Dividend play

The final dividend of 18 Scts could be the only positive from SIE’s results and the main reason for holding the stock. FY14’s core net profit was below our expectations (at 94% of our forecast), but in line with consensus (at 98% of consensus FY). Revenue growth was slower than expected at 2.7% compared to our forecast 7%. Higher subcontractor costs were also the reasons for SIE’s 3% yoy dip in earnings. We cut our FY15-17 EPS by 7-10% for slower revenue growth. Our target price (still based on blended valuations of 19x P/E & DCF) is reduced accordingly. Our Hold rating is maintained. Rerating catalysts could come from stronger-than-expected revenue and associates/JV growth.

104% dividend payout

SIE declared a final dividend of 18 Scts, bringing its total dividend to 25 Scts, with a total payout of 104%. This is on the back of its net cash of S$536m (+2% yoy). We believe this is helped by higher dividends repatriated from associates and JVs. This keeps the yield reasonably attractive at about 5%.

Slow revenue growth, higher sub-contractors, associates dominate profits

FY14’s revenue grew by 2.7% to S$1.18bn. Line maintenance grew by 3.5% yoy to S$438m, in line with our expectations. However, airframe MRO and fleet management grew by 2.6% yoy to S$744m vs. our expected S$795m. Operating costs were up 4% yoy to S$1.06bn. Staff costs were kept stable at 43% of total op. costs. However, subcontractor costs grew 22% yoy to S$43m (or 16% of total op. costs), possibly due to more outsourced work. Associates/JV remained the largest contributor at 61% of SIE’s PBT (+2% yoy).

Stable outlook

Management said that the demand for MRO services in Asia has continued to grow, but the aviation industry faces competitive challenges which have exerted pressure on MRO rates. Overall, the performance of the group is expected to remain stable, management said.

Limited near-term upside

SIE is trading close to +1 s.d above its 5-year mean. We see limited catalysts in the near-term given the muted revenue and earnings growth.

Rising labour costs a worry

• 3Q FY14 net profit down 10% y-o-y, misses estimates • Rising labour costs a drag on core operating profits, mitigated partly by higher JV/ assoc contributions
  
• Cut FY14/15 earnings estimates by 4-5%
  
• Dividend potential is key silver lining; maintain HOLD rating with lower TP of S$4.80
  

Highlights

Core operating profit weaker y-o-y. 3Q FY14 net profit fell 10% y-o-y to S$60.5m, dragged down by high operating costs at SIAEC level, largely staff costs and overheads. Operating margin was the weakest in over four years at 8.9%, and significantly below FY13 margin (11.2%). Given that 1H FY14 operating margin was not much stronger either at 9.6%, 9M FY14 net profit edged down 2% to S$200.5m despite flattish revenues.

Higher JV/ associates’ contributions offset weak core profit. Contribution from JV/ associates grew 2.5% y-o-y to S$41m in 3Q FY14, and is up almost 14% in 9M FY14 to account for 59% of Group PBT. The engine MRO centers and other JV/ associates have been posting rising contributions due to the cluster of strategic partnerships that SIE has established in various pockets of the MRO value chain in recent years.

Our View

Rising costs a challenge. Although demand for the Group’s core MRO services should be stable in the near term, margins may be pressured by rising labour costs and inflation at its home base in Singapore. As a result, we cut FY14/15 earnings estimates by 4-5%. Earnings are now forecast to be flat in FY14 and see tepid growth at best in FY15/16.

Recommendation

Special dividend may be only catalyst. SIE should end FY14 with over S$500m cash holding, and there remains the small possibility of a special dividend in addition to our forecast 15Scts final dividend for FY14 (interim: 7 Scts already paid out). But chances are slim given the weak operating performance. Hence, we maintain our HOLD call for SIE and revise down our TP to S$4.80 after adjustments to bring the stock in line with current peer valuation metrics.

3Q14 results a miss

• 3Q14 basic EPS down 11% YoY
  
• Rising costs
  
• Maintain HOLD
  

3Q14 disappointment

SIA Engineering Company’s (SIAEC) 3Q14 results missed ours and the street’s expectations. 9M14 basic EPS of 18.0 S cents formed 70% of ours and the street’s prior FY14 estimates. 3Q14 revenue climbed 2.0% YoY to S$283.8m but operating profit fell 19.2% to S$25.2m due to staff, subcontract and material costs. Share of profits from associated and JV companies expanded by only 2.5% to S$41.0m, representing a contribution of 58.7% of the group’s pre-tax profits. 3Q14 PATMI thus contracted 9.7% to S$60.5m. 3Q14 basic EPS of 5.43 S cents is down 10.7%. 9M14 PATMI and basic EPS are down 1.8% and 2.8% respectively. Foreign exchange movement was less favourable in 3Q14 for SIAEC, with an FX gain of S$0.1m clocked (versus S$1.6m a year ago).

Compressed operating margin 3Q14 salary costs increased 1.5% YoY to S$126.7m. Overheads (depreciation, amortization of intangibles, company accommodation and other operating expenses) jumped 8.1% to S$45.6m Subcontract services rose 6.9% to S$35.7m and material cost expanded by 8.6% to S$50.6m. In sum, expenditure rose 4.7% to S$258.6m. Operating profit margin at 8.9% was significantly lower than the 11.2% a year ago.

Cost pressures

Management sees rising business costs, especially labour costs, as a continuing operational challenge. Management also expects that the group’s business will remain stable despite the uncertainties in the world economy. The company will continue focusing on improving productivity and minimizing costs.

Maintain HOLD

We lower our FY14F basic EPS forecast to 24.2 S cents, 6% lower than our previous estimate of 25.7 S cents. Rolling forward our model to FY15F figures, we reduce our FV from S$5.14 to S$4.77 (based on EPS forecast of 25.1 S cents and a lower peg of 19.0x, versus 20.0x previously). We maintain a HOLD rating on SIAEC and forecast a FY15F dividend yield of 4.6%.

Look beyond the soft quarter

• Weak set of 3QFY3/14 results with net profit sliding 9.7% YoY to SGD60.5m. The results disappointed.
  
• Economic uncertainties and rising business costs notwithstanding, management expressed confidence that group performance would remain stable.
  
• Structural drivers are still intact. Maintain BUY.
  

Disappointing results

SIA Engineering (SIAEC) reported a fairly weak set of 3QFY3/14 results with net profit sliding 9.7% YoY to SGD60.5m. Operating profit shrank 19.2% YoY, weighed down by labour costs, subcontract fees and material expenses. In line with HAECO’s earlier guidance for lower workload at HAESL, dividend contribution from the engine maintenance unit came in lower YoY. SAESL and IECO surprised on the downside, with the weakest earnings contribution in eight quarters at only SGD18.8m. As at end-2013, SIAEC’s net cash position of SGD444m was higher than the SGD425m in the same period the previous year. Despite global economic uncertainties and rising business costs, management expressed confidence that the group’s performance would remain stable.

Structural drivers intact

Although SIAEC’s third-quarter performance came in softer than expected, we believe the structural drivers of the stock are still intact. As a dominant MRO service provider, it is the best proxy to the unprecedented level of expansion at Changi Airport. Its network of associates and joint ventures would also continue to provide a solid stream of earnings and return cash dividends to shareholders. We see the spin-off of its JVs and bumper dividends as potential stock catalysts. SIAEC is one of our key stock picks in the Singapore transportation space. Reiterate BUY and SOTP–based TP of SGD6.34.

Strong Quarter, Associates Outperformed

Maintain BUY, TP: SGD6.34. We remain positive on SIAEC and raised our estimates by 2%-4% over FY14-16, mainly to account for better-than-expected performance from its associates. SIAEC is a key beneficiary of plans to double Changi Airport’s capacity over the next decade and is our top pick in the Singapore Transportation space. We maintain our BUY rating and raised our TP to SGD6.34.

SAESL & IECO continue to shine. The combined earnings from SAESL & IECO increased by 13% YoY for 1HFY03/14 (34% of PBT) due to growing demand for maintenance work with the influx of Trent engines into the region. The outlook for these units is highly visible given the huge aircraft orders for Trent engines (Fleet: 324, Order: 416). These two units will continue to be a key profit driver and account for half of our valuation for the stock.

Contributions from associates beat expectations. We are positively surprised by the strong associate contributions for 1HFY03/14 (+30% YoY, 25% of PBT), lifted by the Line & Component cluster. The Pratt & Whitney related companies, which provides the engine & engine part repair & overhaul services, reversed the decline in earnings over the past year to report higher contributions for 1HFY03/14 (+21% YoY).

Offset soft performance at core Line, Repair & Overhaul business. Performance for the core Line Maintenance, Repair and Overhaul business of the company was fairly soft with operating profits declining 14% YoY for 1HFY03/14, largely due to a 5.5% YoY increase in staff cost. While labour-induced margin pressure persisted, the long-term outlook for this business remains bright, in our view. The plan to double Changi Airport’s capacity over the next decade will increase workloads for MRO companies based in Singapore. As a dominant player in the Line Maintenance market, SIAEC is a direct proxy to this trend. The expansion into the Philippines will increase SIAEC’s competitiveness by tapping into cheaper source of labour.