Tuesday, December 25, 2012

Sales of SIA Engineering

SIA Engineering purchased at average price of $3.562 and sold at average price of $4.107 with total dividend received of $0.10 in early November 2012. Total gain is 18.1% in a timespan of 10 months.

Before we review the rationale for sale, it is important to look at the rationale of purchase. At that point in time (Dec 2011), it was 3 months into my investing journey and I had given up on speculation. At that time, SIA EC drops to $3.55 and it looks like one of the blue chips that I can rely on after drifting into the red. MRO is a growing business and SIA EC has quite a strong market share in MRO and line maintenance with its link to SIA. Both segment of the businesses are pretty resilient given the regulation in place for checks to be conducted. It has a very clean balance sheet and shows a respectable ROE. Strong free cash flow yield and dividend from associate results in a close to 6% dividend. In other words, safety was my key concern then.

Rationale for Sale

And in 2012, we witness a mild bull run among all the dividend stocks, be it in REITs or in the high-dividend paying blue chips. This yield compression is as a result of the uncertain gloomy economics condition, continued monetary easing and the low interest rate circumstances which investors are stuck in with no other place to go. Will interest rate continue to stay low forever? Perhaps for the next 2-3 years until US's unemployment rate falls below 6.5%. In any case, there seemed to be a limit to further yield compression though Mr Market can be really unpredictable at times. Hence, the upside seemed limited on the assumption of the same dividend paid.

While all along I have known the importance of the JVs and associates to SIA EC, it was only after attending  the AGM that I realised the amount of cannibalisation going on during the past decade and that 3 particular associates account for a highly significant proportion of the results from associates and JV. And the problem is that I am unable to fully understand ESA and SAESL though their profitability seemed to be amazing. I hate it when I cannot get a good grasp of all there's to know about the company especially when these are significant contributors to the bottom line.

As for its growth potential, there's seemed to be some factors that might slow the growth. Slow is the word and not no growth. Firstly, almost all of its associates and JV's revenues are earned in USD. And as everybody knows, the USD has been depreciating against the Sing dollars and over the decade this has greatly reduced the absolute Sing dollar growth from its associate. If they reinvest all their profits, then this exchange rate problem will be just a mere accounting problem. However, since it is so highly reliant on its associate and JV to fund its dividend, those USD will have to be converted to SGD and hence growth will continue to be impacted by the movement in exchange rate. Margin will be impacted as labour cost is paid in SGD. For as long as USA still prefers to print money to resolve its debt and economic problem, USD will continue to weaken.

Another factor will be that new aircraft has much lower maintenance cost as compared to other aircraft. For e.g. Boeing 787 Dreamliner will only need to undergo a D check after 12 years as compared to the traditional 4-5 years for normal aircraft. In all, Boeing claims that it will reduce the maintenance cost by 30%. It seemed to be a trend that newer aircraft requires much lesser maintenance as compared to the previous generation.

Fundamentally, the overall growth of the MRO sector seemed intact but I believe that the 2 factors mentioned above will be a drag on its growth. And on a portfolio basis, as the STI continues to rise, it seemed like holding on to the cash option sounds much more attractive. As I have advanced in my investment journey, small cap and mid cap will be preferred over the blue chip unless great opportunities arrive. I believed that more opportunities will exist in the small cap and mid cap space where they are less covered and attract less attention from the institutional investor.

Monday, December 10, 2012

Genting Singapore - Part 2

For this part, we shall have a look at the business of Genting Singapore. As everybody knows, the key attraction of Genting Singapore is that it is one of the only 2 IR operators in Singapore and many believe that casino and duopoly equate to a highly profitable business as seen from the prosperous Macau.

Understanding the business model of a casino

More than 80% of Genting Singapore's revenue come from its gaming revenue while the other 20% comes from hotel, USS and Marine Life Park. Hence, gaming is at the core of Genting Singapore and will be the focus of the post today. To operate a casino, one needs a license from the government and in the case of Singapore, the area of casino is capped at 15,000 sqm. Thus, within this limited 15,000 sqm area, a casino will have to optimize its area by placing the table and machine at the appropriate place to maximize its revenue per sqm. Next, for each table it has to maximize the turnover by having as much game played as possible. Finally, odds are calculated in such a way that the casino operator will always have an edge over the gambler. Win rate for the casino operator is often much lower at 1-8% as compared to much higher rate than Toto, 4D or lottery operator. Hence, volume is much more important for casino and the higher the volume, the higher their profit and the more likely the win rate tends to their edge due to the law of large numbers. Another reason why volume is important is that casino requires huge initial capital expenditure and outlay as seen from Genting's balance sheet where PPE accounts for 55% of their asset.  There's also high fixed cost in the number of dealers, tables and cards which need to be paid for regardless whether there's only 1 gambler at the table or there're 10.

Industry Outlook

It is indeed true that the casino operators in Singapore enjoy a very healthy duopoly market structure which should theoretically bestow upon them high profit margin and ROE. However, many have not realized that for the casino in Singapore to prosper, they will need to rely much more on foreigner rather than the locals. Singapore certainly has a much lower population compared to other countries in the region which means that to generate higher volume of gamblers, Singapore will need to continue to attract tourist and foreigners to come to Singapore to gamble. What this means is while we can safely say that it is a duopoly in terms of capturing the local market, it seemed to be a regional competition for foreign gamblers that is much more important.

However, as a results of its initial success for its 2 IRs, there are now increasing competition in the region as we see numerous countries in the region opening new casinos from 2012 -2015. Vietnam, Philippines and Cambodia will be opening new casinos in 2012 and 2013. Russia and South Korea will also be building new casinos to attract the tourist while Taiwan has already legalized casinos. Both Japan and Thailand are also debating on the issue of legalization of casinos. As such, it seemed like competition is fierce within the region with better and newer casinos built over the next few years.

Given these various forms of competition, it seemed like Macau is still going to be the most thriving gaming countries in Asia. More casinos are going to open in the Cotai Strip and Macau easily outclassed the 2nd largest casino market, Las vegas, by 2-3x more in revenue. Despite supposed slowdown in China in lieu of the changeover of leadership, Macau is still expected to grow by 10-15% this year as compared to 5% for Singapore according to S&P. In the next 5 years, Macau's gaming industry is expected to grow by 15% as compared to 5-8% for Singapore. So what exactly is the secret to Macau's success that is hard for Singapore's 2 IRs to replicate? What is the reason to Macau's average ROA of 20% and ROE of 60% as compared to Genting Singapore's 10-15%.

The business model of Macau's casino

Essentially, Macau's casino runs on a junket model where the junket accounts for 75% of their revenue. Junkets are middleman who will bring in the high net worth individual (HNWI) to the casino and will take in a portion of the HNWI's total chips played. The casinos will also offer rebates and free chips to HNWI to attract these big whales to play in the casino. Hence, in such a model, the profit margin for the casino operators will be much lower. However, they will be able to attract the volume which is essential for the casino as the fixed cost of a casino is high.

In fact, junket has been the critical factor for the success of Macau's gambling industry that other countries are unable to replicate. These junkets are like the private bankers that establish the relationship with important clients and bring in the revenue. Many of the HNWI from China will prefer to go in a group lead by junket as they enjoys special rebate and networking opportunity. Coupled with its close proximity to China, Macau is the natural destination for the wealthy Chinese which takes on a more active attitude towards gambling as compared to the Westerner.

However, in the case of Singapore, the government does not allow and is very cautious of junket operation. Even for the 2 operators allowed for Genting Singapore, they are called as International Market Agent and they are very small players based in Malaysia and not Macau or Hong Kong. This is bad for RWS and MBS as the mass market often stagnate within 2-3 years and it is the junket that is needed to drive VIP's volume growth.

High DSO and impairment loss of receivables

In part 1, I have discussed about the high DSO of 5 months for Genting Singapore and the frequent impairment loss on receivables of 17% for Genting Singapore.This is in fact linked to the lack of junket operation in Singapore. In Macau, not only does the junket brings in the HNWI, they are also responsible for the collection of the debt. As such, Macau has very low receivables on its balance sheet and is able to enjoy higher ROA and better working capital management. Debts are often a problematic issue for VIP customers for casino as they are also afraid that being too aggressive in collection of debt will deter the clients from visiting their casinos again.

For Singapore, due to the lack of junket operation, the 2 operators have been slack on their credit policies in a bid to attract the VIP customers. They allow them higher credit, longer term of collection and these results in the high receivables amount as seen on its balance sheet. If we were to take into account that the mass market often produces no receivables as no credit is to be issued to them, the actual DSO from the VIP business is much higher. As seen, the implication of junket is not just a higher revenue but a better working capital management as well as higher quality of earning.

Given the huge differences in growth potential, ROE, DSO, it seemed like the 2 casino operators pale in comparison to the many Macau's casinos listed on the Hong Kong exchange who are also able to offer much higher dividend yield as compared to Singapore. Unless the government approves the junket operation in Singapore (which is very unlikely), it seemed like Genting Singapore is going to face a stagnant market where growth will at best be single digits and the fact that 16% of its receivables have to be impaired annually.

Tuesday, September 11, 2012

Genting Singapore - Part 1 (Financial Statement Analysis)

This is likely to be one of the last New company that I will do an analysis on for the next 2-3 months as I intend to focus on my studies which has been a bit overloading at times. Nonetheless, I do hope to be able to resume research on new company when holiday is here. I will still continue coverage on VICOM and Silverlake Axis whenever possible.

This will be a 2-part analysis and as always I will start off with financial statement analysis. Genting Singapore operates one of two casinos in Singapore, owning 6 hotels with 1800 rooms as well as 2 key attractions of USS and Marine Life Park. While price might have fallen quite a bit from its peak, it may still have been overvalued at its current price. For the past few years, investors have been pricing in high teen growth rate for this company that seemed to have a long way to go. However, it seemed like RWS might have reached a stagnant market already.

Figure 1 - Income Statement

For the 1st half of 2012, Genting Singapore reported decline in gaming revenue of 19% and 4% for the first 2 quarter which seemed to imply that they have been affected by the decline in macroeconomic condition. Total revenue dropped by 14.2% and 2.9% in Q1 and Q2 2012 as 80% of Genting's revenue comes from gaming. And the decline was as a result of lower rolling chip volume and not lower hold rate (luck factor of casino). In Q2 2012, VIP rolling volume dropped by 14% and Mass volume contracted by 4% in spite of a slightly higher win rate of 3.1% than the theoretical win rate.

There has also been decline in the profit margin which the management has attributed to pre-opening expense of Marine Life Park. However, pre-opening expense increase is very insignificant and the fact is simply a lower gaming revenue. Despite 2 of its hotels, Equarius and Beach Villas, being opened in Feb 2012 which results in 8% increase in room inventory, non-gaming revenue only rises by 1%. RWS also recorded higher average room rent of $432 and occupancy rate of 92% as well as higher visitation rate. These did not lead to    significant increase in non-gaming revenue which could imply the use of its non-gaming asset as complementary to attract the VIP players. If this trend continues, then we should not expect much from the non-gaming revenue as well.

 Figure 2 - Balance Sheet

For the balance sheet, the right column of 2012 Q1 and Q2 is where I transferred the $2.3 billion worth of perpetual securities to the long-term debt. While it is being accounted as equity, it is clearly a form of debt of which the company will have to pay $118 million in interest tax per year, representing 9.6% of FY 11 net profit. While the company has the right not to pay out interest, it is cumulative and will hurt the company's reputation. Of course, debt level is still manageable as it can be cleared by Genting with 3-5 years of profits.

In any case, the company has not proven its need to raise cash through perpetual securities though the cost of debt is lower than its ROA of ~8%. Instead, "the Group invested in a portfolio of quoted securities, unquoted equity investment and compounded financial instruments amounting to S$1,148.9 million" in Q2 2012. This amounts to 9% of its total asset and yet there is a lack of transparency as to what sort of equity investment and financial instrument did Genting Singapore decide to play with. In any case, equity investment is definitely not a core competency of Genting Singapore.

Figure 3 - Receivables
Figure 4 - DSO Not Accounting the Mass Market Revenue

Figure 3 is something that I don't find very comfortable with, which is that Days' Sale Outstanding of Genting Singapore is as high as around 3 months and have been rising ever since RWS commenced operation in 2010. And if we take into account the fact that casino is not supposed to grant any Singaporeans and PRs credit unless they are Premium Player (deposited $100k as credit balance), the actual DSO is much higher as seen in Figure 4.  In fact, it has gone up as high as 150 days in 2012 1H which is equals to 5 months of receivables. This is just the tip of the iceberg...

Figure 5 - Impairment Loss of Receivables

In actual fact, Genting Singapore has been taking significant amount of impairment loss ever since RWS started. It has ranged at an average of 17% of total receivables and 4% of total revenue which is not a small amount. This figure is not shown explicitly in the Income Statement as it is hidden in the "PROFIT/ (LOSS) BEFORE TAXATION – CONTINUING OPERATIONS" under rows of figures. Alternatively, it can also be found in the cash flow statement. Performing impairment losses every quarter is something that's worth noting about and I will elaborate on the reasons for the receivables in Part 2.

Figure 6 - Profitability Ratio

Figure 7 - Profitability Ratio of Macau Peers

I have always thought that being one of two casinos in Singapore should have made it very profitable, but it seemed otherwise with its average ROA of 7-8%, ROE of 12-13% and ROIC of 12-13%. While some might have thought that the $2.3 billion perpetual securities have dragged the profitability, ROA and ROE are at 7% and 12% after taking away the perpetual securities. Such profitability ratio seemed to imply an average company and not one with sustainable competitive advantage.

Now, compare to Macau Peers with an average ROA of 20% and ROE of 60%, it seemed like RWS really pale in comparison especially as an Integrated Resort company operating in a duopoly structure. Given that Genting Singapore has a high profit margin of 23% to 31%, it means that its asset turnover ratio is very low. Not forgetting that Macau's casino are subjected to a 40% tax on gross gaming revenue as compared to 12% in Singapore. Looking back at Figure 2, PPE accounted for 45% of total asset, which means that volume is much more important than profit margin in order to drive operating leverage. Macau's peers does have a lower  profit margin, but they are able to make it up with high asset turnover. This will be explained in Part 2.

Figure 8- Cash Flow Statement

Figure 9 - Cash Flow Analysis

Free cash flow has been unstable as the company is still at an investment phase as the West Zone and Marine Life Park is not yet opened. Until the investment phase is over, we will not be able to see a clear picture of the maintenance capex and derive a stable state FCF.  However, as a guide, PPE as a percentage of revenue has been around 20-40% of revenue during this phase and I expect the maintenance figure to be around 5% -8% of total revenue when it is done with the initial investment.

In conclusion, we can see from its financial statement that it is certainly not a company with a very strong business model. In that case, it seemed to have been overpriced at PER of 16x and 18X based on FY 11 results and forecast FY 12 result. Part 2 will be on the industry and Genting's business model. 

Monday, August 20, 2012

VICOM - 2012 1H Update

With the release of 2012 1H results, VICOM has hit an all-time high of $4.70 after PAT increased by 10.7% in 2012 1H.

Figure 1 - Income Statement

The 1st quarter has been the most spectacular with profit growing by 13.2%. Comparatively, Q2 2012 has not been as fantastic, delivering a 8.1% growth on profit after taxation. Revenue for both period grows at an average of 7.9%. Unfortunately, VICOM no longer discloses the segmental result after the change of CEO. Personally, I believe that both segments should be delivering similar growth at 7-8% and not that one particular segment has been driving the growth. 

Back to operating expense, total operating expense increases by 8.6% in 2Q 2012 and 3.1% in 1Q 2012. Staff cost increases by only 0.4% in 1Q 2012 due to write-back of provisional bonus while in 2Q2012 it is in line with total revenue growth. Depreciation expenses increase as a result of higher depreciation coming from the new building at teban garden. All other operating expenses continue to increase above the increase in revenue which makes me wonder if cost-saving is indeed achieved from shifting the HQ to teban garden.

With the help of lower taxation in 2Q 2012, VICOM managed to achieve a 8.1% growth in profit. Lower taxation comes from "enhanced capital allowances on qualifying expenditure under the Productivity and Innovation". http://iras.gov.sg/irasHome/page04.aspx?id=13838

Figure 2 - Balance Sheet

After the distribution of $9.4m in final dividend, cash and bank balances manage to increase by $600k despite a $3.5m reduction in trade and other payables. Nothing else worth mentioning about the balance sheet other than that compared to FY2011, vehicles, premises and equipment decreases from $55.5m to $54.7m which shows that depreciation is more than total capital expenditure.

For cash flow statement, VICOM generated 81% operating cash on net profit after taxation. It is supposed to be higher as trade receivables increased by $1m and trade payables decreased by $3.5m. Total capital expenditure is only $1.9m for 1H 2012 which is about 15% of net profit. Personally, I do expect a 100% and above FCF/Net Profit Yield for FY 2012. As capex has been significantly reduced with the completion of new HQ at SETSCO, the interim dividend declared increases from 6.9 cents to 7.5 cents. This is still a very comfortable payout ratio for VICOM and there's certainly room for another 10-20% more. Total dividend paid for the interim will be $6.6m which is approximately net profit for a single quarter.

Prospect

Just last month, Minister Lui has announced a few measures to ease the spike in prices of COE which are marginally beneficial to VICOM. Initially, car population growth rate is supposed to be cut from the current 1.5% to 0.5% by August this year and continued until 2014 where the growth rate will be subjected to change. The authority has since delayed the cut to 0.5% to February 2013 while maintaining a 1% growth rate from August 2012. According to LTA, an additional 390 COE will be made available per month which works out to an extra 2340 vehicles in total.

The clawback of oversupply of COEs will also be delayed by a year to July 2013, making available 266 more COE per month, which is 3192 in total. In another move, LTA has set the taxi fleet growth rate at 2% pa from Aug 2012 to December 2013 and they will not be bidding for COE. While the 2% growth rate will come at the expense of Cat E COE, a taxi contributes 7x the revenue of a civilian car in a 3 years period.

These measures are temporary moves that will only defer the cut so as to alleviate the spiking COE prices which played an important role in our CPI. Most importantly, they signal the will of the government to resolve the problem of overcrowding vehicle population.

Figure 3 - Age Distribution Data

The age distribution data has been one of the most important data that I monitored monthly from the LTA site as it determines the proportion of the population undergoing inspection. The continued ageing profile of vehicle population has continued to amaze me. As seen from Figure 3, the proportion of vehicle aged 6 years and above has increased by 9.7% in July 2012 as compared to December 2011. When this ageing will start to peak is beyond my ability though I do expect the trend to continue at least until the end of this year. For as long as the price of COE remains at the current level, I do not foresee any significant reversal in the age profile.

As for SETSCO, I am not aware of any new service that they have been accredited in FY 2012. As for inspection of central alarm monitoring station (CAMS), they are currently still the only one with the appropriate accreditation.

Should the earning growth continues, we should expect a minimum of 8-10% profit growth in FY 2012. Assuming a 10% growth, total dividend to be paid out for FY 2012 will be $0.194 based on similar payout ratio of 60%. At the current price of $4.56, it will give us a 4.25% dividend yield, PER of 15.4x or Forward PER of 14.3. Many will definitely ask me whether it is the right price to buy or not and my answer will be that the margin of safety at the current price will be limited. However, I will still be holding on to my shareholding as I believe that the growth story of VICOM is not yet over and will be able to prove its resilience during this period of economic uncertainty.

Tuesday, August 14, 2012

Healthway Medical Corp Ltd - Turnaround probably not in the short term

Healthway Medical Corp is one of the few companies in the healthcare sector listed on the SGX, operating the biggest clinic network in Singapore. Other than operating GP clinics and dental services, they are also involved in specialist & wellness healthcare division which is involved in Paediatrics, Orthopaedics and Aesthetic Medicine.

Figure 1 - Income Statement

FYI, 2005 to 2007 results are PRO FORMA results found from the IPO prospectus and hence might differ from the actual figure that you see from the FY 2008 annual report. In fact, the pro forma result in 2007 is the highest level of profit that the group has ever recorded in its operating history. The trouble in Healthway occured in 2010 when a group of specialists decided to leave en mass which created a vacuum and losses of customers. What happened is the start of a drop in profitability which accumulated till 2011 where a $58m of intangible asset is being written off. In 2010, they should have also been in the red if not for gain from acquisition of Crane Medical and disposal of Healthway Medical Enterprises. 

2012 1H looks like a pretty good set of result that shows some turnaround occurring with Healthway recording a 10% margin for 2 straight quarters. The question is then has it really turned around? In actual fact, it seemed like the company has largely relied on its other income to boost its profitability. Looking back into the annual report 2011, the company has deferred booking $7.1m in income due to prudent reason of which it has booked approximately $1.6m in 2012 Q2 and perhaps another $1.2m in 2012 Q1 under other income. For more details regarding the deferred income, please refer to http://info.sgx.com/webcoranncatth.nsf/VwAttachments/Att_6AF4D9F6C8EC525F482579E10075BE16/$file/HMCMaterialVariances.pdf?openelement
Now, I shall present the pro forma income statement for 2012 Q1 and Q2 after stripping out these deferred income from 2011.

Figure 2 - Pro Forma Income Statement for 2012 1H

What we see is that nothing much has changed for 2012 1H after taking away the deferred income from 2011, and the company is obviously still struggling to maintain its profitability. Since these deferred income is non-recurrent in nature, it seemed like the company is still stuck in the limbo.

Figure 3 - Operating expense ratio

Figure 3 will allow us to understand the loss in profitability of the company since 2010. From figure 3, we can easily see that the main cause of the losses has been staff cost which has risen from around 44% in 2008 and 2009 to approximately 56% of revenue ever since 2010. In 2012 Q1 and Q2, this has also been held true which goes to show that the level of profitability is similar to that in 2010 and 2011. Do take note that actual percentage for 2011 should also be around 55% as the company chose to "derecognised staff cost recharges of $4.5 million to a 3rd party which remained unpaid" (part of the $7.1 million in deferred income).

However, it is not all bleak from the above figure. The cost of medical supplies and other operating expense as a percentage of revenue have held pretty steady which means that the company has been able to pass on increase in medicine cost and rental to its customers. Another positive point to note lies in its staff cost which in fact provide huge potential for operating leverage given that this is largely a fix cost. If Healthway can focus on increasing its revenue per clinic per doctor, it will definitely be able to return to its profitability in 2009. However, it seemed like the company's main focus is still on further expanding their services be it in specialist, aesthetic or in China.

Figure 4 - Balance Sheet

This is definitely not the ideal balance sheet that any company should have and the biggest problem will be in the intangible asset which stands at $119m compared to $198m in total asset and $160m in total equity. I will discuss about the intangible asset later on. The new management has done a pretty good job in reducing the total debt from a high of $68m in 2008 to the current debt level of $17m. Cash has unfortunately dwindled down to a worryingly level of $5m which raise the prospect of some form of financing option in the short term. However, the group has a loan receivables of $15m which are supposed to be returned to them in the current financial year and this will hopefully strengthen their balance sheet.  

Intangible Asset

Let's explore the intangible asset which is worth $179m at its high in 2007. When company A uses $10m to acquire company B with net tangible asset of $5m, the excess $5m over the NTA will be booked under intangible asset. Therefore, we have to trace back the history of HMC to understand how did such a huge amount of intangible asset appears in the first place.

Founded by Dr Wong Weng Hong in 1990, HMG expanded its network of clinic to 15 by 1997 and 31 in 2002 before it went on to acquire 4 clinics under "Singapore Family Clinic and Surgery". A management buyout was carried out in 2006 by the founder together with Fan Kow Hin, Dr Jong Hee Sen and a few other investors. By the end of 2006, the group only has a total of 38 clinics, which paled far in comparison to the 80+ they had by the time they were listed in 2008. In the mere span of 1 year, the group went on a massive acquisition spree paying $72.32 million for "Silver Cross" and "Peace" group of family clinic, "Aaron" and "Universal" groups of dental clinics, "Paediatric Centre", "BCNG Laser and Medical Aesthetics". They also went into agreement to acquire IOC, IOCH, SBCC Clinic and SBCC S&T for $107.9m. Therefore, by spending $180m the group managed to expand from a sole family medicine clinic chain into specialist and wellness healthcare services before they got themselves listed on the exchange. Given that they do not have that much cash at that point in time, the acquisition was done through offering of share which lead to its specialist leaving en mass in 2010.

Figure 5 - Intangible Asset

Figure 5 shows us the breakdown of intangible asset as well as the impairment loss carried out in 2011. We can see that the bulk of the write down are for Paediatrics and Orthopaedics which falls under the specialist segment. Family medicine is probably their strongest division as no write-down has been carried out so far. It seemed like it has been a huge mistake for the firm to acquire IOCC, Paediatrics Centre and SBCC in 2007.  

The greater concern currently will then be is the write-down in 2011 the last of impairment loss? Unfortunately, what I see is that another $60m in intangible asset needs to be written down. The calculation of impairment is based on DCF calculation using a discount rate of 8.5% and projecting a terminal value based on the EBIT "from the 6th year at annual growth rate of 1% to 3% to perpetuity." This is definitely acceptable to me. The devil is in the detail where the cash flow growth is projected for the first 5 years. For Family Medicine, Dentistry and Wellness and aesthetics, expected annual revenue growth is approximately 4% from 2012 to 2016.

However, for the Paediatrics and Orthopaedics division, the anticipated annual revenue growth is 9% from 2012 to 2016! Remember that these 2 divisions were the ones that have to be written off in 2011, then why does it have so much higher projected revenue growth than the family medicine? Specialist and Wellness segment produced a loss of $3.7m on revenue of $25.6m before the impairment loss. What's more, the anticipated annual revenue growth in FY 2010 for  Paediatrics and Orthopaedics was at 4% and after 1 year of poor performance, they are now expected to deliver double the revenue growth in FY 2011. I believe that the increase in anticipated annual revenue growth from 4% to 9% is done so as to reduce the amount of impairment loss being recognised in 2011 for both Paediatrics and Orthopaedics division. In any case, I believe that it is pretty reasonable to expect a complete write-off of total intangible asset of $59.5 m for these 2 particular divisions. Garbage In, Garbage Out, but not unexpected from a firm that seemed to love performing financial engineering since they are listed.

Figure 6 - Profitability Ratio

Many might have pointed out that its ROA even in its most profitable year is unimpressive at 7.7% based on the Pro Forma statement. However, if we were to strip out the intangible asset, it seemed like we have a highly profitable business at least before what happened in 2010. As for free cash flow, it seemed like has the ability to generate good cashflow in the long run should profitability stay or improve. Total capex for 5 years are only at $8.5 million of which majority occurred in 2010 where multiple specialist clinics are opened especially the ones at Tripleone Somerset. 

From a valuation point of view, despite the fact that price has tumbled since IPO, the company does not look attractive. With a PSR of 2.0, even if the company manages to return to a 10% profit margin, it will be a PER of 20 which is just slightly lower than the well-run Raffles Medical Group which has a much better track record and balance sheet.

To conclude, an actual turnaround has not really occurred despite the return to profitability in 2012 1H. Discounting the deferred income from 2011, profitability probably remains the same as the past 2 years. For as long as the intangible asset stays in the balance sheet, I believe it will be a time bomb that will not be welcomed by investor. While it is reasonable to say that some gestation period is needed for new clinics to turn in profits, it seemed like there remains numerous loss-making clinics around.

Without doubt, things have definitely changed for the better with the new CEO, Mr Lam Pin Woon in Jan 2011 as we see debt being pared down and a much lower staff turnover rate. Discounting the intangible asset, it is likely that they do have a crown jewel in family medicine clinic and management of clinic and asset. However, it seemed like the company has yet to internalise the importance of focus in operation as they embark on their expansion plan in China and specialist division in Singapore at a point where their balance sheet is weak and certain operations are bleeding. Whether the strategy will work out remains to be seen though it is likely that any turnaround will be visible only in the middle to long term, especially when their clientèle base for specialist and wellness builds up.

Sunday, August 5, 2012

SIA Engineering - 3rd Core Business in Engine Overhaul

Many that have attended the AGM for SIA Engineering on 20th July 2012 will have agreed that it has been a great session that provides important insights into the SIAEC's business model during the past decade. One of the most important will have been the fact that the management has been very willing to cannibalise their business to support the growth of their JVs and associate companies.

The first reason is that OEMs are increasingly going into the MRO space and it is either you compete or collaborate. However, as with all collaborations, there must be something which you can offer before the other party will be willing to do so (SIA's business). The second reason is that this is one of the best way for SIAEC to reach out to global clients. Without a JV, the management explained that other airlines might not be willing to engage the service of SIAEC due to certain sensitive data. By forming a JV with credible partners, competing airlines will be less guarded and SIAEC will also be able to tap onto the network of its partner.

The question that pops up now is obviously to what extent has the cannibalisation taken place? However, upon digging deeper into the past years annual report, initial prospectus, analyst presentation, I found a shocking truth with regards to its network of 26 JVs and associate companies. In actual fact, of the 26 joint ventures, there were only 3 that are really important - Eagle Services Asia, Singapore Aero Engine Service Limited and International Engine Component Overhaul Private Limited. What is even more surprising is that the share of profit of these 3 companies are very close to the total operating profit of SIAEC's core business of Line Maintenance and Repair and Overhaul. Coincidently, these 3 companies can in fact be grouped under the Engine Overhaul business and they are with 2 of the top 3 aero engine manufacturers Rolls Royce and Eagle Services Asia.

Figure 1 - Associates

Now, I will take you through the accounting of its associates and JV before I delve deeper into its Engine Overhaul Business. This part might be slightly complicated as it involves accounting for associates and joint venture. Note that Eagle Services Asia is being accounted as part of the Associated Companies as it is 49% owned by SIAEC. "Unquoted shares, at cost" is the initial outlay of capital by SIAEC in forming the associate. Under normal balance sheet term, it is also known as share capital under the Equity portion. "Share of post-acquisition profit" is SIAEC's share of the accumulated profit or retained earning by the companies. Translation adjustment is there as these associate companies don;t report their financial statement in SGD, instead most of them are reporting in terms of USD. 

Figure 2 - Share of Profits of Associates Companies

For 2005 and 2006, 100% of revenue, asset and profits are reported before the accounting is changed in 2007 onwards, where only SIAEC's share of the profit and equity of the company is being reported. Luckily, sufficient information has been divulged for us to understand the profitability of its associated companies. 

Starting with the balance sheet, there is supposedly very little off-balance sheet financing done as the non-current liabilities are only around 3% of net asset. The best measure of profitability are always profit margin as well as ROA and ROE. These figures have been very impressive for its associated companies as we see a profit margin of 8-15%, ROA of 15-25% and ROE of 19-28%. Just by its ROA of 15-25%, we can easily conclude that this business is definitely worth something. 

Something that your might have noticed is that, the performance of its associated companies seemed to have peaked in 2009 with share of profit as well as the profitability ratios dropping. Asking the CEO, he told me that as all its associated companies are being accounted in USD, it has suffered the effect of depreciating USD. Notice that I have sought to account for the translational effect in Figure 1. I applied this to the revenue and net profit and what we see is that revenue has increased but profits have dropped which means that certain business have been dragging the profitability. Given that 3 new ventures have been set up in the past 3 years namely Safran Electronics Asia, Southern Airports Aircraft Maintenance and Panasonic Avionics Services, it could be likely that some of it has not reached its point of break even and hence incurred some losses. 
Joint Venture

Joint Venture
Share of Profit of Joint Venture

There is a very interest fact about its JV, which is that it comprises of only 2 companies, Singapore Aero Engine Services Pte Ltd and International Engine Component Overhaul Pte Ltd which are formed with Rolls Royce. Therefore, we can safely conclude that all of SIAEC's share of profit of joint venture, comes from these 2 JVs which are in the business of engine overhaul.

Over the years, this division has been very successful in growing the top and bottom line ever since it started full operation in 2002. Given that the share of profit from JV companies is $74.7 million, it means that total revenue and profit from these 2 companies amount to $1.5 billion and $148m which is more than total revenue and operating profit of SIAEC in 2012! Compared to the associate companies, the balance sheet for JV is not as clean as there is a $58 million of long-term liabilities which is likely to be debt. Comparable margin with the associate companies, though it seemed to be a super profitable business with a ROA of 28.76% and ROE of 64.94%.  It is very rare to have such a high ROA, which is usually reserved for companies involved in technology or business services. Since 2010 onwards, dividend payout ratio has been close to 100%, which might mean that the business is in a rather auto-pilot mode already. 

Figure 5 - SIA contribution and Engine Overhaul Business

Figure 5 is made up of data derived from the analyst presentation done by SIAEC after release of its full year result. The first row is basically the contribution coming from different segment of its associates and JVs. Initially, it was just Engine Overhaul which comprises of Eagle Service Asia and Singapore Aero Engine Service, as well as all others. As we can see ESA and SAESL easily contribute around  60% of the total profit for share of profit of associate and JV for SIAEC. After FY08/09, the format has changed from Engine Overhaul to Engine Overhaul and Component.

The first table can also help us to pinpoint the weak division that has been dragging down the share of profit of associate. Ever since 2009, both division has taken some hit though the "others" have not yet recovered. What we can deduce is it is likely that the multiple new start-up in Safran, Panasonic and Southern Airport have created some losses, coupled with perhaps a slight drop in profitability of certain associate. As for engine and overhaul, we can easily deduced that ESA might be the culprit as we see that the result from JV has been improving over the years.

Moving on to the 2nd table which is SIA's contribution of JV & associate revenue, and which will reveal the extent of cannibalisation done by SIA to support the JV and associate. For "Others", SIA's contribution has been increasing hitting a peak in FY1112 with $55m in revenue contribution. This does confirm that the Panasonic Avionics is likely to account for the $14m increase in revenue contribution and the reason which the CEO attributed for dragging down the profitability of line maintenance.

For Engine Overhaul and Component, what we see is fluctuating numbers with the lowest point being in FY1011. And this coincides with the decrease in profitability of the division in FY 0910 and 1011. What actually happened? Checking through the Singapore Registered Aircraft Information from CAAS, I realised that it is because SIA has been reducing its number of B747 which runs on P&W engines from 33 in Jan 2008 to 20 in Jan 2011. With the addition of A330 and A380, 80% of the aircraft of SIA are now running on Rolls Royce Engine. This certainly explains why profit from its JV has been increasing over the years while the ESA has been suffering. Some might ask then if SIA switches from P&W engine to Rolls Royce engine, should not the overall contribution by SIA for Engine and Overhaul remains the same? The answer is simply that the new aircraft probably does not need to do an engine overhaul, and hence we starts to see SIA's revenue contribution return to the peak in FY 1112 as these aircraft reaches the stage where repair and overhaul needs to be done.
Now to the 3rd and 4th table, Non-SIA's contribution of JV & associate revenue, we can see that demand for Engine Overhaul and Component has a pretty strong demand. As for others, revenue drops by 60% since FY1011 and I wonder if this is due to an allocation of some revenue from Others to Engine Overhaul and Component. In any case, we can see that total revenue from Non-SIA has been increasing from $1.265 billion in FY0506 to $2.67 billion in FY1112. They have achieved success in growing the Non-SIA business  to more than 80% for the last 3 years.

Eagle Service Asia and Singapore Aero Engine Service Pte Ltd

Without much doubt, these 2 forms the core of SIAEC's associate and JV and they are in the business of engine overhaul and repair for P&W and Rolls Royce. Usually, when engines are purchased from the OEM, a package is purchased that includes repair and overhaul for a period of time. These aftercare services are often more profitable than the actual selling of the engine and also provides future source of income for the OEM.
Figure 6 - P&W

Eagle Service Asia is an important arm of Pratts & Whitney handling the engine overhaul business in South East Asia. P&W also provides engine overhaul services in New Zealand, North America, China and Turkey.  From a cost point of view, airlines will send their plane to the nearest service centre, giving ESA a monopoly status over the SEA region for repairing of planes running on P&W engine. And in 2012, ESA has been the first engine center designated to service the PW1500G engine, which has been selected as the exclusive engine for Bombardier CSeries aircraft. The PW1000G engine series will be in production by 2013.

Singapore Aero Engine Service Pte Ltd is Rolls Royce's Centre of Excellence that specialises in the repair and overhaul of the successful family of Rolls-Royce Trent aero engines. It is also the only one currently that is able to service all variants of "in-service" Trent Engine. As a reference, the Trent Engine has commonly been used in popular aircraft like B777, A340 and A380 which forms the bulk of SIA's fleet. SilkAir, Tiger Airways and JetStar Airways are all using 2 type of aircraft which are A319 and A320 which are all running on Rolls Royce V2500 engines. Currently, the facility is able to service up to 250 Trent Engines every years. While I am not sure how many other engine overhaul centres are in service around the world, it is likely that the OEM will want to minimize the number of such centres to reduce cost.

In conclusion, SIAEC has a 3rd core business in Engine Overhaul business, just that this has been done through partnering with P&W and Rolls Royce. It has also been a good thing that it has partnered with both OEMs in case any of the 2 loses to each other in competition to be the engine of choice. For this segment, growth will be directly linked to the total number of aircraft in service. As for its other 23 associates, it seemed like they are minor contributors though there is a serious lack of information on them. Feel free to comment on the data above.

Sunday, July 22, 2012

Lessons Learnt From My First 3 Months

Not too long ago, I was introduced to this portfolio tracking tool on Excel called the XIRR. I give up on using it as it don't seemed very accurate or perhaps I made some error because I don't fully understand it. Since I have compiled my trade history, I think it will be useful to share my wonderful experience with the market during my first 3 months. It was a really good experience and without with I think I will not have improved much especially when it comes to emotional balance.
Figure 1 - Trade History

So this is my trade history when I just started out in the market. The decision to take the plunge at the onset of the current Euro Zone crisis last September is a wise move as I started to get used to market gyration. So on 22nd September 2011, I got my trading account and bought my first 2 stocks - VICOM and Eratat. VICOM was a great choice and I bought it for I think it is a great piece of business. 


For Eratat, I thought it was being deeply undervalued and I was drawn into its story of going up the value chain to price itself as a premium brand.  Profit margin is growing and profit and revenue have been jumping higher each year. Coupled with its high cash position and low P/E of less than 2, it looks like an ideal value stock. I sold 2/3 of it in 10th November 2011 at a loss of 9.7%. Lesson Learnt - Accounting skill is extremely important when doing fundamental analysis. 

3 days later, I flew to Australia as part of military exercise and thus I did not do any trading until I came back   at the end of October. I bought into this stock called Sunvic Chemical as it has some share buyback programme and I think it is going to deliver a good quarterly result as price of the ester commodity seemed to be doing fine. Subsequently, I can no longer stand the price fluctuation and decide to sold it at a loss. Lucky, I sold it as it subsequently reported a 40% drop in quarterly profit. Lesson Learnt - Do not buy a stock if you cannot stand the price fluctuation.

While the loss was only 2.97% and maybe a few hundred, I cannot take the losses and was determined to get back into the black. Not long after, I got to know about this stock called Mewah through some investment website and blog. Basically, there was insider buying and speculation that it will have be a turnaround for the next quarter. I was hoping to be able to recoup my losses but I ended up losing money yet again though I was quick to cut my losses. Lesson Learnt - Don't buy on rumours.

As I continue to slump into the losses, I was even more determined to get out of it. So I went into Sunvic again, hoping to make some quick bucks. Luck was not on my side and I sold it off 4 days later at 4.94% losses. Lesson Learnt - Things get worse when you are speculating aka gambling...

Subsequently, I bought into UOL($4.26) since it seemed to be undervalued though I did not really do much analysis. 2 days later, ASSD was announced and all the property counter starts to crash heavily and I sold it at a 5% loss once again. Of course, if I have done my homework I might not have sold UOL given that it holds hotels, offices and retail malls. Lesson Learnt - Always do your homework.

I also bought into SIA Engineering as I want to reduce my "gambling" chips as I am quite scared about the losses coming from speculation. However, I did make a mistake in buying again the next day at $3.53, thinking that I was averaging down. Lesson Learnt - Averaging down target should at least be 10-20% lower.

After that, I bought OUE at $2.05 and sold it at $2.05 incurring brokerage losses. Once again, I was trying to recoup my ballooning losses but I cannot take it and sold it. Lesson Learnt - Even if you manage to sell away your stock at the original price, you will still be incurring brokerage losses. 

Then I bought into SMB United as a arbitrage play given that the original offer from Boer is a bit too cheap. I was thinking that even if the offer fails, the company is still worth more. Finally, Lady Luck smiled on me and I got away with a 13.2% gain though I am still quite in the red.

Getting away lucky, I venture into CD/XD play with UtdOAus which was trading in SGD but declared the dividend in Aussie. I got away with a 2.68% gain though I am sure I am still speculating.

At the end of the year, I bought into San Teh upon the declaration of dividend distribution the previous night. Not only was i speculating, I keyed in twice the amount as I was not aware that I failed to cancel the previous trade. Needless to say, I made ~8% losses again as I sold it within 3 days as I know I do not have enough money to pay for it. Lesson Learnt - Always check the trade that you have entered especially if you are doing online trading on your own.

In all, I made 11% in realised losses using NAV within 3 months and I told myself that I am going to stop speculating once and for all. I have read The Intelligent Investor before I have started, but I simply cannot control the very powerful feeling of greed and fear within me. 

However, I am glad that I have paid for the lesson and become determined to follow the proper path. I restructure my portfolio and sold the loss-making Eratat. I bought companies like HR Glass ($1.06) and additional stake in VICOM before the minor bull returned in 2012.

Summary of Lessons Learnt –
  1. Accounting skill is extremely important when doing fundamental analysis. 
  2. Do not buy a stock if you cannot stand the price fluctuation.
  3. Don't buy on rumours.
  4. Things get worse when you are speculating aka gambling...
  5. Always do your homework.
  6. Averaging down target should at least be 10-20% lower.
  7. Even if you manage to sell away your stock at the original price, you will still be incurring brokerage losses. 
  8. Always check the trade that you have entered especially if you are doing online trading on your own.
That's why I have always said that I am blessed to have started on September 2011 in the midst of the trial and tribulation ongoing in the market. The bear is where you learnt the most as it is akin to putting yourself on a survival mode out in the open sea. If I have started in a bull market, I supposed I will have made much better gain before my portfolio will get wiped out when the bear returns. I am happily waiting for the giant bear to come though it will probably not be any time soon. That will be where I can get to understand my character and emotional balance best.

Saturday, July 14, 2012

SIA Engineering Company (Operation)


Fig 1 - Operating Segments

SIAEC has 2 core operations in repair and overhaul as well as in Line Maintenance. Line management makes up around 35% of total revenue while repair and overhaul makes up the other 65%. However, if we were to look at the results, line management makes up 65% as compared to 35% for repair and overhaul. This implies that line management is a much more profitable business for SIAEC as compared to repair and overhaul.

Repair and Overhaul

Under the rules of aviation authority worldwide, planes have to undergo periodic inspection before they are allowed to fly off (being deemed airworthiness). This rule is implemented to ensure the safety of passenger as a faulty plane is fatal in the air. Other than the scheduled routine maintenance, SIA also provides other services like aircraft modification,  paint stripping, conversion of  aircraft cabin interiors and e.t.c. Fees are typically being charged based on a fixed fee per man-hour as well as cost of all the materials used. 

Commonly, there are 4 checks which a plane has to undergo throughout its lifespan in order for it to be approved for flying off. These are known as the "A", "B", "C" and "D" check. "A" check is the most basic level of check and will be done every 500 flight hours. "B" check is an expanded form of "A" check and is done every 4-6 months. "C" check involves the whole aircraft and is performed every 15 months or 5000 flight hours. The aircraft will have to be put out of service for around 1-2 weeks when performing a "C" check. Last but not least, "D" check is performed every 25,000 flight hours or 5 years, whichever is earlier. This is the most comprehensive and expensive check and will take around 1-2 months to complete. For the reason of cost, some airline might choose to scrape off the plane before it reaches its next "D" check.

Theoretically, we can hence view this part as fairly resilient as an airline has to continue its scheduled maintenance unless they choose to ground it or scrap it. Decision to ground an aircraft may not be the most cost-efficient move. Planes are not cheap and with a lifespan of 15 years (for SIA's plane), grounding it for a year or 2 will represent a waste of capacity. Other planes will also has to bear with heavier load and should the airline decides to de-ground it all the previous check missed will have to be carried out. For your information, "Aircraft maintenance and overhaul costs" represent 3% of total revenue for SIA. 

Figure 2 - Number of Registered Aircraft

Given that SIA and its subsidiaries and associates account for a huge percentage of total revenue, let's have a look at their number of registered aircraft throughout the past 5 years. As seen from the table, there has only been a slow increasing trend for SIA, Silkair and Tiger Airway (30+% owned by SIA). During the difficult time of 2008 to 2009, we hardly see any contraction in the numbers. For 31-Mar-12, 2 planes has been transferred to Scoot. From 31-Jan-2007 to the latest data as of 30-Jun-2012, there has been an increase in total number of aircraft from 128 to 156, representing a 20% increase.

Figure 3 - Number of Checks Performed by SIAEC

Digging into the 11 years data, I have compiled the number of checks performed by SIAEC as well as its maintenance and overhaul revenue. I have also highlighted recessionary year in orange - namely 2001 9/11, 2003 SARS and 2008 GFC. For FY 2007/2008,  there is a revised maintenance schedule that extend the interval between each check, creating a drop in A check for 2007/2008. From the table, we can easily deduce that a normal financial crisis is not enough a dampener for SIAEC as revenue manages to hold on well. However, a greater aviation crisis like SARS is able to reduce its revenue by 20%. One point to note is that as customers are charged based on man-hour, an "A" check revenue is not equal to that of a "C" check or "D" check. Depending on the extent of check, an "A" check requires 500-1000 man-hours as compared to 1000-8000 for "C" check and 20,000-50,000 for a "D" check. 

Line Maintenance and Technical Ground Handling

For line maintenance, its job is to "release certification, such as aircraft transit checks, night-stop checks and rectification of defects as well as maintenance and repair of aircraft radio systems, navigation and
communication systems, radar and cabin management interactive video systems". SIAEC's main task is to ensure that the aircraft has done all relevant checks before they are issued with the airworthiness certification.   

For technical ground handling, they provide services "such as push-back and towing of aircraft, water and lavatory servicing and the provision of aircraft ground support equipment". To sum up, this division is highly correlated with the number of flights received by Changi Airport as the higher the number of flight, the higher the revenue is. SIAEC has approximately 80% market share in Changi Airport Singapore.

This division also enjoys a high profit margin of 20% as noted earlier as a result of the low expenses involved. For Repair and Overhaul, material cost and equipment depreciation are involved resulting in a much lower profit margin. However, for line maintenance, it is relatively asset-light and fees are charged based on a flat fee per flight handled basis with the bulk of the cost being manpower.

Figure 4 - Flights handled by SIAEC at Changi Airport

Just as how the number of departure flights have increased over the years, number of flights handled by SIAEC has also shown a similar trend. Revenue is also correlated with the number of flights being handled. Hence, this division will be in sync with future growth in air traffic at Changi Airport, especially with the ASEAN Open Skies agreement in 2015 where traffic is expected to expand by at least 5% per year. Air traffic is relatively stable apart from the 2003 SARS where there is a 25% drop in revenue as a result of a drop in number of flights handled. 

To conclude, both of SIAEC's core operations are relatively stable even during a normal recession. Should a crisis like SARS occur once again, we can then expect some significant drop in revenue at a range of 20-30%. The line maintenance business also have a chance to grow in line with the air traffic at Changi Airport. However, SIAEC has a huge proportion of earnings coming from its investment, associates and JV, which we cannot overlook.

Investments, Associates and Joint Ventures

Not willing to be solely dependent on Singapore's air traffic for growth, SIAEC has been constantly seeking growth through external partnership. Its external partnership strategy is a two-pronged approach where it partners with well-known high-tech OEM to build its expertise as well as seeking overseas partner to start line maintenance business to grow its revenue base.

Figure 5 - Joint Venture with OEM

It has always been part of the strategy to invest in a joint venture with established OEM to expand the breadth and depth of their services. Not only will they get an increase in revenue, SIAEC will also be able to provide better technical expertise for its MRO customers. Partners can also benefit from the customer base of SIAEC in Singapore. 

Some of the major partners involved are like Rolls-Royce and Pratt & Whitney which are 2 of the 3 largest aero-engine manufacturers. A wide range of repair services are also provided like hydraulic pump, thermal coating, engines, fuel accessory, turbine, aircraft cabin, landing gear, compressor and avionics. These services help SIAEC to market itself as a one-stop service contractor that can take care of all needs.

Figure 6 - Line Maintenance Joint Venture

 While SIAEC have joint venture  in Pan Asia Pacific Aviation Services and PT JAS Aero-Engineering Services, they seemed to have adopted a new strategy ever since the joint venture of Aviation Partnership (Philippines) Corporation was formed in 2005. The strategy has been to make use of line maintenance activities which require lower capital expenditure and start-up time to expand into repair and overhaul services at a later stage. The line maintenance partnership will allow them to forge a critical mass of customer base and business volume.

After the partnership with Cebu Pacific Air in Philippines, SIA Engineering (Philippines) commences operation in 2009 becoming their first overseas based heavy maintenance facility. In 2007, SIAEC acquired Aircraft Maintenance Services Australia (AMSA) which offers line maintenance services in Sydney, Brisbane, Coolangatta, Melbourne, Adelaide and Perth. After the success in Philippines, SIAEC went on to establish Southern Airports Aircraft Maintenance Services (SAAM) with Southern Airports Corporation. Having commenced operation in late 2010, there has been plan to expand to other airports in Vietnam and to scale up operations to provide heavy maintenance.

To conclude, SIA Engineering will be a better way to take advantage of growing air traffic rather than SIA which is subjected to fuel cost, higher capex and more intense competition. While its resilience is respectable, expect some decline in both top-line and bottom-line during a global epidemic on the scale of SARS. There has also been signs that they are seeking to expand beyond their stronghold in Singapore to countries like Philippines, Vietnam, USA and Indonesia. Meanwhile, shareholders can benefit from the slow and steady growth in air travel industry in Singapore with our 2 IRs, F1 and other events.

Tuesday, July 10, 2012

SIA Engineering Company (Financial Statement)

SIA Engineering Company (SIAEC) is a leading provider of maintenance, repair and overhaul (MRO) services of aircraft as well as providing line maintenance services and technical ground handling in Changi Airport as well as in airports in USA, Hong Kong, Indonesia, Philippines and Vietnam. Without further ado, let's look at the financial statement of SIAEC.

Figure 1 - Income Statement

Revenue has been on a slowly increasing uptrend from $878m in 2002 to $1.17 bn in 2011 which is an increase of 33% in 10 years. Other than in 2003 where there is a huge dip in revenue of 25%, the business is fairly recession proof with a 5% drop in 2009. This has to do with its business model which I will explain later. For expenditure wise, Staff cost is the highest contributor as the business is essentially reliant on a skilled labour force to perform MRO. 2nd biggest cost is material costs which is all the spare parts and repair material used in MRO of the aircraft. Together, they make up 58.9% of the total revenue. 

Something not commonly seen is that the net profit is always higher than the operating profit. This is due to the fact that it has 25 joint ventures and subsidiary which contributed a significant amount of profit. This has been part of its expansion strategy as it sees a limit to its organic growth. Since 2006, contribution coming from investment, associates and JV have exceeded 50% of net profit, and this will be discussed in greater detail later on. 


Figure 2 - SIA contribution to revenue

With the support of its parent company, SIA accounts for a huge portion of SIAEC's revenue. The figure is derived from SIA's annual report using inter-segment revenue under its engineering arm. I have also pro-rated the figure to account for the distribution of SATS by SIA in 2008. SIAEC provides technical support to Beijing Aviation Ground Services Company which is a JV by SATS. From the above table, we can infer that SIA contribution has been very stable over the decade and it is contribution from other airlines that have been driving growth in the top line. 

Figure 3 - Balance Sheet

There's also something very interesting about its balance sheet which is that it does not have any Non-current liability in the annual report. I have decided to classify the "deferred taxation" found under equity as long-term liability in line with the usual form of presentation. The company is very cash-rich with insignificant debt such that cash + short term deposit is around 40% of total equity. Receivables is insignificant being at around 8% of total revenue, which means they are collected every 28.56 days. PPE comprises another $300m and it is made up of $165m in leasehold land and building, $90m in Aircraft Rotable Spares and $37m in plant, equipment and tooling. Aircraft Rotable Spares are anything that requires routine replacement like enginer, pumps and tires. We can see that equipment needed for MRO is not very capital intensive. For its liability, it is pretty impressive that it is more than twice the amount of receivables at $263m. At a day payable outstanding of 82 days, it shows that SIAEC has significant leverage over its supplier. In all, this is a very clean balance sheet.

Figure 4 - Cash Flow Statement

For the net cash flow from operating activities, profits coming in from investment, JV and associates are being taken out and only the dividends are accounted under cash flow from investing activities. In calculating the FCF, I have taken into account purchase of intangible asset, dividend received from long-term investment, associate and JV. FCF/Net Profit ranged from 50% to 94% usually, and is susceptible to some fluctuation as they may not received 100% of profit from associate as dividend. There is a noticeable dip in 2007 and 2008 and this is due to much higher capex by the company in ensuring that its maintenance facility is A-380 ready. As such, get ready for a slight drop in dividend the next time there is another mega jumbo plane coming out. Under normal circumstance, the company should be able to maintain a FCF/Net Profit of around 85%.

Figure 5 - Financial Ratio

SIAEC has managed to maintain an operating profit margin of above 10% for the decade. While this might not be the net profit margin, the only negative item to deriving the net profit is taxation. Net profit margin might not be an accurate representation as they are being falsely inflated by the huge amount of share of profit of associate, JV and dividend from investment which are not accounted for in the revenue.

For a more accurate picture, we will then have to look at the ROA, ROE and ROIC. The figures are strong with ROA and ROE staying above 15% and 18% (other than the 2003 SARS) and ROIC above 14%. Discounting the effect of JV and associates, I have also did an adjusted ROA and ROE to look at SIAEC's organic operation. Adjusted ROA managed to stay above 11% while ROE is 13% which goes to show that its organic operation provides respectable return as well.

By all counts of financial leverage ratios, SIAEC has a very clean balance sheet as explained earlier. It has excellent working capital management as it has a negative cash conversion cycle of at least 30 days and more. Basically, this means that SIAEC can afford to distribute all its cash and short-term deposit without affecting its ability to continue operation. Not many firm has a negative cash conversion cycle.

The next part will be on the operation aspect.