DBS Group Research analyst Jason Sum has downgraded SIA Engineering Company (SIAEC) to “hold” as the group’s 2QFY2025 ended Sept 30 results missed his expectations from cost headwinds and supply chain disruptions.
During the 2QFY2025, SIAEC reported a net profit of $35.6 million, 10.1% higher y-o-y and 7.2% higher q-o-q. The quarter’s net profit brought SIAEC’s 1HFY2025 net profit to $68.8 million, which came up to 44% of the consensus estimates and 41% of Sum’s full-year estimates.
“Notably, while the engine and components (E&C) segment saw significantly narrower operating losses (1HFY2025: -$7.1 million, 1HFY24: -$15.4 million), this improvement was largely offset by weaker performance in the base and line maintenance (B&LM) segment,” Sum writes.
“Despite a 9% y-o-y increase in revenue, the B&LM segment suffered margin erosion (-150 basis points y-o-y in 1HFY2025) to 2.4%, likely due to higher labour costs and supply chain bottlenecks that led to idle time and extended check durations, resulting in cost inefficiencies and delayed revenue recognition,” he adds.
The compression in margins for the 1HFY2025 came despite a positive revenue mix, which was “particularly concerning” in Sum’s view. “A greater proportion of base maintenance work was performed on legacy, previous generation aircraft with higher maintenance, repair and overhaul (MRO) content that was supposed to be margin-accretive.”
“Management mentioned that while the labour situation is no longer as tight as in the previous year, broad-based part shortages continue to make planning and coordination difficult, often leading to delays as they wait for parts to arrive,” he explains, adding that the aviation supply chain could remain “stretched” in the next one to two years despite the group’s efforts to overcome these bottlenecks.
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Sum also notes that start-up and development costs, which remain undisclosed, may impede improvements in margins over the medium term and make it more challenging for SIAEC’s core business to return to a “healthy” level of profitability.
In addition, these costs may impact contributions from SIAEC’s associates and joint ventures (JVs). “As key associates/JVs like Eagle Services Asia (ESA) and SAESL expand their capacity over the next few years, they will incur ramp-up costs to reach full operational pace,” Sum points out.
Another downside, in Sum’s view, is SIAEC’s contract renewal with Singapore Airlines C6L (SIA), which will only take place in 2026.
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“To recap, SIAEC renewed its service agreement contract with SIA in 1Q2023 (4QFY2023). While the contract was initially due to conclude in 1Q2025 (4QFY2025), SIA has an option to extend it by another year, which it will likely exercise to control costs, as it did with the previous service agreement renewal in 2019 (a two-year term + option to extend for an additional two years),” Sum notes.
“While there are escalation clauses in the current contract with SIA, SIAEC urgently needs re-pricing given the dramatic escalation in costs over recent years,” he adds. “Thus, we can only expect a potential uplift in rates charged to SIA, which accounted for 50% - 60% of its revenue in FY2024, from FY2027 onwards.”
To this end, Sum has lowered his FY2025/FY2026 earnings estimates by 15% to 20% as he expects to see slower revenue growth for SIAEC. In the same vein, the analyst has lowered his revenue estimates by 3% to 4% for the same period, as well as lower operating margin assumptions.
“We now expect the core business to be barely profitable in FY2025, followed by a modest 1.7% margin in FY2026,” says Sum.
The analyst has also reduced his share of profit estimates from JVs and associates due to supply chain constraints, ongoing cost pressures, and start-up and ramp-up costs.
“While the stock has held up well post-results, the current valuation at 18 times -20 times forward P/E is no longer justified given the dimmer earnings outlook over the next one to two years, especially with risks skewed to the downside,” says Sum.
Sum’s report stands in contrast to his peers at CGS International and OCBC Investment Research, who remained bullish on SIAEC’s prospects.
In addition to the downgrade, the analyst has reduced his target price to $2.50 from $2.80, in line with his lowered earnings estimates.
Shares in SIAEC closed 2 cents lower or 0.82% down at $2.42 on Nov 11.
