SI Research: What SIA Engineering Company’s 1Q19 Results Reveal?

On 30 July 2018, the share price of SIA Engineering Company (SIAEC) closed at $2.93, which is a level not seen since 2009! Is the drop in share price simply an overreaction following its recent disappointing earnings results? Have the fundamentals changed for SIAEC or is the beaten-down share price an opportune entry point for investors?

Latest Earnings

In the latest 1Q19, SIAEC’s revenue declined 5.5 percent to $257.7 million. Management attributed its weak top line performance to lower airframe and component overhaul as well as fleet management revenue.

The two biggest cost components of operating expenses, staffs costs and material costs fell 1.2 percent and 3.7 percent respectively, lagging the revenue decline. However, operating profit slumped 45.5 percent to $10.2 million, translating to a core operating margin of just four percent compared to FY18 core operating margin of seven percent.

Despite a deteriorating top line performance, net profit improved 10.4 percent to $40.5 million, lifted by upswing in income from joint ventures (JV) and associates. JV and associates income grew 53.6 percent to $32.4 million. Earnings per share grew 10.4 percent to 3.62 cents.

Balance sheet wise, SIAEC’s financial health remains robust with a total of $570.9 million of short term deposits and cash in hand and minimal gross debt of $22.2 million. The strong net cash position should sustain the current dividend level of 13 cents per share, translating into a dividend yield of 4.3 percent, based on the prevailing share price of $3.02.

Net asset value per unit stood at $1.381, up 4.1 percent from a year ago. Notwithstanding that, the group remains cash generative, with operating cash flow coming in at $56 million in 1Q19.

Industrial Headwinds

Though associates lifted the bottom line, SIAEC continued to face protracted headwinds in the maintenance, repair and overhaul (MRO) space. Its bread and butter airframe overhaul and line maintenance revenue continued its decline for the fourth consecutive year in FY18. Going forward, the trend is likely to continue as new generation of commercial aircraft would require longer maintenance intervals than older fleets. Furthermore, original equipment manufacturers (OEM) such as Boeing are increasingly entering to the MRO space leading to greater competition and induced further pressure on the margin front.

Notwithstanding that, SIAEC’s fleet management business is facing challenges, with the fleet size shrinking from 181 aircraft in 2015 to the current 89 aircraft in 2018.

On a positive note, the cabin retrofitting work on Singapore Airlines (SIA)’ legacy A380s is currently underway. The 14 aircraft will be joining back the fleet by the end of 2018. This should help to bolster its SIAEC’s top line in the coming quarters owing to higher workload from SIA.

JV and Associates

Management attributed its strong growth in JV and associates to the higher profit of $11.8 million from engine and component centres. This lends further credence that it is beginning to see signs of an engine MRO cycle upswing.

Moreover, recent reports about durability issues with Rolls Royce Trent 1000 engines have grounded a sizeable fleet of aircraft for extra engine inspections thus increasing engine shop visits. The rectification works for problematic Trent 1000 have increased at a faster rate than expected since the end of 2016.The repair campaign is expected to continue until 2020. This phenomenon should provide some support for the MRO sector.

On the other hand, SIAEC’s JV with Pratt & Whitney Eagle Services Asia (ESA) should continue to perform as retirement of classic Boeing 747 aircraft ramp up. Previously, airlines had delayed their retirement of Boeing 747s due to the low fuel price environment in the past two years. Against a backdrop of rising oil prices, airlines would resume to phase out the gas guzzling Boeing 747 and replace them, with the twin-engine Boeing 787s. On a bright side, ESA was the first engine overhaul centre for engines that are used to power A380s. With the A380s’ engines added into the service portfolio, this could further contribute to the JV profit.

Furthermore, SIAEC’s collaboration with GE Aviation should be operational by 2019 or early 2020. The JV forms an engine overhaul company featuring a factory equipped with robotics, digitalisation and data analytics. Apart from the additional income, SIAEC could “learn” the technical expertise from GE Aviation and replicate the model in its own line.

Valuation

SIAEC closed at $3.05 on 2 August 2018, falling nearly 14.3 percent from a year ago. On a trailing 12-months earnings basis, the group is now trading at 17.9 times compared to 23.7 times a year ago.

Going forward, we are less optimistic of SIAEC’s core operation, as the MRO environment continues to remain challenging. Another worry would be the thin 4.1 percent margin SIAEC is operating with, given that JV and associates contribute more than 80 percent of profit before tax.

That said, SIAEC has been investing in various productivity programmes to drive future growth. While investors should acknowledge that challenges in the MRO environment, SIAEC is still fundamentally a good company. However, we think the current valuation is low for correct reasons and hence investors should wait for prospects to improve before buying into the stock.