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Author: simonsg   |   Latest post: Sat, 12 Jun 2021, 10:08 AM

 

SIA Engineering 4QFY20 - Government Wage Support Leads to Earnings Beat; Long Road to Recovery; Downgrade to SELL

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  • SIA Engineering’s 4QFY20’s earnings beat expectations due to the government wage support (GWS).
  • Looking ahead, we believe aircraft utilisation would be on a long and uncertain rate of recovery and MRO spend would take an even longer period to recover as airlines are likely to ground older aircraft.
  • While admittedly late in downgrading the stock, we still believe investors might be underestimating the extent and duration of the downturn.
  • Downgrade to SELL and slash target price to S$1.57.

SIA Engineering 4QFY20 Results

Better-than-expected results, aided by $26.5m government wage support (GWS).

  • SIA Engineering (SGX:S59)’s full-year net profit at S$193.5m was better than our estimate of S$177m and street estimate of S$173m. The earnings beat in the fourth quarter was mainly because of:
    • S$25.6m in wage support, primarily from the job support scheme (JSS) and to a lesser extent from wage credit support, and
    • higher JV and associate income and also due to a tax credit in the quarter.
  • The degree of operating leverage was quite high in 4QFY20, as the decline in operating profit was more than double the rate of the decline in revenue. Excluding the impact of GWS, staff cost would have risen by about 3% y-o-y.
  • SIA Engineering also recognised S$9m in provision for impairment loss for doubtful debts and notables provision for the quarter.
  • SIA Engineering declared a final dividend of 5 S cents, (previously 8 S cents), taking the full-year payout ratio to 46%, the lowest in more than 13 years.

SIA Engineering Warns of Adverse Impact on Operations Due to COVID-19

  • SIA Engineering highlighted that a decline in flight arrivals will have an immediate impact on line maintenance revenue out of Singapore and overseas line maintenance ventures. As for base maintenance or heavy maintenance works, SIA Engineering noted that a reduction in flight hours will extend the maintenance intervals and reduce maintenance check requirements. The same applies to engine maintenance. SIA Engineering noted that line maintenance will be the first to recover if travel picks up, followed by the other two segments.

SIA Engineering Likely to Go Into the Red in FY21

  • We estimate that flight arrivals at Changi will decline by at least 38% in FY21 and base maintenance revenue could decline by a greater quantum. Consequently, we estimate that revenue could decline by 40% in FY21.
  • Given SIA Engineering’s relatively high fixed cost structure, such a steep decline in revenue should lead to an operating loss, despite an estimated $140m in rebates via the JSS. We also believe that the engine JVs and associates could also be in the red, as lower utilisation would lead to lower checks.
  • SIA Engineering also highlighted that the JVs and associates are likely to receive lower JSS and thus we estimate weak contribution from the segment for FY21.

Maintenance and Repair and Overhaul (MRO) Industry Is Facing Its Greatest Challenge Ever

  • We had earlier downgraded ST Engineering on expectation that a full recovery in traffic will likely to take at least 2 years, while a recovery in heavy maintenance and repair work could take longer. The same applies to SIA Engineering but the latter’s operating leverage appears to be higher given that staff costs appear to be relatively sticky.
  • SIA Engineering also has a higher exposure to wide-bodied aircraft that are primarily used on long haul flights. The general expectation is that domestic and short haul travel will recover first before longer haul flights recover. Thus, SIA Engineering’s heavy maintenance shops will likely have a longer road to recovery.
  • SIA Engineering sole saving grace would be its high exposure to line maintenance at Changi but margins are likely to be lower as airlines are likely to seek discounts amid the tough operating environment.

SIA Engineering’s Fortunes Are Also Inevitably Tied to Its Parent

  • SIA Engineering’s fortunes are also inevitably tied to its parent which accounted for about 60% of operating revenue in prior periods and 29% of total revenue including JVs and associates in FY21. Overall, we estimate that FY20’s earnings are unlikely to be surpassed in the next 3 years.

Downgrade to SELL

  • We cut our FY21 earnings estimate from S$186m to a loss of S$7.0m. Our FY22 earnings estimate is also lowered by 61%. The implementation of safe distancing on-board aircraft and the wearing of masks could lead to a slower rate of recovery for airlines and consequently for MRO operators. Downgrade to SELL.
  • We continue to value SIA Engineering on a DDM basis but have slashed our fair value from S$3.13 to S$1.57. We have lowered our terminal growth rate from 1.2% to 0.9%. We also raised our COE assumption from 6.3% to 8.1%, to factor in the uncertain operating environment.
  • At our fair value, SIA Engineering will be trading at 44.0x FY22F PE.

Source: UOB Kay Hian Research - 12 May 2020

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