Aviation Services

Kim Eng on 20 Aug 2014

• Rich valuations against challenging outlook. Downgrade to Underweight from Overweight. Top SELL is SATS. Switch to HAECO in North Asia.
• Changi Airport’s flight traffic growth slowed to 2.9% YoY in 6M14, weakest since GFC. Workload under pressure.
• Rising cost pressures amid smaller workload to hit near-term profitability. DPS set to decline.

Rich valuations; Downgrade to Underweight
We turn negative on Singapore’s aviation services as the sector could face a “perfect storm” in the coming quarters. Workload is falling at a time of rising cost pressures. Judging from the sector’s rich valuation of 21x P/E (27% premium over 10-year average), we believe the market has not priced in its challenging outlook. Investors seeking exposure to the sector could consider HAECO (BUY, TP HKD100), which is less exposed to issues affecting its Singapore peers.

Smaller workload + cost pressures = EPS decline
Passenger throughput at Changi Airport has been softening throughout the year. Consequently, rising cost pressure has not been matched by a corresponding increase in workload at SATS (1QFY3/15 inflight meals +0.5%, passengers handled +0.8%). This drove its EBITDA margins down to a mere 13.0%, their lowest in at least three years. We expect continued pressure.
Changi Airport’s flight traffic has been expanding faster than passenger throughput, underscoring the region’s overcapacity. Accordingly, we expect airlines to scale back their capacity to fill cabins. Lower aircraft utilisation would translate into lower maintenance requirements and MROs could be hit next. Furthermore, engine shop visits could be chronically fewer with a ramp-up only at end-2016. SIAEC is most exposed to these negatives.
Potential DPS cuts a de-rating catalyst?
We forecast lower YoY DPS. In response to weaker profitability, SATS and SIAEC could cut their interim DPS as early as Oct/Nov 2014, when they report mid-year results. We expect STE to lower its FY14E payout to 75% (FY13: 80%), as it seeks to retain cash abroad (mainly the US) for expansion and to avoid paying withholding tax by repatriating cash to Singapore.