SIA Engineering Company

[AQ.]

Briefing Report from UOB Kayhian with some interesting bits.

============

Post briefing, we are even more bearish on the company’s prospects for the next two years, due to the changing industry landscape. We believe there is substantial downside risk for the stock, and both earnings and dividends are likely to decline further.

Maintain SELL. Target price lowered by 14% to S$3.00.

WHAT’S NEW
We attended SIAEC’s analysts’ briefing and these are the key takeaways.

■ Management maintained its cautious stance on repair and overhaul business… Most of the discussion centred around the evolution of the repair and overhaul business. New generation aircraft require less maintenance and airlines are breaking up maintenance checks to include line maintenance. For example, A-checks, which are light checks typically performed on a quarterly basis are now broken down into shorter intervals to encompass line maintenance checks as well. Thus there are less labour hours spent on maintenance and this has been the main reason for the 8.8% decline in repair and overhaul revenue for FY15. Notably, most of the decline in operating revenue came from third-parties, suggesting competitive pressure was also a reason.

■ …but expects long-term growth to be underpinned by JVs with OEM. SIAEC believes that OEM could value add by packaging aircraft sales with after-market maintenance services, thus benefitting SIAEC. The JV focuses on B737, B747, B777 and B787 aircraft types, but thus far, SIA is the sole customer. Our view is that it is less imperative for airlines to take up a maintenance package with OEMs and more with independent maintenance providers, the exception being if airlines enter into an operating lease with Boeing.

■ Engine maintenance revenue is likely to decline at least over the next two years. While management did not expressively guide as such, almost half of the engine shop visits in FY15 was Pratt & Whitney’s PW4000 variant, which is used in older aircrafts such as B747, B777-200s and A300’s. These aircrafts are increasingly being phased out and as such, the Pratt & Whitney JV’s contribution is likely to decline over the next 2-3 years. It remains to be seen if the JV will add capabilities for other engine variants in future. Meanwhile, SIAEC’s other engine JV is unlikely to offset the decline as new engine variants will only reach their maintenance cycle in 2-6 years.

■ New wide-bodied hanger at Clark, the Philippines will be operational by August, but likely losses at the onset. Utilisation is likely to be low, given that Cebu Pacific is the anchor customer with just five wide-bodied aircraft in operations. Profitability hinges on the ability to secure third-party airlines.

STOCK IMPACT
■ No longer status quo, earnings are likely to decline over the next two years. We believe consensus will be cutting earnings and the relatively high PE multiples can no longer be justified.

■ Current dividend yield will no longer be representative; we expect dividends to decline 17% in FY16 and a further 8% in FY17. Dividends from associates & JVs are also likely to decline over the next two years.

EARNINGS REVISION/RISK
■ We lower our FY16 and FY17 net profit estimates by 30% and 31% respectively.

VALUATION/RECOMMENDATION
■ Maintain SELL and lower our price target by 14% to S$3.00. We revise our valuation methodology slightly by employing a straight DDM versus an average of DDM and PE previously. At our fair value, SIAEC will still be trading at lofty 23x forward earnings, vs historical mean of 16x.

[csl123]

^^ As per what we discussed 6 months ago:
http://www.valuebuddies.com/thread-3-pos...l#pid99289

Does csl123 or other VBs has any insight on what was impact of SIA woes and on-wing maintenance (which is the JV)?

I think the business fundamentals remains the same and it is unlikely going to change in the mid term. I think the strategies for the company is to
1) Acquire companies using a combination of share swap/debt. The stock is trading at high PEs.
2) Cut its cost structure through a reduction of benefits, staff retrenchment.
3) Improve productivity through business process re-engineering.

I do not think SIA is in trouble, since it is given a life line by low oil prices. I think profit for the next year will be very good, likely to be one of the best in the past ten years.

Hi csl

Actually I am more keen on the Ex-post analysis on whether the on-wing maintenance that we discussed was really hitting their earnings or just unsubstantiated concern.

As discussed in the SIA thread, SIA has been in trouble for the past few years from branding to positioning to TigerAir. Oil price is not something they can control but competitive advantage is. And their moat has more or less been eroded away. Ironically focusing on cost cutting can't build a moat in a service industry

My analysis prior shows that it is one of the concerns, and older engines being phased out is another. You might want to do your own due diligence to validate this point.

As to your second point, I agree to your point but want to point out that profit is still a function of the cost structure. Oil is a major cost component, ~35-40%. On this note, to be provocative, I am going to give a buy call on SIA.

[csl123]

Briefing Report from UOB Kayhian with some interesting bits.

============

Post briefing, we are even more bearish on the company’s prospects for the next two years, due to the changing industry landscape. We believe there is substantial downside risk for the stock, and both earnings and dividends are likely to decline further.

Maintain SELL. Target price lowered by 14% to S$3.00.

WHAT’S NEW
We attended SIAEC’s analysts’ briefing and these are the key takeaways.

■ Management maintained its cautious stance on repair and overhaul business… Most of the discussion centred around the evolution of the repair and overhaul business. New generation aircraft require less maintenance and airlines are breaking up maintenance checks to include line maintenance. For example, A-checks, which are light checks typically performed on a quarterly basis are now broken down into shorter intervals to encompass line maintenance checks as well. Thus there are less labour hours spent on maintenance and this has been the main reason for the 8.8% decline in repair and overhaul revenue for FY15. Notably, most of the decline in operating revenue came from third-parties, suggesting competitive pressure was also a reason.

■ …but expects long-term growth to be underpinned by JVs with OEM. SIAEC believes that OEM could value add by packaging aircraft sales with after-market maintenance services, thus benefitting SIAEC. The JV focuses on B737, B747, B777 and B787 aircraft types, but thus far, SIA is the sole customer. Our view is that it is less imperative for airlines to take up a maintenance package with OEMs and more with independent maintenance providers, the exception being if airlines enter into an operating lease with Boeing.

■ Engine maintenance revenue is likely to decline at least over the next two years. While management did not expressively guide as such, almost half of the engine shop visits in FY15 was Pratt & Whitney’s PW4000 variant, which is used in older aircrafts such as B747, B777-200s and A300’s. These aircrafts are increasingly being phased out and as such, the Pratt & Whitney JV’s contribution is likely to decline over the next 2-3 years. It remains to be seen if the JV will add capabilities for other engine variants in future. Meanwhile, SIAEC’s other engine JV is unlikely to offset the decline as new engine variants will only reach their maintenance cycle in 2-6 years.

■ New wide-bodied hanger at Clark, the Philippines will be operational by August, but likely losses at the onset. Utilisation is likely to be low, given that Cebu Pacific is the anchor customer with just five wide-bodied aircraft in operations. Profitability hinges on the ability to secure third-party airlines.

STOCK IMPACT
■ No longer status quo, earnings are likely to decline over the next two years. We believe consensus will be cutting earnings and the relatively high PE multiples can no longer be justified.

■ Current dividend yield will no longer be representative; we expect dividends to decline 17% in FY16 and a further 8% in FY17. Dividends from associates & JVs are also likely to decline over the next two years.

EARNINGS REVISION/RISK
■ We lower our FY16 and FY17 net profit estimates by 30% and 31% respectively.

VALUATION/RECOMMENDATION
■ Maintain SELL and lower our price target by 14% to S$3.00. We revise our valuation methodology slightly by employing a straight DDM versus an average of DDM and PE previously. At our fair value, SIAEC will still be trading at lofty 23x forward earnings, vs historical mean of 16x.

I think securing customers in Cebu is going to be a long shot. Lufthansa Technik Phillippines is setup in Phillippines since 2000, which means SIAEC is 15 yrs behind a very established competitor. Not to mention, there are many MRO competitors such as (Sepang Aircraft Engineering in Malaysia and GMF Aeroasia in Indonesia).

[specuvestor]

^^ As per what we discussed 6 months ago:
http://www.valuebuddies.com/thread-3-pos...l#pid99289

Does csl123 or other VBs has any insight on what was impact of SIA woes and on-wing maintenance (which is the JV)?

I think the business fundamentals remains the same and it is unlikely going to change in the mid term. I think the strategies for the company is to
1) Acquire companies using a combination of share swap/debt. The stock is trading at high PEs.
2) Cut its cost structure through a reduction of benefits, staff retrenchment.
3) Improve productivity through business process re-engineering.

I do not think SIA is in trouble, since it is given a life line by low oil prices. I think profit for the next year will be very good, likely to be one of the best in the past ten years.

Hi csl

Actually I am more keen on the Ex-post analysis on whether the on-wing maintenance that we discussed was really hitting their earnings or just unsubstantiated concern.

As discussed in the SIA thread, SIA has been in trouble for the past few years from branding to positioning to TigerAir. Oil price is not something they can control but competitive advantage is. And their moat has more or less been eroded away. Ironically focusing on cost cutting can't build a moat in a service industry

My analysis prior shows that it is one of the concerns, and older engines being phased out is another. You might want to do your own due diligence to validate this point.

As to your second point, I agree to your point but want to point out that profit is still a function of the cost structure. Oil is a major cost component, ~35-40%. On this note, to be provocative, I am going to give a buy call on SIA.

Am I right that if on-wing maintenance is an issue it will show on the JV part of the PnL? I'm guessing analysts are lumping everything under MRO problem cause they are not as detailed as VBs .

To be provocative Do you think Cathay or Qantas or even China Eastern will do better than SIA since oil is also a major component? Point I'm trying to say is "find the alpha stock"

[csl123]

^^ As per what we discussed 6 months ago:
http://www.valuebuddies.com/thread-3-pos...l#pid99289

Does csl123 or other VBs has any insight on what was impact of SIA woes and on-wing maintenance (which is the JV)?

I think the business fundamentals remains the same and it is unlikely going to change in the mid term. I think the strategies for the company is to
1) Acquire companies using a combination of share swap/debt. The stock is trading at high PEs.
2) Cut its cost structure through a reduction of benefits, staff retrenchment.
3) Improve productivity through business process re-engineering.

I do not think SIA is in trouble, since it is given a life line by low oil prices. I think profit for the next year will be very good, likely to be one of the best in the past ten years.

Hi csl

Actually I am more keen on the Ex-post analysis on whether the on-wing maintenance that we discussed was really hitting their earnings or just unsubstantiated concern.

As discussed in the SIA thread, SIA has been in trouble for the past few years from branding to positioning to TigerAir. Oil price is not something they can control but competitive advantage is. And their moat has more or less been eroded away. Ironically focusing on cost cutting can't build a moat in a service industry

My analysis prior shows that it is one of the concerns, and older engines being phased out is another. You might want to do your own due diligence to validate this point.

As to your second point, I agree to your point but want to point out that profit is still a function of the cost structure. Oil is a major cost component, ~35-40%. On this note, to be provocative, I am going to give a buy call on SIA.

Am I right that if on-wing maintenance is an issue it will show on the JV part of the PnL? I'm guessing analysts are lumping everything under MRO problem cause they are not as detailed as VBs .

To be provocative Do you think Cathay or Qantas or even China Eastern will do better than SIA since oil is also a major component? Point I'm trying to say is "find the alpha stock"

Generally, all these stocks will be positively affected by low oil prices. I dont think I have sufficient data to find THE alpha stock. But I think airline industry will be the alpha sector in the near future. But there is definitely uncertainty in the long term potential of this sector, as oil disruptions, global pandemic or fleet grounding, will impact the profitability significantly.

If I run SIA's fuel department, I will stop the fuel hedging strategy, and buy as many futures at +10% of current fuel price as possible, and lock in the future cost structure.

[CY09]

Hi Csl,

Your idea sounds fantastic- buy oil at the price of $64-65 in the long run to lock in future cost structure. However, not many airlines will be willing to do it because they do not want to look stupid in the short run should oil prices decrease to $40 in the interim period. This is where employees/mgmt of the company are worried of short term performance than what happens in the long run (what they do in 2015 affects their bonus and it is more impt to keep their job). This is similar to fund managers who are impeded by quarterly performance, which in turn affects the fund's overall performance.

[csl123]

Hi Csl,

Your idea sounds fantastic- buy oil at the price of $64-65 in the long run to lock in future cost structure. However, not many airlines will be willing to do it because they do not want to look stupid in the short run should oil prices decrease to $40 in the interim period. This is where employees/mgmt of the company are worried of short term performance than what happens in the long run (what they do in 2015 affects their bonus and it is more impt to keep their job). This is similar to fund managers who are impeded by quarterly performance, which in turn affects the fund's overall performance.

I understand your point. But what I am driving at is that at 85 dollars for JET A1, the airline can make a "BIG" profit. But is it worth while to be greedy to aim for JET A1 at 65? For certain airlines, maybe. Personally, I don't see the need to scrap the bottom of the barrel. Since at 85, I reckon operating profit will increase by at least S$700 - 1000 M. This will be a good opportunity to use the profits to 1) Reward shareholders, 2) Reward employees (the poor folks at SIA are only having 1mth bonus for the past few years. And still have to put on a smile for their customers), 3) expedite the change of the fleet into the next gen fleet (A350, B787, B777X) which is more fuel efficient (10-15%), lower labour maintenance and longer maintenance intervals (bad news for SIAEC), higher aircraft availability (due to the maintenance nature of the new aircraft, which is done in smaller packages when the aircraft stopovers at the line. Also a lot more possibility of On-Wing Maintenance for the Engines)

<<Moderator: I am sorry if I had too much discussion on SIA in an SIAEC Thread>>

[specuvestor]

If say oil goes to $20-40 what do u guys think will happen to price of plane tickets and fuel surcharge?

If competitors lower their fares and SIA stuck with higher fuel cost, margins will be impacted. Look no further than our supposedly liberalised power sector that their tariff has incredible lag from fuel prices on the downside, supposedly from hedged prices, and which I'm not even sure if there are competitive forces

[csl123]

If say oil goes to $20-40 what do u guys think will happen to price of plane tickets and fuel surcharge?

If competitors lower their fares and SIA stuck with higher fuel cost, margins will be impacted. Look no further than our supposedly liberalised power sector that their tariff has incredible lag from fuel prices on the downside, supposedly from hedged prices, and which I'm not even sure if there are competitive forces

Good point about revenue impact.

So far, I have not seen SIA or other competitors significantly lower their price of the tickets. While logically it seems plausible, the airlines is not lowering prices, even with crude oil dropping from >100 to ~60 USD.

So will there be a drop in fuel surcharge if oil drops to 40USD? Probable. Will the drop be significant? Maybe not, as least in my opinion.

[specuvestor]

There is usually around 3-6 months lag to adjustments:
http://www.straitstimes.com/news/world/m...t-prices-a
http://www.straitstimes.com/news/singapo...s-20150214

I'm not a frequent flyer so need others to guesstimate if this is reasonable historically for Cathay:
http://www.flyertalk.com/forum/cathay-pa...arges.html