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.


  1. Very good analysis. You have the potential to be a good investor. I work in the aerospace sector too. I would say the MRO in Singapore is peaking. With B747-400 passenger aircraft gone, there will be lesser business for Eagle Services Asia. Now, all eyes on Rolls-Royce in Seletar and SAESL.


    1. Hi, it has also been part of the plan to move up the value chain to service the newer aircraft where competition is relatively mild. It is not all lost for ESA yet if P&W can become successful with their PW1000 series engine

  2. Do u regret selling away your SIA Eng. shares?

    1. On hindside, it will be yes since it is at least 10% higher than my last sale price. However, i do not regret selling it as i see that it is rather fairly to overvalued. And i do not have much detail on SAESL which is likely to be the most important key driver for SIAEC.

  3. What the fair value of SIA Eng shares should be at?

    1. I find it hard to give an exact figure given the uncertainty over the JV in SAESL which is likely to be the most profitable division.