SIA Engineering - DBS Research 2019-11-05: Robust Core Operating Performance

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SIA ENGINEERING CO LTD (SGX:S59)

SIA Engineering - Robust Core Operating Performance

• SIA Engineering's  2QFYMar20 net profit was above consensus estimate.
• Continued improvement in core operating margin inspires confidence.
• Interim dividend of 3Scts/share declared.
• Maintain BUY with higher Target Price of S$3.30.

Maintain BUY with higher Target Price of S$3.30.

• SIA ENGINEERING (SGX:S59)’s core operations had another strong showing in 2Q20, with core operating margins at the highest level since 4Q17. Going forward, we see several promising earnings drivers like:
  1. further expansion in SIA Engineering’s core operating margin, bolstered by cost-cutting initiatives and progress in its transformation programme,
  2. increased workload at its engine shops owing to persistent problems with the Trent-1000 engines,
  3. recovery in associate/ JV profits from the low in 1HFY20 as startup costs related to new engine capabilities have mostly been already accounted for and
  4. a boost in maintenance work volumes due to delays in retiring older aircraft following the protracted global grounding of the B737 MAX aircraft.
• While privatisation remains a crucial catalyst for the stock, the current valuation for SIA Engineering is attractive at close to multi-year lows at about 17x forward PE and dividend yield is healthy at 4.3%. See SIA Engineering Dividend History.

Convincing trend in core EBIT margin

2Q20 net profit above consensus estimate.

• SIA Engineering's 2Q20 net profit of S$46.0m (+21% y-o-y, +11% q-o-q) surpassed consensus expectations comfortably, with 1H20 net earnings of S$87.6m forming 52.0% of consensus’ full-year estimates. See SIA Engineering Announcements; SIA Engineering Latest News.
• The outperformance during the quarter was primarily driven by an improvement in SIA Engineering’s core operating margins, which offset weakness at the associate/ JVs line. There was also a disposal gain of S$2.3m recorded during the quarter.

Top line was stable.

• SIA Engineering's 1H20 revenue was up slightly by 0.7% y-o-y to S$512.7m, as an increase in SIA Engineering’s primary airframe and line maintenance revenue (S$456.4m, +3.1% y-o-y) mitigated lower revenue from its fleet management programme (S$43.9m, -13.6%) and inhouse engine and components division (S$12.4m, -20.5%). While the grounding of certain aircraft might have altered the maintenance schedule of certain airlines, activity in 1H20 was mostly up across the board as elaborated below:
  • SIA Engineering’s Singapore hangars saw a decent uptick in utilisation, with the number of ‘A’ and heavier ‘C’ checks growing to 241 (+8.1% y-o-y) and 31 (+34.7% y-o-y). Utilisation at the Clark base was resilient as the strong demand for other maintenance work offset a decrease in the number of ‘C’ checks to 23 (-23% y-o-y).
  • The number of flights handled at Changi rose to 77,797 (+2.7% y-o-y) despite a minor fall in flights arriving at Changi, as SIA Engineering managed to score some new customers and secured contract renewals.
  • Engine and components’ work volume was up, but revenue in the segment was down because of a reduction in SIA Engineering’s share in the Cseries aircraft engine Risk-Revenue Sharing Program with Pratt & Whitney to 1% in 2H19 from 3% previously.
  • Number of aircraft under management dipped again to 75 from 82 as at end-FY19, as more Boeing-series aircraft was novated to its JV – Boeing Asia Pacific Aviation Services (BAPAS).

Strong showing in core EBIT margin underpinned by successful transformation initiatives.

• SIA Engineering’s core operating margin in 2Q20 widened to 7.7%, the highest level in the past 10 quarters. This was largely driven by SIA Engineering’s focus on worker productivity and operational efficiency. SIA Engineering is gradually incorporating more technological capabilities in its operations, such as using drones for inspection, automating logistics like using autonomous guided vehicles and a pneumatic tube system for the delivery of small parts, and virtual reality to facilitate staff training and augment productivity.
• Given the recent trend in margins despite largely flattish revenues, we believe this can be sustained or improved, going forward.

Earnings from associates and JVs down slightly on start-up costs incurred by its JV, Eagle Services Asia (ESA).

• Associates and JV profit was lower than expected at S$27.4m in 2Q20 (- 9% y-o-y, +5% q-o-q), as ESA incurred costs to upgrade its facility for overhaul work on the Pratt & Whitney geared turbofan engine that powers the A320neo aircraft, and the GP7200 engine that powers the A380 aircraft. Though ESA will likely be a drag for a while given that it is still in its gestation period for the above new engine types, the bulk of the ramp up costs were already incurred in 1H20, hence we should see sequential improvements.
• SIA Engineering’s line maintenance JV with NokScoot should also commence operations by end- 2019/early 2020, though the partnership will also likely be in the red for some time due to start-up costs.

Interim dividend flat y-o-y; balance sheet strengthens again.

• In line with its operating performance, SIA Engineering’s operating cash flow in 1H20 grew to S$66.2m (+46% y-o-y), counteracting the dip in dividends received from its associates and JVs (S$37.9m, -14.2% y-o-y). The company declared an interim dividend of 3Scts/share, which is on-par with 1H19.
• SIA Engineering’s net cash position as at end-1H20 was S$488m (up from S$434m in 1H19), and we believe that the recovery in its core operations should enable the company to bump up its final dividend to 9Scts/share (from 8Scts/share in FY19). This implies a dividend yield of 4.3% based on a total dividend per share of 12Scts for FY20 at the current share price. See SIA Engineering Share Price; SIA Engineering Dividend History.

Raised FY21F net profit estimate by 5%; maintain BUY with higher Target Price of S$3.30.

• We have largely maintained our FY20F net profit estimate as we expect softer contribution from SIA Engineering’s associates and JVs to offset better core operating performance. However, we lift our FY21F net profit projection to reflect our view of a sustainable uptrend in operating margins and the absence of start-up costs at ESA.
• We reiterate our BUY call with a higher Target Price of S$3.30, as we roll over valuations to blended FY20/21 numbers. The Target Price also factors in a conservative 15% privatisation premium to reflect SIA Engineering’s privatisation prospects as highlighted in our recent report on the SIA Group, “No smoke without fire”. See SIA Engineering Share Price; SIA Engineering Target Price.
• The stock remains attractively priced at an undemanding 18x forward PE, with a healthy dividend yield of around 4.3%.

Where we differ:

• Higher than consensus net profit estimates as we are more sanguine on SIA Engineering’s transformation programme bearing fruit. We raised our FY21F earnings by 5% and now expect stronger 6% earnings growth in FY21.

Suvro Sarkar DBS Group Research | Jason SUM DBS Research | https://www.dbsvickers.com/ 2019-11-05

SGX Stock Analyst Report BUY MAINTAIN BUY 3.30 UP 3.010