Currently trading at $3.73, SIA Engineering Company (SIAEC) shares have not reached the 5-year low of $3.35. But it does not mean that the company is doing fantastic either. SIAEC shares had been sliding from a record level of $5.29 since 2013 and many investors wonder whether it would be worth investing in SIAEC shares now.
For 1Q16, SIAEC announced profits amounting to $199.8 million as compared to $41.7 million in 2015. The explosive increase was due to $141.6 million gain from the divestment of its 10% stake in Hong Kong Aero Engine Services Ltd (“HAESL”) to Rolls-Royce Overseas Holdings Limited (“RROH”) and Hong Kong Aircraft Engineering Company Limited (“HAECO”).
In addition, the Group received a special dividend of $36.4 million from HAESL following the divestment of HAESL’s 20% stake in Singapore Aero Engine Services Limited (“SAESL”) to Rolls-Royce Singapore Pte Ltd (“RRS”), bringing the overall gain from the divestment to $178.0 million.
SIAEC financial performance
Apart from the one-off divestment, there are few bright spots for SIAEC. Revenue has declined for the past two years and for 1Q16, SIAEC registered a decline of revenue to $271.6 million from $277.3 million in 2015. Some analysts predicted in the news lately that lower passenger traffic for SIA would have serious impact on SIAEC’s business. But I beg to differ.
To put things into perspective, the aviation sector is very heavily regulated and this is even more so for aircraft maintenance tasks. So regardless of market conditions, operators like SIA are required to send their aircraft for maintenance checks. Thus, to attribute SIAEC’s decline in business to SIA’s decreasing passenger traffic does not make sense to me.
In fact, if investors bother to analyze the FY15 financial results, actually SIAEC derived only 34% of its revenue from SIA. The bulk of its revenue (66%) came from non-SIA work through its subsidiaries and joint ventures. Given the diversified revenue sources, SIAEC’s business performance being impacted by its parent company’s passenger load is minimal. So what could be the root cause for SIAEC’s decline?
One possible reason is the failure of management to capture growth. Recently, the company established joint ventures with Boeing and Airbus in a bid to leverage on their strengths to access larger market. However, prior to this, SIAEC had not been making significant investments to gain market share. With such a strong balance sheet and so much cash on hand, perhaps SIAEC may want to consider penetrating new markets like China or India for its lucrative line maintenance segment.
It does not help that new generation aircraft like A350 and B787 require less maintenance and longer maintenance intervals. This is because of the new technologies used in these aircraft and the use of composite fuselage has reduced the frequency of maintenance checks. Although the improvements brought by technology advancement are good for airlines, this trend results in less business for the MRO players.
Can SIAEC shares fight gravity or will this become the new normal for this MRO stalwart? Much of this will depend how management navigates the current headwinds. To continue to grow, SIAEC must pursue more strategic partnerships and deepen its overseas market penetrations. Based on past few years’ track record, SIAEC’s approach had always been calibrated and cautious. It is not SIAEC management’s style to pursue aggressive growth through mega acquisition deals. At least not that I know of in recent years. Thus, I expect a soft landing for SIAEC share price.
My strategy for SIAEC
Under the current business climate, it is not business as usual for SIAEC. Even though the company has been distributing dividends consistently over the years and business had been extremely profitable, the current price level does not reflect its financial performance. I expect share price to continue to slide unless management came out with something drastic to reverse the sluggish growth. I will enter this counter only at $2.20 per share.
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SG Wealth Builder