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Singapore Aviation Singapore Industrials 1 August 2017 Singapore Aviation Initiation: leveraging on global aircraft additions We highlight the aircraft maintenance, repair and overhaul (MRO) segment as a bright spot within the Asian aviation industry Valuations might look stretched, but we see consolidation among the players in Singapore as a key catalyst for further rerating Royston Tan Initiating on STE (Buy [1]) and SIAEC (Outperform [2]); maintaining (65) 6321 3086 Hold (3) on SATS and Underperform (4) on Singapore Airlines [email protected] Investment case: We initiate on the Singapore Aviation sector with a Key stock calls Positive view, and favour the maintenance, repair and overhaul (MRO) New Prev. players over Singapore Airlines (SIA). With Airbus forecasting the global Singapore Airlines (SIA SP) Rating Underperform Underperform aircraft fleet to almost double over the next 20 years, we expect aviation Target 9.060 9.060 service providers to benefit from increased air/ground traffic and higher Downside q 12.8% volumes of after-market MRO work. Hence, we believe the time is ripe for a SATS (SATS SP) consolidation of Singapore’s MROs, which we flag as a possible catalyst for a Rating Hold Hold further rerating of the MRO segment. Target 5.050 5.050 Upside p 4.6% Catalysts: aircraft growth to drive demand for aviation services. Singapore Technologies Engineering (STE SP) Rating Buy Airbus’ forecast for the global aircraft fleet suggests a supportive Target 4.460 environment for aviation service providers, with services such as ground Upside p 18.3% handling and inflight catering seeing demand rise in step with regional air SIA Engineering (SIE SP) travel. In our view, existing operators that are quick to adapt to new Rating Outperform technologies and recognise the need for production automation should be Target 4.100 Upside p 12.6% in a position to expand their market shares. Source: Daiwa forecasts Income erosion concerns look overplayed. We consider the MRO providers to be long-term beneficiaries of expansion in the global aircraft fleet. Concerns over a possible erosion of maintenance income amid a transition towards new-generation aircraft look overplayed to us, as we think higher spending on advanced-engine MRO would more than offset any decline from traditional heavy airframe MRO. Time is ripe for consolidation. SIA, parent of SIA Engineering (SIAEC; SIE SP, SGD3.64), has announced a strategic review. We think one possible course of action could be the divestment of its 77% stake in SIAEC to STE’s aerospace division. Now could be an opportune time for a merger, given the need to realise cost synergies amid an increasingly competitive MRO landscape, which is weighing on incumbents’ margins. We would expect a merger of Singapore’s MRO heavyweights to capture economies of scale and boost consolidated profits by 41% by 2019. Valuation: We initiate on Singapore Technologies Engineering (STE SP, SGD3.77) with a Buy [1]) and SIAEC an Outperform [2]), with DCF-based TPs of SGD4.46 and SGD4.10, respectively. While both stocks’ valuations look stretched, at more than 1SD above their past-2-year average 12- month forward PERs, we see scope for higher multiples upon a corporate merger. Separately, we maintain our Hold (3) and Underperform (4) ratings on SATS (SATS SP, SGD4.83) and SIA (SIA SP, SGD10.39), respectively. Risks: A key risk to our Positive sector call would be weaker-than-expected MRO demand if airlines were to delay non-essential MRO work. See important disclosures, including any required research certifications, beginning on page 65 Singapore Aviation: 1 August 2017 How do we justify our view? Growth outlook Valuation Earnings revisions Growth outlook Global air transport fleet: 20-year growth Airbus forecasts the global aircraft fleet to expand by 45,000 c.36% over the next decade. In turn, we forecast demand 40,000 for aircraft after-market services will see a CAGR of 3.8% 35,000 22,030 Growth over the next 10 years. Moreover, we believe independent 30,000 MRO providers such as STE and SIAEC which can forge 25,000 strategic partnership with OEMs will be the key 20,000 beneficiaries in an environment of rising demand for air 15,000 travel. While the industry’s bright prospects have attracted 12,870 Replacement 20,500 new entrants and depressed incumbents’ margins, we see 10,000 5,000 the time as ripe for the 2 Singapore MRO heavyweights to 7,630 Stay consolidate their businesses and realise better margins. 0 Beginning 2017 2036E Source: Airbus Valuation Singapore Aviation: EPS CAGR vs. forward PER Valuations do not seem cheap, with all stocks trading Forward PER (x ) 25.5 above their past-2-year average PER multiples. We believe SIA SIAEC has the most earnings potential over the next 3 25.0 SIAEC years, albeit from a low FY17 base. We see STE as having 24.5 the best mix of earnings growth vs. PER, while SIA is likely 24.0 the most over-valued among the 4 stocks on this matrix. 23.5 While valuations might seem stretched relative to the past- 23.0 SATS 2-year average PERs, we believe dividend-paying blue 22.5 chips warrant a premium in today’s yield-compressed 22.0 environment. Besides, there is the possibility of a corporate 21.5 STE merger of STE and SIAEC to form a global third-party 21.0 0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 MRO heavyweight. 3-years earnings CAGR (% ) Source: Boeing Earnings revisions Singapore Aviation: Bloomberg EPS revisions The market has revised down its 3-year forward earnings 5% forecasts for the Singapore Aviation Sector in the YTD. We 0% have all along been more bearish than the street on SIA’s earnings outlook, and broadly in line with the consensus on (5%) SATS’ earnings potential. Meanwhile, YTD the street has (10%) marginally tapered its earnings outlook for both STE and SIAEC. Compared with the consensus, our FY1-3 EPS (15%) forecasts are 0-17% higher, due likely to our more positive (20%) view on the companies’ aerospace divisions. (25%) SIA STE SIAEC SATS FY 1 FY 2 FY 3 Source: Bloomberg 2 Singapore Aviation: 1 August 2017 Sector stocks: key indicators EPS (local curr.) Share Rating Target price (local curr.) FY1 FY2 Company Name Stock code Price New Prev. New Prev. % chg New Prev. % chg New Prev. % chg SATS SATS SP 4.830 Hold Hold 5.050 5.050 0.0% 0.216 0.216 0.0% 0.235 0.235 0.0% SIA Engineering SIE SP 3.640 Outperform 4.100 0.155 0.183 Singapore Airlines SIA SP 10.390 Underperform Underperform 9.060 9.060 0.0% 0.336 0.393 (14.6%) 0.280 0.291 (3.5%) Singapore Technologies Engineering STE SP 3.770 Buy 4.460 0.174 0.190 Source: Bloomberg, Daiwa forecasts 20-year global air passenger growth 20-year global air transport fleet growth 8,000,000,000 45,000 7,000,000,000 40,000 6,000,000,000 35,000 22,030 Growth 5,000,000,000 30,000 4,000,000,000 25,000 3,000,000,000 20,000 15,000 2,000,000,000 12,870 Replacement 10,000 20,500 1,000,000,000 5,000 0 7,630 Stay 0 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2006 2009 2015 2035 2003 2012 1970 Beginning 2017 2036 Source: ICAO, IATA Source: Airbus GMF 2017 Note: Passenger aircraft above 100 seats, freighter aircraft above 10 tonnes 10-year global commercial air transport MRO demand growth 10-year global MRO incremental spending by key geographical (USDbn) regions (USDbn) 120 104 Asia-Pacific (ex-china) 100 China 80 68 Middle East 60 North America Latin America 40 Eastern Europe 20 Africa 0 2016 2026 Western Europe Engine Component Line Airframe Modifications 0 1 2 3 4 5 6 7 8 9 Source: Aviation Week Source: Bloomberg, ICF Singapore aviation: Key operational data and ratios FY 1 FY 1 FY 2 FY 1 FY 1 Net WACC LT-growth FY 1 BBG Share Mkt Cap OPM PER PER Div Yield gearing assumption assumption ROE Company Code price (USD m) (%) (x) (x) (%) (%) (%) (%) (%) SIA SIA SP 10.38 9,180 4.7 30.9 37.1 1.9 Net cash N.A. N.A. 3.0 ST Engineering STE SP 3.77 8,640 8.5 21.6 19.8 4.1 Net cash 7.3 1.0 24.5 SIA Engineering SIE SP 3.64 3,000 8.1 23.5 19.9 3.8 Net cash 7.3 1.0 11.1 SATS SATS SP 4.82 3,970 13.6 22.4 20.5 3.7 Net cash 7.3 1.0 14.9 Source: Bloomberg, Daiwa forecasts Note: ST Engineering OPM is based on its Aerospace division 3 Singapore Aviation: 1 August 2017 Table of contents Singapore Aviation: a tale of two stories ............................................................... 5 Airlines still flying under a cloud of uncertainty; positive on service providers’ underlying fundamentals .....................................................................................................................5 Singapore aviation: service providers likely to outperform; possible M&A driving valuation premiums ...........................................................................................................................5 MRO: both an opportunity and a threat .................................................................. 8 Opportunity from larger aircraft fleet size ...........................................................................8 Threat from shift toward new-generation planes ................................................................9 Increasing OEM after-market participation ....................................................................... 11 Growing the Singapore MRO pie through consolidation ................................................... 12 Initiating on STE with Buy (1), SIAEC with Outperform (2); maintaining Hold (3) for SATS, Underperform (4) for SIA ................................................................................................. 14 Key risks to our Positive sector view ....................................................................16 Demand for air travel weaker than expected ...................................................................
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