SIA Engineering - UOB Kay Hian 2019-05-13: 4QFY19 Earnings In Line, Aided By Engine Checks, But Unsure Of Sustainability

SIA ENGINEERING CO LTD (SGX:S59)

SIA Engineering - 4QFY19: Earnings In Line, Aided By Engine Checks, But Unsure Of Sustainability

We are perturbed by the fifth consecutive year of decline in revenue and the low elasticity of staff costs. On the positive side, earnings from JV and associates picked up sharply, but we have little confidence on its sustainability.
Meanwhile, SIA Engineering’s line maintenance ventures have a relatively long gestation period for scale and profitability.
Maintain HOLD and target price of S$2.55.
Suggested entry level: S$2.30.

SIA ENGINEERING CO LTD (SIAEC, SGX:S59)’s FY19 net profit declined 13.9% y-o-y to S$160.9m, in line with our and consensus estimates. Excluding the prior period’s S$15m gains on divestment of ACTS and S$3.5m impairment charges, 4QFY19 profit would have increased 10.3% y-o-y.
However, revenue has been decreasing for six straight quarters and five consecutive years, although part of the decrease over the past two years was due to the novation of Boeing airframe maintenance contracts to a JV with Boeing.
SIA Engineering also said the 7.4% y-o-y decline in 4QFY19 revenue was mainly due to lower fleet management activities. It also noted that full-year earnings were impacted by S$3.4m increase in tax provision. As expected, SIA Engineering lowered final dividend by 1 S cent to 8 S cents, with full-year payout amounting to 76.5%.

rather than the expected Rolls Royce Trent 1000 checks. SIA Engineering had previously guided that the PW4000 was a mature engine and that such checks will eventually phase out.
However, SIA Engineering had an increase in shop visits from the engine type as various other maintenance centres had ceased operations on the same engine type. Hence, while there is a possibility that such maintenance could kick in again, it would be highly dependent on improving air cargo demand and low jet fuel. As for the Rolls Royce Trent 1000, management indicated that it expects to see a pick-up in the current financial year.

The JV will focus on Nok Scoot’s five aircraft and subsequently aim at securing other customers including Nok Air and Scoot at Don Mueang airport.
SIA Engineering admitted that it would probably not have scale initially but hopes to eventually expand to other airports in Thailand. Prospects could be challenging, as much of the growth is driven by low-cost carriers, some of which perform line checks on their own.

SIA Engineering adopted IFRS1 and IFRS 15 for FY19 retrospectively and restated the financial statements. The new accounting standards led to a restatement of S$2.7m and S1.2m increase in FY18 and 4Q18 net profit respectively. SIA Engineering will adopt IFRS 16, the new leasing standard which capitalises all leases, from 1 Apr 19.
SIA Engineering guided the estimated impact on balance sheet as at 1 Apr 19 is a S$103.4m increase in right-of-use assets and lease liabilities. The lease liabilities pertain to land and hangar leases. SIA Engineering also estimated that the net profit impact due to this standard would be S$1.2m and S$0.6m decrease in net profit for FY19-20 and FY20-21 respectively. There would be no impact on cash flow.

It also indicated that the grounding of B737 Max could impact the scheduled maintenance of other narrow bodied aircraft or even wider bodied aircraft as airlines aim to maximise utilisation. We reckon work on SIA aircraft could be reduced in FY20. Meanwhile, we remain concerned about the continued deterioration in revenue and relative inelasticity of staff cost.
For FY19, staff and subcontract costs fell by only half the rate of the decline in top-line. Although SIA Engineering has stepped up line maintenance operations overseas, these have yet to make any meaningful contribution.

We are unsure if the P&W4000 engine shop visits will continue in FY20 and whether the incremental shop visits from Rolls Royce Trent 1000 will be able to offset the decline in the former over the next two years.
The lack of visibility is a concern as dividends from JVs & associates are generally higher than operating cash flow.

We lower our FY20-21 net profit estimates by 4.3% and 3.4% respectively, factoring in lower airframe and line maintenance revenue, and higher opex.

Given the uncertainty in estimating JV & associate income (hence cash flow), we move from a DCF-based valuation to a DDM-based valuation.
We estimate that DPS will remain unchanged over the next three years, and have estimated COE and terminal growth rate of 6.6% and terminal growth rate of 1.0%. At our target price, SIA Engineering will be trading at 17x FY20 earnings and offer a dividend yield of 4.3%.
Suggested entry level is S$2.30.

K Ajith UOB Kay Hian Research | https://research.uobkayhian.com/ 2019-05-13

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