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.


  1. hi shanrui, i think your points are valid. maintenance may be a good business but technological optimisation can be the key here.

    1. I read in an Edge article that ST Eng is going into global asset services and diversifying into other area. Of course, there is still a line maintenance segment that is more dependent on air traffic in Singapore than the maintenance requirement. At the end of the day, I still feel that there will be some growth and especially the JVs, though the current price is likely to have priced them in, providing limited upside.

  2. Hi Shanrui, just my thoughts:

    Regional MRO should boom due to LCCs, but I can't see any way to buy into it. The MRO provider market is fragmented compared to their airline customers, so they have no network advantage or pricing power. Engine manufacturers have this, but they are only small parts of larger listed companies (except Rolls Royce, which has no direct exposure to LCCs).

    Could the JVs and associates be a way for SIA Eng to diversify away from SIA and high-cost Changi? Better to cannibalize yourself than have someone else do it.

    I've no stake now, but looking for somewhere (STE or Sia Eng) to park some CPF during the next recession. But its not an industry or companies that I would fall in love with though.

  3. In terms of pricing power, SIA still remains the largest shareholder cum customers of SIA EC. On the assumption that they still follow their previous 10-years contract, SIA will be priced based on the weighted average labour rate of their top 10 customers and then given a 5% discount. In any case, I believe that the scale which SIA has provided them has been crucial for their growth.

    Without SIA backing, it is highly unlikely that SIA EC will be able to tap into the customer base of its JVs and associates partner. The most attractive associates in SIA EC portfolio are SAESL and ESA which are the engine MRO unit for Rolls Royce and P&W in the South East Asia. These are highly lucrative from the ROA and ROE I see from its balance sheet. In fact, if you have taken into account the extent of which USD has depreciated 10 years ago, you will be surprised by the real extent of growth of its associates and JVs.

    However, as I am unable to get more information on these very important associates coupled with the non-stop money printing by the US government, I do not feel as comfortable holding on to it.

  4. Hmmm.... I'm not worried about falling USD. What arbitrary currency they price their items in dosent matter. Only competition in the marketplace makes prices fall.

    Agree about the transparency. On first look, they are not so dependent on SIA (78% of JV/assoc revenue and 48% company revenue is non-SIA). But still very dependent on Changi (most JVs situated there). LCCs may not want (Changi as) a hub since they use a point-to-point model. Wish SIA Eng would a provide segment and geographic breakdown for the JVs.

    1. In terms of competition, line maintenance wise they are pretty strong controlling the bulk of the market though the market share has fallen over the last decade from a high of 90% in 1999 to 75-80% currently. The competitive advantage lies in the human resources as these people has to have the experience before they can undergo the licensing process. Hence, it is not easy for anyone to match up to their labour pool as qualified personnels are hard to find.

      And for maintenance, I believed they face much stronger competition for C and D checks as compared to A and B. For A and B, it makes no sense for airline to fly to somewhere further away just to save on the penny cost. But for C and D check, they do face regional competition though currently they still enjoy some technological superiority whereas those Chinese MRO players are focused on the saturated 747 market.

      I believe their strongest moat lies in the JV of ESA and SAESL, being at least what I believe to be the only engine overhaul and maintenance centre for Rolls Royce and P&W in Southeast Asia. Their profitability looks really exellent but information on these is insufficient which makes me feel uncomfortable.