Stock Review: SIA Engineering

SIA Engineering (SIAEC) is a company providing aircraft maintenance services. I have been a shareholder of SIAEC for a few years but I had not really read their financial reports in detail. There are 3 reasons why I bought their shares, in order of priority:

1. High barrier to entry -> Economic Moat
2. Very low staff turnover -> Human Capital Moat
3. No debt, net cash -> Financial Moat

Unfortunately, its share price had been falling ($5.10 in Jul 2014) and falling ($3.80 in Sep 2016) and falling ($2.90 in Nov 2018) and falling ($2.20 in Dec 2018)... now $2.40. I wonder if there are problems with my 3 reasons.

Economic Moat

Every quarter, SIAEC had been reporting decreased in revenue, due to new planes that require fewer (fewer engines (from 4 reduced to 2) and higher mileage between servicing intervals) and shorter (improve designs and technology) servicing, which is a good thing if you think about air travel as a whole, because planes are safer and turnaround times are shorter. This means that airlines with newer planes will spend less on maintenance, which is bad for SIAEC. The good thing for SIAEC is that there are also more planes now because planes have become cheaper to acquire and maintain.

While aircraft checks have become fewer and shorter, I believe that the complexity has increased. This is because software is likely the enabler for these hardware improvements. This means that a maintenance engineer has to also learn how the software controls the hardware, in addition to all the new planes and the constant software updates these planes receive. As the servicing interval is further apart and maintenance window shorter, a maintenance engineer also needs to have a lot more experience to rectify problems and also identify potential issues in a shorter duration. SIAEC is in a very specialised area of business and this gives it its economic moat. It's very unlikely you will see another competitor beyond the existing one -- ST Engineering -- which mainly deals with military aircraft maintenance.

As long as aircrafts are in use, there will be a demand for aircraft maintenance services. This moat should still exist for a while..

Human Capital Moat

Being so specialised, SIAEC will likely have recruitment issues because staff can only come from a similar aircraft maintenance company based outside of Singapore, ST Engineering, military, or university/polytechnic graduates. Salaries also need to be higher. The good thing is they have very low staff turnover of 2%. If you are an aircraft engineer seeking a job switch, then you either join the defence/aviation government agencies, or pre/post/sales teams of Boeing/Airbus/Rolls Royce/similar in Singapore, or leave Singapore to join a similar company elsewhere. The community is small.

At 2%, I think it's a very good indicator that their engineers are well looked after. This is very important because the quality of services delivered depends on them. The only risk is potentially retirees leaving over the next few years, but this risk is present in every company in Singapore, because of the baby boomers generation. It just has a greater impact for companies dealing with very specialised products and services.

SIAEC Annual Report 2017 Page 29

Financial Moat

SIAEC has no debt throughout the years, which is good, but you may wonder if they are overly stingy with investments (~$30M in capex and intangible assets, 3Q18, pg7). Unfortunately, it's not stated what these investing activities are, but we can guess that it is around robotics, automation, and new toys they are trying out. Their Dividends from investments ($85.7M, 3Q18 pg7) = 2 x Net cash from operating activites ($39.8M, 3Q18 pg6). (I am dreaming of the day where my dividend from investments = 2 x my employment income too...). These numbers suggest really frugal and long-term financial management, which is something I really like about them.

Valuation

Net profit margin was 14.6% for 9 months ending 31 Dec 2018, compared to 16% a year ago. This was calculated with profit attributable to owners of parent / revenue. To me, it's a close enough figure to show that they are keeping a close watch on expenses too. Usually for companies that rely on human capital to deliver services, drops in revenue eat into profit margins, so it's important that the margin isn't too lean (i.e. <5%) and doesn't change too much (i.e. >5%).

At $2.40, it is just a little higher than its historical low of $2.20 on 26 Dec 2018. A dividend of $0.12 may not be too much to ask for, although the market is likely pricing in a lower dividend of $0.10 (because historically, SIAEC's yield hovers around 4%).

To determine what price to buy at, you ask yourself how badly you want to buy, and how much margin of safety you want to have. Assuming a lower dividends gives you a higher safety margin. If you want it badly, you just buy regardless of the price, like what I did. And if you like it so much, you buy more every time the price falls 10%.

$2.40, $0.12 dividend = 5%
$2.40, $0.10 dividend = 4.1%
$2.20, $0.12 dividend = 5.4%
$2.20, $0.10 dividend = 4.5%

I may be blinded by my vested interest in SIAEC, but I still like their moats.