SIA Engineering 2QFY20 - UOB Kay Hian 2019-11-05: Impressive Turnaround, Margins Likely To Improve Further

SIA ENGINEERING CO LTD (SGX:S59)

SIA Engineering 2QFY20 - Impressive Turnaround, Margins Likely To Improve Further

SIA Engineering’s revenue rose for two consecutive quarters. We are also impressed by transformational plans which led to operating profit rising 74% y-o-y on just 1.3% y-o-y increase in top-line.
We expect margins to improve further in 2HFY20 as improvement in efficiency gathers momentum. On top of that, we expect SIA Engineering to raise its final dividend. See SIA Engineering Dividend History.

SIA Engineering (SGX:S59)’s 2QFY20 net profit gains were driven mainly by a 74% y-o-y improvement in operating profit. That in turn was due to:
1. 50% reduction in accommodation cost;
2. 13% reduction in sub-contract cost; and
3. 19% reduction in other operating expenses including positive forex variance, including cost savings arising from productivity innovation.
The reduction in sub-contract costs varied directly with a corresponding decrease in fleet management revenues. See SIA Engineering Announcements.
SIA Engineering declared an unchanged interim dividend of 3 S cents. See SIA Engineering Dividend History.

We believe the substantial operating leverage was partly due to automation efforts. SIA Engineering highlighted that the use of automated aircraft towing tugs reduced manpower requirement. In addition, while Changi Airport’s aircraft movements fell 1.3% y-o-y in 1HFY20, SIA Engineering’s flights handled at Changi rose 2.7% y-o-y due to the acquisition of four new airline customers.

SIA Engineering indicated that this was mainly due to start-up costs at Eagle Services Asia (ESA) due to higher expenses associated with the ramping up of maintenance capabilities for the GTF engine. The engine is one of two variants used for the Airbus A320 Neo.
Still, there was sequential improvement in 2QFY20 as earnings fell only S$2.6m y-o-y vs 1QFY20’s S$4.4m reduction.

Over the past few quarters, we had highlighted the growing competition from regional maintenance and repair and overhaul (MRO) centres. These challenges remain but SIA Engineering is expanding its line maintenance operations, which is typically a high-margin business. At the same time, it managed to improve efficiency by reducing manhours and improving turnaround time.
SIA Engineering highlighted the use of:
1. remote-controlled aircraft tugs;
2. drones;
3. Pneumatic tube system for parts delivery;
4. robotic process automation; and
5. addictive manufacturing.
Among all these initiatives, we believe the use of remote-controlled aircraft tugs will lead to the greatest quantum of operating leverage.

The 49%-owned associate has invested in new technologies to provide maintenance for the GTF engine. According to Flight Global, there are 1000 A320 Neo family aircraft that are currently in operation, almost double from the start of the year. The GTF engine is used on about 46% of the aircraft and thus maintenance checks are likely to accelerate in coming years.

SIA Engineering quoted “Transformational efforts are translating into improvement in operating performance” under its outlook statement and the company appears to be more optimistic now than in earlier quarters. Guided by that, we believe SIA Engineering’s FY20 operating margin is likely to be higher in 2HFY20 (2QFY20: 7.7%, up 3.2ppt y-o-y).
In fact, excluding impairment provisions in the latest quarter, operating margin would have been 8.1%. Given the gradual implementation of cost-savings measures, we expect line maintenance margins to improve further in 2HFY20.
2H is typically a stronger period for SIA Engineering due to higher aircraft movements, which in turn lead to higher line maintenance margins. We are also encouraged by the quarterly improvement in jv and associate income, which SIA Engineering had highlighted was due to ramp-up costs relating to the Pratt and Whitney, GTF engine.

We raise our FY20-21 net profit estimates by 8.4% and 16.7% respectively as we factor in positive jaws for the airframe and line maintenance business over the next two years as well as higher engine maintenance margins.
We also expect net profit to rise by 12.5% in FY20 and 9.8% in FY21

We expect SIA Engineering to raise FY20 final dividend by 1 S cents to 9 S cents and expect total dividend to increase by 1 S cent in FY21. See SIA Engineering Dividend History.
We continue to value SIA Engineering on a DDM basis and have also lowered our risk-free rate assumption from 2.75% to 2.5%. We raise our terminal growth rate from 1.0% to 1.2%. At our fair value, SIA Engineering will be trading at 19.4x FY20F PE. This is lower than its 5-year mean PE of 20.7x. See SIA Engineering Share Price; SIA Engineering Target Price.

K Ajith UOB Kay Hian Research | https://research.uobkayhian.com/ 2019-11-05

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