Singapore Aviation Sector - UOB Kay Hian 2021-07-27: SIA Engineering’s Strong Sequential Earnings From JV & Associate Bode Well For ST Engineering

SIA ENGINEERING CO LTD (SGX:S59) SINGAPORE TECH ENGINEERING LTD (SGX:S63)

Singapore Aviation Sector - SIA Engineering’s Strong Sequential Earnings From JV & Associate Bode Well For ST Engineering

SIA Engineering (SGX:S59)’s results came in better than expected due to a steep sequential improvement in JV and associate earnings. This could be due to a pick-up in return to service engine checks. Consequently, we raised our earnings and upgraded SIA Engineering to HOLD, with a target price of S$2.25.
We see a positive read-through on ST Engineering (SGX:S63)’s aerospace business from this and Honeywell, which is ST Engineering’s partner in the US, and has reported strong 2Q revenue growth from the aerospace division.

This was entirely due to a steep rise in JV and associate earnings, which matched pre-pandemic levels. SIA Engineering (SGX:S59) did not provide any reason for the q-o-q improvement in its business update but we reckon this could be related to return to service checks on SIA (SGX:C6L)’s and third party airlines or the absence of an impairment charge.

On a q-o-q and a y-o-y basis, revenue growth was significantly lower than the 13% q-o-q and 97% y-o-y respective growth in flights handled suggesting pressure on line maintenance ASP. Operating profit is likely dragged down by a reduction in government grants, notably the Jobs Support Scheme (JSS).
SIA Engineering noted that the JSS was lower than the prior year and we believe it was lower q-o-q as well. Excluding the government support scheme, SIA Engineering would have recorded a loss of S$24.1m.

Singapore’s Finance Minister Lawrence Wong stated that Singapore expects 80% of its population to be vaccinated by September and will start reopening borders and establishing travel corridors with other countries or regions. At this stage, we are unsure if the quarantine-free travel refers to returning travellers out of Singapore or inbound travellers. In any case, we believe that a recovery in air travel will likely be gradual given slower rates of vaccinations outside Singapore.

The extent and the sustainability of improvement in JV and associate earnings are the key uncertainties. Aside from an increase in return to service checks, the engine JV and associates likely benefitted from JSS payouts, which are expected to decline over the next three quarters.
In the near term, SIA Engineering could benefit from higher line maintenance revenue if SIA adds capacity and we have factored in a 40% y-o-y increase in flights handled at Changi.
From a longer term perspective, SIA’s grounding of older aircraft is likely to result in lower airframe repair revenue and engine checks related revenue. This is because older aircraft require more extensive checks, reflecting the longer flight cycles.

The q-o-q improvement in SIA Engineering’s JV and associate earnings, which are mainly engine maintenance related, should lead to a similar improvement in ST Engineering’s component and engine aircraft maintenance earnings.
Meanwhile in the US, Honeywell International reported better-than-expected 2Q21 results with aerospace revenue rising 9% y-o-y. The commercial aerospace aftermarket or maintenance, repair and overhaul (MRO) segment was said to up double-digits sequentially.
Honeywell has also partnered with ST Engineering since 2019, with ST Engineering using Honeywell’s avionics and other software services for Airbus and Boeing MRO. Thus, we are optimistic that ST Engineering’s commercial aerospace earnings are likely to show significant sequential improvement for the Jun 21 quarter. The company is also likely to guide for continued strength in that segment.

Maintain BUY on ST Engineering with a target price of S$4.26.
Upgrade SIA Engineering to HOLD with a target price of S$2.25 (previously S$2.00).
See
We think the worst is over for SIA Engineering, but the road to recovery is likely to be rocky and current valuations are likely pegged to FY23 or FY24’s levels. We raise our DCF-based target price (including dividends from associates) to S$2.25 from S$2.00. At our target price of S$2.25, SIA Engineering will be trading at 21.7x FY24E’s earnings.

K Ajith UOB Kay Hian Research | https://research.uobkayhian.com/ 2021-07-27

SGX Stock Analyst Report HOLD UPGRADE SELL 2.25 UP 2.000

BUY MAINTAIN BUY 4.260 SAME 4.260