SIA Engineering - UOB Kay Hian 2022-11-03: 2QFY23 Results In Line; Recovery Gaining Traction But Cost Pressure Remains

• SIA Engineering’s core net profit continued to improve, reaching S$17.3m in 2QFY23 (1QFY23: S$4.2m). While the business recovery is taking good shape, cost pressure from workforce ramp-up and material prices was slightly higher than our expectations.
• Overall, we expect SIA Engineering’s profitability to increase further in 2HFY23 as business recovery continues. We trim our FY23-25 EPS forecasts by 7.3-9.0% to reflect the higher cost pressure. Maintain BUY recommendation on SIA Engineering with a slightly lower target price of S$2.60.

SIA Engineering (SIAEC)'s 2QFY23 results broadly in line.

• SIA Engineering (SGX:S59)’s 2QFY23 (Jul to Sep 2022) headline net profit rose 53.8% q-o-q (+87.5% y-o-y) to S$19.5m in 2QFY23. 1HFY23 headline net profit of S$32.5m (+29.8% y-o-y) accounted for 35.4% of our full-year forecast. Revenue rose 37.4% y-o-y to S$362.2m, driven by higher line maintenance and base maintenance volume. However, opex rose slightly faster by 38.0% y-o-y, due to:
  1. a ramp-up of its workforce,
  2. reduction in government wage support, and
  3. higher material prices.
• As a result, SIA Engineering ended up with an operating loss of S$10.8m in 1HFY23, though this was more than offset by strong profit contribution from JVs/associates (mainly in the engine and component segment) at S$41.4m (+54.3% y-o-y).
• Core net profit improved for the sixth consecutive quarter. Excluding the government wage support, core net profit has been on a consistent recovery track. After returning into the black in 1QFY23 (at S$4.2m), SIA Engineering’s core net profit continued to widen in 2QFY23, reaching S$17.3m. The recovery trend should continue for the rest of FY23.
• Rock-solid balance sheet. As of end-2QFY23, SIA Engineering had a sizeable net cash balance of S$606m, equivalent to about 24% of its market cap. No dividend was declared for 1HFY23.

Benefitting from the recovery of flight activities at Changi Airport.

• With about 80% share of Changi Airport’s line maintenance business volume, SIA Engineering is a key beneficiary of the rising flight activities at Changi Airport, which is on track to recover to about 80% of the pre-pandemic levels by the end of 2023 (Changi Airport’s estimate). This compares with the current recovery level at 63.7% as of 2QFY23.
• Changi Airport’s projection is largely in line with SIA Engineering’s parent company Singapore Airlines’ estimate, which previously guided a plan for its passenger capacity to recover to 81% by Dec 22. These projections have provided good visibility to SIA Engineering’s business recovery.

Cost pressure adding some drag to profitability recovery.

• The upbeat near-term business recovery aside, management highlighted the increasing risk of recession and that high inflation, which impacts labour cost and material prices, is adding some cost pressure. We note that the cost pressure has led to a flatter-than-expected curve of the profitability recovery for SIA Engineering’s consolidated entities.
• Despite the meaningful service volume recovery during 2QFY23 (flights handled by SIA Engineering rose 23.2% q-o-q to about 63% of the pre-pandemic levels), SIA Engineering was still in a loss-making position at the operating profit level in 2QFY23 (although the loss narrowed q-o-q). We now push back our expectation for operating profit breakeven to sometime between 3Q-4QFY23, from the previously expected 2Q- 3QFY23.
• As the consolidated entities push towards breakeven, SIA Engineering’s group-level core net profit will remain bolstered by the faster profit recovery of engine and component JVs and associates.

SIA Engineering – Earnings forecast revision & recommendation

• We lower our FY23-25 EPS estimates for SIA Engineering by 7.3-9.0% to reflect the higher cost pressure. Maintain BUY with a slightly lower DCF-based target price of S$2.60.
• SIA Engineering is our top pick among the Singapore aviation plays. We like SIA Engineering for:
  1. the good visibility of its business recovery,
  2. its local market leadership (it holds a market share of around 80% of Changi Airport’s line maintenance business volume), and
  3. undemanding valuation - SIA Engineering's Share Price is currently trading at 14.3x FY25 (normalised year) P/E (or 10.7x if ex-net-cash), 2.4 standard deviation below its FY14-19 (pre-COVID-19 years) average P/E of 23.2x.
• Re-rating catalysts for SIA Engineering include:
  • organic earnings recovery and
  • events that can unlock the value of its significant cash pile, including earnings-accretive acquisitions or special dividend payment.
• Key risks for SIA Engineering include:
  • steeper-than-expected cost ramp-up;
  • sector recovery losing steam beyond FY24 (if China does not re-open).