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SIA Engineering

Price of SIA Engineering have come down a  fair bit this week. We take a look at it. (SIA ENGG  is tracked in the Dividend Stock tracker)

Markets go through euphoric moments and downright pessimism but SIA Engineering have shown a respectable set of quarterly results. It is certainly strange that on days when yield stocks were beaten down, it managed to stay up well, only for it  to sell down well.

We always like SIA Engineering, and at a lofty price of $5 there are little justification to buy it. Its certainly a good business but does not present us with a good margin of safety.

Would $4.60 be a good price? Technically we have a strong support zone near $4.45. If that doesn’t hold, we go back to 2011 territory.

I think many would welcome that scenario.

Summary of fundamental data

No of outstanding shares: 1110 mil

Market Cap: SGD 5120 mil

Debt: SGD 0 mil

Cash: SGD 522 mil

Enterprise Value: SGD 4598 mil

Earnings 2013: SGD 274 mil

Free Cash Flow 2013: SGD 255 mil

Dividend: 22 cents or SGD 244 mil

Dividend Yield: 4.77%

Free Cash Flow Yield: 4.98%

Earnings Yield: 5.3%

PE: 18 times

EV/FCF: 18 times

8 Year Financial Data

What you are getting in a box

We like SIA Engineering for a few reasons business wise, as a maintenance and repair arm of leading regional airline SIA, SIA Engineering enjoys a sustain business that is unlikely to be challenged by competitors.

SIA have a substantial stake in SIA Engineering.

On top of that, SIA is known around the world as a premium air travel brand, whose operation standards are higher than the norm. SIA Engineering have developed a reputation for quality service.

Being associated with a premium airlines is useless and likely will be found out if you are no results to show for it.

Through its  joint ventures with major component providers, they have developed expertise in carrying out better service,  improve the turn around time.

It is also an industry where you are likely not  going to be competing on price alone since, safety and operations matter much more to the airlines than just  cost.

Not all is a bed of roses. Rivals have developed their own MRO businesses and are  edging in. You cannot say you are the only good providers around.

Not just that, sometimes ago, the aircraft manufacturers also thought it will be great to develop a recurring income in maintenance. Imagine for the same component repair, SIA Engineering’s quote will be 15% higher than that quoted by the aircraft manufacturers who would the customer  choose.

Thankfully one  customer is SIA, who would stand on the side of the company with the vested interest.

The key to circumvent and alleviate this is probably through the Joint Ventures that SIA Engineering have been developing with major component providers so that both sides stands to gain from this recurring business.

Contracts are typically long and whether its firm fixed price or cost based, performance and inflationary  component would have built in.

Air travel looks to be here to stay. Singapore government indicates that they would want to develop addition of a terminal 5 which is larger than 2 and 3 combined, this means that more airlines will need servicing.

There will be competition, but that is a industry growth, one which we believe SIA Engineering will be able to take advantage of.

In summary it has become a business that is recurring, long duration and predictable, with little unknown shocks that can be expected.

Dividend Valuation

I think it won’t be wrong to say that if you take up a yearly position in SIA Engineering and selling it when it becomes overvalued, you stand to make much more than if you were to hold it as a yield stock.

Even at a lofty price of $5.00, the yield stands at 4.4%. That’s not much different from current yield of 4.77%.

At a lower price of $4.20, you would get 5%. And if your required return is 6%, you better hope it gets low to $3.66.

$3.66 is entirely possible considered we got that at the tail end of 2011 in a bull market. Incidentally that is probably where I feel is a good  compensation for a stock like SIA Engineering.

PE and EV/FCF

At 18 times PE,  SIA Engineering fits the profile of a company, reflecting its predictable earnings capability over a long duration. That share price matches the black box that I described previously.

In the case of another business, that would look awfully expensive. Expensive because its hard to find a business  that is as predictable and strong a business  model.

If you have found something as good and a lower PE, its time to switch!

Incidentally the Dairy Farms and Raffles Medical, models  which would classify as such trades at higher PE than this. Had they be lower than this, we will be diving into them.

As a comparison, Hong Kong Aircraft Engineering (44:HKG) trades at 23 times PE.

The cash hold of SIA Engineering looks big but really isn’t that large consider is less than 2 years of free cash flow.

Therefore EV/FCF looks about the same as the PE.

SIA Engineering on this basis isn’t cheap, and you are probably better looking at it at 3.66 for a 20% margin of safety.

Permanent Edge?

Or are we  thinking too much. There are some things that we can buy that we  can accept a fair price because its business model is like fine wine, it gets better with  edge.

And they can sustain long. Warren Buffett used to do this purchasing even at fair prices business with such strong economic moats.

SIA Engineering consistently enjoy a 20% ROE and 16% ROA, not just over a year but throughout that 8 year with a really bad bear market.

That to me is a sign of a model that we  can pay fair value for.

The one thing that I realize is that the growth rate of earnings per year have been rather low as well as  the free cash flow.

If there is an edge to this, we should see a 4-5% annual growth in these 2 segments. Perhaps competition is a bigger factor here.

Nevertheless, should you not be willing to pay fair value for an asset that at this point not showing the growth that is required, a lower share price might be necessary.

Summary

SIA Engineering might be the more stable cousin to SATS, or the more conservative one. The  earnings doesn’t grow , but it doesn’t make risky acquisitions. Perhaps they do not need to.

Will I prefer SATS, not sure about that. Its been some time since I looked at it. I am not some investor who looks at a really big picture and think that will definitely be worth it for ANY price. Perhaps SATS will do much better, I dunno but I hope it shows me a better free cash flow profile than SIA Engineering.

As for SIA Engineering, its got really high investing cash flow. This is mainly due to the dividends from its joint ventures. This is a segment that up till 2011 we are very happy about growing at an astounding rate.

Then it stopped. We thought that is the jackpot for SIA Engineering.

Will it continue? Let us keep a close watch.

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B

Tuesday 10th of September 2013

Do you know why in 2012, the dividend paid is $329M which is much more than 2013 even though in both years it is giving out 22 cents/share. And I don't see any share buyback so it must mean the number of outstanding shares must be the same. Is there a special dividend/bonus/rights in that year?

Kyith

Tuesday 10th of September 2013

Hmm I hope it's ot because I posted some erroneous figures

Ed

Tuesday 3rd of September 2013

Hi All, Any views on SATS? =)

Musicwhiz

Monday 2nd of September 2013

Hi Drizzt, Thanks for the reply. What I meant was that the spreadsheet should clearly separate and delineate the components of the FCF, which is simply the OCF minus the capex. Then you should add the dividends received from associates and JV as a separate line, to then obtain adjusted FCF. For SIAEC, the strength in their business comes from the share of profits from associates/JV and also the dividends from these associates and JV. I do have this compiled in a spreadsheet and am tracking the slow but steady growth of these cash flows. Granted, it is not increasing in a straight line and may be erratic depending on the economic situation and also industry factors, but from the increases in dividends so far I can at least feel assured that the Company is growing its business, albeit slowly. Since I don't make use of any form of technical analysis or charts (what I call the science of squiggles), I must once again reiterate that purchasing at a decent valuation and holding for long-term capital appreciation and yield is what I would strongly recommend. I will not use Starhub as a comparison with SIAEC, and it is not because they are in different industries. If you look at their capital structures, Starhub is holding a lot of debt and potential may have more capital commitments down the road for their 4G network, spectrum and infrastructure. Thus, their capex requirements are quite different from SIAEC and though they may be paying a decent dividend now, I always question the Telco model and whether it is sustainable without huge investments in required infrastructure just to stay ahead (and relevant). Perhaps I do not always think the way others do about these "blue-chip" businesses, but companies you stated like SingTel, Starhub and Keppel all do not really fit into my criteria for investment. They are either too complex, have a capital structure I do not fancy (hence I cannot get comfortable with the business) or may not present sufficient margin of safety considering the risks inherent within the business. Or perhaps I am being too stringent. The fact is that SIAEC does not show stellar growth - this is a fact and I am very comfortable owning a very boring but stable company. It is also a fact that dividends have increased over the last 3 years, with the potential to increase further as well. If you do another post on the qualitative and industry aspects of SIAEC, I would really appreciate it. Then we can always have another fruitful discussion. I hope this reply isn't too long!

Kyith

Tuesday 3rd of September 2013

if verizon can lever up 60 bil to buy 12 bil of dividends, i am sure starhub is well within their means.

Kyith

Tuesday 3rd of September 2013

the leverage on these blue chips are ok. Starhub can lever up 4 x EBITDA for its NET DEBT and would still be able to pay down. it is a very safe business. ditto Singtel but not sure about keppel.

the infra for 4G is already invested sans specturm. but to be fair to cover Singapore, I doubt you need as much specturm as other countries. consider that the advantage of a small country

Kyith

Tuesday 3rd of September 2013

the leverage on these blue chips are ok. Starhub can lever up 4 x EBITDA for its NET DEBT and would still be able to pay down. it is a very safe business. ditto Singtel but not sure about keppel.

the infra for 4G is already invested sans specturm. but to be fair to cover Singapore, I doubt you need as much specturm as other countries. consider that the advantage of a small country

Kyith

Tuesday 3rd of September 2013

the leverage on these blue chips are ok. Starhub can lever up 4 x EBITDA for its NET DEBT and would still be able to pay down. it is a very safe business. ditto Singtel but not sure about keppel.

the infra for 4G is already invested sans specturm. but to be fair to cover Singapore, I doubt you need as much specturm as other countries. consider that the advantage of a small country

Kyith

Tuesday 3rd of September 2013

the leverage on these blue chips are ok. Starhub can lever up 4 x EBITDA for its NET DEBT and would still be able to pay down. it is a very safe business. ditto Singtel but not sure about keppel.

the infra for 4G is already invested sans specturm. but to be fair to cover Singapore, I doubt you need as much specturm as other countries. consider that the advantage of a small country

Dividend Warrior

Monday 2nd of September 2013

SIA Engineering has the potential to benefit from Changi Terminals 4 and 5.

Musicwhiz

Monday 2nd of September 2013

Could you kindly provide details of what you mean? How would SIA Engineering benefit from Terminals 4 and 5? Thanks.

Musicwhiz

Sunday 1st of September 2013

Not sure I can agree with this statement - "I think it won’t be wrong to say that if you take up a yearly position in SIA Engineering and selling it when it becomes overvalued, you stand to make much more than if you were to hold it as a yield stock." How would you substantiate timing the share price of SIA Engineering to ensure you consistently are able to profit from it? Isn't this similar to timing your entry and exit for any other company? The main problem with the above statement is how would you assess if it is "undervalued" and when it is "overvalued"? Short-term price movements do tend to overshoot and undershoot intrinsic value quite often, but it will not be productive to try to continually time your entry and exit just to make a quick profit. Instead, the idea would be to purchase when the yield is attractive and to continue to enjoy the yield as the business grows. The strength of SIA Engineering is not just in its core operations, but the focus should be on the cash flows and share of profits from its associates and joint ventures. I feel your spreadsheet does not pay adequate attention to this aspect. To give an example, if I were to look at just FY 2013 and FY 2012, share of profits from both associates and JV took up 124% and 121% of core operating profit respectively. Core operating profit is rather erratic and flat for SIAEC; in fact the share of profits gives a better indication of the potential of their business and also the state of the aviation industry. Share of profits peaked in FY 2009 at $173m and then fell to $129.7m in FY 2010 as the GFC took its toll on the economy and businesses. But if you track the totals over FY 2011, 2012 and 2013, they were $144.4m, $156.9m and $159.2m (increasing steadily) and for 1Q 2014 it was $45.6m. If we look at the cash flow from dividends from associates and JV, it also shows a similar trend. The peak was in FY 2011 at $165.3m and it then fell to $128.7m in FY 2012 and $137.5m in FY 2013. For 1Q 2014, the cash flow was already $39.4m (which, if annualized, would yield about $157.6m). So the potential for SIAEC lies in its associates and JV. However, you did bring up a point which is that airlines may be having their own MRO services and may not rely on SIAEC. This is something we will have to watch out for. One final point - core dividends (interim + final) have been increasing since FY 2009, all the way till FY 2013 (16c, 18c, 20c, 21c and 22c). In fact, the only "dip" was seen from FY 2008-FY 2009, when core dividend fell from 20c to 16c. Then again, it had risen from 12c in FY 2007 so this did seem like an abnormally big jump. If we smooth it out FY 2008 probably should have been split into a 14c interim+final and a 6c special instead, and we will then see a very smooth transition in dividends from FY 2004 onwards. The fact that SIAEC is able to increase dividends steadily even through the GFC is testament to a strong business model in its JV and associates, and its strong cash flow generation ability. Comments are welcome, thanks.

Kyith

Sunday 1st of September 2013

hi musicwhiz, if all my readers give this kind of replies i am really going to die.

the timing is a succient topic that there is no right or wrong. those making use of candlesticks and technical analysis will have their idea. those that make use of systematic yield compression targets as well.

i think my spreadsheet makes it perfectly clear on the free cash flow portion. it takes into consideration core and the joint venture.

essentially, cash flow depends a lot on the investors understanding of what are legetimate sources and the way i see it, it doesn't differ much from full year profits.

we are not talking about a company whose dividend is a comfortable portion of free cash flow. starhub is actually better in that aspect. solid business that they have leeway to pay more or smooth out.

Yes they have shown that they increase their core dividend in recession. they are not the only one. in fact many blue chips have shown that. starhub is an example, singtel is another. Keppel is another.

the fact is that they have shown in this 3 short years we dont expect surprising growth.

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