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Muted results continue into 3QFY15

• 3QFY15 results disappoint
  
• Decline in aircraft checks to continue
  
• Unchanged FV; maintain SELL
  

3QFY15 results below expectations

SIA Engineering Company’s (SIAEC) weak performance continues as it reported a 23.5% YoY drop in its 3QFY15 PATMI to S$46.3m. The lower PATMI is mainly due to a 6.5% decline in its 3QFY15 revenue to S$265.3m as well as a 33.2% decrease in share of profits from associated and JV companies to S$25.3m. Similar to the trends seen in 1HFY15, SIAEC’s 3QFY15 saw lower revenue from its airframe and component overhaul services (ACS) segment on lower heavy checks though mitigated by higher fleet management programme (FMP) and line maintenance (LM) revenue. The plunge in share of profits from associated and JV companies came mainly from the engine repair and overhaul centres as 3QFY15 contributions fell 54.9% YoY to S$15.6m on lower in engine shop visits as engines’ check intervals are deferred with improvement modifications. SIAEC’s 9MFY15 PATMI were below expectations with a 29.2% drop to S$141.9m, as it formed 70.8% and 71.8% of consensus and our FY15F forecasts, respectively.

Outlook remains challenging for next 12 months

We expect the issue of deferred aircraft checks to have negative impact on SIAEC’s ACS revenue for the next 12 months. While FMP and LM revenue is likely to continue to show improvements, the higher subcontract costs will negate partially the increase in revenue. Efforts put in to manage costs through productivity and operating efficiencies is starting to bear fruit as SIAEC’s operating margin improved 3.6ppt QoQ to 9.2% in 3QFY15 and recorded a 9.5% reduction in staff costs. However, we believe there is a limit to which SIAEC can achieve through such cost management and we think the savings is unable to offset much of the decline in revenue in the near-term.

Unchanged FV; maintain SELL

Hence, given the disappointing results and still-muted outlook, we decrease our FY15F and FY16F PATMI forecasts by 3.8% and 8.9%, respectively. Rolling forward our valuations, our FV estimate remains unchanged at S$3.80 based on 20x FY16F PER (0.25 SD above 3-year historical average). Maintain SELL.

Muted results continue into 3QFY15

• 3QFY15 results disappoint
  
• Decline in aircraft checks to continue
  
• Unchanged FV; maintain SELL
  

3QFY15 results below expectations

SIA Engineering Company’s (SIAEC) weak performance continues as it reported a 23.5% YoY drop in its 3QFY15 PATMI to S$46.3m. The lower PATMI is mainly due to a 6.5% decline in its 3QFY15 revenue to S$265.3m as well as a 33.2% decrease in share of profits from associated and JV companies to S$25.3m. Similar to the trends seen in 1HFY15, SIAEC’s 3QFY15 saw lower revenue from its airframe and component overhaul services (ACS) segment on lower heavy checks though mitigated by higher fleet management programme (FMP) and line maintenance (LM) revenue. The plunge in share of profits from associated and JV companies came mainly from the engine repair and overhaul centres as 3QFY15 contributions fell 54.9% YoY to S$15.6m on lower in engine shop visits as engines’ check intervals are deferred with improvement modifications. SIAEC’s 9MFY15 PATMI were below expectations with a 29.2% drop to S$141.9m, as it formed 70.8% and 71.8% of consensus and our FY15F forecasts, respectively.

Outlook remains challenging for next 12 months

We expect the issue of deferred aircraft checks to have negative impact on SIAEC’s ACS revenue for the next 12 months. While FMP and LM revenue is likely to continue to show improvements, the higher subcontract costs will negate partially the increase in revenue. Efforts put in to manage costs through productivity and operating efficiencies is starting to bear fruit as SIAEC’s operating margin improved 3.6ppt QoQ to 9.2% in 3QFY15 and recorded a 9.5% reduction in staff costs. However, we believe there is a limit to which SIAEC can achieve through such cost management and we think the savings is unable to offset much of the decline in revenue in the near-term.

Unchanged FV; maintain SELL

Hence, given the disappointing results and still-muted outlook, we decrease our FY15F and FY16F PATMI forecasts by 3.8% and 8.9%, respectively. Rolling forward our valuations, our FV estimate remains unchanged at S$3.80 based on 20x FY16F PER (0.25 SD above 3-year historical average). Maintain SELL.

Navigating through turbulence

• 2QFY15 earnings disappoint, down 41% y-o-y
  
• Affected by deferments/cancellations of heavy aircraft checks, extension of engine check intervals
  
• Cut FY15/16F earnings by 23%/11% to factor in lower workload, margins
  
• Dividend cut also likely in FY15; downgrade to FULLY VALUED with lower TP of S$3.80
  

Worst quarterly showing in a long time. 2QFY15 net profit of S$42.1m was down 41% y-o-y and 21% q-o-q. Revenue dropped by 3%, dragged down by lower heavy maintenance revenue. The weaker capacity utilisation resulted in poor operating margin of 5.6% (vs. 7.0% in 1QFY15 and an average of 9.8% achieved in FY14). Growth in fleet management revenue resulted in high subcontract costs as well. Share of profits from associates and JVs also dropped sharply to S$29m (- 36% y-o-y) as the engine MRO centres underperformed. We had highlighted the weakness at SIE’s engine centres earlier as older engine models are being retired on an accelerated

basis and newer models require less engine shop visits, thus lowering utilisation rates and profitability.

Challenges expected to persist in near term. Management indicated that operating environment continues to be challenging in the near term as airlines may continue to extend maintenance cycles for airframes and engines in consultation with OEMs and relevant regulatory authorities. While pent up demand will come back eventually and longer term fundamentals remain intact for the MRO industry, timing of recovery remains uncertain. Meanwhile, pressure on margins continues, with rising business costs and intense competition. SIE has recently entered into a proposed JV with Boeing (49:51) to provide fleet management services to Boeing customers in South Asia Pacific region. This and other collaborations with strategic OEM partners should drive long term growth prospects for SIE.

Lower yield prospects. We cut our FY14/15F earnings by 23%/11% to factor in the challenges described above. Likewise, we lower FY15 dividend expectation to 16Scts (vs. 25Scts in FY14), including the 6Scts interim dividend already announced. Hence, current valuations are unattractive with SIE trading at 26x PE and 3.6% yield. Hence, we downgrade the stock to Fully Valued with a lower TP of S$3.80 (details inside).

2QFY15 results below expectations

• 2QFY15 PATMI plunged 40.7% YoY
  
• More aircraft checks deferred
  
• Downgrade to SELL
  

Disappointing 2QFY15 results

SIA Engineering Company’s (SIAEC) reported a 3.0% YoY decline in its 2QFY15 revenue to S$285.2m and a 40.7% drop in PATMI to S$42.1m. Its 1HFY15 results were below expectation as its revenue and PATMI formed 47.8% and 34.5% of our FY15 forecasts. SIAEC’s 1HFY15 revenue decreased 0.7% to S$579.3m, due to lower airframe and component overhaul services (ACS) revenue from fewer aircraft checks, partly offset by the higher fleet management programme (FMP) revenue. Its 1HFY15 PATMI declined 31.7% to S$95.6m, on higher subcontract costs and a 36.2% YoY drop in share of profits from associated and JV companies to S$29.1m. SIAEC’s key JV, SAESL (services Rolls-Royce engines) experienced a 30% reduction in works on engine cowls due to improvement modifications that reduced engine shop visits. Its main associate, Eagle Services Asia, also saw reduction in earnings as Pratt & Whitney engines are near the end of life-cycle.

Longer interval between checks

We think SIAEC is going through the cyclical period where customers deferring aircraft checks (i.e. increase interval between checks). The number of ‘C’ checks declined from 37 in 1HFY14 to 34 in 1HFY15 and more significantly for ‘D’ checks, the number dropped from 23 in 1HFY14 to 10 in 1HFY15. The number of ‘A’ checks remained resilient at 192 in 1HFY15 compared to 193 in 1HFY14. Note that ‘D’ checks has the most impact with an estimated revenue of S$3m-S$6m per check. With lower revenue from ACS and high staff costs, SIAEC reported an S$7.4m operating loss for its ACS segment. We expect SIAEC to face this situation for at least the next 12 months, until which, the demand for checks from customers should pick up gradually as their extended interval runs out.

Lower FV; Downgrade to SELL

With disappointing results, expected depressed earnings for the next 12 months, and change in analyst coverage, we cut our FY15 and FY16 PATMI by 28.7% and 18.1% respectively. Hence, we lower our FV from S$4.71 to S$3.80 based on 19.0x blended FY15/16F PER, and downgrade to it SELL.