• We think the recent SIA Engineering’s share price surge has already priced in the optimism of a possible take-over by Singapore Airlines (SGX:C6L), which we think may not occur in the near term.
• With Singapore Airlines’s net gearing likely stretched to 73% by end-FY20F, from 28% now, due to aircraft delivery, we see no imminent need for Singapore Airlines to take SIA ENGINEERING (SGX:S59) private.
• Maintain ADD with an unchanged Target Price of S$3.11, still based on DCF valuations.
• SIA Engineering is a yield stock (c.4%) backed by its cash balance.

Too Fast Too Furious

• SIA Engineering’s share price has risen by more than 11% over the past two days on market expectations for Singapore Airlines to take SIA Engineering private. This has been our ongoing wish (refer to our report dated 31 Jul 2018 - SIA Engineering - CGS-CIMB Research 2019-07-31: Cash Rich, Long-term Event-driven Stock).
• SIA Engineering is an event-driven stock, awaiting privatisation by Singapore Airlines, as we find very little reason for SIA Engineering to remain listed. However, our channel checks, coupled with SIA Engineering’s response to SGX on the recent trading irregularity with it being “not aware of any possible explanation”, suggest that this wish may not come true so soon.

SIA Balance Sheet Is Stretched With Impending Aircraft Delivery

• With 28 aircraft due Raymond Yap forecast Singapore Airlines’s net gearing rising from 28% at end-FY3/19 to 73% at end-FY20F, as total borrowings could double to S$12.2bn (FY19: S$6.7bn). Singapore Airlines ended FY3 S$2.1bn. We believe it is better strategy for Singapore Airlinesto conserve cash for now.

SIA Has Enough Issues on Hand

• We think management and time with issues such as
  1. yield pressure long-haul flights,
  2. weakness the cargo business,
  3. competition the Chinese, and
  4. higher oil.
• SIA Engineering has its own issues to deal with, including lower engine and component maintenance, as the industry is being encroached by OEMS in addition to stronger airframe composites (longer interval for heavy checks).

Positive for SIA Engineering’s Share Price and Minimal Earnings Accretion to SIA

• Our Target Price implies 21x CY 21F P/E or 2.2x FY19F P/BV, in line with its 1021x.
• SIA Engineering had a net cash of S$50/19. If a privatisation takes place at our Target Price, it would cost Singapore Airlines S$655m in cash outlay for the deal, after netting interests (22%) portion of SIA Engineering’s cash of S$520m.
• SIA Engineering and its associates/JVs generate 30/70% of their revenue from Singapore Airlines and non Singapore Airlines customers. The consolidation of the MI portion of non-Singapore Airlines earnings to Singapore Airlines could add minimal or 3% to its earnings (before interest costs). We think the risk-reward is not attractive and efforts to privatise can be better channeled elsewhere.

Maintain ADD and Unchanged Target Price of S$3.11

• Given the sharp SIA Engineering’s share price gains, we think optimism of the ‘event-driven’ angle has been priced in. We keep our ADD call still based on DCF (LTG: 0.3%, WACC 8%)
• A sudden slowdown of the economy and aviation industry are downside risks, while stronger-than-expected engine repair from its associates/JVs are upside risks.

Could This be Another Keppel/KTT?

• Maybe not, in our view, even though Singapore Airlines/SIA Engineering and Keppel Corp (SGX:BN4)/Keppel T&T (SGX:K11) have similar shareholding structures, with the parent company holding 80% of their respective subsidiaries. Keppel T&T was privatised at S$1.91 (40% above its last traded price on 26 Sep 18).
• We see more rewards for Keppel Corp to reap from Keppel T&T than Singapore Airlines from SIA Engineering. These include a more efficient allocation of resources and capital within the conglomerate. It also makes asset injection from Keppel T&T into Keppel DC REIT (SGX:AJBU) more seamless with a leaner shareholding structure.

No Difference to SIA Engineering’s Operations

• SIA Engineering has been a key wingman for Singapore Airlines' new generation aircraft expansion plan. SIA Engineering has been facing pressure from OEMs encroaching into third-party territory and the privatisation may not enhance its position.
• Conversely, it may not necessarily change the perception of independence from parent airline group to win new contracts because SIA Engineering has an established track record as a choice engine MRO provider given the long-term tie-ups with Rolls Royce and Pratt & Whitney. Therefore, it makes no difference to SIA Engineering’s operations with or without privatisation, in our view.

Earnings Accretion Minimal to SIA

• SIA Engineering generates about 45% and 79% respectively of non-Singapore Airlines revenue for itself and among the JVs and associates. We use a blended average of 62% to calculate the net non-Singapore Airlines earnings from SIA Engineering to Singapore Airlines. Excluding financing costs, the minority interest portion consolidation could add about S$22m-25m of earnings to Singapore Airlines for the non-Singapore Airlines work, or 3% to Singapore Airlines’s earnings.

Source: CGS-CIMB Research - 5 Jul 2019