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.

9 comments :

  1. as usual great analysis. so the summary is that specific business risks to changi airport poses higher problems that overall systematic risks

    the dividend yield is not good i feel.

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    1. The dividend yield is average at the current price but if you have gotten it during GFC at $1.60 to $1.90, the yield will have been awesome though there are many other cheap dividend plays out there at the same time as well. What I like about this stock is that its balance sheet is very clean.

      If we look at Profit before Taxation, Line Maintenance will account for 27% of the profit, while Repair and overhaul will account for 14.5% of profit. The rest of the 58% comes from share of profit of associate and joint venture. Line Maintenance's revenue is highly correlated to air traffic at Changi Airport as it is charged based on a flat fee x number of planes cleared.

      As for its repair and overhaul as well as JVs business, it will then not be as reliant on Changi Airport. There are a number of airlines that send their planes for inspection and maintenance to Singapore instead of where they are based at. As a reference, Singapore accounted for 21.5% of total aerospace MRO revenue in Asia Pacific in 2009. Skilled labour force is one reason why Singapore has been able to capture a large share of the pie. For this division, the more planes that an airline has, the higher the revenue.

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  2. What is the reason for decrease in profitability since listed? Domnihaihai

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    1. Hi, can you be more specific about the decrease in profitability?

      I assume that you are talking about the operating profit. If we look at the operating expense, the major expense is staff cost and this has been a major factor of operating profit.

      Since listing till 2006, there has been a fluctuation in staff cost that is not in line with the revenue growth. This is actually attributable to the Profit sharing bonus formula that is linked to SIA Group and not SIAEC.

      In 2000-2001, a payment equivalent to 4.54 months of basic wage ($58.2 million) was made. In 2001-2002, no bonus is being paid out which resulted in the highest operating profit ever recorded thus far. In 2002-2003, $51.3 million of bonus was being paid out. In 2003-2004, despite a drop in revenue, a bonus of 2.05 months of basic salary and "one-off lump sum payment to make up for the wage cut taken in 2003,plus 15%".

      As such, this profit sharing agreement that is linked to SIA Group can create huge fluctuation in SIAEC's profit. However, from FY 2006-2007 onwards, the profit sharing bonus formula is no longer linked to SIA Group and will be linked to SAEC's financial and operational performance indicator. Therefore, it will be better to look at the operating profit from 2007 onwards.

      Nonetheless, labour cost is still something which the company has to keep a tight control on as the insufficient pool of skilled labour has been an issue for MRO operators. for the latest FY 2011-2012, the main cause for a slight drop in operating margin has been the 18.9% increase in subcontract cost incurred to support revenue growth in the repair and overhaul segment

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  3. Yes I am refering to operating profit.

    Your analysis on face value look good but by looking at your figure, it does not really show that way.

    These numbers tell me(yes I have not look into SIAEC in detail) they are generating more with less 10 years ago. That mean they are facing more pressure on revenues rather than cost. And that does fit well to an industry with weak customers and in an industry where customer and supplier depend very much on each other, even if one is having better profitbility, it will going to 'share' with the other party.

    I can't find any reason for them not to face pressure on revenue side. I don't think it is the need to perform those checks or line services that maintain the margin. Can SIAEC survice with half the current profitbility? Why not.

    The worse thing to happen is pressure on both revenue and cost.

    donmihaihai

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    1. Hi, I do appreciate your counter-argument but I am sorry to say that I am unable to give you a satisfactory answer right now.

      After attending the AGM, I have just gained some critical perspective that actually disrupt the whole model of SIA EC as I have thought it was on the surface.

      Basically, the management said that they have allowed JV to cannibalise on their internal sales and I have just realised that 2 JVs contributed a huge portion of the profit. I am still trying to fully digest all the information, but rest assured I will give you a satisfactory reply in a new post when time permits. For now, I have to try to rework the model and the historical statement

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  4. Hi Shanrui,

    Not sure what you mean by Management allowing JV to "cannibalize on their internal sales". If sales are internal then they will be eliminated upon consolidation, as they are considered inter-segment sales. If you are referring to the JVs which provide similar services to what SIAEC is already providing, what I can say is that there is surely some overlap as SIAEC is covering more bases than just purely MRO and Line Maintenance, as can be seen in the diverse JVs and associates that they had over the years (for details, my blog has a breakdown of these strategic partnerships in the last 10 years).

    Rather than be too bothered about the potential overlap and cannibalization, the strength of their business model is not in the top-line growth, which has been admittedly weak on a CAGR basis. Operating margins have also not been splendid, and most of the growth in bottom line has been contributed by JVs and associates' cash flows and share of profits. Your model should drive the assumptions from the point of view of the synergies which the JVs and associates bring to the table for SIAEC, rather than focusing solely on the core MRO and Line Maintenance aspects. But note that these two core businesses are also growing along with higher air traffic to Changi Airport, and will also see expansion as more airlines buy more planes to cater to increased global air travel demand. This evening, SIAEC just announced a S$166 Million Cebu Air Contract, and this is just one of their partners who plans to increase their fleet significantly over the next five years.

    If you account for the explosion in LCC and the very new yet promising segment of LCLH (Low Cost Long Haul), there is obviously potential for more entrants to come in. Whether they are profitable or will survive is not the question - SIAEC can choose to partner the "winners" and the overall growth in supply of aircraft can only bode well for the industry and for players like SIAEC over the long-term.

    Your model probably also has not accounted for more potential JVs and tie-ups with more partners over time, as these are hard to predict with certainty and we also will not know the structure (SIAEC taking up how many %). So to be conservative, your model should provide for zero growth in JV M&A, but allow for organic growth in aviation industry; and also to forecast a healthy CAGR for Line Maintenance and MRO services.

    Current yield is below 5% as I type this but if Mr. Market is willing, we can always wait for his manic mood swings again.

    Cheers.

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    1. Hi,

      It is really a pity that you did not go for the agm yesterday. Of the 3 agms that I have went so far, SIAEC is the most important one as it absolutely changes how I used to look at this company.

      Basically, the synergies of its JV and SIAEC are much more deeper to the extent that SIAEC is willing to cannibalise their business to support the growth of its JV. Given that its holding in JV and associates are 50% and below, that is definitely a huge sacrifice.

      For e.g. when Singapore Aero Engine Services was started, SIA delivers all their 777 engines to the JV for overhaul instead of SIAEC. At that point in time, the JV only has SIA as the customers. As a guide, SIA group provided $540 million in revenue to these JVs and associates in FY 2002-2003. And if you have noticed, the reason why line maintenance margin drops in the latest FY is that the in-flight system servicing has been outsourced to Panasonic Avionics. The extent of which SIAEC is willing to cannibalise their organic business to support growth of JVs is one of the most important perspective that I have gained. This is also the main reason that the management said on why their organic business seemed to have been impacted year after year.

      Another key point is that the share of profit of JVs comes from only 2 companies - Singapore Aero Engine Services and International Enginer Component Overhaul Pte Ltd. If you look at note 18, look at the margin and ROA, as well as consider the 100% result, you will have realised that they actually have higher profit than SIAEC's organic operating profit. If you look at the 10 years result of the share of profit of JV, I think I will consider this segment as SIAEC's 3rd core operation.

      As for profit of associate, result has been fluctuating due to currency fluctuation. I am trying to work back the translational effect but it seemed like this has also been rather impressive. As SIAEC reports in SGD, all the profits of its foreign associates have to been translated back to SGD which impacted the result for the past 3 years. Though we cannot deny the hard truth that when dividends are being paid out to SIAEC, SIAEC will suffer forex risk as well.

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  5. Hi,

    My philosophy is to attend AGMs for my smaller and mid-cap companies, as they are perceived to be growing and thus more risky. SIAEC is considered a blue-chip and I had done extensive analysis on it, therefore I am not too worried. Add to that, I was also busy that day and really could not make time for it.

    From what you have mentioned, I wonder exactly how much of SIAEC's revenue was "cannibalized" by the JVs and associates. Is it really significant and will it be significant going forward? If you see it from the point of view of the JV having more growth than their core MRO or Line Maintenance operations, then it may provide a reason as to why they are willing to do this - after all some of Management's moves may be more strategic and tactical in nature rather focusing on short-term boosts. Also, a JV or associate means that there is another party (whether Panasonic Avionics or some other major player) who can provide funding and operational support. I believe SIAEC is also leveraging on their partners to grow the JV/associates and they are riding on this to keep their Balance Sheet clean; this may be why there is a lot of off-Balance Sheet debt.

    I am curious as to why it changes the way you perceive the business. By looking at JV/Associate contributions over the years, and seeing the increase over the same period, it should have occurred to you that SIAEC is becoming increasingly more reliant on these JV/Associates to grow bottom line. The cash flows which come from these JV and Associates also cannot be ignored, as they boost ICF to the point of being +ve, while OCF is also always strongly positive. Add the two together and you can see why dividends can continue to be sustained till now.

    If you come from the point of view that SIAEC is placing too much reliance on JV/Associates, then I suggest you attempt to quantify this impact and decide if it is material (whether as a % of SIAEC's revenue base, profit or enterprise value).

    The translation effect will be hard to work backwards as these are associates and you will need their separate BS and PL in order to compute the currency effects, as SIAEC's Group accounts only recognizes the share of profits due to equity accounting.

    You didn't address my last points - what is your view on air traffic growing and SIAEC's ability to also grow their MRO and Line Maintenance offerings? Any views on the Cebu Air contract and do you think there will be more to come?

    Enjoy engaging with you on SIAEC.

    Regards.

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