Tailwinds blowing; maintain Overweight. We remain Overweight Singapore’s aviation services sector. With airlines in the region poised to embark on capacity expansion in 2014, we see a higher volume of workload in store for domestic companies such as SATS (BUY, TP: SGD4.00), SIA Engineering (SIAEC, BUY, TP: SGD6.34) and ST Engineering (STE, HOLD, TP: SGD4.21). Tailwinds from higher air traffic due to ongoing airspace liberalisation efforts are also expected to yield positive outcomes in the long run.

Changi Airport expansion the best leading indicator. Analysis by our regional aviation team suggests that Singapore’s air traffic growth would likely be constrained in the near term due to limited runway capacity (c.31% from 2012 level). However, plans are afoot to build a third runway by 2020 to spur air traffic growth. Changi Airport’s terminal handling capacity would also be doubled by mid-2020. In our view, this unprecedented scale of expansion will fuel structurally higher demand for aviation services and is an investment opportunity not to be missed.

What to look out for in 2014

Issue #1: Impact of rising interest rates. Companies in the aviation services sector are widely considered to be steady dividend plays. We therefore expect the market to keep an eye out for any increase in interest rate. Should rates creep up, dividend yields may become less attractive as sector spreads narrow. While this is overall negative for the sector, we believe individual companies’ ungeared balance sheet would still cast the sector in a favourable light vis-à-vis other leveraged dividend-paying sectors (think REITs, business trusts and telcos).

Issue #2: Ability to raise DPS. We also expect the market to focus on the companies’ ability to raise their DPS. In our view, STE should be able to maintain payout ratio at 90% as in the past four years, though DPS may be flat due to comparable earnings for 2013. As for SATS and SIAEC, both would have the ability to raise DPS and could surprise with higher distributions next May.

Issue #3: Key events for individual stocks. Come 2014, SATS would see the completion of its acquisition of the Singapore Cruise Centre and enjoy maiden contributions from its JV at the Singapore Sports Hub. A resolution to the Sino-Japanese tensions would lift its subsidiary TFK Corp’s sluggish volumes. For SIAEC, the opening of its ninth aircraft hangar and Trent XWB launch are key milestones, while progress on the US Coast Guard tender will be a major catalyst for STE.

SATS is our top pick for 2014. We expect SATS to outperform its peers in 2014, lifted by the positive events mentioned above. This should position the group for growth in the future. For now, the stock trades at a compelling valuation of 14.4x FY15F PER (a 15% discount to the sector average of 17.0x) and offers attractive dividend yields of 5.1-5.8% over the next three years. Reiterate BUY.  

Source: Maybank Kim Eng Research - 16 Dec 2013