SINGAPORE (Jan 7): UOB KayHian is upgrading SIA Engineering (SIAEC) to “buy” with a target price of $2.70, saying the stock should outperform this year after seeing an excessive 28% slump last year.

SIAEC was a key underperformer in 2018 amid concerns over a deteriorating top-line. While challenges remain, UOB says SIAEC is addressing this by growing its line maintenance business.

SIAEC is banking on growing this business in Japan and the US, where it hopes to add scale by providing higher value-added services such as component manufacturing and installation as well as engine checks. While SIAEC does not expect any material contribution for at least another two years, UOB is encouraged by the fact that SIAEC is taking steps to grow this business.

However, a more immediate stock price catalyst could come in the form of strong JV & associate income, related to engine checks on the Rolls Royce Trent 1000, which should boost 3QFY19’s earnings and beyond.

“We raise our FY19-20 net profit estimates by 10% and 19%,” says UOB analyst K Ajith in a Monday report.

SIAEC’s steep share price decline can be attributed to concerns over a 7% y-o-y decline in 1H19’s revenue and a resulting 51% decline in core operating profit for the same period.

Still, net profit fell by only 1.6% in 2Q19 and rose by 4.2% in 1H19, due to strong earnings contributions from engine JVs.

“Thus, we believe that the selldown is a tad excessive and we believe there is scope for an upward re-rating,” says Ajith.

Various airlines that operate the Boeing B787 aircraft powered by the Trent 1000 engines had issues with corroded turbofan blades and stalled engines. SIAEC’s sister company, Scoot, operates 18 Dreamliners powered by the same engines that had faced similar problems, and this should benefit SIAEC in the form of greater engine checks.

Rolls Royce had also indicated that it will be providing parts for engine overhaul in late 2018 and this should benefit SIAEC as it has an engine JV with Rolls Royce and is a centre of excellence for Trent 1000 engines repairs.

Ajith believes that the JV, SAESL, is likely to provide such repairs on third-party airlines which operate Dreamliners such as ANA, Air New Zealand.

As at 1H19, SIAEC’s JV and associate earnings rose by 42% y-o-y, with the engine repair segment accounting for 67% of the earnings and rising by 90%. For 2H19, UOB had initially estimated a 30% y-o-y rise for the entire JV & associate income.

“We now raise this to 44% for 2HFY19,” says Ajith.

As at 11.34am, shares in SIAEC are trading flat at $2.39.