• SIA Engineering’s 1HFY21’s loss was below street expectations, even after excluding the S$35.2m in impairment loss. We believe that SIA Engineering is facing structural challenges, which have been heightened by the COVID-19 pandemic.
• We are now less convinced of its ability to make a turnaround post-COVID-19, and believe that SIA Engineering's share price is likely to head towards book value if earnings do not recover in FY22.
• Downgrade SIA Engineering to SELL.

SIA Engineering's 1HFY20 Results

• SIA Engineering (SGX:S59)'s 1HFY20 earnings vastly below street’s full-year estimates of S$48.6m even after excluding S$35.2m in impairment charges. Excluding the Jobs Support Scheme (JSS) payout of S$95.6m, the group would have recorded a loss of S$114.6m or a S$202.5m decline from 1HFY20.
• The impairment charge was related to the future cash generating potential of base maintenance assets, as SIA Engineering believes that some of its older parked assets might not return to service. The quantum was higher than our initial estimate of S$18m, and the firm warned that it could provide further impairments.
• Excluding the impact of JSS, staff cost declined by 27.9% y-o-y. SIA Engineering instituted compulsory no-pay leave and reduced contract staff by more than 1,000. SIA Engineering did not provide detailed quarterly numbers, but 2QFY21’s operating loss was 116% higher q-o-q even after factoring in similar JSS payouts.
• Operating cash flow before working capital changes fell 69.5% to S$21.2m, despite SIA Engineering having received the bulk of JSS payouts for the period.

Airframe and Line Maintenance Most Affected

• While arrivals at Changi Airport fell 86% y-o-y in 1HFY21, airframe and line maintenance earnings dropped by a significantly lower quantum. We believe SIA Engineering could have benefitted from the conversion of pax aircraft to cargo carrier in 1HFY20, and that might not be repeated in 2H. As such, we expect revenue from the segment to be flat at best in 2HFY20, even factoring higher flight arrivals at Changi Airport.
• It is worth noting that even with the S$95.7m in JSS payouts and additional cuts in subcontract and staff costs, the division swung to a S$25.1m loss vs a S$39.4m profit.

SIA Engineering Highly Dependent on JV and Associates

• While SIA Engineering recorded group revenue of S$223m, the non-equity portion of revenue amounted to 90% of theoretical revenue. While JV and associates’ revenue declined by a smaller quantum, net margins are razor thin at just 1.4%.
• We believe that the entities would have also received an even greater quantum of JSS, and there is a possibility that the division could swing into a loss as JSS is withdrawn in 2HFY22.
• SIA Engineering is also not optimistic of a recovery in engine checks from Eagle Services, given that most of the Pratt & Whitney engines are used on older aircraft, which might now come into service post-COVID-19.

Impairment Write-down Indicative of Bleak Prospects

• Even prior to COVID-19, SIA Engineering struggled to make its main airframe business profitable. SIA Engineering recently announced the acquisition of the remaining 35% stake in its Philippines’ heavy airframe business for US$7.7m. However, the unit has not made a material difference to earnings since 2008.
• SIA Engineering’s fortunes are also dependent on Singapore Airlines (SGX:C6L)’s own recovery, which remains uncertain. JV associates’ thin margin, coupled with exposure to a mature engine type that is unlikely to return to service, do not lend much confidence to its longer-term outlook.

Downgrade SIA Engineering to SELL

• We cut our SIA Engineering's FY21 earnings estimate from a S$7m loss to S$36.9m, factoring in 1HFY21’s impairment loss. We have also lowered our FY22 earnings forecast by S$67m, after factoring in lower associate earnings and slower rate of recovery.
• We continue to value SIA Engineering on a DCF basis factoring in dividends from associates, but our fair value is reduced to reflect lowered cash flow. At our fair value, SIA Engineering would be trading at 1.1x FY21F book value.

Source: UOB Kay Hian Research - 5 Nov 2020