Mixed bag

• 1QFYMar14 net profit of S$69m largely in line
  
• Weaker core operating margins offset by stronger contributions from JV/ associates
  
• Trading cum dividend (FY13 final DPS of 15Scts) till 25 July; lacks major catalysts for any further re-rating
  
• Maintain HOLD while revising our TP higher to S$5.10, as we benchmark valuations to listed peers
  

Highlights

Weaker core operating margins. 1QFY14 net profit of S$69m (up 5% q-o-q, down 2% y-o-y) came in largely within expectations, and made up more than 24% of our full-year FY14 earnings estimates. Revenue of S$289.4m showed similar flattish trends – lower 4% y-oy on lower material and fleet management revenue – but core operating margins dipped during the quarter to 9.6%, down from 10.9% in 4Q13 and 11.4% in 1Q13, likely on the back of higher subcontract costs.

Offset by strong performance at JV/assoc level. The performance of the Group’s JV/ associates – largely driven by its engine shops like SAESL and Eagle Asia – picked up strongly in 1Q14, likely helped by a stronger USD as well. Contributions from JV/ associates improved 14% y-o-y to S$45.6m, accounting for close to 58% of Group PBT during the quarter.

Our View

Near term outlook steady but unexciting. We expect sustained demand for the Group’s core MRO businesses in the near term, despite the uncertain macro environment. SIE should continue to benefit from growth in air traffic in the Asia-Pacific region, supporting the relative resilience of Asian carriers. Growth will be driven by its cluster of strategic partnerships that SIE has established in various pockets of the MRO value chain over recent years, but the ramp up will be gradual, as evidenced by the flattish growth in FY13.

Recommendation

Trading at close to +2 S.D. valuations, maintain HOLD. Cash generation continued to be robust in 1Q14 and net cash is now close to S$620m, supporting the Group’s ability to pay steady dividends. However, further growth in dividends is unlikely in FY14 and current valuations look rich at 20x FY14 PE. Given the lack of significant near term catalysts, we maintain HOLD at a revised TP of S$5.10 (adjusting for higher relative valuation pegs).

Customers’ Fleet Development a Positive For JV

60% more aircraft on order to use Trent engines at SIA group. SIA recently announced new aircraft orders and engine selections. Our analysis of the updated fleet and orders for the SIA group shows that there are 60% more aircraft on order that would be utilising the Trent series of engines, implying a huge amount of maintenance work in future for SAESL, a key JV of SIAEC.

Not just about SIA. We would like to debunk a common misconception that SIAEC only benefits from maintenance work for SIA. While SIAEC still derives more than 60% of sales from SIA, non-SIA customers drive more than 70% of sales at its associates and JVs.

Customers’ fleet development bodes well for SAESL. The company in focus for this report, SAESL, services 13 other airline customers outside of the SIA group. Our review of the fleet development for SAESL’s customers points to an increasingly positive outlook. In addition to an existing fleet of 238 Trent-powered aircraft, we estimate that these non-SIA clients have a combined order of 277 aircraft that would be utilising Trent engines in future. In the near term, we expect SAESL to benefit from the fleet development at Air Asia X, MAS, Thai, Garuda, Air NZ and Virgin Atlantic. Aircraft orders at Qatar, Emirates, Etihad and Yemenia would provide longer-term upside.

We expect capacity expansion to keep pace with growing demand. With the positive demand outlook, we believe that SAESL would need to increase its capacity beyond the current 250 engine repairs a year, to meet the growing volume of maintenance work.

Maintain BUY, TP: SGD6.16. We reiterate our positive view on SIA Engineering (SIAEC) and believe that it is time for the market to look deeper and appreciate the hidden value within SAESL, a top-notch franchise in the group. While the market tends to value SIAEC on a PER basis, we argue that SIAEC is not a stock that trades on earnings, but rather, on cashflow. We forecast FCF of SGD224-270m for FY14-16E, which translates to an FCF yield of 4.5-5.4%.

Worth More Than The SOTP Now

Beneficiary of SIA’s constant re-jig of business models. SIA had been trying out various means to restructure its business model over the years, which includes the introduction of Low Cost Carrier units (Scoot & Tiger Airways), aircraft reconfigurations to fit business conditions and orders for new aircraft. In order to cater to growing demand for regional air travel, SIA also recently placed a record aircraft order for SilkAir. Collectively, SIA, SilkAir and Scoot have 143 aircraft on order as compared to their current combined fleet of 127 aircraft, which is a reflection of the future growth in MRO work for SIAEC. On top of this, we believe that SIA Engineering Company (SIAEC) offers excellent exposure to the structural growth in air traffic in the Asia-Pacific region, which would account for 35% of global aircraft deliveries over the next 20yrs. 65% of the group’s pro-forma revenue comes from non-SIA customers.

New angle – unlocking latent value in the JVs. We believe that there is latent value in the JVs held by SIAEC, which could be unlocked with a separate listing. In particular, we are bullish on the outlook for one of its JVs with Rolls Royce, SAESL, which specializes in the repair and overhaul of Trent engines. Our bullish view on the prospects for the JV is backed by the 2,400 Trent engines on Rolls Royce’s order book (vs the 2,200 Trent engines currently in service). For the aircraft on SIA’s order book, 5 A380s (Trent 900), 40 A350s (Trent XWB) and 14 A330s (Trent 700) will be utilizing the Trent series of engines. We believe that SAESL’s future workload could increase even further, if Scoot decides on using the Trent 1000 engines for its new fleet of 20 B787s.

Upgrade to Buy, TP of SGD6.16 based on SOTP. Given the diversity of the underlying businesses, we believe that the stock is best valued using a sum-of-the-parts (SOTP) methodology. While P/E multiples appear rich relative to its historical trading range, we argue that there is hidden value within its business units that are not fully reflected with a P/E valuation method. Our SOTP does not take into account potential upside from a separate spin-off of its JVs. Furthermore, in the current low interest rate environment, we expect stock interest to remain high with its strong track record of dividend distributions. On our forecast, SIAEC offers potential 3yr yield of 4.6-5.0%.

FY13 within expectations

• PATMI climbs 0.4% YoY
  
• EPS is 98% of ours and street’s FY13 est.
  
• Increase FV to S$5.00
  

FY13 as anticipated

SIA Engineering Company’s (SIAEC) FY13 results were in line with ours and the street’s expectations. Revenue decreased 2.0% to S$1,147m, chiefly due to lower fleet management and project revenue. Project revenue refers to the provision of services for the cabin interior reconfiguration of aircraft. Operating profit fell 1.2% to S$128.1m. Share of profits from associated and JV companies increased 1.5% to S$159.2m, representing a contribution of 52.0% of the group’s pre-tax profits. PATMI was up 0.4% to S$270.1m. Basic EPS of 24.51 S cents formed 98% of ours and the street’s FY13 estimates.

Slight improvement in operating margin

Salary costs increased 5.7% to S$498.2m due to wage increases; headcount stayed roughly flat. Increase in staff cost was outweighed by decreases in subcontract services (-19.3% to S$136.7m on the back of lower project costs), material cost (-2.2% to S$214.2m) and overheads (-6.3% to S$169.5m), leading expenditure to fall 2.1% to S$1,019m.

Business likely to remain stable

Management guides that the group’s business is expected to remain stable in the near term while acknowledging that the operating environment remain challenging due to uncertainties regarding the world economy. SIAEC will continue to focus on improving productivity and controlling costs. Management is continuously evaluating potential investment opportunities.

Maintain HOLD

The board is recommending a final ordinary dividend of 15.0 S cents, which will bring total FY13 dividends to 22.0 S cents per share. SIAEC intends to maintain a payout ratio of 85-90%. Increasing our P/E peg from 17.1x to 20.0x and using an EPS forecast of 25.0 S cents for FY14F, we increase our fair value from S$4.38 to S$5.00 and maintain our HOLD rating on SIAEC.

Yield compression

SIE’s share price has outperformed the index by 12% YTD due to investors’ preference for high yield plays. However, with its less-than-spectacular FY3/13 results and dividend yield compression to 4.4%,we see limited upside to the share price.Maintain Neutral.

FY13 net profit is below expectations, at 94% of our forecast and 97% of consensus, because of a revenue shortfall. 4Q net profit accounted for only 23% of our FY13. SIE increased its dividend payout from 85% to 90% with a final DPS of 15 Scts (total DPS: 22 Scts). We cut our FY13-15 EPS by 8% for lower revenue but raise our target price, still based on blended P/E (19x from 15x) and DCF, in view of increased appetite for yield stocks.

Lower revenue, higher staff costs

4Q revenue fell 10% yoy but was stable qoq, taking FY13 revenue to S$1.15bn. FY13 revenue from repair and overhaul fell 5% yoy to S$725m due to lower volume of FMP and project revenue (cabin interior reconfiguration of aircraft). Revenue from line maintenance improved 5% yoy to S$421m, backed by a higher number of flights handled/day (+1% qoq, +5% yoy) in Changi Airport. EBITDA margin dipped 30bp to 14.3% due to higher staff cost, which accounted for 43% of operating costs (previously 40%). EBITDA margin would have been 11.6%, if not for the S$3.6m write-back of debt provisions and S$3.3m forex gain.

Weaker associates

Associates’ profit fell 30% yoy to S$63m while JV profit rose 22% yoy to S$96.2m. This could due to a weaker showing by Eagle Services (services P&W engines) compared to SAESL which services Rolls Royce engines.

Zero growth in earnings

Despite steady growth in flights handled in Changi airport in FY13 with no major capacity cuts among airlines, SIE achieved zero profit growth vs. its historical c.4% p.a. Management expects its performance to be stable in the near term but emphasised that the operating environment remains challenging due to uncertainties in the global economy.