• Secular growth in aerospace where commercial aircraft orders have a 10-year backlog.
• Turnaround to record profits under new management. Earnings in the past 12 months rose 9-fold.
• Initiate coverage with a BUY recommendation and target price of S$0.20. Our valuation is based on 10x PE FY19e. This is a discount to global aerospace parts supply chain valuations. We believe the discount will narrow on the back of the future scale and consistent profitability.

Company Background

JEP was listed on the SGX as Alantac Technology in 2004. It initially specialised in semiconductor and hard disk drive parts. In 2007, Alantac made a major acquisition of JEP Precision Engineering (JEPS) to venture into precision parts for the aerospace and oil and gas industries. The combined entity was renamed JEP in 2010. In January 2018, SGX-listed UMS Holdings acquired a 29.5% stake in JEP. New management was installed after Mr Andy Luong was appointed as the Executive Chairman in February 2018. Eighteen months later, UMS Holdings launched a mandatory conditional cash offer at S$0.15 per share. Its offer lapsed as the level of acceptances did not cross 50% of the voting shares.

Investment Merits

1. Secular growth of the aerospace industry. Aerospace accounts for 54% of revenue. JEP has been building a track-record in precision machining parts for the aerospace industry. Global backlog for aircraft deliveries has risen to around 10 years. There is a global search for capacity.

2. Turnaround under new management. After UMS took over management of the company in middle 2018, JEP has turned around and booked record earnings in the past 12 months. Initiatives taken include right-sizing its workforce, transferring labour intensive work to lower-cost Malaysia and contract price renegotiations. Earnings in the past 12 months rose 9-fold.

3. Attractive entry point. We believe the valuations are attractive. Sector peers trade at an average of 20x forward PE. Our target price factored in a 50% discount for JEP’s smaller scale of operations.

Outlook

JEP’s growth is expected to stem from, firstly, resilient demand for commercial aircraft. Global passenger air travel is rising the fastest in decades. According to Airbus, aircraft demand is expected to sustain at a growth rate of 4.4% CAGR from 2018 to 2037. Low penetration of air travel in emerging economies and a booming middle-class are some of the triggers of growth. Commercial aircraft deliveries currently have a 10-year backlog of orders; Secondly, we expect further cost optimisation efforts from JEP’s transfer of more projects to lower-cost Malaysia. Thirdly, we are expecting JEP to gain more traction with existing and new customers. JEP in improving its execution and track record which will elevate their supplier status. The current trade spat between the U.S. and China is another likely opportunity to move more aircraft components manufacturing into Southeast Asia.

Initiating coverage with a BUY rating and target price of S$0.20.

We initiate coverage of JEP with a BUY rating and target price of S$0.20. Our target price is based on 10x PE FY19e, a 50% discount to the industry’s 20x in view of JEPs smaller size. We expect its discount to narrow with future scale and consistent profitability. 

History

History of JEP dates back to 1994, under the name Atlantac Engineering Works. The focus of the company was precision machining parts for hard disk and semiconductor industry. Atlantac was listed in September 2004 on the SGX. In 2007, Alantac made a major acquisition of JEP Precision Engineering (JEPS) to venture into the manufacturing of precision parts in the aerospace and oil and gas industries. Management of JEPS effectively took control of Alantac and the company renamed in 2010. In January 2018, UMS Holdings acquired a 29.5% stake in JEP. New management was installed after Mr Andy Luong was appointed as the Executive Chairman in February 2018. Almost 18 months later, UMS Holdings launched a mandatory conditional cash offer at S$0.15 per share. The offer lapsed as the acceptances did not cross 50% of the voting shares.

Milestones

Source: Company, PSR

Revenue

Revenue for JEP has doubled over the last five years. The major driver to earnings has been aerospace, from 60% to 70% of sales (excluding trading). Trading as a contributor to revenues surged post-acquisition of JEP Industrade. The weakest division has been oil and gas with revenue collapsing almost 90%.

In terms of products for aerospace, the main components are engine casing (CFM), landing gear, air and management system. We are forecasting mid-single-digit revenue growth as we expect management focus to be on growing margins.

Some of JEP customers include:

1. Aerospace: Safran (landing gear), Collins Aerospace (air management) and Singapore Aerospace Manufacturing (engine casing).
2. Oil and gas: Aker
3. Large format printing: HP
4. Semiconductor: Kulicke & Soffa (wire bonders), VAT Semiconductor

Margins

JEP was hardly profitable in the past 4 years (2014 -2017). Gross margins of 11% or S$8mn to $10mn per annum could not cover the huge annual operating cost of S$10 to S$11mn.

We saw the turnaround in 2H18 when gross margins surged to around 19%. The highest on record. Operating expenses also registered a S$2mn decline. There were S$1.5mn exceptional administrative expenses in FY17 from the relocation cost plus rental expenses on the old unoccupied factory premise.

There are several reasons for the higher margins:

1. Rightsizing of the workforce. Headcount at JEP has declined from 374 in 2017 to less than 298 currently. Employee cost is around 21% of sales.
2. Move labour intensive work to lower-cost operations in Penang, Malaysia.
3. Renegotiate pricing of low margin products.
4. Moving from being a Tier 2 to Tier 1 supplier.
5. Discard loss-making contracts.

Cash-flow

Operating cash-flow has been positive the past five years totalling around S$13mn. The bulk of the improvement in cash-flows was 2018 positive operating cash-flows of S$10mn.

The bulk of the cash-flow has been spent on capital expenditure in particular in 2016/17. Past five years, capex was a cumulative outflow of S$37mn.  The capex has been funded 2/3 by loans and 1/3 from new issuance of shares

Balance Sheet

Assets: Total assets grew over the past five years by around S$40mn. The jump was from a rise in fixed assets (S$24mn) and trade debtors ($11mn). Fixed assets expanded significantly in 2016 following the acquisition of the new plant. A rise in trade debtors is in-line with the improvement of revenue, especially with the acquisition of the trading business

Liabilities: Bulk of the liabilities are in loans (60%) and trade payables (20%). Loans more than doubled in 2016 to S$36mn in order to fund the expansion into the new factory.

Industry

The basic supply chain of aerospace industry can be divided into:

Aircraft manufacturers:

Boeing, Airbus, Bombardier, Embraer, Textron

Engine makers:

Engines are the typical razor and razorblade business model where higher margins are in the engine spares and services. Manufacturers can sell engines even at a loss. Some leakages occur when non-OEM parts are used.

• General Electric: Under GE Aviation, it is a major aircraft engine supplier. It formed a JV with Safran to create CFM International focused on mid-sized engines. CFM has produced successful series of engines such as the CFM56 and recently the CFM LEAP engine. GE Aviation is also producing the GEnx engine for widebody planes.
• Safran: A french company, formerly known as Snecma, Safran is the JV partner of GE in CFM International. Safran other businesses include aerospace propulsion (civil, military, helicopter, space) and aircraft equipment (landing gear, brakes, nacelles, control systems).
• Rolls-Royce: Key engine in civil aviation is the Trent series. A key product is the Trent XWB for the widebody Airbus A350 (Figure 6). Trent 1000 for Boeing 787 has been facing delays (till 2Q20) due to issues with the turbine blades.
• United Technologies: Owns Pratt and Whitney (PW), the OEM engine market. PW has been more focused on engines for the narrow-body planes. The latest generation of engines is the Geared Turbofan (GTF) series. The PW1100G is powering the A320/A321.
• MTU Aero Engines: Is a german aircraft engine manufacturer. PW and MTU partnered to deliver the general turbofan (GTF) engine. GTF is used in A220 and A320. It is also a leading independent maintenance, repair, overhaul and spares provider.

As per Figure 7, the highest volume engine for narrowbody aircraft will be CFM Leap. CFM is a joint venture between GE Aviation and Safran.

Component makers

United States:

• TransDigm: Large part of earnings is from the aftermarket. Products include actuation systems, audio systems, gear pumps, ignition systems, connectors and latches, latching and locking devices, cockpit security devices, etc.
• Honeywell: aerospace is approximately 40% of sales. It includes avionics, auxiliary power unit, airframe assemblies, navigation and flight management
• Parker-Hannifin: aerospace is around 20% of sales and products include fuel systems, flight and vibration controls, sensors, actuation, fuel systems, wheels and brakes
• Spirit AeroSystems: a spin-off from Boeing. The company manufactures fuselages (50% of sales), propulsion systems and aeroplane wings.
• Hexcel: provides advanced composite materials for the commercial aerospace industry.

Europe:

• Meggitt (UK): aircraft thermal systems, sensors, engine valves, brakes.
• Senior (UK): aircraft component manufacturer and assembler – engine parts (casing, gas turbine, latches, brackets, etc), landing gear, aircraft frames and fluid conveyance. Other parts of the business include automobile and oil and gas components.
• Thales (France): In-flight entertainment and connectivity.
• Cobham (UK): oxygen systems, refuelling equipment, communication systems and safety and survival mission systems

Taiwan:

• Aerospace Industrial Development Corp (AIDC): Taiwan’s largest aerospace contract manufacturer. Product into military and commercial aircraft and engine components.
• Magnate Technology: manufacture aircraft parts such as engine casing, landing gear, heat exchange, actuator, etc. A subcontractor for AIDC.
• Aero Win Technology: Manufacture engine component for customers including Safran, Pratt & Whitney, MTU Aero.

Japan 3 Heavies:

• Mitsubishi Heavy Industries: aircraft components for Boeing and Bombardier (main wings, fuselage, entry doors)
• Fuji Heavy Industries (Subaru Corp): centre wing box, integrate the wings with the landing gear for Boeing
• Kawasaki Heavy Industries: forward/midsection of fuselage, main landing gear well, wing trailing edge.

Korea:

Hanwha Aerospace: Aircraft and military engine; land-based weapon vehicles, security cameras and surveillance equipment and air/gas compressors.

There has been a spate of consolidation in the aerospace industry such as Safran acquiring Zodiac and United Tech purchasing Rockwell Collins.

Outlook

We are positive on the outlook for JEP. From the macro perspective, global air travel is expanding the fastest in decades. Some of the factors contributing to air travel are the growth of low-cost airlines and rising middle class and low penetration of air travel, especially in emerging markets. As per Figure 8, 2008-18 has been the fastest growth for air travel in decades.

Specific to JEP, earnings growth will come from improvement in vendor tier, shifting of production to Malaysia and securing new customers.

Investment Merits

1. Secular growth of the aerospace industry. Aerospace accounts for 54% of revenue. JEP has been building a track-record in precision machining parts for the aerospace industry. Global backlog for aircraft deliveries has risen to around 10 years (Figure 10 and 11). There is a global search for capacity.
2. Turnaround under new management. After UMS took over management of the company in mid-2018, JEP has turned around and booked record earnings in the past 12 months. Initiatives taken include right-sizing its workforce, transferring labour intensive work to lower-cost Malaysia and contract price renegotiations. Earnings in the past 12 months rose 9-fold*.
3. Attractive entry point. We believe the valuations are attractive. Sector peers trade at around 20x PE. Our target price factors in a discount for its smaller scale of operations.

*Based 12 mth rolling profit, Jun 18 against Jun 19.

Valuation

We initiate coverage with a BUY recommendation and target price of S$0.20. Our target price is based on 10x PE, a 50% discount to the industry’s 20x in view of JEPs smaller operations. We expect its discount to narrow with future scale and consistent profitability. 

*Our target price exclude 12.8mn (3.1% of total shares) outstanding warrant dilution, warrants will expire 22 Dec 19.

Source: Phillip Capital Research - 18 Oct 2019

JEP Holdings Ltd – Taking Off Under New Management

JEP Holdings Ltd – Taking Off Under New Management

SINGAPORE Press Holdings (SPH) will cut 5 per cent of staff from its media group, it said on Thursday, as the company posted a 23.4 per cent decline in net profit for the full year ended Aug 31.

KEPPEL Corp's third-quarter net profit fell 30 per cent to S$159 million from a restated S$227 million a year ago, led by the absence of gains from divestment of a commercial development in Beijing and higher net interest expense.

SINGAPORE regulators are poised to award four 5G telecom licences, two more than previously planned, as Minister for Communications and Information S Iswaran called for bids for the high-tech new spectrum on Thursday.

The leading American maker of electronic cigarettes, Juul Labs, announced on Thursday it is suspending sales of some flavoured vaping products in the United States, as the US government prepares a nationwide ban.

CapitaLand, Razer clinch first enterprise 5G grants by non-telcos

Source: SGX Masnet, The Business Times, Bloomberg, Channel NewsAsia, Reuters, PSR

• FTSE S-REIT index return gained 1.3% MTD and 25.1% YTD. Strongest gains were from the Industrial sector (+3.7% MTD) and weakest showing at the Healthcare (-0.9% MTD).
• Performance in September: Best – Keppel DC REIT (+13.5%), Worst – MapleTree North Asia Trust (-7.5%)
• Sector yield spread compressed MoM to 245bps, -1.5 standard deviation (s.d.) over the benchmark 10-year SGS (10YSGS) yield.
• 3-month SOR fell 40bps to 1.57% at 16 October 2019 versus 1.75% last month. Elevated P/NAVs expected to persist in the lower interest rate environment.
• Remain NEUTRAL on S-REITs sector. Sub-sector preferences: Office and Hospitality.

SECTOR SNAPSHOT

S-REIT yield spread declined 47bps YTD and 21bps MoM to 245bps as at mid-October, at the -1.5 s.d level. Although still below the -1s.d. level, this is a recovery from the 226bps (-19bps) low in May 2019. The S-REIT dividend yield was 4.14% as at 20 October 2019.

3-month SOR has fallen 40bps YTD to 1.57% while the 10YRSGS yield fell 44bps YTD to 1.68%. The lower interest rate environment is conducive for REIT in terms of lower cost of borrowings which makes acquisitions more accretive. The greater investor appetite for yield instruments has also resulted in the oversubscription of private placements ranging 1.2x to 9.3x, despite high P/NAVs valuations. Since the start of 2019, REITs have raised S$4,074mn (figure 1) through equity fund raising (2018: S$4.3bn), predominantly to finance asset acquisition. Including the S$2,519mn (figure 2) raised through the fixed income markets, a total of S$6,589mn has been raised by REITs in 2019.

Keppel REIT announced the divestment of Bugis Tower for S$547.5mn (contributes 6.6% of NPI), at a 6.3% premium to the latest valuation conducted on 8 August 2019. The proposed divestment comes at the 22-year high of the commercial property market and the sales price translates to an exit yield of 3%.

MapleTree Commercial Trust (MCT) announced the acquisition of MBC Phase II comprising four blocks of  business park space (MBC 50, 60, 70 and 80) which are located adjacent to MCT’s existing MBC I. With a NPI yield of 5%, the acquisition of MBC II will increase AUM by 20% and further entrench MCT’s presence in the Greater Southern Waterfront area.

Coworking operator WeWork and its backers, JPMorgan Chase&Co and SoftBank Group, look to debt markets to rescue the company after failed IPO. JPMorgan’s proposal seeks to raise US$5bn that could include a US$2bn pay-in-kind bonds yielding 15%.

Retail: Retail sales (excluding motor vehicle sales) declined -1.1% YoY in August, on a seasonally adjusted basis. The RSI (excl. MV) growth has been in the red since the start of 2019. July’s figures were dragged down largely by the furniture & household equipment (-9.9%) and the watches & jewellery (-8.4%) sectors. The F&B index was up +2.9% YoY (seasonally adjusted) in August.

Hospitality: The SG hospitality segment was expected to benefit from the tapering room supply coming onto the market (2019-2021 CAGR: 1.5% vs 3-year historical CAGR: 4.4%). However, recovery this was dampened by the absence of biennial events in the first half of 2019 and weaker economic outlook due to the US-China trade uncertainty. Room rates finally showed some strength, increasing 2.8% to 8.5% across the four room tiers.

The hospitality sector was off to a promising start 2H19. August’s visitor arrivals increase 3.1% YoY (July 4.0%). Room rates finally showed some strength, increasing 2.8% to 8.5% across the four room tiers. Average RevPAR improved 4.9% YoY in August, on the back of higher average room rate (ARR) and occupancy. All segments recorded RevPAR growth, with the economy  sector coming in highest at +9.6% and luxury bringing up the rear at +2.1%.

INVESTMENT ACTIONS

Remain NEUTRAL on the S-REITs sector, with selective sub-sector preferences.

Strong rally in prices due to the dovish stance communicated by the FED has resulted in the FTSE S-REIT index return gains of 25.9% YTD. Most of the upside from the lower interest rate stance have been priced in, with many REITs trading at rich valuations (+2 std. dev. P/NAV). The P/NAV is supported by investor’s appetite for yield instruments. The current interest rate environment is conducive for REITs, which have been busy with acquisitions and equity fund raising, as well as terming out loan maturities to lock in the lower interest rates.

Top-down view (unchanged)

We like the Commercial and Hospitality sub-sectors due to tapering supply after the surge in supply in the prior two to three years. We are cautious on the Retail sub-sector as retail sales due to the softer retail outlook as seen by the weaker retail sales index.

Tactical bottom-up view (unchanged)

REITs that can better weather through the rising interest rate environment would be those with:

1) Low gearing; 2) High-interest coverage; 3) Long weighted average debt to maturity; and

4) A high proportion of debt on fixed interest rates

Source: Phillip Capital Research - 17 Oct 2019

Keppel Reit posts Q3 DPU of 1.4 S cents on higher rents, T Tower contribution.

MAINBOARD-LISTED Ellipsiz has expanded its foothold in the semiconductor and electronics industry by acquiring a 51 per cent stake in local engineering solutions firm AXIS-TEC for S$3.6 million, it said on Wednesday.

SOILBUILD Business Space Reit on Wednesday posted third-quarter distribution per unit (DPU) of 0.918 Singapore cent, down 26.3 per cent from 1.245 cents in the same period a year earlier.

MAINBOARD-LISTED integrated fish service provider Qian Hu on Wednesday announced a 72 per cent year-on-year increase in net profit for the third quarter ended Sept 30 on the back of improved margins from the aquaculture business.

CATALIST-LISTED Atlantic Navigation has been queried by its sponsor SAC Capital on its Oct 11 trading activity which saw its shares plunge S$0.035 or 44.9 per cent to S$0.043

Source: SGX Masnet, The Business Times, Bloomberg, Channel NewsAsia, Reuters, PSR

• 3Q19 NPI and DPU were in line with our estimates. 9M DPU formed 74.2% of our FY19 estimates
• Portfolio metrics healthy; occupancy crept up 0.7% ppts and while post-acquisition gearing will settle at 30.3% (historical average 30.7%)
• Maintain ACCUMULATE with a higher target price of $2.06 (previously $2.00). We raise our estimates by 2% to reflect the tightening DC market which will help provide support for rents

The Positives

• Ramp-up in operations was more than able to make up for the income support falling off. The rental support for KDC SG 5, KDC Dub 2 and Milian DC were fully utilised as at 2Q19. Management commented that the ramp-up stabilisation of these assets surpasses the rental support previosuy drawn.
• Portfolio occupancy improved 0.3ppts QoQ from 93.2% to 93.6%. This was due to new leases signed at KDC SG 1 (+0.7ppts) and KDC Dub 1 (+3.9ppts). Post-retrofitting, KDC Dub 2’s occupancy increased 9.3ppts to 100%.
• Refinanced all loans maturing in 2019 with a 6 year term loans. All-in cost of borrowing expected to be unchanged at c.1.7%.

The Negatives

• No improvement in stubborn vacancy rate at Basis Bay DC (Malaysia). Occupancy has remained at 63.1% for the last 10 consecutive quarters.

Outlook

Vacant, non-DC NLA poses potential for conversion to data centre (DCs), making KDC a beneficiary of tapering DC supply in Singapore. Currently, 22,178 sqft of NLA – 6.4% and 15.8% from KDC SG 1 and KDC SG 5 – are non DC space. KDC is in the midst of getting government approval to bring more IT power onsite to convert the space at KDC SG 5 to DC space.

Maintain ACCUMULATE with a higher target price of $2.06 (previously $2.00)

We raise our estimates by 2%  to reflect the strong demand for DCs admist the tightening DC supply. Our TP of $2.06 implies a 3.8%/4.46% FY19e/FY20e DPU yield.

Source: Phillip Capital Research - 16 Oct 2019

The pound rallied on Tuesday to five-month peaks amid optimism over a breakthrough in Brexit talks while Wall Street stocks rebounded following an upbeat start to earnings season.

Oil prices fell on Tuesday, as investors worried that the unrelenting US-China trade war would keep squeezing the global economy, and that swelling US crude inventories would further pressure prices.

Wall Street stocks surged on Tuesday following a batch of mostly good corporate earnings while investors shrugged off a downcast IMF forecast that emphasised the drag from trade wars.

SINGAPORE Press Holdings (SPH) has partnered real estate asset manager Bridge C Capital to set up a fund focused on investing in aged care and healthcare assets in Japan.

HIGHER contribution from its assets - VivoCity, Mapletree Business City (MBC) I, PSA Building and Bank of America Merrill Lynch HarbourFront Mapletree Commercial Trust - boosted Mapletree Commercial Trust's (MCT) second-quarter performance, all except for Mapletree Anson.

KEPPEL Pacific Oak US Reit (KORE), previously known as Keppel-KBS US Reit, on Tuesday posted a third-quarter distribution per unit (DPU) of 1.50 US cents, unchanged from the same period a year earlier.

KEPPEL DC Reit on Tuesday posted a third-quarter distribution per unit (DPU) of 1.93 Singapore cents, up 4.3 per cent from 1.85 cents in the same period a year earlier.

MAINBOARD-listed food and beverage player BreadTalk Group has obtained regulatory approval for its buyout of food operator Food Junction, paving the way for the group to become the third-largest food-court operator in Singapore.

Source: SGX Masnet, The Business Times, Bloomberg, Channel NewsAsia, Reuters, PSR