Thursday, September 09, 2010

SIA Engineering – Analysis of Purchase Part 1

This is Part 1 of a 5-part series in my analysis of purchase for SIAEC, and is the most comprehensive analysis I had done so far for my value investing. However, please note that this investment analysis was done with safety of principal in mind, and capital preservation is of utmost importance as I hold value investing concepts close to my heart.

As mentioned in my August 2010 portfolio review, this will be the final comprehensive analysis I will post up, as it involves huge amounts of time, effort and research. Future purchase decisions will be summarized in a more succinct manner for brevity, while keeping the underlying reasons and rationale intact.

Introduction

SIA Engineering Company (SIAEC) is a major provider of aircraft maintenance, repair, and overhaul services in Asia Pacific. The Company has a client base of more than 80 international carriers and aerospace equipment manufacturers. It provides line maintenance services at Singapore Changi Airport for more than 50 international carriers, as well as airframe and component overhaul on some of the most advanced and widely used commercial aircraft in the world.

The company was formed on April 1, 1992 from the engineering division of Singapore Airlines Limited (SIA) and was listed on the Stock Exchange of Singapore on May 12, 2000 (FY 2001). It is still currently 80.1% held by SIA and has a total issued share capital of 1.08 billion shares. It has been a listed entity for 10 years and has historical data for 10 years which can be analyzed through annual reports and corporate announcements/press releases. Information for this research and analysis of purchase report were all obtained from public sources such as industry reports, annual reports as well as published financial statements of publicly-listed competitor companies.

SIAEC also has approvals from 23 national aviation regulatory authorities to provide MRO services for aircraft registered in the U.S., Europe and Japan, among others.

Disclaimer: The author accepts no liability or responsibility for the accuracy and reliability of the information contained herein; so please do your own reading and research to obtain the facts and figures which you require to verify details within this report.

This analysis of SIAEC is pretty detailed and will therefore be broken up into five (5) parts, as follows:-

Part 1 – Introduction and Financial Analysis (P&L, B/S and CFS – 10 years)
Part 2 – Divisional Analysis, timeline, history, developments and status, including operational review
Part 3 – List of Subsidiaries, Associated Companies and Joint Ventures + Profits and cash flows (dividends) attributable to the Group
Part 4 – Competitive Analysis (using HAECO, ST Aerospace and Vector Aerospace)
Part 5 – Global MRO Industry Outlook, recent developments for SIAEC, prospects, pros and cons analysis and conclusion.

Financial Analysis


Profit & Loss Analysis

By referring to the above 10-year analysis, we can see that revenues have remained relatively stable over time and have grown marginally over the years (from S$662 million in FY 2001 to S$1 billion in FY 2010). Expenditure has more or less tracked growth in revenues in terms of following the highs and lows of the economy, in which the aviation and travel industry was affected by several major events including the 911 disaster in 2001, SARS in 2004 and the global financial crisis in 2008-2009. Operating margin remained fairly consistent at around 13.9% on average; and represents SIAEC’s core businesses of Repairs and Overhaul (including Fleet Management) as well as Line Maintenance. Part 2 will delve a little deeper into SIAEC’s business divisions and how they have fared in terms of operations and in generating decent margins for the Group.

One should note that over the years, net profits attributable to shareholders has been steadily increasing, and this was due to the greater recognition of share of profits from associated companies and joint ventures, of which SIAEC has 24 currently. The global financial crisis had brought down SIAEC’s profit attributable to shareholders to S$236 million, from S$260.6 million a year back. Share of profits from associated companies and joint ventures, however, has been steadily increasing and hit a peak in FY 2009 at a total of S$173 million, and this dipped to S$129.7 million in FY 2010 due to the crisis as a result of depressed air travel (detailed numbers for this will be provided in Part 3 of this Analysis of Purchase). With the recovery in the global economy and Changi Airport reporting a surge in air travel, this will also benefit the MRO industry and with SIAEC continuing to invest in their core competencies and in joint ventures, this share of profits will continue to rise in the foreseeable future.

As a result of this steady stream of profits from its associated companies and joint ventures, net profit margin for FY 2009 was 24.9%, while for FY 2010 this dipped 1.4 percentage points to 23.5%. Average net margin over the 10 years was 23.1%, so it would seem this is currently the normal range. For 1Q 2011 the net margin was 24.6% as there was more contributions from associates and JV, but it remains to be seen if this can continue as the years go by.

Balance Sheet Review

SIAEC’s Balance Sheet is very interesting as it contains no debt at all! One would have expected that a leading MRO player with technical capabilities would need to invest in a lot of fixed assets and hence would need a lot of gearing, but for SIAEC this is not true and this also adds to its attractiveness as an investment. Contrast this to ST Aerospace (Part 4 of this analysis) which has quite a bit of debt in its books. Apparently, capex is very manageable for the Group and is low compared to its revenues, and thus there is no need for leverage as internally generated cash flows (I will come to that in a while) are more than sufficient to cater for expansion, strategic alliances as well as staff salaries; with a lot to spare!

The current ratio has also been consistently high in the last few years, ranging from a high of 3.3 in FY 2004 to the current 3.08 for FY 2010. The average current ratio is 2.49 over the last 10 years, so this shows that SIAEC’s Balance Sheet is very strong and one need not lose sleep over it. Working capital has also been steadily increasing over the years and stood at S$502 million as at March 31, 2010, and S$580 million as at June 30, 2010.

Return on Equity has also been consistently high; with a 10-year average of 22.5%. For FY 2010, ROE was 18.7% due partly to the crisis and the depressed volume of air traffic, thus affecting SIAEC’s business. However, for 1Q 2011, ROE picked up to 21.1%, and if air travel continues to pick up and the global economy rebounds, ROE should bounce back towards the 10-year average.

(Note: Quick Ratio and metrics such as stock turnover ratios were not used as SIAEC is predominantly a service provider, hence inventories are negligible and not an important aspect of the Group).

Cash Flow Statement Analysis


A quick look at SIAEC’s cash flows over the last ten years reveals that operating cash flows were consistently positive; and that for 1Q 2011 the operating cash flows rose to S$71.7 million. Assuming we annualise it, we would get something close to S$280 million operating cash inflow for FY 2011, which is unusual as operating cash inflows did not surpass S$200 million in any of the last ten years! Whatever the case, the more important metric here is Free-Cash-Flows (FCF), defined as operating cash inflows minus capital expenditures. FCF was consistently positive for every year in the last ten financial years, except that it did dip dangerously low during the recession periods such as SARS and the recent global financial crisis. Capex will be for equipment and machinery which are used for testing and inspection, as well as the building of new hangars which had taken place over the years (e.g. Hangars 4, 5 and the current Hangar 6 for servicing of A380 aircraft). Surprisingly, capex is not high for SIAEC as a % of revenues, with most years seeing not more than 5% of revenue being spent on capex. This can be attributed to the many strategic alliances and joint ventures which SIAEC has (more on this in Part 3) which means they can leverage on the expertise and financial strength of their partners without having to cough up additional capital themselves.

In terms of investing cash flows, SIAEC is unique in that they usually end up with positive investing cash flows, while most other companies show a negative figure as this is the section where the Group spends on capex and investments in companies (e.g. subsidiaries and associated companies). From FY 2006 onwards, net cash flows from investing activities turned strongly positive (S$35.6 million for FY 2006) and stayed so every single year thereafter and peaked in the latest financial year FY 2010 (S$115.5 million). Most of the cash which came in was the result of dividends received from associated companies, joint venture companies as well as long-term investments. Over the years, as SIAEC’s pool of joint venture companies has grown, so has the amount of cash flowing in from these companies. Part 3 will give a very clear indication of this trend, which is set to continue as the Group shows no sign of slowing down on their strategy to partner global names to expand the Group’s capabilities.

For Financing Cash Flows, the bulk of the outflows (>90%) was due to payment of dividends to shareholders. There’s nothing much else to say here as the Group has no bank loans to pay back, no cash to raise from shares or rights and also no need for payments for convertible bonds or any such debt/derivative instruments. In other words, this section of the Cash Flow Statement is very “clean”.

To summarize, the Group is basically churning out cash at an alarming rate, which they have been paying out as dividends over the years. The next section will look at the dividend history for SIAEC and how it has been increasing over the years. Note that cash balances stood at S$531 million as at June 30, 2010 (1Q 2011).

Dividend History and Review


It can be seen from the above table that dividends from SIAEC have been consistently rising over the years, beginning with 4.0 cents for FY 2001 to the current 18.0 cents for FY 2010. Note too that the Group always pays an interim dividend as well as a final dividend, and only in two out of the last ten financial years did they pay a special dividend (of 20 cents – in FY 2004 and FY 2006). The strong FCF of SIAEC means that they can continue to pay increasing dividends, even as they plough some of that cash back into growing and expanding the business.

What I’ve noted is that for both the years in which special dividends were paid, cash balances had hit a high of close to S$500 million. For FY 2004, cash balance hit S$472 million while for FY 2006, it hit S$500.6 million; and in both years a special dividend was declared. As at 1Q FY 2011 (June 30, 2010), note that cash balances have hit a new high of S$531 million. Cash flows from associated companies and JV remain very strong and FCF was S$71.7 million for 1Q 2011 alone, so there is a good chance of this cash balance increasing further; and this also increases the probability that a special dividend may be declared for FY 2011. Of course, one should also be aware that total dividends were much lower than in recent years; hence it was possible to pay out a special dividend of about S$200 million without severely reducing the cash balance for the Group. With last year’s total dividend at 18 cents/share (or S$180 million), there is probably less chance of a “bumper” dividend, though I do acknowledge the likelihood of a smaller one (depending on their cash flows for the remaining three quarters of FY 2011)

However, the above is only a possibility; and even if there is no special dividend, the interim + final dividend would give me a yield of at least 4.38% based on FY 2010’s dividend payout.

This concludes Part 1 of this analysis of purchase. Part 2 will delve deep into SIAEC’s business segments and operating divisions, and will provide some background on them and also some operating numbers over the years.

14 comments:

Jacky Wong said...

Hi Musicwhiz, thanks for the detailed analysis. I am a keen follower of your blogs. I also noted that you were active at Afralug Value Investing Forum @ http://afralug.com/wsforum/forumdisplay.php?fid=3 . However, I found out the link no longer exists. Do you guys move to a new forum? If so, would you be able to let me know the link to the forum pls? Thanks.

financiallyfreenow said...

MW, I was waiting impatiently for this post! Thanks for posting.. Gonna read it soon!

financiallyfreenow said...

Hi MW,

Very well analysed post as usual! Keep it up!

Regarding SIAEC's competitors, I don't think Vector Aerospace is involved in airline maintenance but rather in helicopter (rotary wing) and aircraft engine maintenance as per their website. But only their engine maintenance is of interest in your analysis I suppose.

When I was on attachment, I worked for Singapore HAECO (or SHAECO for short). There were some HK technicians there and they said that HAECO in HK is just like SIAEC in SG. It's even much bigger than the engineering arm of HK national carrier, Cathay Pacific. SHAECO, though, is very small in the local MRO industry. HAECO also owns a certain percentage of SAESL, which is also 50% owned by SIAEC.

You may also want to look at Emirates Engineering and Lufthansa Technik for your competitor analysis. They are huge players as well.

Locally, the major MRO players are SIAEC and ST Aerospace. Jet Aviation does private jets and they are very reputable and famous world over for private jet maintenance. Jet Aviation has maintenance facilities in SG also.

Musicwhiz said...

Hi Jacky,

You're most welcome. Sadly, the Afralug (Wallstraits) forum has been down since August 1, 2010. Attempts to contact the Administrator of the forum have been futile, so it may be the case that Singapore's last value investing forum is down permanently!

Regards,
Musicwhiz

Musicwhiz said...

Hello FFN,

Thanks very much for visiting!

Yes, Vector is more of an aircraft cum helicopter maintenance company, but I used it as a basis for comparison because it had similar business as SIAEC; and also because it is a Canadian company so there is comparison across regions. HAECO is Hong-Kong based, while ST Aerospace is a Singapore competitor.

The analysis has actually been done already for these 3 competitors, and I will post it up progressively. Thanks for the information you provided though, it's most useful!

Cheers,
Musicwhiz

Chin Yee Hong said...

Hi,

I've always admired your analysis of companies, and I too think that SIAEC is a excellent company. And I just want to ask if the current P/E is too expensive?


Btw, I've just set up a blog of my own yeehong.wordpress.com
Maybe it can help you, as your blog has helped me.

Musicwhiz said...

Hi Yee Hong,

Thanks visited your blog; keep up the good work!

SIAEC is currently trading at about 14-15x historical PER, which does seem to make it "expensive". However, I took into account factors such as consistency of high ROE, good FCF and clean Balance Sheet to make my decision. My view is that SIAEC is fairly valued (not under-valued), and the yield would act as a buffer cushion against potential capital loss in the short-term. For the long-term, I think I would be able to preserve my capital unless the business experiences a permanent and severe deterioration (of which I can't anticipate).

These are some of the pros and cons I used for evaluating this investment. To be frank, there is no "perfect" investment - and I have to accept that some factors may not always be favourable; yet there are others which balance it out and make it worthwhile to invest.

Perhaps you can comment further when I post up my other parts of this analysis? Would appreciate it very much, thanks!

Cheers,
Musicwhiz

Black Cat said...

Hi MW,

Very interesting abt their free cashflow and low capex (negative capex!). I have not looked at SIAEC, but now will.

My old, short notes on STE & MRO are at http://profithunting.blogspot.com/2009/02/ste.html, not sure if they would be of any use to you. In the end, I did not get to know it well enough to buy it.

Musicwhiz said...

Hi Black Cat,

Thanks a lot, I went to browse your website and the information was useful!

While I agree MRO does follow the airline industry's ups and downs, apparently this did not impact SIAEC's fortunes too much or result in too much volatility in its earnings. Cash Flows remained strong even though there were slumps in air travel during the 10 years period I reviewed.

It is true the MRO industry is fragmented and most airlines have their own "in-house" MRO facility, so ST Aerospace and SIAEC are two companies which are independent of airline. I did note during my research that there are many players but apparently SIAEC is able to expand its JV and its business gradually to grow. While I do not see a trend towards consolidation as yet, this may happen slowly over time; then again as budget carriers become more popular, it would also mean more business for companies like SIAEC and ST Aero which are not tied to any airline. By contrast, full services airlines such as Lufthansa should feel worried about the proliferation of such competitors who may threaten their market share, and hence their piece of the MRO pie. That's just my perspective on it.

Thanks!

Musicwhiz

Akatsuki said...

Hey Mz,

Will you be touching on the growth prospects of SIA Eng?
Or perhaps, have you attended one of their AGM already? If so, what is the management like? Are they competant, have very positive outlook for the company, perhaps they have some plans in mind to expand?

Musicwhiz said...

Hi Akatsuki,

Yes, the next few sections will talk about their plans and prospects, so stay tuned!

I have not attended any AGM yet and have not met the Management. This analysis was done purely from analyzing the numbers and reading through all annual reports and industry reports; the same way I did it for Kingsmen Creatives too.

Cheers,
Musicwhiz

Akatsuki said...

Thumbs up for you.

gunawan said...

Hi Musicwhiz,

I invite you and other forummers of http://www.afralug.com - dog, dyx, cif5000, market uncle, donmihaihai, seafoodlee, etc to post on new forum dedicated to value
investing http://www.valuebuddies.com
Thanks.

Musicwhiz said...

Hi Gunawan,

Thank you for the invite, and I have registered as the first user of Value Buddies! I am in the process of trying to get the old members of Afralug to join as well, but the process will take time.

Could I trouble you to split up the forum into various categories please?

1. Value Investing Discussions
2. Listed Companies
3. Economic News
4. Property
5. Personal Finance
6. Introductions and General Chat
7. Other categories as you see fit

This will help to compartmentalize the forum much better.

Thanks!
Musicwhiz