6.4%, operating profit for the segment declined by a whopping 43% to S$22.0m.
SIAEC indicated that line maintenance revenue in 1HFY19 grew in line with the 2.6% y-o-y rise in flight arrivals out of Changi. We can thus infer that airframe maintenance revenue on its own fell sharply in 1HFY19 and 2QFY19.
Also given that SIAEC, line maintenance typically commands operating margins in the 18-20% range, we can infer that the losses at the airframe maintenance business was substantial. This is likely due to the following reasons:
1. competitive pressures from other regional MROs;
2. newer generation of aircraft requiring fewer checks; and
3. transfer of Airbus MRO framework to the JV level.
SIAEC also noted that the MRO environment will continue to remain challenging.

We had been positive on this segment earlier in the year, as we expected SIAEC to benefit from problems with Rolls Royce Trent 8888 engines. SIAEC affirmed that the bulk of the growth was due to checks on the Trent 8888 engines and the company indicated that the backlog should continue for the next two years.

Faced with a high operating cost environment, SIAEC is seeking to expand its capacity to lower cost centres, like the Philippines.
In the interim, the company faces substantial challenges in reducing costs to mitigate the trend of lower revenue.
While engine MRO is likely to rise, we now do not expect the business to offset the decline in the airframe business. SIAEC is banking on growing its line maintenance business in Japan and the US, where it hopes to add scale by providing higher value-added services such as component manufacturing and installation as well as engine checks. However, SIAEC does not expect any significant improvement until at least another two years.

We lower our FY88/88 net profit estimates by 8.8% and 8% respectively as we factor in weaker top airframe maintenance revenue.

We continue to value SIAEC using DCF on recurring free cash flow (inclusive of dividends from associates).
We however, lower our terminal growth rate from 8.8% to 8.8%.
At our fair value, SIAEC will be trading at 88x FY88F’s earnings. Recommend accumulating at S$8.88 or -8SD to long-term mean.

K Ajith UOB Kay Hian Research | https://research.uobkayhian.com/ 2018-11-12

SGX Stock Analyst Report HOLD MAINTAIN HOLD 2.70 DOWN 3.400