Few days ago, I relate a case study when I shared my perspective on price earnings ratio. You can read it here. I wrote:
The earnings and cash flow are recurring, but most of the time the PE is around 20 times, and when you pay out 5% or so dividend, this looks good.
The long term growth rate of the industry is 5% so if you look at it from a 5 year or 10 year perspective, it doesn’t look a value purchase, but for a consistent earnings business over 20 years its not bad.
You also learn the story of a possible one or two bad years when in the past year, it bleed negative free cash flow.
Apparently what was a really good recurring business, the OEM players are looking to edge in as well. And the OEM held a lot of the pricing power.
Is this going to affect SIA Engineering 20 year earnings growth out look? Its your job to figure that out.
SIA Engineering announced their full year earnings this evening.
The management wrote:
The operating environment for the MRO industry remains challenging. Advancements in the newer generation engines have improved their reliability while the older generation engines are being phased out. These developments will continue to result in a reduction in engine shop visits in the next few years.
With the changing landscape in the MRO industry, the Company has been taking initiatives to position itself for the future. One such initiative is the fleet management joint venture with Boeing that will incorporate a part of our fleet management business. This joint venture is on track for commencement of operations in this financial year, although it is not expected to be accretive in the near term.
Given the growth in the operating fleet within the region, the Company remains confident that the demand for engine and aircraft MRO work will pick up in the future. With our strong balance sheet, the Group is well positioned to meet challenges, and we will continue to pursue various opportunities and strategic initiatives.
While revenue didn’t fall by much, net profit fell from $271 million to $185 million, a 31% fall in net profit. Free cash flow fell from $216 million to $166 million, a 23% fall. The dividend was cut severely from $0.25 to $0.145. That was drastic.
If you look at my Dividend Stock Tracker, the dividend yield fell to 3.4%.
The PE short up from 17.6 times to 25.7 times. The recent price fall for SIA Engineering would look like a good opportunity to accumulate this blue chip recurring maintenance business on the cheap. This looks like a fixable problem (and perhaps still is!).
However if you have failed to look at this good opportunity through the lens of a business owner, you would not have appreciated how much the E in PE will revised down.
Without appreciating the business aspect, being an owner operator, you would not have tried your best to sense a conservative estimate for your E. I was lucky that I was in touch with someone in the industry who explain the issues within the MRO situation. This was confirmed by a friend working in General Electric that this is not a one time thing.
At 25 times, SIA Engineering looks very expensive. To be worthwhile a purchase, SIA Engineering’s profits or free cash flow would need to grow at possibly 7-9% for the next 20 years. Doable but is it realistic in this industry? Bear in mind that they lean on SIA and 2 more terminals are being developed over the years.
It is pricey and if the stock market weighs SIA Engineering for the value of its business, the share price should revised down.
I would consider purchase of it, if I deemed that despite the challenges, the business is misunderstood, that SIA Engineering can conservatively earn a revised lower earnings and free cash flow. The earnings and free cash flow yield on this conservative earnings and free cash flow is adequate a return versus other assets under consideration.
Hope this builds on well together with the previous piece.