SIA Engineering – 1H FY 2012 Analysis Part 1

SIA Engineering (SIAEC) released their 1H FY 2012 results on October 28, 2011; and following that on October 31, 2011, they released a set of presentation slides which were used to present to analysts at the analyst briefing. Since it has been a while since my original purchase of SIAEC, and subsequently I had also added to my initial position on two separate occasions, I thought it timely for me to do an analysis and review of the Company. I shall limit the analysis to the financials, cash flows, associates and joint ventures (JV), dividends as well as some of the qualitative aspects and growth prospects for the Company. This shall be divided into two parts for ease of reading.

Part 1 shall focus mainly on the financials and numbers including the year on year comparisons and nine-year history, cash flow categories and presence of free cash flow (FCF), share of profits and dividends from associates and JV; as well as dividend history. Part 2 shall be shorter and will touch briefly on SIAEC’s operational performance, recent activities and strategic tie-ups and partnerships.

Financial Analysis

From the above table, one can note that revenues have been generally flattish for the last 5 years, and costs and operating profits have also remained fairly constant. In fact, operating margin for 1H 2012 was the same at 12.5% compared to a year ago (1H 2011). The main bulk of the profits, which comes from share of profits from associate companies and JVs, also rose just marginally by 1% from $77 million to $77.7 million. Therefore, the only reason for the slight increase in net profit to $139.3 million was actually because of a tax writeback! On the bright side, flat profits and revenue may also signify resilience in the face of growing uncertainties in the global economy as well as aviation industry; with SIA reporting a 62% plunge in half-year profits due to higher fuel costs, perhaps it is mollifying to know that SIAEC can hold its own due to its business model (which does not have reliance on oil prices).

On a positive note, the Balance Sheet continues to remain solid with debt of just $2 million against a cash balance of $388.9 million. Working capital has dipped to $455.3 million from last year’s $504.9 million but is still high compared to the last five years. Current ratio has dipped from 3.10 to 2.58, mainly due to the payment of the special dividend of 10 cents/share, and this will bring its current ratio more in line with long-term averages of around 2 to 2.8. Interestingly, annualized ROE is higher at 23.3% for 1H 2012 as a result of a lower equity base, against 21.9% for 1H 2011. The dividend declared of 6 cents/share (unchanged from 1H 2011) was somewhat of a pleasant surprise – I had expected a cut to 5 cents/share due to lingering uncertainties in the economy and also a possibly depressed aviation industry outlook. The Company will have to cough up $66 million to pay out to shareholders in late November 2011, and this pay out will be reflected in the 3Q 2012 results.

Cash Flows and Cash Balance

Cash inflow did suffer during 1H 2012, compared to the same period last year. Net operating cash inflows plunged nearly 70% to just $20.7 million against $66.6 million a year ago, while investing inflows also dipped 6.5% to $40.2 million. Due to the payment of the large final cum special dividends, cash outflow from financing activities increased two-fold to $253.8 million. The result was a significant drop in cash of about $192 million, which followed a record-high cash balance as at March 31, 2011 of $581.4 million. Apparently, the practice is for SIAEC to pay out a special dividend when cash balances hit levels which are considered higher than normally required for working capital purposes. Capital expenditures dipped to just $15.3 million for 1H 2012, thus there was still some free-cash-flow (FCF) of $5.4 million, though this is pitifully low compared to the same period last year, when FCF stood at $40.1 million.

By observing the upcoming 3Q 2012 results, it will be possible to project if SIAEC will have sufficient cash generation ability to at least maintain its final dividend at 14 cents/share. Looking back at 3Q 2011, operating cash flow was very high at $77.7 million, investing cash flows was $39 million, while financing cash flows shows an outflow of $57.5 million (payment of interim dividend for 1H 2011). The net cash inflow turned out to be $53.2 million, which is decent. For 4Q 2011, operating cash flows were very strong at $80.5 million, investing cash flows were $39.5 million and financing cash flows showed an inflow of about $4 million. This adds up to about $124 million in additional cash for 4Q, and for two quarters alone the combined inflow was about $183.2 million. A final dividend of 14 cents would drain about $154 million in cash, and therefore it can be seen that the two quarters’ strong cash inflow could sustain this final dividend, with the special dividend being declared to reduce cash reserves which were considered in excess of working capital requirements. Hence, the next two quarters’ cash flows will be critical to be able to appraise the situation better; and qualitative data about the industry and corporate announcements from SIAEC should also be used to support any potential dividend payouts.

Associated Companies and Joint Ventures – Profits and Cash Flows

I have taken the liberty of re-listing the profits and cash flows from associated companies and joint ventures once again for SIAEC from FY 2000 till FY 2011. Although profits had undergone some fluctuations in the last five financial years, the cash flows from dividends received (parked under Investing Activities) seems to have gone from strength to strength. Notice that from FY 2009 to FY 2010 there was a big jump, presumably because of the increased JV activities and tie-ups which SIAEC had for MRO work and line maintenance. With the recovery of the economy back in FY 2010 due to the massive QE 1, cash flows jumped and hit a (then) record high. Following that was FY 2011’s $165.3 million cash inflow, and when viewed from this perspective, these two years could have been anomalous as the real problems with the economy had persisted and were simply masked behind the massive pumping of liquidity. Thus, if we normalize the trend for cash flows, FY 2012 could see a dip before the resumption of the upward trend.

If we just compare the year on year half-yearly profits and cash flows from associates and JVs, we can see that the total for profits remained largely flat, while for cash flows it had dipped about 15% to $62.8 million. This reinforces my point that cash flows may dip for this year, which may result in a lowering of final dividend from last year’s 16 cents/share. Though no specific reasons were provided for this dip, the fragile recovery and ongoing worries in the global economy would be sufficient reasons for the weaker performance of all of SIAEC’s associates and JVs. Profits here make up 50.1% of pre-tax profits, and I feel this will be poised to increase further in the coming years. More on that in Part 2.

Dividends

For dividends, I have decided to analyze the core dividends declared by SIAEC since listing, and therefore have a row which excludes the effects of special dividends (there have been three such instances over the last eleven financial years as can be seen from the table above). Core dividends have been picking up only from FY 2006 onwards, but an interesting point to note is that interim dividend has been on an increasing trend over the last eleven years, even though final dividend is more erratic. Interim dividend was just 1.5 cents/share back in FY 2000 but has increased over the years to 6 cents/share. Notice that as SIAEC expanded their JV and tie-ups with strategic partners, interim dividend declared has also steadily inched upwards, but in general it remains constant over at least two consecutive years before increasing.

For the final dividend, although it may appear rather erratic at first glance, do note that apart from FY 2008 which seemed like an anomaly, it has also risen slowly but steadily. If you look at core dividends, the trend seems to be an increase of 2 cents/share per financial year beginning from FY 2006, with FY 2008 being a “blip” as it should have been 14 cents/share (but was instead 6 cents more at 20 cents/share). Going by this logic, FY 2012 should see a total dividend of 22 cents/share, which implies that the upcoming final dividend would be 16 cents/share.

However, let me caution that this is just a rather simplistic extrapolation on my part, and what is more important to note are the actual operating results and cash flows from SIAEC’s core business and their numerous JVs and associated companies.

Part 2 will touch on operational aspects and some qualitative characteristics of the Company, as well as discuss future plans and how SIAEC intends to expand amid turbulence in the industry (no pun intended).