SIA Engineering - DBS Research 2019-05-14: Unexciting Growth Prospects

SIA ENGINEERING CO LTD (SGX:S59) | SGinvestors.io SIA ENGINEERING CO LTD (SGX:S59)

SIA Engineering - Unexciting Growth Prospects

  • SIA ENGINEERING CO LTD (SGX:S59)'s 4Q19 earnings in line; margins surprised on the upside.
  • Difficult to sustain margin outperformance amid sluggish heavy maintenance revenue outlook.
  • Dividend cut to 11Scts in FY19 vs. 13Scts in FY18.
  • Earnings growth outlook muted; maintain HOLD with lower Target Price of S$2.60.



Maintain HOLD as upside catalysts seem limited.

  • In our last report (see SIA Engineering - Dividend Expectations Lowered), we highlighted the possibility of lower dividends, and indeed, SIA Engineering announced a total dividend of only 11Scts for FY19, compared to 13Scts in FY18, as headline net profit fell 14% y-o-y (though core profit was higher).
  • Core operating margin improved to 7.6% in 4QFY19 from 6.2% in 3Q19 and 4.2% in 1HFY19, but we believe this will be difficult to sustain amid challenging conditions in the heavy maintenance segment.
  • Going forward, revenues and operating margins will likely remain under pressure, due to additional headwinds stemming from the recent unforeseen grounding of the B737 MAX aircraft worldwide and more recently, grounding of a few B787 aircraft in the region.
  • The grounding of new generation aircraft models has led some airlines to defer heavy maintenance checks on older planes to mitigate the sudden shortage of available planes. Prospects for JV/associate earnings, driven by engine MRO, still remain fairly healthy though, but overall earnings growth projections for FY19/20 remain pretty flattish.


Where We Differ:



Potential Catalyst:

  • Upside could come from investments in JVs in the region or outright acquisitions, which offer immediate accretion to earnings. The higher cash reserve maintained after cutting dividends could be a precursor to that, but there is no visibility at this point.


Valuation:

  • Factoring in lower dividend assumptions, we arrive at a lower Target Price of S$2.60 for SIA Engineering and maintain our HOLD recommendation.
  • The Target Price is based on a blended valuation framework (PE, EV/EBITDA, dividend yield and DCF).


Key Risks to Our View:

  • Upside risk from better than expected core operating margins.


WHAT’S NEW - Lingering operational challenges could impede earnings growth


Net profit in line with expectations.

  • SIA Engineering's 4Q19 net profit of S$49.3m (-10% y-o-y, +49% q-o-q) was in line with ours’ and consensus expectations. Core EBIT margin during the quarter was better than expected at 7.6%, compared to 6.2% in 3Q19, and 4.0-4.5% in 1H19, continuing the sequential improvement trend since the low in 1Q19. However, it may be difficult to sustain margins at this level, as we explain later.
  • Full year headline net profit was down 14% y-o-y to S$160.9m, on the back of a 7% decrease in revenue and core margin erosion to 5.6% from 7.2% in FY18. Of course, there was a one-time divestment gain of around S$15m recorded in 4Q18, compared with adverse one-off items of around S$20m recorded in 3Q19.
  • Adjusting for these effects and other exceptional items, FY19 core net profit would have been around S$180m, up around 5.5% y-o-y compared to FY18 core net profit of around S$170m.

Top line shrinks again for the 5th consecutive year.

  • SIA Engineering's FY19 revenue of S$1,021m was down 7% y-o-y as mentioned above, attributable to a reduction in heavy maintenance checks and a lower amount of aircraft under fleet management programme.
  • FY19 airframe and line maintenance revenue fell to S$891m (-5% y-o-y), primarily driven by lower heavy maintenance activity, as the number of ‘C’ checks at the Singapore and Clark bases declined to 125 (-13% y-o-y). This was, however, offset by higher line maintenance work volume, as the number of flights handled at Changi airport grew to 153,006 (+4.3% y-o-y) in FY19.
  • Fleet management revenue decreased to S$100m (-20% y-o-y), owing to less aircraft under management (82 in FY19 vs 89 in FY18), as SIA Engineering continues to novate Boeing aircraft under management to its JV with Boeing – Boeing Asia Pacific Aviation Services (BAPAS).

Core revenues and EBIT margins expected to be under pressure.

  • Despite the improvement in 4Q19, overall FY19 core EBIT margin of 5.6%, compares poorly to FY18 core EBIT margin of 7.2%. This also marks the third year of annual decline in core EBIT margin, amid a secular downturn in hangar utilisation and competitive market environment for heavy maintenance operations.
  • Going forward, SIA Engineering's revenues and operating margins will likely remain under pressure, due to additional headwinds stemming from the recent unforeseen grounding of the B737 MAX aircraft worldwide and more recently, grounding of a few B787 aircraft by Singapore Airlines and others on the back of engine problems and in China, GPS software issues.
  • The grounding of Boeing’s newest most popular aircraft model has led some airlines to defer heavy maintenance checks on older planes to mitigate the sudden shortage of available planes. This puts a spanner on the demand for heavy maintenance checks in the near term.
  • The recently established line maintenance stations in Japan, and the new line maintenance JV between NokScoot and SIA Engineering, which is slated to begin operations at Don Mueang airport later in the year, are also unlikely to be significantly earnings accretive in the near term, given that they are still nascent and in the start-up phase.
  • Furthermore, contribution from fleet management segment will likely be muted, as operating margins could diminish due to SIA Engineering’s inadequate scale. We believe the number of aircraft under management could shrink further as SIA Engineering continues to transfer more Boeing aircraft under management to BAPAS, and as it will take some time for the current smaller customers like Salamair to expand to their planned fleet size.

Contributions from associates and JVs remain firm as anticipated.

  • Associates and JV profits came in at S$32.3m in 4Q19 (+29% y-o-y, +68% q-o-q) and S$113.9m (+4% y-o-y) for the full year FY19 respectively. The full-year figure includes some one-off items, excluding which, associate/JV contributions would have come in around S$134m, which would imply an annual increase of around 22%, in line with the recovery in engine MRO cycle, and commencement of support for new engine types.
  • Looking ahead, we expect work volumes at the engine shops to sustain solid momentum for the next 12-18 months, on the back of an upturn in the engine MRO cycle. Additionally, demand may also be bolstered by problems at the new Trent-1000 TEN engine, which was recently added to the list of engines that require rectification work, similar to issues with its predecessor, the Trent-1000 engine.
  • Capabilities for new engine types will also be a boost as Eagles Service Asia, the JV between SIA Engineering and Pratt & Whitney, begun servicing PW1100-JM PurePower Geared Turbofan engines in 4Q19. This will be only the second shop in Asia capable of servicing the Turbofan engines, which are used in narrowbody aircraft including the A320neo family.
  • The long-term prospects are also boosted as SIA Engineering anticipates the GE state-of-the-art engine facility in Singapore to be operational by mid-late 2022. We expect the group to continue expanding its portfolio of JVs and associates through strategic partnerships with OEMs.

Dividends lower than expected; but balance sheet remains robust.

  • In our last report, we highlighted the possibility of lower final dividends, in line with lower headline profits. (see SIA Engineering - Dividend Expectations Lowered)
  • Indeed, SIA Engineering declared a lower final dividend of 8Scts, which when taken together with the interim dividend of 3Scts, translates into a total dividend of 11Scts for FY19. This implies a 4.5% yield at current prices, but in absolute terms a marked decline compared to total dividends of 13Scts in FY18, and a payout ratio of only 77% of headline profit (and an even lower 69% of core net profit), which is much lower than usual range of 80-90%. See SIA Engineering's dividend history.
  • Operating cash flow of S$75m was better than FY18, though working capital needs have intensified over the last 2 years. SIA Engineering, however, ended the year with a healthy net cash of S$502m. Hence, the cut in dividends could suggest that the company is preserving a buffer for M&A and/or spending on productivity improvements.


Growth projections muted, maintain HOLD.

  • We lower our revenue assumptions for FY19/20 by around 5% p.a. owing to continuing headwinds in heavy maintenance space, compounded by grounding of new generation aircraft types. Hence, our EBIT margin assumptions remain muted and we expect flattish earnings growth overall in FY19/20, despite support from the JV/ associate line. As a result, we maintain our HOLD call at a slightly lower Target Price of S$2.60 (on the back of lower dividend assumptions), which is based on a blended valuation methodology.
  • Upside could come from investments in JVs in the region or outright acquisitions, which offer immediate accretion to earnings. The higher cash reserve maintained after cutting dividends could be a precursor to that, but there is no visibility at this point.

A look at Company's listed history – what drives SIA Engineering's share price?

  • See Appendix1 in attached PDF report.





Suvro Sarkar DBS Group Research | Singapore Research Team DBS Research | https://www.dbsvickers.com/ 2019-05-14
SGX Stock Analyst Report HOLD MAINTAIN HOLD 2.6 DOWN 2.700



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