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Is SIA Engineering Company a value trap?

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SIA Engineering Company announced on 30 June 2016 the divestments of its 10% stake in Hong Kong Aero Engine Services Ltd (HAESL) to Rolls-Royce Overseas Holding Ltd. At the same time HAESL will divest its 20% stake in Singapore Aero Engine Services Pte Ltd (SAESL). The divestments will result in a net gain of $178 million for the SIAEC Group, representing a windfall for SIA Engineering Company (SIAEC).

The move to divest SIAEC’s stakes in several joint ventures is long overdue as its network of joint ventures (JV), associates and subsidiaries have become so complex that it affects the company’s ability to compete for the aircraft aftermarket business. To a certain extent, some of its JV may even be competing against each other for maintenance, repair and overhaul (MRO) business. So this streamlining operation may bode well for the company going forward.

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Investments

Business Challenges

Unlike its parent, SIA, the MRO business is more stable and predictable as compared to airline operations. This is because aircraft are required to be maintained at certain interval in order to be deemed as airworthy. Thus, the business model of SIAEC is recurring. However, the emergence of new composite aircraft like B787 and A350 changed the game for big MRO players like SIAEC and ST Aerospace.

The next generation aircraft require less maintenance works and longer interval of inspections and maintenance because of better materials and advanced technologies used in the design of the aircraft. While this trend is good for airlines like SIA, it presents a challenge for SIAEC, in terms of lesser work.

To mitigate the impact of technology advanced fleets, SIAEC went into recent partnerships with aircraft manufacturer like Boeing and Airbus. These strategic moves are needed in order for SIAEC to gain bigger market and increased competitiveness.

Shares buy-back

SIAEC has been buying back shares aggressively after its share price has plunged from a high of $5.29 in 2013. While analysts may argue that a company buying back its shares is a good sign that the shares are undervalued, one should be wary of value trap.

Notwithstanding the company has a profitable business model, its Net Asset Value (NAV) is only $1.32 while its Net Current Asset Value Per Share (NCAVPS) is only $0.55. So this means that SIAEC shares may be over-valued.

Investors may be caught off-guarded if business sentiments suddenly turned sour and resulted in massive market correction. The potential plunge may not be able to off-set the accumulated dividends dished out over the years. It is also a question mark when the stock price will recover, thus creating opportunity loss for investors as well.

New normal

The aviation landscape and trends have changed drastically over the last few years. While SIAEC’s business is recurring because of the nature of aircraft fleet maintenance, technology has reduced the level of maintenance tasks needed.

SIAEC’s investments in joint ventures with aircraft OEMs are good developments but they essentially wild-cards for the long-term. Whether such investments will become game-changers for the company will remain to be seen.

My strategy

At Price/Earning ratio of 23.37%, I feel that it is risky to buy the shares at the current price. Since July 2014, SIAEC’s share price has been on a downward slide. The dividend yield is only 3.81% and therefore does not justify the risk.

The record low share price for SIAEC for the past 10 years was $1.58, during the Great Financial Crisis in 2009. Thus, I would pay a premium but set a safety buffer for SIAEC’s shares. I would enter this counter only at $1.00. Not vested but monitoring this stock closely.

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