On 4 October, SIA Engineering Company shares tumbled to 6-year low following news of JP Morgan’ sale. Share price fell in the early morning of trading to $3.15 before recovering to $3.20 level. In my opinion, the correction is long overdue as the business outlook for the MRO giant has considerably dimmed in recent years with the entry-into-service of new aircraft requiring much less maintenance works.
Financial results for 1Q2017/18 revealed that profit declined 82% to $36.2 million. The huge decline was because of the absence of divestment gain in last year (SIA Engineering divested 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”)).
However, even after excluding the impact of the divestment in the quarter ended 30 June 2016, profit for the current quarter of $36.2 million was $1.8 million or 4.7% lower. Revenue also remained flat, at $272.8 million. Although the results were not exactly that disappointing, they seemed to suggest that SIA Engineering business fundamentals might have peaked.
To be fair to the management, SIA Engineering had tried to engineer growth in view of the challenging operating environment. Last year, SIA Engineering began to streamline its pantheon of joint ventures. Its joint ventures with Pratt and Whitney, Component Aerospace Singapore Pte. Ltd. (“CAS”) and International Aerospace Tubes-Asia Pte. Ltd, were integrated, presumably to reduce costs and create synergies between the subsidiaries. The group made a profit of $146 million from the divestment of HAESL. There was also the amalgamation of the business and operations of SAESL and International Engine Component Overhaul Pte Ltd (“IECO”), their second joint venture with Rolls Royce in Singapore, into a single entity.
In February 2017, SIA Engineering and Airbus formed a joint venture to provide airframe maintenance, cabin upgrade and modification services for Airbus A380, A350 and A330 aircraft families in Asia-Pacific and beyond. Interestingly, in June 2017, SIA Engineering have agreed to form a joint venture with GE Aviation to provide (MRO) services for the GE90 and GE9X engines. For the longest time, SIA Engineering had joint ventures with two of the biggest engine makers in the world, Pratt and Whitney and Rolls Royce. The agreement with GE Aviation to set up MRO base in Singapore should finally cement Singapore as the leading engine MRO hub in the world.
The recent announcement of the incorporation of joint venture company, Moog Aircraft Services Asia is unlikely to have major impact on SIA Engineering’s growth. In my point of view, Moog is not considered a game-changer as it is not an aircraft OEM nor an engine maker. The joint venture provides maintenance, repair and overhaul services for Moog manufactured flight control systems fitted on new generation aircraft including the Boeing 787 and Airbus A350.
However, I am pretty excited about the joint ventures with Boeing, Airbus and GE Aviation. These are the big boys in aviation and the long-term impacts should be more significant.
The strategy to keep forming joint ventures with OEMs is needed to diversify revenue sources. According to last year financial results, FY2016/17 saw SIAE itself derived 67% of its revenue of $662 million from parent company, Singapore Airlines. However, when revenue from subsidiaries and joint ventures were factored in, the total revenue from SIA accounted for only 33% ($1.49 billion) while non-SIA clocked in $3 billion. So the importance of the contributions from the subsidiaries and joint ventures cannot be underestimated.
The business fundamentals were still sound, with Return on Equity (ROE) standing at double digits for the past 5 years. This indicated that management had been pretty good at generating returns for the shareholders. The management was also prudent in managing the balance sheet, with cash balance of $628 million. With so much money on hand, the long-term debts of $20.7 million seems like peanuts. Nevertheless, the total revenue has been declining since 2014, from $1.178 billion to $1.1 billion in 2017. The drop in the revenue performance has seen the stock price fallen from a high of $5.12 in 2014 to the current $3.20 level.
Indeed, the outlook for SIA Engineering would be challenging as it is hit by changing trends in the aviation sector. Stiff competition among airlines had led to many operators implementing cost measures and these caused the pressure on the MRO rates. In addition, many airlines are renewing their fleets with new aircraft that comes with lesser maintenance needs and longer maintenance intervals. Examples would be SIA’s A350, Scoot’s B787 and SilkAir B737 Max.
Notwithstanding the challenges, growth opportunities remain because ultimately all aircraft would still need to be maintained according to airworthiness requirements. In this regard, the MRO business remains lucrative because of the nature of its recurring income. SIA Engineering’s various collaborative agreements with OEM would bode well because they serve to add value to airlines. However, these are all long-term investments and it would take time for the yield to be seen.
The motive behind the block sale of SIA Engineering was unknown. Perhaps the big boys were not confident of the growth prospect of the company. Maybe the sale was part of the institutional investors investment reshuffling. But when the big boys are in action, retail investors should be cautious. If you are not careful, chances of losing money are high when the “whales” flipped.
In conclusion, this SGX blue chip is currently navigating through un-chartered waters and this had impacted the business considerably. Is the current correction in stock price represents a good buying opportunity? To be frank, I don’t think so. At Price/Book Value of 2.449 and P/E ratio of 22.8, the share price still has room for correction. My entry price for this counter is still $2.20.
Read my other articles on SIA Group:
- Research report on SIA Engineering Company
- SIAEC share price crashed to 5-year low
- Is it worth investing in SIAEC shares now?
- Is SIA Engineering Company a value trap?
- Retrenchment for Singapore Airlines?
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