5 reasons why SIA Engineering isn't freaking out amid 8% sales drop

A lot of things to be happy about.

According to Phillip Securities, despite an 8% decline in sales, net Income for SIAEC increased by 5.5% to S$67.0mn. Operating profits for the company improved by 9.9% due to improved profitability. Profit contributions from the JVs with Rolls Royce increased by 22%y-y. Phillip Securites still views SIAE as a positive stock because of the following:

Exposure to aviation w/o a view on oil: According to forecasts by Boeing, global air traffic is expected to increase by 5% p.a. in the next 20 years.

While this growing demand for air travel is a positive long term trend, investors are often hesitant to get a direct exposure by buying an airline stock with the constant worry over their exposure to volatile oil prices.

We believe that the aviation services sector provides a unique exposure to this long term trend without taking an explicit position on oil. SIAEC is one of the largest MRO service providers in the world and would benefit from this positive long term trend.

 Dominant player at Changi Airport: SIAEC dominates the Line Maintenance market in Singapore’s Changi Airport with highly profitable operating margins in excess of 20%.

With majority of visitors travelling into Singapore by air, SIAEC would benefit from the explicit target by the Singapore Tourism Board (STB) to achieve 17mn visitor arrivals in 2015. As compared to the visitor arrivals in 2011, STB’s target translates to a CAGR of 6.6%.

 Exposure to record orders by SIA group: In late 2012, the SIA announced huge orders for new aircrafts for the three airline units. While part of the order book would be used to replace the older aircrafts, we believe that majority of the new aircrafts would be used for fleet growth.

In particular, Scoot is still in its first year of operation and would require a much larger aircraft fleet for sufficient operating scale. Furthermore, robust demand and liberalisation of airspace in the region would justify SilkAir’s record order for B737s.

With a larger fleet in the SIA group, we expect increased demand for maintenance work at SIAEC in the future. We also expect the company to expand its existing hangar capacity and build a 7th hangar to support the higher workload.

Moats in the JVs: SIAEC holds valuable stakes in various associates and joint ventures, which we believe are underappreciated by the market. In particular, we see excellent prospects for its joint ventures with Rolls Royce: SAESL and IECO.

SAESL was formed in 2001 as a Trent Centre of Excellence and currently services the Trent 800 (B777), Trent 700 (A330), Trent 500 (A340) and Trent 900 (A380) engines.

In order to cater to the newer engine models, SAESL would also develop capabilities for the Trent XWB and Trent 1000 models of engines in the future. To power the new aircrafts ordered, SIA placed a US$2.6bn order for Trent XWB and Trent 900 engines to power the 20 A350-900 and 5 A380s in Oct 2012.

Scoot has yet to announce the engine selection for the 20 B787s and we believe that there is upside for SAESL, if the Trent 1000 engine is subsequently selected by the carrier.

A Cash Cow: SIAEC generates very high FCF of more than S$250mn a year in FY14E and beyond, which allows the company to consistently pay out growing level of dividends to shareholders.

While we have not explicitly forecasted a special dividend payout in our forecast years, we note that SIAEC have a track record of dishing out excess cash whenever its cash hoard gets too large.